0000320333-05-000011.txt : 20051027 0000320333-05-000011.hdr.sgml : 20051027 20051027132131 ACCESSION NUMBER: 0000320333-05-000011 CONFORMED SUBMISSION TYPE: 8-K PUBLIC DOCUMENT COUNT: 12 CONFORMED PERIOD OF REPORT: 20051020 ITEM INFORMATION: Results of Operations and Financial Condition ITEM INFORMATION: Changes in Registrant.s Certifying Accountant ITEM INFORMATION: Financial Statements and Exhibits FILED AS OF DATE: 20051027 DATE AS OF CHANGE: 20051027 FILER: COMPANY DATA: COMPANY CONFORMED NAME: HANOVER DIRECT INC CENTRAL INDEX KEY: 0000320333 STANDARD INDUSTRIAL CLASSIFICATION: RETAIL-CATALOG & MAIL-ORDER HOUSES [5961] IRS NUMBER: 138053260 STATE OF INCORPORATION: DE FISCAL YEAR END: 1227 FILING VALUES: FORM TYPE: 8-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-08056 FILM NUMBER: 051159458 BUSINESS ADDRESS: STREET 1: 1500 HARBOR BLVD CITY: WEEHAWKEN STATE: NJ ZIP: 07087 BUSINESS PHONE: 2018653800 MAIL ADDRESS: STREET 1: 1500 HARBOR BLVD CITY: WEEHAWKEN STATE: NJ ZIP: 07087 FORMER COMPANY: FORMER CONFORMED NAME: HORN & HARDART CO /NV/ DATE OF NAME CHANGE: 19920703 8-K 1 form8k_102705.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 8-K

CURRENT REPORT

PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Date of report (Date of earliest event reported): October 20, 2005

Hanover Direct, Inc.

(Exact Name of Registrant as Specified in Charter)

Delaware	1-12082	13-0853260
(State or Other Jurisdiction Incorporation)	(Commission File Number)	(I.R.S. Employer Identification Number)

1500 Harbor Boulevard, Weehawken, NJ		07086
(Address of Principal Executive Offices)		(Zip Code)

Registrant’s telephone number, including area code:

(201) 863-7300

N/A

(Former Name or Former Address, if Changed Since Last Report)

Check the appropriate box below if the Form 8-K filing is intended to simultaneously satisfy the filing obligation of the registrant under any of the following provisions (see General Instruction A.2. below):

|_| Written communications pursuant to Rule 425 under the Securities Act (17 CFR 230.425)

|_| Soliciting material pursuant to Rule 14a-12 under the Exchange Act (17 CFR 240.14a-12)

|_| Pre-commencement communications pursuant to Rule 14d-2(b) under the Exchange Act (17 CFR 240.14d-2(b))

|_| Pre-commencement communications pursuant to Rule 13e-4(c) under the Exchange Act (17 CFR 240.13e-4(c))

Item 2.02 Results of Operations and Financial Condition.

As set forth in greater detail in Item 4.01 below, the Audit Committee of the Board of Directors of Hanover Direct, Inc. (the “Company”) has dismissed the Company’s current principal independent auditors, KPMG LLP (“KPMG”) prior to their completion of the audit of the Company’s financial statements for the 2004 fiscal year. Because the Company’s new auditors, once selected by the Audit Committee, will require an indeterminate period of time to audit the Company’s financial statements which will further delay the already delayed filing of the Company’s fiscal year 2004 Annual Report on Form 10-K and Quarterly Reports on Form 10-Q, the Company has included as exhibits to this Current Report a current draft of the Company’s fiscal year 2004 Annual Report on Form 10-K and a current draft of the Quarterly Report on Form 10-Q for the Quarterly Period ended June 25, 2005. Management believes that the financial statements included in the draft of the Form 10-K are accurate and are in a form that management was prepared to file had the Company received an audit report from its independent auditors. Similarly, the financial statements included in the second quarter 2005 Form 10-Q have not been reviewed by an independent auditor. Accordingly, neither the draft Form 10-K nor the draft Form 10-Q comply with the requirements of the Securities Exchange Act of 1934.

Moreover and as described below, prior to KPMG’s dismissal, KPMG identified material weaknesses in internal controls and informed the Company in a September 22, 2005 letter (“September 22nd KPMG Letter”) that it would have to perform additional audit procedures before KPMG could issue a report on the Company’s financial statements. KPMG did not perform these additional audit procedures prior to its dismissal.

The Company’s new independent auditors may require revisions to the financial statements and/or disclosures included in the drafts of the 2004 Form 10-K and second quarter 2005 Form 10-Q. In addition because of external factors beyond the Company’s control and because of the passage of time before the filing of the Form 10-K and Form 10-Q, the drafts included as exhibits may require other changes. Consequently, it is probable that these documents will be modified before being filed. Readers are cautioned that there can be no assurances that these modifications will not materially affect the financial results reported in and/or the disclosures contained in the draft filings.

Section 4. Matters related to Accountants or Financial Statements

Item 4.01. Changes in Registrant’s Certifying Accountant

On October 20, 2005 the Audit Committee of the Company’s Board of Directors dismissed KPMG for the reasons set forth below.

KPMG was appointed as the Company’s principal independent auditors on May 14, 2002, succeeding Arthur Andersen LLP. KPMG issued an unqualified opinion on the Company’s fiscal year end 2002 and 2003 financial statements (which should no longer be relied upon as noted below) and reviewed the first two fiscal quarters of 2004. In May 2004, the Company appointed a new Chief Executive Officer and a month later identified a revenue recognition cut-off issue. The Company subsequently restated its prior period financial statements in its Form 10-Q for second fiscal quarter of 2004. On November 9, 2004, the Audit Committee met with KPMG and determined that an error identified by management in the accounting treatment of the Company’s Buyers’ Clubs also required restatement of the Company’s previously issued consolidated financial statements. The Company then announced on November 10, 2004 that its previously filed financial statements should no longer be relied upon. On November 16, 2004 the Audit Committee instituted an investigation relating to the restatement of the Company’s financial statements and other accounting-related matters and engaged independent outside counsel to assist with the investigation. In addition, during the course of preparing the Company’s financial statements for the third fiscal quarter of 2004 and fiscal year end 2004, four additional issues that resulted in restatement adjustments were identified.

In November of 2004, KPMG informed the Audit Committee that it had identified the first material weakness in internal controls noted below. KPMG later expanded the list to include the last two material weaknesses.

•	The Company lacks a sufficient number of financial and tax personnel with the appropriate level of expertise to independently monitor, interpret and implement the application of financial accounting standards in accordance with generally accepted accounting principles.
•	The environment of the Company was such that members of management were not encouraged to discuss transactions and events that could impact the appropriate financial reporting of the Company.
•	The Company does not have adequate policies and procedures relating to the origination and maintenance of contemporaneous documentation to support key accounting judgments or to effectively document the terms of all significant contracts and agreements and the related accounting treatment for these contracts and agreements.

The Company replaced its senior management commencing with the May 5, 2004 appointment of a new Chief Executive Officer. Under new management, the Company has enhanced its internal controls and established a new corporate culture that focuses on ethics, unfettered communication within the organization and compliance. On July 12, 2005, the Audit Committee of the Board of Directors memorialized the remediation steps implemented by current management set forth below by adopting the Remediation Plan.

•	Appointed a new Chief Executive Officer, Chief Financial Officer, General Counsel and Corporate Controller;
•	Replaced its Director of Internal Audit;
•	Replaced its outside counsel;
•	Instituted a policy of open channels of communication including regularly scheduled meetings of, and with senior management;
•	Instituted weekly meetings between the CEO and Director of Internal Audit to review the status of internal audits and assess internal controls;
•	Instituted periodic trips by senior management to the Company’s remote facilities to foster communication and ensure compliance with the Company’s reporting, internal control and ethics policies; and
•	Filled open finance positions which resulted from earlier terminations and other departures;
•	Instituted weekly reviews of financial results with the Chief Financial Officer and senior management to enhance transparency and accountability;
•	Instituted a policy that requires review and approval of all material agreements and marketing plans by the legal and financial departments;
•	Instituted a policy that requires all systems changes that could impact financial reporting be subject to approval by the financial department; and

•	Revised the Company’s reporting structure to have the catalog finance directors report to the CFO.

Subsequently, management added the following additional remediation steps:

•	Documented the Company’s significant accounting policies and implemented a procedure to periodically review and update these policies; and
•	Implemented a policy that requires the preparation of contemporaneous memoranda and related documentation to support key accounting judgments and to maintain and document the significant terms of material contracts and the accounting treatment thereof.

After management cooperated with KPMG throughout the audit which spanned over nine months, KPMG issued the September 22nd KPMG Letter (copy attached as Exhibit 99.01). The letter informed the Company that due to the nature of the items causing the restatement adjustments and due to the material weaknesses identified above, KPMG would need to re-assess the nature and extent of audit procedures it had performed for all periods reported on by KPMG. The KPMG September 22nd Letter provided an estimate of additional audit fees ranging from $300,000 to $450,000 and at least an additional month. In discussions with management, KPMG informed the Company that in order to complete its audits, KPMG expected management to perform certain procedures and reviews relating to fiscal 2003 and 2002, periods that preceded the appointment of current management, and KPMG needed to perform further audit procedures. The additional procedures to be performed by KPMG and those that KPMG had requested management to perform were not completed prior to KPMG’s dismissal.

The Audit Committee, after careful consideration, concluded, among other reasons, that it would be in the best interests of the Company and its shareholders that the Company engage new auditors who had no involvement in the prior audits to conduct the review and complete the audit.

The audit reports of KPMG on the Company’s financial statements for the 2002 and 2003 fiscal years (prior to those audit reports being withdrawn as discussed above) did not contain any adverse opinion or disclaimer of opinion, nor were they qualified or modified as to uncertainty, audit scope, or accounting principles, except that KPMG’s report on the fiscal 2003 and 2002 financial statements includes a paragraph which states that the Company’s balance sheet as of December 28, 2002 has been restated to classify certain debt as current. In connection with the audits of the two fiscal years ended December 27, 2003, and during the course of KPMG’s audit of the fiscal year ended December 25, 2004, and the subsequent interim period through October 20, 2005 (no interim periods have been reviewed by KPMG subsequent to the quarterly period ended June 26, 2004), there were (i) no disagreements with KPMG on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedures, which disagreements, if not resolved to KPMG’s satisfaction, would have caused KPMG to make reference to the subject matter of the disagreement in connection with its audit opinion, and (ii) no reportable events of the type described in Item 304(a)(1)(v) (A) through (D) of Regulation S-K, except (a) in connection with its audit of the Company’s financial statements for the year ended December 25, 2004, KPMG identified the material weaknesses noted above and (b) KPMG reported to the Company that it could not issue its report on the Company’s 2004 fiscal year end financial statements without performing additional audit procedures and without management performing additional procedures which procedures were not completed prior to KPMG’s dismissal.

The Company has authorized KPMG to respond fully to the inquiries of the Company’s new independent auditors, once selected by the Audit Committee, concerning the subject matter of the material weaknesses identified by KPMG and the additional audit procedures identified in the September 22^nd KPMG Letter.

The Company has requested that KPMG furnish it with a letter addressed to the Securities & Exchange Commission stating whether it agrees with the disclosure made in this Current Report. The Company will file KPMG’s letter by an amendment to this Current Report within two days of its receipt from KPMG.

Section 9. Financial Statements and Exhibits

Item 9.01. Financial Statements and Exhibits.

10.01	Thirty-Second Amendment to Loan and Security Agreement, dated as of December 30, 2004, among Congress Financial Corporation and the Borrowers and Guarantors named therein.

10.02	Thirty-Third Amendment to Loan and Security Agreement, dated as of March 11, 2005, among Congress Financial Corporation and the Borrowers and Guarantors named therein.

10.03	Thirty-Fourth Amendment to Loan and Security Agreement, dated as of July 29, 2005, by and among Wachovia Bank, National Association and the Borrowers and Guarantors named therein.

10.04	First Amendment to Loan And Security Agreement dated as of November 30, 2004, by and among Chelsey Finance, LLC and the Borrowers and Guarantors named therein.

10.05	Second Amendment to Loan And Security Agreement dated as of December 30, 2004, by and among Chelsey Finance, LLC and the Borrowers and Guarantors named therein.

10.06	Third Amendment to Loan And Security Agreement dated as of July 29, 2005, by and among Chelsey Finance, LLC and the Borrowers and Guarantors named therein.

10.07	Credit Card Program Agreement between Hanover Direct, Inc. and World Financial Network National Bank dated as February 22, 2005.

10.08	Amendment Number One to Credit Card Program Agreement between Hanover Direct, Inc. and World Financial Network National Bank dated as March 30, 2005.

16.01	Letter from KPMG LLP to the Securities & Exchange Commission. To be filed by an amendment to this Form 8-K.

99.01	Letter from KPMG LLP to Hanover Direct, Inc. dated September 22, 2005.

99.02	Draft Annual Report on Form 10-K for the Fiscal Year ended December 25, 2004.

99.03	Draft Quarterly Report on Form 10-Q for the Quarterly Period ended June 25, 2005.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.

	HANOVER DIRECT, INC.
	(Registrant)

October 27, 2005	By:	/s/ John W. Swatek
		Name:	John W. Swatek
		Title:	Senior Vice President, Chief Financial Officer and Treasurer

EX-10.01 2 exhibit10_01.htm

Exhibit 10.01

THIRTY-SECOND AMENDMENT TO LOAN AND SECURITY AGREEMENT

THIS THIRTY-SECOND AMENDMENT TO LOAN AND SECURITY AGREEMENT (this “Amendment”), dated as of December 30, 2004, is entered into by and among CONGRESS FINANCIAL CORPORATION, a Delaware corporation (“Lender”), BRAWN OF CALIFORNIA, INC., a California corporation (“Brawn”), GUMP’S BY MAIL, INC., a Delaware corporation (“GBM”), GUMP’S CORP., a California corporation (“Gump’s”), HANOVER REALTY, INC., a Virginia corporation (“Hanover Realty”), THE COMPANY STORE FACTORY, INC., a Delaware corporation (“TCS Factory”), THE COMPANY OFFICE, INC., a Delaware corporation (“TCS Office”), SILHOUETTES, LLC, a Delaware limited liability company (“Silhouettes LLC”), HANOVER COMPANY STORE, LLC, a Delaware limited liability company (“HCS LLC”), DOMESTICATIONS, LLC, a Delaware limited liability company (“Domestications LLC”), KEYSTONE INTERNET SERVICES, LLC, a Delaware limited liability company (“KIS LLC”), and THE COMPANY STORE GROUP, LLC, a Delaware limited liability company (“CSG LLC” and, together with Brawn, GBM, Gump’s, Hanover Realty, TCS Factory, TCS Office, Silhouettes LLC, HCS LLC, Domestications LLC and KIS LLC, collectively, “Existing Borrowers” and each, individually, an “Existing Borrower”), BRAWN, LLC, a Delaware limited liability company (“Brawn LLC” as hereinafter further defined, and together with Existing Borrowers, collectively, “Borrowers” and each, individually, a “Borrower”), HANOVER DIRECT, INC., a Delaware corporation (“Hanover”), HANOVER HOME FASHIONS GROUP, LLC, a Delaware limited liability company (“HHFG LLC”), CLEARANCE WORLD OUTLETS, LLC, a Delaware limited liability company (“Clearance World”), SCANDIA DOWN, LLC, a Delaware limited liability company (“Scandia Down LLC”), LACROSSE FULFILLMENT, LLC, a Delaware limited liability company (“LaCrosse LLC”), D.M. ADVERTISING, LLC, a Delaware limited liability company (“DM Advertising LLC”), AMERICAN DOWN & TEXTILE, LLC, a Delaware limited liability company (“ADT LLC”), and HANOVER GIFTS, INC., a Virginia corporation (“Hanover Gifts” and, together with Hanover, HHFG LLC, Clearance World, Scandia Down LLC, LaCrosse LLC, DM Advertising LLC and ADT LLC, collectively, “Guarantors” and each, individually, a “Guarantor”).

W I T N E S S E T H:

WHEREAS, Existing Borrowers, Guarantors and Lender are parties to the Loan and Security Agreement, dated November 14, 1995, as amended by the First Amendment to Loan and Security Agreement, dated February 22, 1996, the Second Amendment to Loan and Security Agreement, dated April 16, 1996, the Third Amendment to Loan and Security Agreement, dated May 24, 1996, the Fourth Amendment to Loan and Security Agreement, dated May 31, 1996, the Fifth Amendment to Loan and Security Agreement, dated September 11, 1996, the Sixth Amendment to Loan and Security Agreement, dated as of December 5, 1996, the Seventh Amendment to Loan and Security Agreement, dated as of December 18, 1996, the Eighth Amendment to Loan and Security Agreement, dated as of March 26, 1997, the Ninth Amendment to Loan and Security Agreement, dated as of April 18, 1997, the Tenth Amendment to Loan and Security Agreement, dated as of October 31, 1997, the Eleventh Amendment to Loan and Security Agreement, dated as of March 25, 1998, the Twelfth Amendment to Loan and

Security Agreement, dated as of September 30, 1998, the Thirteenth Amendment to Loan and Security Agreement, dated as of September 30, 1998, the Fourteenth Amendment to Loan and Security Agreement, dated as of February 28, 2000, the Fifteenth Amendment to Loan and Security Agreement, dated as of March 24, 2000, the Sixteenth Amendment to Loan and Security Agreement, dated as of August 8, 2000, the Seventeenth Amendment to Loan and Security Agreement, dated as of January 5, 2001, the Eighteenth Amendment to Loan and Security Agreement, dated as of November 12, 2001, the Nineteenth Amendment to Loan and Security Agreement, dated as of December 18, 2001 (as amended hereby, the “Nineteenth Amendment to Loan Agreement”), the Twentieth Amendment to Loan and Security Agreement, dated as of March 5, 2002, the Twenty-First Amendment to Loan and Security Agreement, dated as of March 21, 2002, the Twenty-Second Amendment to Loan and Security Agreement, dated as of August 16, 2002, the Twenty-Third Amendment to Loan and Security Agreement, dated as of December 27, 2002, the Twenty-Fourth Amendment to Loan and Security Agreement, dated as of February 27, 2003, the Twenty-Fifth Amendment to Loan and Security Agreement, dated as of April 21, 2003, the Twenty-Sixth Amendment to Loan and Security Agreement, dated as of August 29, 2003, the Twenty-Seventh Amendment to Loan and Security Agreement, dated as of October 31, 2003, the Twenty-Eighth Amendment to Loan and Security Agreement, dated as of November 4, 2003, the Twenty-Ninth Amendment to Loan and Security Agreement, dated as of November 25, 2003, the Thirtieth Amendment to Loan and Security Agreement, dated as of March 25, 2004, and the Thirty-First Amendment to Loan and Security Agreement, dated as of July 8, 2004 (as so amended, the “Loan Agreement”), pursuant to which Lender has made loans and advances to Borrowers;

WHEREAS, Existing Borrowers and Guarantors have requested that Lender consent to (a) the conversion of Brawn of California, Inc. from a California corporation to a Delaware limited liability company by reason of the Brawn/Brawn LLC Merger (as hereinafter defined), (b) the merger of HHFG LLC with and into CSG LLC, with CSG LLC as the surviving limited liability company, and (c) certain amendments to the Loan Agreement and the other Financing Agreements in connection with the Hanover 2004 Reorganization (as hereinafter defined); and

WHEREAS, the parties hereto desire to enter into this Amendment to evidence and effectuate such consents and amendments, in each case subject to the terms and conditions and to the extent set forth herein;

WHEREAS, Lender is willing to agree to provide such consents and make such amendments, subject to the terms and conditions and to the extent set forth herein;

NOW, THEREFORE, in consideration of the premises and covenants set forth herein and other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, the parties hereto agree as follows:

1.	Definitions.

(a) Additional Definitions. As used herein or in any of the other Financing Agreements, the following terms shall have the meanings given to them below, and the Loan Agreement shall be deemed and is hereby amended to include, in addition and not in limitation, the following definitions:

(i) “Brawn LLC” shall mean Brawn, LLC, a Delaware limited liability company, and its successors and assigns.

(ii) “Brawn/Brawn LLC Merger” shall mean the merger of Brawn with and into Brawn LLC, with Brawn LLC as the surviving limited liability company.

(iii) “Hanover 2004 Reorganization” shall mean, individually and collectively, the mergers, reorganization steps and transactions effected under the Hanover 2004 Reorganization Agreements.

(iv) “Hanover 2004 Reorganization Agreements” shall mean, collectively, the agreements, documents and instruments listed in Schedule 1 hereto and all related agreements, documents and instruments executed, delivered or filed in connection with, or otherwise evidencing, each of the transactions consented to in Section 2 hereof as the same now exist or may hereafter be amended, modified, supplemented, extended, renewed, restated or replaced.

(v) “HHFG LLC /CSG LLC Merger” shall mean the merger of HHFG LLC with and into CSG LLC, with CSG LLC as the surviving limited liability company.

(b)	Amendments to Definitions.

(i) Brawn. All references to the term “Brawn” in the Loan Agreement and the other Financing Agreements shall be deemed and each such reference is hereby amended to mean “Brawn LLC”.

(ii) Guarantors. All references to the term “Guarantors” in the Loan Agreement and the other Financing Agreements shall be deemed and each such reference is hereby amended to mean, jointly and severally, individually and collectively, Hanover, Clearance World, Scandia Down LLC, La Crosse LLC, DM Advertising LLC, ADT LLC, Hanover Gifts and each other existing and future direct or indirect Subsidiary of Hanover which owns any assets in excess of Ten Thousand Dollars ($10,000), other than Non-Guarantor Subsidiaries, and each of their respective successors and assigns.

(iii) Revolving Loan Borrowers. All references to the term “Revolving Loan Borrowers” in the Loan Agreement and the other Financing Agreements shall be deemed and each such reference is hereby amended to mean, individually and collectively, Brawn LLC, GBM, Gump’s, Silhouettes LLC, HCS LLC, Domestications LLC, CSG LLC and KIS LLC.

(c) Interpretation. All capitalized terms used herein and not defined herein shall have the meanings given to such terms in the Loan Agreement.

2. Consent to Hanover 2004 Reorganization. Subject to the terms and conditions contained herein and in the Loan Agreement and in the other Financing Agreements, and notwithstanding anything to the contrary contained in Sections 6.5, 6.6(a), 6.6(c) or 6.9 of the Loan Agreement, Lender consents, effective upon the earlier of the date hereof or the effective date of the applicable transaction of the Hanover 2004 Reorganization, to the following transactions:

(a) the formation by CSG LLC of Brawn LLC as a Delaware limited liability company in accordance with the applicable Hanover 2004 Reorganization Agreements;

(b) the merger of Brawn with and into Brawn LLC pursuant to the Brawn/Brawn LLC Merger, with Brawn LLC as the surviving limited liability company, in accordance with the applicable Hanover 2004 Reorganization Agreements;

(c) the merger of HHFG LLC with and into CSG LLC pursuant to the HHFG LLC/CSG LLC Merger, with CSG LLC as the surviving limited liability company, in accordance with the applicable Hanover 2004 Reorganization Agreements;

3. Assumption of Obligations; Amendments to Guarantees and Financing Agreements. Effective as of the earlier of the date hereof or effective date of completion of the Hanover 2004 Reorganization as to the respective parties thereto:

(a) Brawn LLC hereby expressly (i) assumes and agrees to be directly liable to Lender, jointly and severally with the other Borrowers, for all Obligations under, contained in, or arising out of the Loan Agreement and the other Financing Agreements applicable to all Borrowers and as applied to Brawn LLC as a Borrower and Guarantor, (ii) agrees to perform, comply with and be bound by all terms, conditions and covenants of the Loan Agreement and the other Financing Agreements applicable to all Borrowers and as applied to Brawn LLC as a Borrower and Guarantor, with the same force and effect as if Brawn LLC had originally executed and been an original Borrower and Guarantor party signatory to the Loan Agreement and the other Financing Agreements, and (iii) agrees that Lender shall have all rights, remedies and interests, including security interests in and to the Collateral granted pursuant to the Loan Agreement and the other Financing Agreements, with respect to Brawn LLC and its properties and assets with the same force and effect as Lender has with respect to the other Borrowers and their respective assets and properties as if Brawn LLC had originally executed and had been an original Borrower and Guarantor party signatory to the Loan Agreement and the other Financing Agreements.

(b) Each of the respective Guarantee and Waivers made by the Existing Borrowers as of that date in their capacities as Guarantors, as heretofore amended (collectively, the “Borrower Guarantees”) shall be deemed further amended to include Brawn LLC as an additional Guarantor party signatory thereto. Brawn LLC hereby expressly (i) assumes and agrees to be directly liable to Lender, jointly and severally with the other Borrowers signatories thereto and the Guarantors, for all Obligations as defined in the Borrower Guarantees, (ii) agrees to perform, comply with and be bound by all terms, conditions and covenants of the Borrower Guarantees with the same force and effect as if Brawn LLC had originally executed and been an original party signatory to each of the Borrower Guarantees, and (iii) agrees that Lender shall have all rights, remedies and interests with respect to Brawn LLC and its properties under the

Borrower Guarantees with the same force and effect as if Brawn LLC had originally executed and been an original party signatory to each of the Borrower Guarantees.

(c) Each Guarantor, including without limitation, Brawn LLC, in its capacity as Guarantor pursuant hereto, hereby expressly and specifically ratifies, restates and confirms the terms and conditions of its respective Guarantee(s) in favor of Lender and its liability for all of the Obligations (as defined in its Guarantee(s)), and all other obligations, liabilities, agreements and covenants thereunder.

(d) Each Borrower, including, without limitation, Brawn LLC, and each Guarantor hereby agrees that all references to Borrower or Borrowers or other terms intended to refer to a Borrower or Borrowers, such as Debtor or Debtors, contained in any of the Financing Agreements are hereby amended to include Brawn LLC, and each other person or entity at any time hereafter made a “Borrower” under the Loan Agreement, as an additional Borrower or Debtor, or other appropriate term of similar import, as the case may be. Each Borrower, including, without limitation, Brawn LLC, and each Guarantor hereby agrees that all references to Guarantor or Guarantors or other terms intended to refer to a Guarantor or Guarantors, such as Debtor or Debtors, contained in any of the Financing Agreements are hereby amended to include Brawn LLC, in its capacity as Guarantor and each other person or entity at any time hereafter made a “Guarantor” under the Loan Agreement, as an additional Guarantor or Debtor, or other appropriate term of similar import, as the case may be.

4. Acknowledgments with respect to Mergers pursuant to the Hanover 2004 Reorganization.

(a) As of the effective date of the Hanover 2004 Reorganization as to the respective parties thereto, each Borrower and each Guarantor hereby acknowledges, confirms and agrees that, by operation of law and as provided in the Hanover 2004 Reorganization Agreements, as the case may be, and this Amendment:

(i) Brawn LLC, as the surviving limited liability company pursuant to the Brawn/ Brawn LLC Merger, has continued and shall continue to be directly and primarily liable in all respects for the Obligations of Brawn arising prior to the effective time of the Brawn/Brawn LLC Merger.

(ii) CSG LLC, as the surviving limited liability company pursuant to the HHFG LLC/CSG LLC Merger, has continued and shall continue to be directly and primarily liable in all respects for the Obligations of HHFG LLC arising prior to the effective time of the HHFG LLC/CSG LLC Merger.

(iii) Lender shall continue to have valid and perfected security interests, liens and rights in and to all of the assets and properties owned and acquired (A) by Brawn LLC, as the surviving limited liability company of the Brawn/Brawn LLC Merger, and (A) by CSG LLC, as the surviving limited liability company of the HHFG LLC/CSG LLC Merger, and all such assets and properties shall be deemed included in the Collateral or the Guarantor Collateral, as the case may be, and such security interests, liens and rights and their perfection and priorities have continued and shall continue in all respects in full force and effect;

(b) Without limiting the generality of the foregoing, (i) none of the transactions contemplated by the Hanover 2004 Reorganization Agreements shall in any way limit, impair or adversely affect the Obligations now or hereafter owed to Lender by any existing or former Borrowers or Guarantors or any security interests or liens in any assets or properties securing the same, (ii) the security interests, liens and rights of Lender in and to the assets and properties of Brawn LLC, as the surviving limited liability company of the Brawn/Brawn LLC Merger, and CSG LLC, as the surviving limited liability company of the HHFG LLC/CSG LLC Merger, or any Borrower or Guarantor that is the recipient, assignee or transferee of any assets or properties contributed, assigned or transferred pursuant to the Hanover 2004 Reorganization Agreements, have continued and, upon and after the consummation of the Brawn/Brawn LLC Merger and the HHFG LLC/CSG LLC Merger, or such contribution, assignment or transfer, as the case may be, shall continue to secure all Obligations to Lender of Brawn LLC, CSG LLC, or the predecessor owner of such assets and properties, as the case may be, in addition to all other existing and future Obligations of Brawn LLC, CSG LLC, or such Borrower or Guarantor, as the case may be, to Lender.

5. Representations, Warranties and Covenants. Borrowers and Guarantors represent, warrant and covenant with and to Lender as follows, which representations, warranties and covenants are continuing and shall survive the execution and delivery hereof, the truth and accuracy of, or compliance with each, together with the representations, warranties and covenants in the other Financing Agreements, being a condition of the effectiveness of this Amendment and a continuing condition of the making or providing of any Revolving Loans or Letter of Credit Accommodations by Lender to Borrowers:

(a) This Amendment and each other agreement or instrument to be executed and delivered by Borrowers or Guarantors hereunder have been duly authorized, executed and delivered by all necessary action on the part of Borrowers and Guarantors which is a party hereto and thereto and, if necessary, their respective stockholders (with respect to any corporation) or members (with respect to any limited liability company), and is in full force and effect as of the date hereof, as the case may be, and the agreements and obligations of Borrowers or Guarantors, as the case may be, contained herein and therein constitute legal, valid and binding obligations of Borrowers and Guarantors, as the case may be, enforceable against them in accordance with their terms.

(b) Neither the execution and delivery of the Hanover 2004 Reorganization Agreements, nor the consummation of the transactions contemplated by the Hanover 2004 Reorganization Agreements, nor compliance with the provisions of the Hanover 2004 Reorganization Agreements, shall result in the creation or imposition of any lien, claim, charge or encumbrance upon any of the Collateral or Guarantor Collateral, except in favor of Lender pursuant to this Amendment and the Financing Agreements as amended hereby.

(c) None of the membership interests in Brawn LLC have been evidenced by a membership certificate or other certificate, document, instrument or security. All of the membership interests in Brawn LLC (i) are noted in the respective books and records of such company, (ii) have been duly authorized, validly issued to CSG LLC and (iii) are fully paid and non-assessable, free and clear of all claims, liens, pledges and encumbrances of any kind, except those security interests existing in favor of Lender.

(d) No court of competent jurisdiction has issued any injunction, restraining order or other order which prohibits the consummation of the Hanover 2004 Reorganization or any part thereof, and no governmental action or proceeding has been threatened or commenced, seeking any injunction, restraining order or other order which seeks to void or otherwise modify the transactions described in the Hanover 2004 Reorganization Agreements.

(e) As of the date hereof (i) Brawn LLC is a limited liability company, duly formed and validly existing in good standing under the laws of the State of Delaware, and (ii) Brawn LLC (A) is duly licensed or qualified to do business as a foreign limited liability company and is in good standing in each of the jurisdictions set forth in Schedule 2 hereto other than in any such jurisdiction which is designated as “pending”, which are the only jurisdictions wherein the character of the properties owned or licensed or the nature of the business of Brawn LLC makes such licensing or qualification to do business necessary; and (B) has all requisite power and authority to own, lease and operate its properties and to carry on its business as it is now being conducted and will be conducted in the future.

(f) The assets and properties of Brawn LLC are owned by it, free and clear of all security interests, liens and encumbrances of any kind, nature or description, as of the date hereof, except those security interests existing in favor of Lender and those granted pursuant hereto in favor of Lender, and except for Liens (if any) permitted under Section 6.4 of the Loan Agreement or the other Financing Agreements.

(g) Upon the effectiveness of the Brawn/Brawn LLC Merger and the HHFG LLC/CSG LLC Merger, each such merger will become effective in accordance with the terms of each of the applicable Hanover 2004 Reorganization Agreements applicable to it and of the applicable corporate or limited liability statutes of the States of incorporation or formation of each Borrower and each Guarantor that is a constituent corporation or limited liability company pursuant to the mergers so consented to. As of the date of the effectiveness of the Brawn/Brawn LLC Merger, Brawn LLC will be and will continue to be and shall be the surviving limited liability company of the Brawn/Brawn LLC Merger, and as of the date of the effectiveness of the HHFG LLC/CSG LLC Merger, CSG LLC will be and will continue to be and shall be the surviving limited liability company of the HHFG LLC/CSG LLC Merger.

(h) Neither the consummation of the Brawn/Brawn LLC Merger and the HHFG LLC/CSG LLC Merger, nor the execution, delivery or filing of the Hanover 2004 Reorganization Agreements applicable to the Brawn/Brawn LLC Merger and the HHFG LLC/CSG LLC Merger as consented to under Section 2 hereof or any other agreements, documents or instruments in connection therewith, nor the consummation of the transactions therein contemplated, nor compliance with the provisions thereof before the date hereof or upon the effectiveness of such mergers (i) has violated or will violate any Federal or State securities laws, any State corporation law, or any other law or regulation or any order or decree of any court or governmental instrumentality in any respect, (ii) does or will conflict with or result in the breach of, or constitute a default in any respect under any material mortgage, deed of trust, security agreement, agreement or instrument to which any existing or former Guarantor or Borrower is a party or may be bound, other than conflicts or defaults under certain real estate leases, intellectual property licenses and equipment leases, (iii) does or will violate any provision of the Certificate of Incorporation or Certificate of Formation, as applicable, or By-Laws or Operating Agreement, as applicable, of any Borrower or Guarantor, or has resulted in or if

consummated or effected after the date hereof shall result in the creation or imposition of any lien, claim, charge or encumbrance upon any of the Collateral or Guarantor Collateral, except in favor of Lender.

(i) All actions and proceedings required by the Hanover 2004 Reorganization Agreements applicable to the Brawn/Brawn LLC Merger and the HHFG LLC/CSG LLC Merger, applicable law and regulation, have been or shall be taken prior to the effectiveness of such mergers and all transactions required thereunder have been and shall be, or will be duly and validly consummated.

(j) Each Borrower and Guarantor is solvent and will continue to be solvent after giving effect to the Hanover 2004 Reorganization and the transactions contemplated by the Hanover 2004 Reorganization Agreements, is able to pay its debts as they mature and has (and has reason to believe it will continue to have) sufficient capital (and not unreasonably small capital) to carry on its business and all businesses in which it is about to engage. After giving effect to the Hanover 2004 Reorganization, and after giving effect to the transactions contemplated by the Hanover 2004 Reorganization Agreements, the assets and properties of each Borrower and Guarantor at a fair valuation and at their present fair salable value are, and will be, greater than the indebtedness of each such Borrower and Guarantor, respectively, and including subordinated and contingent liabilities computed at the amount which, to the best of each such Borrower’s and Guarantor’s, represents an amount which can reasonably be expected to become an actual or matured liability.

(k) No action of, or filing with, or consent of any governmental or public body or authority, other than the filing of a UCC financing statement naming Brawn LLC as debtor and Lender as secured party, and no approval or consent of any other party, other than Chelsey, is required to authorize, or is otherwise required in connection with, the execution, delivery and performance of this Amendment and each other agreement or instrument to be executed and delivered pursuant hereto.

(l) The transactions contemplated by the Hanover 2004 Reorganization shall have occurred and be effective in the case of the HHFG/CSG Merger by no later than December 31, 2004 and in the case of the Brawn/Brawn LLC Merger by no later than March 31, 2005 or such later date or dates as Lender shall approve in writing.

(m) Notwithstanding the provisions of Section 20(n) of the Thirty-First Amendment to Loan and Security Agreement, Borrowers and Guarantors shall enter into, on or before January 28, 2005, an Amended and Restated Loan and Security Agreement among Lender, Borrowers and Guarantors and an amendment and restatement of such other Financing Agreements or amendments to or amendments and restatements of any existing Financing Agreements as Lender shall request in connection with the amendment and restatement of the Loan Agreement.

6. Conditions Precedent. Concurrently with the execution and delivery hereof (except to the extent otherwise indicated below), and as a further condition to the effectiveness of this Amendment and the agreement of Lender to the modifications and amendments set forth in this Amendment:

(a) Lender shall have received a photocopy of an executed original or executed original counterparts of this Amendment by facsimile (with the originals to be delivered within five (5) Business Days after the date hereof), as the case may be, duly authorized, executed and delivered by Borrowers and Guarantors;

(b) Lender shall have received, in form and substance satisfactory to Lender, the consent of all Participants to this Amendment and the transactions contemplated hereby; and

(c) Lender shall have received and reviewed lien and judgment search results for the jurisdiction of organization of Brawn LLC, the jurisdiction of the chief executive office of Brawn LLC and all jurisdictions in which assets of Brawn LLC are located, which search results shall be in form and substance satisfactory to Lender;

(d) as soon as possible, but in any event by no later than December 31, 2004, in the case of the HHFG LLC/CSG LLC Merger, and by no later than March 31, 2005, in the case of the Brawn/Brawn LLC Merger, Lender shall have received, in form and substance satisfactory to Lender, (i) true, correct and complete photocopies of all of the Hanover 2004 Reorganization Agreements, (ii) evidence that (A) the Hanover 2004 Reorganization Agreements have been duly executed and delivered by and to the appropriate parties thereto and (B) the transactions contemplated by the Hanover 2004 Reorganization have been consummated as set forth herein, and (iii) evidence that the certificates of merger with respect to the Brawn/Brawn LLC Merger and the HHFG LLC/CSG LLC Merger have been filed with the Secretary of State of the appropriate States of formation or incorporation or formation of each constituent corporation or limited liability company;

(e) Lender shall have received all information with respect to Brawn LLC and CSG LLC necessary for Lender to file UCC financing statements and UCC amendments to the existing UCC financing statements previously filed by Lender against Brawn and HHFG LLC to change either or both of the debtor’s name or mailing address to that of Brawn LLC and CSG LLC, respectively, and other documents and instruments which Lender in its sole discretion has determined are necessary to perfect the security interests of Lender in all Collateral or Guarantor Collateral now or hereafter owned by Brawn LLC, CSG LLC and all other Borrowers and Guarantors;

(f) Lender shall have received from Brawn LLC, (i) a copy of its Certificate of Formation, and all amendments thereto, certified by the Secretary of State of the State of Delaware as of the most recent practicable date certifying that each of the foregoing documents remains in full force and effect and has not been modified or amended, except as described therein, (ii) a copy of its Operating Agreement, certified by the Secretary or Assistant Secretary of the company, and (iii) a certificate from its Secretary or Assistant Secretary dated the date hereof certifying that each of the foregoing documents remains in full force and effect and has not been modified or amended, except as described therein;

(g) Lender shall have received, in form and substance satisfactory to Lender, for each Borrower and Guarantor that is a limited liability company (i) a Management and Incumbency Certificate of each such company identifying all managers, officers or other persons authorized to act on behalf of such company, (ii) Company Resolutions of each such company, evidencing the adoption and subsistence of company resolutions approving the execution,

delivery and performance by each Borrower and Guarantor that is a limited liability company of this Amendment and the agreements, documents and instruments to be delivered pursuant to this Amendment, in each case signed by all members of each such company, and (iii) Certificates of the Secretary or Assistant Secretary of each such company identifying all members of such company;

(h) Lender shall have received, in form and substance satisfactory to Lender, for each Borrower and Guarantor that is a corporation, a Secretary’s or Assistant Secretary’s Certificate of Directors’ Resolutions with Shareholders’ Consent (other than in respect of Hanover) evidencing the adoption and subsistence of corporate resolutions approving the execution, delivery and performance by such Borrower and Guarantor of this Amendment and the agreements, documents and instruments to be delivered pursuant to this Amendment;

(i) Lender shall have received, in form and substance and satisfactory to Lender, an opinion of counsel to Borrowers and Guarantors with respect to the transactions contemplated by this Amendment and the Hanover 2004 Reorganization Agreements addressed to Lender;

(j) each Borrower and Guarantor shall deliver, or cause to be delivered, to Lender a true and correct copy of any consent, waiver or approval to or of this Amendment, which any Borrower or Guarantor is required to obtain from any other Person, including without limitation Chelsey, and such consent, approval or waiver shall be in a form reasonably acceptable to Lender; and

(k) prior to the effectiveness of the Hanover 2004 Reorganization, no court of competent jurisdiction shall have issued any injunction, restraining order or other order which prohibits the consummation of the Hanover 2004 Reorganization or any part thereof, and no governmental action or proceeding shall have been threatened or commenced, seeking any injunction, restraining order or other order which seeks to void or otherwise modify the transactions described in the Hanover 2004 Reorganization Agreements.

7. Effect of this Amendment. This Amendment constitutes the entire agreement of the parties with respect to the subject matter hereof, and supersedes all prior oral or written communications, memoranda, proposals, negotiations, discussions, term sheets and commitments with respect to the subject matter hereof. Except as expressly provided herein, no other changes or modifications to the Loan Agreement or any of the other Financing Agreements, or waivers of or consents under any provisions of any of the foregoing, are intended or implied by this Amendment, and in all other respects the Financing Agreements are hereby specifically ratified, restated and confirmed by all parties hereto as of the effective date hereof. To the extent that any provision of the Loan Agreement or any of the other Financing Agreements conflicts with any provision of this Amendment, the provision of this Amendment shall control.

8. Further Assurances. Borrowers and Guarantors shall execute and deliver such additional documents and take such additional action as may be reasonably requested by Lender to effectuate the provisions and purposes of this Amendment.

9. Governing Law. The validity, interpretation and enforcement of this Amendment in any dispute arising out of the relationship between the parties hereto, whether in contract, tort,

equity or otherwise shall be governed by the internal laws of the State of New York, without regard to any principle of conflict of laws or other rule of law that would result in the application of the law of any jurisdiction other than the State of New York.

10. Binding Effect. This Amendment shall be binding upon and inure to the benefit of each of the parties hereto and their respective successors and assigns.

11. Counterparts. This Amendment may be executed in any number of counterparts, but all of such counterparts shall together constitute but one and the same agreement. In making proof of this Amendment, it shall not be necessary to produce or account for more than one counterpart thereof signed by each of the parties hereto.

[REMAINDER OF THIS PAGE INTENTIONALLY LEFT BLANK]

IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be executed on the day and year first written.

CONGRESS FINANCIAL CORPORATION

By: /s/ Eric Storz

Name: Eric Storz

Title: Vice President

BRAWN OF CALIFORNIA, INC.

By: /s/ Charles E. Blue

Name: Charles E. Blue

Title: Vice President

GUMPS’S BY MAIL, INC.

By: /s/ Charles E. Blue

Name: Charles E. Blue

Title: Secretary

GUMP’S CORP.

By: /s/ Charles E. Blue

Name: Charles E. Blue

Title: Secretary

HANOVER REALTY, INC.

By: /s/ Charles E. Blue

Name: Charles E. Blue

Title: Vice President

THE COMPANY STORE FACTORY, INC.

By: /s/ Charles E. Blue

Name: Charles E. Blue

Title: Vice President

[SIGNATURES CONTINUE ON FOLLOWING PAGE]

[SIGNATURES CONTINUED FROM PREVIOUS PAGE]

THE COMPANY OFFICE, INC.

By: /s/ Charles E. Blue

Name: Charles E. Blue

Title: Vice President

SILHOUETTES, LLC

By: /s/ Charles E. Blue

Name: Charles E. Blue

Title: President

HANOVER COMPANY STORE, LLC

By: /s/ Charles E. Blue

Name: Charles E. Blue

Title: President

DOMESTICATIONS, LLC

By: /s/ Charles E. Blue

Name: Charles E. Blue

Title: Vice President

KEYSTONE INTERNET SERVICES, LLC

By: /s/ Charles E. Blue

Name: Charles E. Blue

Title: Vice President

THE COMPANY STORE GROUP, LLC

By: /s/ Charles E. Blue

Name: Charles E. Blue

Title: President

BRAWN, LLC

By: /s/ Charles E. Blue

Name: Charles E. Blue

Title: Vice President

[SIGNATURES CONTINUE ON FOLLOWING PAGE]

[SIGNATURES CONTINUED FROM PREVIOUS PAGE]

By their signatures below, the

undersigned Guarantors acknowledge

and agree to be bound by the

applicable provisions of this

Amendment:

HANOVER DIRECT, INC.

By: /s/ Charles E. Blue

Name: Charles E. Blue

Title: Senior Vice President and

Chief Financial Officer

HANOVER HOME FASHIONS GROUP, LLC

By: /s/ Charles E. Blue

Name: Charles E. Blue

Title: Vice President

CLEARANCE WORLD OUTLETS, LLC

By: /s/ Charles E. Blue

Name: Charles E. Blue

Title: President

SCANDIA DOWN, LLC

By: /s/ Charles E. Blue

Name: Charles E. Blue

Title: Vice President

LA CROSSE FULFILLMENT, LLC

By: /s/ Charles E. Blue

Name: Charles E. Blue

Title: President

[SIGNATURES CONTINUE ON FOLLOWING PAGE]

[SIGNATURES CONTINUED FROM PREVIOUS PAGE]

D.M. ADVERTISING, LLC

By: /s/ Charles E. Blue

Name: Charles E. Blue

Title: President

AMERICAN DOWN & TEXTILE, LLC

By: /s/ Charles E. Blue

Name: Charles E. Blue

Title: Vice President

HANOVER GIFTS, INC.

By: /s/ Charles E. Blue

Name: Charles E. Blue

Title: Vice President

EX-10.02 3 exhibit10_02.htm

Exhibit 10.02

THIRTY-THIRD AMENDMENT TO LOAN AND SECURITY AGREEMENT

THIS THIRTY-THIRD AMENDMENT TO LOAN AND SECURITY AGREEMENT (this “Amendment”), dated as of March 11, 2005, is entered into by and among WACHOVIA BANK, NATIONAL ASSOCIATION, successor by merger to Congress Financial Corporation (“Lender”), BRAWN OF CALIFORNIA, INC., a California corporation (“Brawn”), BRAWN, LLC, a Delaware limited liability company (“Brawn LLC”), GUMP’S BY MAIL, INC., a Delaware corporation (“GBM”), GUMP’S CORP., a California corporation (“Gump’s”), HANOVER REALTY, INC., a Virginia corporation (“Hanover Realty”), THE COMPANY STORE FACTORY, INC., a Delaware corporation (“TCS Factory”), THE COMPANY OFFICE, INC., a Delaware corporation (“TCS Office”), SILHOUETTES, LLC, a Delaware limited liability company (“Silhouettes LLC”), HANOVER COMPANY STORE, LLC, a Delaware limited liability company (“HCS LLC”), DOMESTICATIONS, LLC, a Delaware limited liability company (“Domestications LLC”), KEYSTONE INTERNET SERVICES, LLC, a Delaware limited liability company (“KIS LLC”), and THE COMPANY STORE GROUP, LLC, a Delaware limited liability company (“CSG LLC” and, together with Brawn, Brawn LLC, GBM, Gump’s, Hanover Realty, TCS Factory, TCS Office, Silhouettes LLC, HCS LLC, Domestications LLC and KIS LLC, collectively, “Borrowers” and each, individually, a “Borrower”), HANOVER DIRECT, INC., a Delaware corporation (“Hanover”), CLEARANCE WORLD OUTLETS, LLC, a Delaware limited liability company (“Clearance World”), SCANDIA DOWN, LLC, a Delaware limited liability company (“Scandia Down LLC”), LACROSSE FULFILLMENT, LLC, a Delaware limited liability company (“LaCrosse LLC”), D.M. ADVERTISING, LLC, a Delaware limited liability company (“DM Advertising LLC”), AMERICAN DOWN & TEXTILE, LLC, a Delaware limited liability company (“ADT LLC”), and HANOVER GIFTS, INC., a Virginia corporation (“Hanover Gifts” and, together with Hanover, Clearance World, Scandia Down LLC, LaCrosse LLC, DM Advertising LLC and ADT LLC, collectively, “Guarantors” and each, individually, a “Guarantor”).

W I T N E S S E T H:

WHEREAS, Borrowers, Guarantors and Lender are parties to the Loan and Security Agreement, dated November 14, 1995, as amended by the First Amendment to Loan and Security Agreement, dated February 22, 1996, the Second Amendment to Loan and Security Agreement, dated April 16, 1996, the Third Amendment to Loan and Security Agreement, dated May 24, 1996, the Fourth Amendment to Loan and Security Agreement, dated May 31, 1996, the Fifth Amendment to Loan and Security Agreement, dated September 11, 1996, the Sixth Amendment to Loan and Security Agreement, dated as of December 5, 1996, the Seventh Amendment to Loan and Security Agreement, dated as of December 18, 1996, the Eighth Amendment to Loan and Security Agreement, dated as of March 26, 1997, the Ninth Amendment to Loan and Security Agreement, dated as of April 18, 1997, the Tenth Amendment to Loan and Security Agreement, dated as of October 31, 1997, the Eleventh Amendment to Loan and Security Agreement, dated as of March 25, 1998, the Twelfth Amendment to Loan and Security Agreement, dated as of September 30, 1998, the Thirteenth Amendment to Loan and Security Agreement, dated as of September 30, 1998, the Fourteenth Amendment to Loan and Security Agreement, dated as of February 28, 2000, the Fifteenth Amendment to Loan and

Security Agreement, dated as of March 24, 2000, the Sixteenth Amendment to Loan and Security Agreement, dated as of August 8, 2000, the Seventeenth Amendment to Loan and Security Agreement, dated as of January 5, 2001, the Eighteenth Amendment to Loan and Security Agreement, dated as of November 12, 2001, the Nineteenth Amendment to Loan and Security Agreement, dated as of December 18, 2001 (as amended hereby, the “Nineteenth Amendment to Loan Agreement”), the Twentieth Amendment to Loan and Security Agreement, dated as of March 5, 2002, the Twenty-First Amendment to Loan and Security Agreement, dated as of March 21, 2002, the Twenty-Second Amendment to Loan and Security Agreement, dated as of August 16, 2002, the Twenty-Third Amendment to Loan and Security Agreement, dated as of December 27, 2002, the Twenty-Fourth Amendment to Loan and Security Agreement, dated as of February 27, 2003, the Twenty-Fifth Amendment to Loan and Security Agreement, dated as of April 21, 2003, the Twenty-Sixth Amendment to Loan and Security Agreement, dated as of August 29, 2003, the Twenty-Seventh Amendment to Loan and Security Agreement, dated as of October 31, 2003, the Twenty-Eighth Amendment to Loan and Security Agreement, dated as of November 4, 2003, the Twenty-Ninth Amendment to Loan and Security Agreement, dated as of November 25, 2003, the Thirtieth Amendment to Loan and Security Agreement, dated as of March 25, 2004, the Thirty-First Amendment to Loan and Security Agreement, dated as of July 8, 2004, and the Thirty-Second Amendment to Loan and Security Agreement, dated as of December 30, 2004 (as so amended, the “Loan Agreement”), pursuant to which Lender has made loans and advances to Borrowers;

WHEREAS, Borrowers and Guarantors have requested that Lender, commencing on the date hereof and continuing through June 30, 2005 increase the amount of Letter of Credit Accommodations that may be permitted to remain outstanding at any one time from $10,000,000 to $13,000,000 as set forth herein;

1. Definitions. All capitalized terms used herein and not defined herein shall have the meanings given to such terms in the Loan Agreement.

2. Letter of Credit Accommodations. Section 2.3(g) of the Loan Agreement is hereby deleted in its entirety and replaced with the following:

($13,000,000) and (ii) the aggregate amount of all outstanding Letter of Credit Accommodations consisting of or relating to banker’s acceptances and any other commitments and obligations made or incurred by Lender in connection therewith, shall not at any time exceed Seven Hundred Fifty Thousand Dollars ($750,000). Lender shall have the right, from time to time, to establish and revise sublimits for Letter of Credit Accommodations for the account of the respective Revolving Loan Borrowers, within the overall limit then in effect on Letter of Credit Accommodations.”

3. Representations, Warranties and Covenants. Borrowers and Guarantors represent, warrant and covenant with and to Lender as follows, which representations, warranties and covenants are continuing and shall survive the execution and delivery hereof, the truth and accuracy of, or compliance with each, together with the representations, warranties and covenants in the other Financing Agreements, being a condition of the effectiveness of this Amendment and a continuing condition of the making or providing of any Revolving Loans or Letter of Credit Accommodations by Lender to Borrowers:

(b) No action of, or filing with, or consent of any governmental or public body or authority, and no approval or consent of any other party, other than Chelsey, is required to authorize, or is otherwise required in connection with, the execution, delivery and performance of this Amendment and each other agreement or instrument to be executed and delivered pursuant hereto.

(c) Neither the execution and delivery of this Amendment, the Private Label Credit Card Agreement, or any other agreements, documents or instruments in connection therewith, nor the consummation of the transactions therein contemplated, nor compliance with the provisions thereof (i) has violated or shall violate any law or regulation or any order or decree of any court or governmental instrumentality in any respect, or (ii) does, or shall conflict with or result in the breach of, or constitute a default in any respect under any mortgage, deed of trust, security agreement, agreement or instrument to which any Borrower or Guarantor is a party or by which it or any of its assets may be bound, or (iii) does or shall violate any provision of the Certificate of Incorporation, Certificate of Formation, By-Laws or Operating Agreement of any Borrower or Guarantor.

4. Conditions Precedent. Concurrently with the execution and delivery hereof (except to the extent otherwise indicated below), and as a further condition to the effectiveness of this Amendment and the agreement of Lender to the modifications and amendments set forth in this Amendment:

(b) Lender shall have received, in form and substance satisfactory to Lender, the consent of all Participants to this Amendment and the transactions contemplated hereby; and

(c) Lender shall have received, in form and substance satisfactory to Lender, for each Borrower and Guarantor that is a limited liability company (i) a Management and Incumbency Certificate of each such company identifying all managers, officers or other persons authorized to act on behalf of such company, (ii) Company Resolutions of each such company, evidencing the adoption and subsistence of company resolutions approving the execution, delivery and performance by each Borrower and Guarantor that is a limited liability company of this Amendment and the agreements, documents and instruments to be delivered pursuant to this Amendment, in each case signed by all members of each such company, and (iii) Certificates of the Secretary or Assistant Secretary of each such company identifying all members of such company;

(d) Lender shall have received, in form and substance satisfactory to Lender, for each Borrower and Guarantor that is a corporation, a Secretary’s or Assistant Secretary’s Certificate of Directors’ Resolutions with Shareholders’ Consent (other than in respect of Hanover) evidencing the adoption and subsistence of corporate resolutions approving the execution, delivery and performance by such Borrower and Guarantor of this Amendment and the agreements, documents and instruments to be delivered pursuant to this Amendment; and

(e) each Borrower and Guarantor shall deliver, or cause to be delivered, to Lender a true and correct copy of any consent, waiver or approval to or of this Amendment, which any Borrower or Guarantor is required to obtain from any other Person, including without limitation Chelsey, and such consent, approval or waiver shall be in a form reasonably acceptable to Lender.

5. Effect of this Amendment. This Amendment constitutes the entire agreement of the parties with respect to the subject matter hereof, and supersedes all prior oral or written communications, memoranda, proposals, negotiations, discussions, term sheets and commitments with respect to the subject matter hereof. Except as expressly provided herein, no other changes or modifications to the Loan Agreement or any of the other Financing Agreements, or waivers of or consents under any provisions of any of the foregoing, are intended or implied by this Amendment, and in all other respects the Financing Agreements are hereby specifically ratified, restated and confirmed by all parties hereto as of the effective date hereof. To the extent that any provision of the Loan Agreement or any of the other Financing Agreements conflicts with any provision of this Amendment, the provision of this Amendment shall control.

6. Further Assurances. Borrowers and Guarantors shall execute and deliver such additional documents and take such additional action as may be reasonably requested by Lender to effectuate the provisions and purposes of this Amendment.

7. Governing Law. The validity, interpretation and enforcement of this Amendment in any dispute arising out of the relationship between the parties hereto, whether in contract, tort, equity or otherwise shall be governed by the internal laws of the State of New York, without regard to any principle of conflict of laws or other rule of law that would result in the application of the law of any jurisdiction other than the State of New York.

8. Binding Effect. This Amendment shall be binding upon and inure to the benefit of each of the parties hereto and their respective successors and assigns.

9. Counterparts. This Amendment may be executed in any number of counterparts, but all of such counterparts shall together constitute but one and the same agreement. In making proof of this Amendment, it shall not be necessary to produce or account for more than one counterpart thereof signed by each of the parties hereto.

[REMAINDER OF THIS PAGE INTENTIONALLY LEFT BLANK]

IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be executed on the day and year first written.

WACHOVIA BANK, NATIONAL ASSOCIATION,
successor by merger to Congress Financial Corporation

By: /s/ Eric Storz
Name: Eric Storz
Title: Vice President

BRAWN OF CALIFORNIA, INC.

By: /s/ Daniel J. Barsky
Name: Daniel J. Barsky
Title: Secretary

BRAWN, LLC

By: /s/ Daniel J. Barsky
Name: Daniel J. Barsky
Title: Secretary

GUMP’S BY MAIL, INC.

By: /s/ Daniel J. Barsky
Name: Daniel J. Barsky
Title: Secretary

GUMP’S CORP.

By: /s/ Daniel J. Barsky
Name: Daniel J. Barsky
Title: Secretary

HANOVER REALTY, INC.

By: /s/ Daniel J. Barsky
Name: Daniel J. Barsky
Title: Secretary

[SIGNATURES CONTINUE ON FOLLOWING PAGE]

[SIGNATURES CONTINUED FROM PREVIOUS PAGE]

THE COMPANY STORE FACTORY, INC.

By: /s/ Daniel J. Barsky
Name: Daniel J. Barsky
Title: Secretary

THE COMPANY OFFICE, INC.

By: /s/ Daniel J. Barsky
Name: Daniel J. Barsky
Title: Secretary

SILHOUETTES, LLC

By: /s/ Daniel J. Barsky
Name: Daniel J. Barsky
Title: Secretary

HANOVER COMPANY STORE, LLC

By: /s/ Daniel J. Barsky
Name: Daniel J. Barsky
Title: Secretary

DOMESTICATIONS, LLC

By: /s/ Daniel J. Barsky
Name: Daniel J. Barsky
Title: Secretary

KEYSTONE INTERNET SERVICES, LLC

By: /s/ Daniel J. Barsky
Name: Daniel J. Barsky
Title: Secretary

[SIGNATURES CONTINUE ON FOLLOWING PAGE]

[SIGNATURES CONTINUED FROM PREVIOUS PAGE]

THE COMPANY STORE GROUP, LLC

By: /s/ Daniel J. Barsky
Name: Daniel J. Barsky
Title: Secretary

By their signatures below, the

undersigned Guarantors acknowledge

and agree to be bound by the

applicable provisions of this

Amendment:

HANOVER DIRECT, INC.

By: /s/ Daniel J. Barsky

Name: Daniel J. Barsky

Title: Secretary

CLEARANCE WORLD OUTLETS, LLC

By: /s/ Daniel J. Barsky

Name: Daniel J. Barsky

Title: Secretary

SCANDIA DOWN, LLC

By: /s/ Daniel J. Barsky

Name: Daniel J. Barsky

Title: Secretary

LA CROSSE FULFILLMENT, LLC

By: /s/ Daniel J. Barsky

Name: Daniel J. Barsky

Title: Secretary

[SIGNATURES CONTINUE ON FOLLOWING PAGE]

[SIGNATURES CONTINUED FROM PREVIOUS PAGE]

D.M. ADVERTISING, LLC

By: /s/ Daniel J. Barsky

Name: Daniel J. Barsky

Title: Secretary

AMERICAN DOWN & TEXTILE, LLC

By: /s/ Daniel J. Barsky

Name: Daniel J. Barsky

Title: Secretary

HANOVER GIFTS, INC.

By: /s/ Daniel J. Barsky

Name: Daniel J. Barsky

Title: Secretary

EX-10.03 4 exhibit10_03.htm

Exhibit 10.03

THIRTY-FOURTH AMENDMENT TO LOAN AND SECURITY AGREEMENT

THIS THIRTY-FOURTH AMENDMENT TO LOAN AND SECURITY AGREEMENT (this “Amendment”), dated as of July 29, 2005, is entered into by and among WACHOVIA BANK, NATIONAL ASSOCIATION, a national banking association (“Lender”), BRAWN OF CALIFORNIA, INC., a California corporation (“Brawn”), BRAWN, LLC, a Delaware limited liability company (“Brawn LLC”), HANOVER REALTY, INC., a Virginia corporation (“Hanover Realty”), THE COMPANY STORE FACTORY, INC., a Delaware corporation (“TCS Factory”), THE COMPANY OFFICE, INC., a Delaware corporation (“TCS Office”), SILHOUETTES, LLC, a Delaware limited liability company (“Silhouettes LLC”), HANOVER COMPANY STORE, LLC, a Delaware limited liability company (“HCS LLC”), DOMESTICATIONS, LLC, a Delaware limited liability company (“Domestications LLC”), KEYSTONE INTERNET SERVICES, LLC, a Delaware limited liability company (“KIS LLC”), and THE COMPANY STORE GROUP, LLC, a Delaware limited liability company (“CSG LLC” and, together with Brawn, Brawn LLC, Hanover Realty, TCS Factory, TCS Office, Silhouettes LLC, HCS LLC, Domestications LLC and KIS LLC, collectively, “Borrowers” and each, individually, a “Borrower”), HANOVER DIRECT, INC., a Delaware corporation (“Hanover”), CLEARANCE WORLD OUTLETS, LLC, a Delaware limited liability company (“Clearance World”), SCANDIA DOWN, LLC, a Delaware limited liability company (“Scandia Down LLC”), LACROSSE FULFILLMENT, LLC, a Delaware limited liability company (“LaCrosse LLC”), D.M. ADVERTISING, LLC, a Delaware limited liability company (“DM Advertising LLC”), AMERICAN DOWN & TEXTILE, LLC, a Delaware limited liability company (“ADT LLC”), and HANOVER GIFTS, INC., a Virginia corporation (“Hanover Gifts” and, together with Hanover, Clearance World, Scandia Down LLC, LaCrosse LLC, DM Advertising LLC and ADT LLC, collectively, “Guarantors” and each, individually, a “Guarantor”).

W I T N E S S E T H:

Amendment to Loan and Security Agreement, dated as of December 18, 2001 (as amended hereby, the “Nineteenth Amendment to Loan Agreement”), the Twentieth Amendment to Loan and Security Agreement, dated as of March 5, 2002, the Twenty-First Amendment to Loan and Security Agreement, dated as of March 21, 2002, the Twenty-Second Amendment to Loan and Security Agreement, dated as of August 16, 2002, the Twenty-Third Amendment to Loan and Security Agreement, dated as of December 27, 2002, the Twenty-Fourth Amendment to Loan and Security Agreement, dated as of February 27, 2003, the Twenty-Fifth Amendment to Loan and Security Agreement, dated as of April 21, 2003, the Twenty-Sixth Amendment to Loan and Security Agreement, dated as of August 29, 2003, the Twenty-Seventh Amendment to Loan and Security Agreement, dated as of October 31, 2003, the Twenty-Eighth Amendment to Loan and Security Agreement, dated as of November 4, 2003, the Twenty-Ninth Amendment to Loan and Security Agreement, dated as of November 25, 2003, the Thirtieth Amendment to Loan and Security Agreement, dated as of March 25, 2004, the Thirty-First Amendment to Loan and Security Agreement, dated as of July 8, 2004, the Thirty-Second Amendment to Loan and Security Agreement, dated as of December 30, 2004, and the Thirty-Third Amendment to Loan and Security Agreement, dated as of March 11, 2005 (as so amended, the “Loan Agreement”), pursuant to which Lender has made loans and advances to Borrowers;

WHEREAS, Borrowers and Guarantors have requested that Lender (a) consent to the private label credit card program of Hanover with World Financial Network National Bank (“WFNNB” as hereinafter further defined) as set forth in the Private Label Credit Card Agreement (as hereinafter defined), (b) conditionally waive certain Events of Default that have occurred and are continuing or still exist, (c) amend the minimum amounts of Consolidated Working Capital, Consolidated Net Worth and EBITDA that Hanover and its Subsidiaries are required to maintain, (d) consent to the license by Silhouettes LLC to Branded, LLC (“Tweeds Licensee” as hereinafter further defined) of the “Tweeds” trademark with an option in favor of Tweeds Licensee to purchase the “Tweeds” trademark, together with the goodwill symbolized thereby, (e) reallocate the Inventory lending sublimits of Revolving Loan Borrowers, (f) to increase the maximum amount of Letter of Credit Accommodations permitted to remain outstanding from $13,000,000 to $15,000,000, and (g) to make certain other amendments to the Loan Agreement and the other Financing Agreements, and Lender is willing to agree to grant such consents and waivers and enter into such amendments, subject to the terms and conditions and to the extent set forth herein; and

WHEREAS, the parties hereto desire to enter into this Amendment to evidence and effectuate such consents, waivers and amendments, in each case subject to the terms and conditions and to the extent set forth herein;

1.	Definitions.

(i) “Co-Brand Account” shall mean a general purpose, open-end revolving line of credit account that may be accessed through a WFNNB Credit Card established by WFNNB for a customer of a Borrower in accordance with the terms and conditions of the Private Label Credit Card Agreement.

(ii) “Existing Defaults” shall have the meaning set forth in Section 14(a) hereof.

(iii) “Hanover Private Label Credit Card Program” shall mean the private label program of Hanover as set forth in the Private Label Credit Card Agreement.

(iv) “Private Label Account” shall mean an individual, open-end revolving line of credit account that may be accessed through a WFNNB Credit Card established by WFNNB for a customer of a Borrower in accordance with the terms and conditions of the Private Label Credit Card Agreement.

(v) “Private Label Credit Card Agreement” shall mean the Co-Brand and Private Label Credit Card Program Agreement, dated as of February 22, 2005, between Hanover and WFNNB, as amended by Amendment Number One to Credit Card Program Agreement, dated as of March 30, 2005, as the same now exists or may hereafter be amended, modified, supplemented, extended, renewed, restated or replaced.

(vi) “Private Label Receivables” shall mean Credit Card Receivables that arise solely from goods or services sold by Borrowers to customers who have purchased goods or services using a WFNNB Credit Card under the Hanover Private Label Credit Card Program.

(vii) “Tweeds Licensee” shall mean Branded, LLC, a Georgia limited liability company, and its successors and assigns.

(viii) “Tweeds Licensing Agreement” shall mean the License-to-Purchase Agreement, dated as of April 18, 2005, between Silhouettes LLC and Tweeds Licensee, as the same now exists or may hereafter be amended, modified, supplemented, extended, renewed, restated or replaced.

(ix) “WFNNB” shall mean World Financial Network National Bank, a chartered national bank, and its successors and assigns.

(x) “WFNNB Credit Card” shall mean a credit card issued by WFNNB to a customer of a Borrower with respect to either a Co-Brand Account or a Private Label Account pursuant to the Private Label Credit Card Agreement.

(xi) “WFNNB Credit Card Accounts” shall mean, collectively, the Co-Brand Accounts and the Private Label Accounts.

(xii) “WFNNB Credit Card Acknowledgment” shall mean the letter agreement, dated as of the date hereof, among Lender, WFNNB and Hanover Re: Hanover Private Label Credit Card Program, as the same now exists or may hereafter be amended, modified, supplemented, extended, renewed, restated or replaced.

(b)	Amendment to Definitions.

(i) Credit Card Acknowledgments. All references to the term “Credit Card Acknowledgements “ in the Loan Agreement and the other Financing Agreements are hereby amended to include, without limitation, the WFNNB Credit Card Acknowledgment.

(ii) Credit Card Agreements. All references to the term “Credit Card Agreements” in the Loan Agreement and the other Financing Agreements are hereby amended to include, without limitation, the Private Label Credit Card Agreement.

(iii) Credit Card Issuer. All references to the term “Credit Card Issuer” in the Loan Agreement and the other Financing Agreements shall be deemed and each such reference is hereby amended to mean any Person (other than a Borrower) who issues or whose members issue credit cards, including, without limitation, MasterCard or VISA bank credit or debit cards or other bank credit or debit cards issued through MasterCard International, Inc., Visa, U.S.A., Inc. or Visa International and American Express, Discover, Diners Club, Carte Blanche and other non-bank credit or debit cards, including, without limitation, credit or debit cards issued by or through American Express Travel Related Services Company, Inc., Novus Services, Inc. and WFNNB.

(iv) Eligible Credit Card Receivables. The definition of “Eligible Credit Card Receivables” in Section 1(a)(v) of the Fifteenth Amendment to Loan Agreement is hereby amended by deleting the word “and” appearing at the end of clause (L), replacing the period with a semicolon and the word “and” appearing at the end of clause (M) and adding a new clause (N) as follows:

“(N) such Credit Card Receivable does not arise from the use by the account debtor of a WFNNB Credit Card with respect to a Co-Brand Account or Private Label Account under the Hanover Private Label Credit Card Program.”

(c) Interpretation. All capitalized terms used herein and not defined herein shall have the meanings given to such terms in the Loan Agreement.

2. Lending Sublimits. Section 2.2 of the Loan Agreement is hereby deleted in its entirety and replaced with the following:

“2.2	Lending Sublimits.

(a) Subject to, and upon the terms and conditions contained herein, the aggregate principal amount of Revolving Inventory Loans and Letter of Credit Accommodations made available to Brawn shall not exceed $2,000,000 at any one time outstanding.

(b) Subject to, and upon the terms and conditions contained herein, the aggregate principal amount of Revolving Inventory Loans and Letter of Credit Accommodations made available to HCS LLC shall not exceed $13,000,000 at any one time outstanding.

aggregate principal amount of Revolving Inventory Loans and Letter of Credit Accommodations made available to Domestications LLC shall not exceed $9,000,000 at any one time outstanding.

(d) Subject to, and upon the terms and conditions contained herein, the aggregate principal amount of Revolving Inventory Loans and Letter of Credit Accommodations made available to Silhouettes LLC shall not exceed $3,500,000 at any one time outstanding.

(e) Without limiting the foregoing lending sublimits, (i) the aggregate amount of Revolving Loans shall not at any one time outstanding exceed the Revolving Loan Limit for all Revolving Loan Borrowers and (ii) the aggregate amount of Revolving Accounts Loans for all Deferred Billing Borrowers, Installment Billing Borrowers, Fulfillment Contract Borrowers and any other applicable Revolving Loan Borrowers shall not at any one time outstanding exceed $7,000,000. Lender shall have the right, from time to time, to establish and revise Revolving Accounts Loan sublimits for each Deferred Billing Borrower, Installment Billing Borrower, Fulfillment Contract Borrower and each other applicable Revolving Loan Borrower within the overall $7,000,000 sublimit applicable to all Revolving Accounts Loans.”

3. Letter of Credit Accommodations. Effective as of June 30, 2005, Section 2.3(g) of the Loan Agreement is hereby deleted and replaced with the following:

“(g) Notwithstanding anything to the contrary contained herein or in any of the other Financing Agreements, the aggregate amount of all Letter of Credit Accommodations pursuant hereto and all other commitments and obligations made or incurred by Lender pursuant hereto for the account or benefit of Revolving Loan Borrowers in connection therewith shall not, at any one time outstanding, exceed $15,000,000; provided, that, the aggregate amount of all outstanding Letter of Credit Accommodations consisting of or relating to banker’s acceptances and any other commitments and obligations made or incurred by Lender in connection therewith, shall not at any time exceed $750,000. Lender shall have the right, from time to time, to establish and revise sublimits for Letter of Credit Accommodations for the account of the respective Revolving Loan Borrowers, within the overall $15,000,000 limit on Letter of Credit Accommodations and within the overall $750,000 sublimit on Letter of Credit Accommodations consisting of banker’s acceptances.”

4. Indebtedness. Section 6.3 of the Loan Agreement is hereby amended by deleting the word “and” appearing at the end of Section 6.3(j), replacing the period with a semicolon and the word “and” appearing at the end of Section 6.3(k) and adding a new Section 6.3(l) immediately thereafter as follows:

“(l) Indebtedness of Borrowers and Hanover to WFNNB for chargebacks and fees payable by Hanover to WFNNB and Indebtedness arising out of the contingent obligation of Borrowers and Hanover to repurchase Private Label Accounts in accordance with the terms and conditions of the Private Label Credit Card Agreement; provided, that:

(i) such Indebtedness is incurred in accordance with and to the extent

permitted by Section 6.4(k) hereof;

(ii) Borrowers and Guarantors shall not terminate the Private Label Credit Card Agreement without the prior written consent of Lender;

(iii) with respect to the contingent obligation of Borrowers and Hanover to repurchase Private Label Accounts under the Private Label Credit Card Agreement in the event of a termination of the Private Label Credit Card Agreement, any repurchase of any Private Label Accounts or any other WFNNB Credit Card Accounts shall not be permitted if any of the amounts used to repurchase any such WFNNB Credit Card Accounts shall be funded, directly or indirectly, using proceeds of any Loans or other advances or accommodations under the Loan Agreement or the other Financing Agreements;

(iv) in the event Hanover or Borrowers are required to fulfill the repurchase obligation due to the termination of the Private Label Credit Card Agreement by WFNNB, Hanover and Borrowers may satisfy such obligation by obtaining alternate financing in the form of equity or debt (“Repurchase Financing”) so long as each of the following conditions have been satisfied as determined by Lender in good faith:

(A) Lender shall have received not less than thirty (30) days’ prior written notice of the intention to repurchase any such WFNNB Credit Card Accounts using proceeds of such Repurchase Financing, which notice shall set forth in reasonable detail satisfactory to Lender, the terms and conditions of such Repurchase Financing and such other information with respect thereto as Lender may reasonably request,

(B) such Repurchase Financing shall be on terms and conditions acceptable to Lender in its good faith discretion, and all of the agreements, documents and instruments evidencing or otherwise related to such Repurchase Financing shall be in form and substance satisfactory to Lender in its good faith determination;

(C) if such Repurchase Financing involves entering into a Credit Card Agreement with a Credit Card Issuer to replace the Hanover Private Label Credit Card Program, Lender shall have received, in each case, in form and substance acceptable to Lender, such Credit Card Agreement and a Credit Card Acknowledgment, that provides for, among other things, the remittance of all amounts payable to Hanover and Borrowers directly to the Blocked Account;

(D) if such Repurchase Financing is in the form of Indebtedness, such Repurchase Financing shall be unsecured and subordinated in right of payment to the prior right of Lender to receive the indefeasible payment in full of all Obligations as set forth in a written subordination agreement, in form and substance acceptable to Lender;

(E) if such Repurchase Financing is in the form of equity, no dividends, payments or distributions in respect of, or repurchases or redemptions of, Capital Stock consisting of such Repurchase Financing shall be permitted until Lender shall have received the indefeasible payment in full of all Obligations;

(F) after giving effect to such Repurchase Financing, no Incipient Default or an Event of Default shall exist or have occurred and be continuing,

(v) Hanover and Borrowers shall not, directly or indirectly (A) amend, modify, alter or change any of the terms of the Hanover Private Label Credit Card Program in effect on March 30, 2005, except, that, Hanover and Borrowers may, after prior written notice to Lender, amend, modify, alter or change the terms thereof so long as any such amendment, modification, alteration or change does not result in terms that are more burdensome or less favorable than the terms of the Hanover Private Label Credit Card Program as in effect on March 30, 2005, or (C) redeem, retire, defease, purchase or otherwise acquire such Indebtedness, or set aside or otherwise deposit or invest any sums for such purpose (other than as permitted by clause (iv) of this Section 6.3(l); and

(vi) Hanover and Borrowers shall furnish to Lender copies of all material notices or demands in connection with the Hanover Private Label Credit Card Program received by Hanover or any Subsidiary of Hanover or on its behalf promptly after the receipt thereof or sent by Hanover or any such Subsidiary on its behalf concurrently with the sending thereof, as the case may be.”

5. Encumbrances. Section 6.4 of the Loan Agreement is hereby amended by deleting the word “and” appearing at the end of Section 6.4(i), replacing the period with a semicolon and the word “and” appearing at the end of Section 6.4(j) and adding new Section 6.4(k) immediately thereafter, as follows:

“(k) right of WFNNB to purchase the Private Label Receivables sold by any Borrower or Hanover to WFNNB pursuant to the Private Label Credit Card Agreement, subject to the terms and conditions of the WFNNB Credit Card Acknowledgment and Section 6.3(d) hereof.”

6. Sale of Assets. Section 6.9 of the Loan Agreement is hereby amended by deleting the word “and” appearing at the end of clause (i) in the proviso of Section 6.9, replacing the period with a semicolon and the word “and” appearing at the end of clause (ii) of such proviso and adding new clause (iii) immediately thereafter, as follows:

“(iii) the sale by any Borrower or Hanover to WFNNB of the Private Label Receivables of such Borrower in accordance with the terms and conditions of the Private Label Credit Card Agreement so long as each of the following conditions shall have been satisfied as determined by Lender in good faith:

(A) all sales of the Private Label Receivables by any Borrower or Hanover to WFNNB shall be subject to the first priority lien and security interest of Lender, subject to the terms and conditions of the WFNNB Credit Card Acknowledgment, and Section 10 of the Thirty-Fourth Amendment to Loan and Security Agreement, dated as of July 29, 2005,

(B) all monies or other amounts at any time payable in respect of such the sale of the Private Label Receivables or otherwise pursuant to the Private Label Credit Card Agreement shall be paid directly to the blocked account set forth in WFNNB Credit Card Acknowledgment in immediately available funds, and

(C) at the time of each such sale, the Private Label Credit Card Agreement shall be in full force and effect and no default or event of default shall exist thereunder by any of the parties thereto.”

7. Inventory Covenants. Section 6.13(b) of the Loan Agreement is hereby amended by adding the following at the end of such Section:

“With respect to any returned Inventory originally purchased with a WFNNB Credit Card, upon the occurrence of an Event of Default or Incipient Default, at the request of Lender, each Borrower and Guarantor shall (i) hold all such returned Inventory in trust for Lender, (ii) segregate all such returned Inventory from all of its other property, (iii) dispose of such returned Inventory solely in accordance with the instructions of Lender, and (iv) not issue any credits, discounts or allowances with respect thereto without the prior written consent of Lender.”

8. Collateral Reporting. Section 6.18(a) of the Loan Agreement is hereby amended by adding subsections (xvi) immediately after subsection (xv) as follows:

“(xiv) Without limiting any of the foregoing, with respect to the Hanover Private Label Credit Card Program:

(A) a monthly (or more frequently as may be requested by Lender if an Event of Default has occurred and is continuing) report on the Accounts of each Borrower and Hanover in respect of Private Label Receivables, including, as to the foregoing, the aggregate outstanding amounts;

(B) a daily schedule of all Private Label Receivables sold by Borrowers or Hanover under the Private Label Credit Card Agreement, including, (1) the amount of net proceeds and all other amounts remitted to the Blocked Account under the Private Label Credit Card Agreement, and (2) the amount of chargebacks, fees and other amounts deducted by WFNNB from the amount of proceeds remitted by WFNNB to the Blocked Account; and

(C) a daily schedule of all returned Inventory purchased by customers of a Borrower under the Hanover Private Label Credit Card Program.”

9. Consolidated Working Capital. Section 6.19(e) of the Loan Agreement is hereby deleted and replaced with the following:

“(e) Hanover shall, commencing with the fiscal month ending July 2005, and for each fiscal month thereafter in any fiscal year thereafter, maintain Consolidated Working Capital, calculated on a consolidated basis for Hanover and its Subsidiaries, of not less than the following amounts as at the end of each such fiscal month:

Period

Amount

January	$5,000,000
February	$7,000,000
March	$3,000,000
April	$6,000,000
May	$6,000,000
June	$6,000,000
July	$6,000,000
August	$7,000,000
September	$9,000,000
October	$7,000,000
November	$5,000,000
December	$8,000,000”

10. Consolidated Net Worth. Section 6.20(e) of the Loan Agreement is hereby deleted in its entirety and replaced with the following:

“(e) Hanover shall, commencing with the fiscal month ending July 2005 and for each fiscal month thereafter in any fiscal year thereafter, maintain Consolidated Net Worth, calculated on a consolidated basis for Hanover and its Subsidiaries, of not less than the following amounts as at the end of each such fiscal month:

Period

Amount

January	($47,000,000)
February	($48,000,000)
March	($46,000,000)
April	($46,000,000)
May	($46,000,000)
June	($45,000,000)
July	($44,000,000)
August	($43,000,000)
September	($42,000,000)
October	($42,000,000)
November	($39,000,000)
December	($37,000,000)

11. EBITDA. Sections 6.31(f) and (g) of the Loan Agreement are hereby deleted in its entirety and replaced with the following:

“(f) Hanover and its Subsidiaries shall not, commencing with the second fiscal quarter of Hanover and its Subsidiaries ending June 25, 2005 and for each fiscal quarter thereafter during the fiscal year 2005, permit EBITDA of Hanover and its Subsidiaries commencing on the first day of such fiscal year and ending on the last day of the applicable fiscal quarter set forth below on a cumulative YTD basis to be less than the respective amount set forth below opposite such fiscal quarter end YTD period:

Fiscal Quarter

End YTD Periods

for Fiscal Year 2005

Cumulative

Minimum EBITDA

(ii) December 26, 2004 through

June 25, 2004

$5,500,000

(iii) December 26, 2004 through

September 24, 2005

$9,600,000

(iv) December 26, 2004 through

December 31, 2005

$15,500,000”

(g) Hanover and its Subsidiaries shall not, as to any fiscal quarter during the fiscal year 2006 of Hanover and its Subsidiaries and for each fiscal quarter thereafter in any fiscal year thereafter, permit EBITDA of Hanover and its Subsidiaries commencing on the first day of such fiscal year and ending on the last day of the applicable fiscal quarter set forth below on a cumulative YTD basis to be less than the respective amount set forth below opposite such fiscal quarter end YTD period:

Fiscal Quarter

End YTD Periods

for Fiscal Year 2006

Cumulative

Minimum EBITDA

(i) January 1, 2006 through

April 1, 2006

$2,800,000

(ii) January 1, 2006 through

July 1, 2006

$5,500,000

(iii) January 1, 2006 through

September 30, 2006

$9,600,000

(iv) January 1, 2006 through

December 30, 2006

$15,500,000”

12. Release of Security Interest in Certain Collateral.

(a) Effective upon the sale by any Borrower of any Private Label Receivables to WFNNB pursuant to the Private Label Credit Card Agreement and the receipt by Lender of all amounts due to Borrowers and Hanover under the Private Label Credit Card Agreement, the security interests and liens of Lender in and upon such Private Label Receivables shall be terminated and released automatically and without further action; provided, that, nothing contained herein or otherwise shall be deemed to be a release or termination by Lender of any security interests in and liens upon the following, which security interests and liens shall continue, and shall be deemed to continue, in full force and effect: (i) the proceeds from the sale of any such Private Label Receivables or any other assets of Borrowers and Guarantors, all of which shall continue in full force and effect, (ii) any returned inventory or merchandise and any indebtedness or obligation of a customer of Hanover under Credit Card Accounts or otherwise with respect to any receivable attributable to such returned inventory or merchandise and (iii) the Private Label Receivable with respect to any WFNNB Credit Card Account that is charged back to Hanover by WFNNB under the terms of the Private Label Credit Card Agreement.

(b) Except as specifically set forth herein, nothing contained herein shall be construed in any manner to constitute a waiver, release or termination or to otherwise limit or impair any of the obligations or indebtedness of any Borrower or Guarantor or any other person or entity to Lender, or any duties, obligations or responsibilities of any Borrower or Guarantor or any other person or entity to Lender.

13. Consent to Tweeds Licensing Agreement.

(a) Notwithstanding anything to the contrary contained in the Trademark Collateral Assignment and Security Agreement, dated as of November 14, 1995, among Borrowers that are signatory parties thereto and Lender, as heretofore amended, or Section 6.7 of the Loan Agreement, subject to the terms and conditions contained herein, Silhouettes LLC may enter into the Tweeds Licensing Agreement with Tweeds Licensee to provide for the license of the “Tweeds” trademark and option in favor of Tweeds Licensee to purchase the “Tweeds” trademark and the goodwill symbolized thereby, as set forth in the Tweeds Licensing Agreement so long as Borrowers and Guarantors remit all payments and other amounts due to Silhouettes LLC under the Tweeds Licensing Agreement to a Blocked Account in accordance with the terms and conditions of the Loan Agreement;

(b) Borrowers and Guarantors represent, warrant and covenant with, to and in favor of Lender the following:

(i) The “Tweeds” trademark is no longer intended to be used in the business of Borrowers or Guarantors and that no sales of Inventory are or will be consummated using the “Tweeds” trademark or name.

(ii) Borrowers and Guarantors have delivered to Lender a true, correct and complete copy of the executed Tweeds Licensing Agreement and each other agreement, document or instrument executed or delivered in connection therewith.

(iii) Silhouettes LLC shall not enter into any amendment, modification or alteration of the Tweeds Licensing Agreement that would in any way reduce the amounts payable thereunder or make any terms less favorable to Silhouettes LLC in any material way.

14. Conditional Waiver of Events of Default.

(a) It has come to the attention of Lender that certain Events of Default have occurred and are continuing or exist as set forth on Schedule 14(a) hereto (the “Existing Defaults”) and in the absence of this conditional waiver, entitle Lender to cease making Loans and to exercise its other rights and remedies under the Financing Agreements, applicable law or otherwise. In reliance upon the representations, warranties and covenants of Borrowers and Guarantors contained herein, and subject to the terms and conditions contained herein, Lender agrees to waive the Existing Defaults so long as Borrowers and Guarantors take the actions set forth on Schedule 14(a) hereto within the time periods and in accordance with the terms and conditions set forth on Schedule 14(a) hereto (collectively, the “Existing Default Cure Actions”).

(b) Borrowers and Guarantors hereby acknowledge and agree that if Borrowers or Guarantors fail to implement an Existing Default Cure Action in a timely manner satisfactory to Lender, or fail to deliver evidence to Lender, in form and substance satisfactory to Lender, that Borrowers and Guarantors have implemented such Existing Default Cure Action, then unless otherwise agreed to by Lender in writing, the waiver of the corresponding Existing Default shall automatically and without further action terminate and be of no force and effect. Lender may thereafter immediately enforce its rights and remedies in accordance with the terms and conditions of the Financing Agreements, including, without limitation, ceasing making any Loans or providing any Letter of Credit Accommodations.

(c) Lender has not waived, is not by this Amendment waiving, and has no intention of waiving, any Event of Default which may have occurred on or prior to the date hereof, whether or not continuing on the date hereof, or which may occur after the date hereof (whether the same or similar to the Existing Defaults or otherwise), other than the specific Existing Defaults, subject to the terms and conditions of Section 14(b) hereof. The foregoing waiver shall not be construed as a bar to or a waiver of any other or further Event of Default on any future occasion, whether similar in kind or nature to the Existing Defaults or otherwise and shall not constitute a waiver, express or implied, of any of the rights and remedies of Lender arising under the terms of the Loan Agreement or any other Financing Agreements on any future occasion or otherwise, including, without limitation, the failure of Borrowers or Guarantors to implement the Existing Default Cure Actions.

15. Fee. In addition to all other fees, charges, interest and expenses payable by Borrowers to Lender under the Loan Agreement and the other Financing Agreements, Borrowers shall pay to Lender, contemporaneously herewith, an amendment and waiver fee for entering into this Amendment and providing for the conditional waiver of the Existing Defaults in the amount of $60,000, which fee is fully earned as of the date hereof and may be charged into the loan account(s) of any Borrower.

16. Representations, Warranties and Covenants. Borrowers and Guarantors represent, warrant and covenant with and to Lender as follows, which representations, warranties and covenants are continuing and shall survive the execution and delivery hereof, the truth and accuracy of, or compliance with each, together with the representations, warranties and covenants in the other

Financing Agreements, being a condition of the effectiveness of this Amendment and a continuing condition of the making or providing of any Revolving Loans or Letter of Credit Accommodations by Lender to Borrowers:

(c) Borrowers and Guarantors have delivered to Lender true, correct and complete copies of the Private Label Credit Card Agreement and all agreements, documents and instruments to be delivered or executed in connection therewith.

(d) Neither the execution and delivery of this Amendment, the Private Label Credit Card Agreement, or any other agreements, documents or instruments in connection therewith, nor the consummation of the transactions therein contemplated, nor compliance with the provisions thereof (i) has violated or shall violate any law or regulation or any order or decree of any court or governmental instrumentality in any respect, or (ii) does, or shall conflict with or result in the breach of, or constitute a default in any respect under any mortgage, deed of trust, security agreement, agreement or instrument to which any Borrower or Guarantor is a party or by which it or any of its assets may be bound, or (iii) does or shall violate any provision of the Certificate of Incorporation, Certificate of Formation, By-Laws or Operating Agreement of any Borrower or Guarantor.

(e) Notwithstanding the provisions of Section 20(n) of the Thirty-First Amendment to Loan Agreement among Lender, Borrowers and Guarantors, on or before October 31, 2005, Borrowers and Guarantors shall enter into an Amended and Restated Loan and Security Agreement among Lender, Borrowers and Guarantors and an amendment and restatement of such other Financing Agreements or amendments to or amendments and restatements of any existing Financing Agreements as Lender shall request in connection with the amendment and restatement of the Loan Agreement.

(f) After giving effect to the waivers and consents set forth in this Amendment, no Incipient Default or Event of Default exists or has occurred on the date hereof.

17. Conditions Precedent. Concurrently with the execution and delivery hereof (except to the extent otherwise indicated below), and as a further condition to the effectiveness of this Amendment and the agreement of Lender to the modifications and amendments set forth in this Amendment:

(a) Lender shall have received a photocopy of an executed original or executed original counterparts of this Amendment by electronic mail or facsimile (with the originals to be delivered within five (5) Business Days after the date hereof), as the case may be, duly authorized, executed and delivered by Borrowers and Guarantors;

(b) Lender shall have received, in form and substance satisfactory to Lender,

(i) the WFNNB Credit Card Acknowledgment, duly authorized, executed and delivered by WFNNB and Hanover; and

(ii) the Amendment Number One to Credit Card Program Agreement between WFNNB and Hanover, and all other agreements, documents and instruments executed or delivered in connection with the Private Label Credit Card Agreement;

(c) Lender shall have received, in form and substance satisfactory to Lender, the consent of all Participants to this Amendment and the transactions contemplated hereby;

(d) Lender shall have received, in form and substance satisfactory to Lender, with respect to each Borrower and Guarantor that is a limited liability company, a Manager’s Certificate for such Borrowers and Guarantors, that (i) identifies all officers or other persons authorized to act on behalf of such company, and (ii) evidences the adoption and subsistence of company resolutions approving the execution, delivery and performance by such Borrower and Guarantor of this Amendment and the agreements, documents and instruments to be delivered pursuant to this Amendment, in each case signed by all members of each such company;

(e) Lender shall have received, in form and substance satisfactory to Lender, with respect to each Borrower and Guarantor that is a corporation, a Secretary’s or Assistant Secretary’s Certificate of Directors’ Resolutions for such Borrowers and Guarantors, that (i) identifies the officers of such corporation authorized to act on behalf of such corporation and (ii) evidences the adoption and subsistence of corporate resolutions approving the execution, delivery and performance by such Borrower and Guarantor of this Amendment and the agreements, documents and instruments to be delivered pursuant to this Amendment; and

(f) Each Borrower and Guarantor shall deliver, or cause to be delivered, to Lender a true and correct copy of any consent, waiver or approval to or of the transactions contemplated by the Private Label Credit Card Agreement, which any Borrower or Guarantor is required to obtain from any other Person, including, without limitation Chelsey, and such consent, approval or waiver shall be in a form reasonably acceptable to Lender; and

(g) As of the date of this Amendment and after giving effect hereto, no Incipient Default or Event of Default shall exist or have occurred, other than the Existing Defaults.

18. Effect of this Amendment. This Amendment constitutes the entire agreement of the parties with respect to the subject matter hereof, and supersedes all prior oral or written communications, memoranda, proposals, negotiations, discussions, term sheets and commitments with respect to the subject matter hereof. Except as expressly provided herein, no other changes or modifications to the Loan Agreement or any of the other Financing Agreements, or waivers of or consents under any provisions of any of the foregoing, are intended or implied by this Amendment, and in all other

respects the Financing Agreements are hereby specifically ratified, restated and confirmed by all parties hereto as of the effective date hereof. To the extent that any provision of the Loan Agreement or any of the other Financing Agreements conflicts with any provision of this Amendment, the provision of this Amendment shall control.

19. Further Assurances. Borrowers and Guarantors shall execute and deliver such additional documents and take such additional action as may be reasonably requested by Lender to effectuate the provisions and purposes of this Amendment.

20. Governing Law. The validity, interpretation and enforcement of this Amendment whether in contract, tort, equity or otherwise, shall be governed by the internal laws of the State of New York but excluding any principles of conflict of laws or other rule of law that would cause the application of the law of any jurisdiction, other than the laws of the State of New York. Without in any way limiting the foregoing, the parties elect to be governed by New York law in accordance with, and relying on (at least in part), Section 5-1401 of the General Obligations Law of the State of New York.

21. Binding Effect. This Amendment shall be binding upon and inure to the benefit of each of the parties hereto and their respective successors and assigns.

22. Counterparts. This Amendment may be executed in any number of counterparts, but all of such counterparts shall together constitute but one and the same agreement. In making proof of this Amendment, it shall not be necessary to produce or account for more than one counterpart thereof signed by each of the parties hereto.

[REMAINDER OF THIS PAGE INTENTIONALLY LEFT BLANK]

IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be executed on the day and year first written.

WACHOVIA BANK, NATIONAL ASSOCIATION

By: /s/ Thomas Grabosky
Name:	Thomas Grabosky
Title:	Director

BRAWN OF CALIFORNIA, INC.
THE COMPANY STORE FACTORY, INC.
THE COMPANY OFFICE, INC.

By: /s/ John Swatek
Name:	John Swatek
Title:	Senior Vice President and
	Chief Financial Officer

BRAWN, LLC
SILHOUETTES, LLC
HANOVER COMPANY STORE, LLC
DOMESTICATIONS, LLC
KEYSTONE INTERNET SERVICES, LLC
THE COMPANY STORE GROUP, LLC

By: /s/ Wayne P. Garten
Name:	Wayne P. Garten
Title:	Manager

By their signatures below, the

undersigned Guarantors acknowledge

and agree to be bound by the

applicable provisions of this

Amendment:

HANOVER DIRECT, INC.

By: /s/ Wayne P. Garten
Name:	Wayne P. Garten
Title:	Chief Executive Officer

[SIGNATURES CONTINUE ON FOLLOWING PAGE]

[SIGNATURES CONTINUED FROM PREVIOUS PAGE]

CLEARANCE WORLD OUTLETS, LLC
SCANDIA DOWN, LLC
LA CROSSE FULFILLMENT, LLC
D.M. ADVERTISING, LLC
AMERICAN DOWN & TEXTILE, LLC

By: /s/ Wayne P. Garten
Name:	Wayne P. Garten
Title:	Manager

HANOVER GIFTS, INC.

By: /s/ Wayne P. Garten
Name:	Wayne P. Garten
Title:	Chairman

EX-10.04 5 exhibit10_04.htm

Exhibit 10.04

FIRST AMENDMENT TO LOAN AND SECURITY AGREEMENT

THIS FIRST AMENDMENT TO LOAN AND SECURITY AGREEMENT (this “Amendment”), dated as of November 29, 2004, is entered into by and among CHELSEY FINANCE, LLC, a Delaware limited liability company (“Lender”), BRAWN OF CALIFORNIA, INC., a California corporation (“Brawn”), GUMP’S BY MAIL, INC., a Delaware corporation (“GBM”), GUMP’S CORP., a California corporation (“Gump’s”), HANOVER REALTY, INC., a Virginia corporation (“Hanover Realty”), THE COMPANY STORE FACTORY, INC., a Delaware corporation (“TCS Factory”), THE COMPANY OFFICE, INC., a Delaware corporation (“TCS Office”), SILHOUETTES, LLC, a Delaware limited liability company (“Silhouettes LLC”), HANOVER COMPANY STORE, LLC, a Delaware limited liability company (“HCS LLC”), DOMESTICATIONS, LLC, a Delaware limited liability company (“Domestications LLC”), KEYSTONE INTERNET SERVICES, LLC, a Delaware limited liability company (“KIS LLC”), and THE COMPANY STORE GROUP, LLC, a Delaware limited liability company (“CSG LLC” and, together with Brawn, GBM, Gump’s, Hanover Realty, TCS Factory, TCS Office, Silhouettes LLC, HCS LLC, Domestications LLC and KIS LLC, collectively, “Borrowers” and each, individually, a “Borrower”). Terms used but not defined herein shall have the meanings assigned to such terms in the Loan and Security Agreement, dated July 8, 2004 (the “Loan Agreement”), by and among Lender and Borrowers.

W I T N E S S E T H:

WHEREAS, Borrowers and Lender wish to amend the Loan Agreement to clarify that the quarterly principal payments referenced therein are at the option of the Borrowers; and

WHEREAS, Lender is willing to enter into such amendment to the extent set forth herein.

1. Amendments. Each of the following amendments to the Loan Agreement shall be effective as of July 8, 2004:

(a) Section 2.4(c) of the Loan Agreement is hereby deleted in its entirety and replaced with the following:

“Subject to the terms and conditions of this Agreement, the Borrowers may prepay the Term Loan, in whole or in part, at any time prior to an Event of Default, without payment of any separate prepayment premium or prepayment penalty. Any amounts paid or prepaid in respect of the Term Loan may not be thereafter reborrowed.”

(b) The first paragraph of Section 2.5(b) of the Loan Agreement is hereby deleted in its entirety and replaced with the following:

“Borrowers may, at their option, make payments of principal in cash in respect of the Obligations of up to the full amount of the Obligations on the final Business Day of each fiscal quarter of Hanover and its Subsidiaries commencing with the fiscal quarter of Hanover and its Subsidiaries ending September 25, 2004, but only to the extent that each of the following shall remain true following such payment of amount:”

2. Representations, Warranties and Covenants. In order to induce Lender to amend the Loan Agreement as set forth herein, Borrowers hereby, jointly and severally, represent, warrant and covenant to and in favor of Lender, that no Event of Default or event which with notice or passage of time or both, would constitute an Event of Default shall exist or have occurred and be continuing.

3. Effect of this Amendment. This Amendment constitutes the entire agreement of the parties with respect to the subject matter hereof, and supersedes all prior oral or written communications with respect to the subject matter hereof. Except as expressly provided herein, no other changes or modifications to the Loan Agreement or any of the other Financing Agreements, or waivers of or consents under any provisions of any of the foregoing, are intended or implied by this Amendment, and in all other respects the Financing Agreements are hereby specifically ratified, restated and confirmed by all parties hereto as of the effective date hereof.

4. Governing Law. This Amendment shall be governed by, and construed in accordance with, the internal laws of the State of New York, without regard to principles of conflict of laws.

5. Binding Effect. This Amendment shall be binding upon and inure to the benefit of each of the parties hereto and their respective successors and assigns.

6. Counterparts. This Amendment may be executed in any number of counterparts, but all of such counterparts shall together constitute but one and the same agreement.

[REMAINDER OF THIS PAGE INTENTIONALLY LEFT BLANK]

IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be executed on the day and year first written.

CHELSEY FINANCE, LLC

By:

/s/ William Wachtel

Name:

Title:

William Wachtel

Manager

BRAWN OF CALIFORNIA, INC.

By:

/s/ Steve Seymour

Name:

Title:

Steven Seymour

President

GUMP’S BY MAIL, INC.

By:

/s/ Jed Pogran

Name:

Title:

Jed Pogran

President

GUMP’S CORP.

By:

/s/ Jed Pogran

Name:

Title:

Jed Pogran

President

HANOVER REALTY, INC.

By:

/s/ Doug Mitchell

Name:

Title:

Doug Mitchell

President

HANOVER COMPANY STORE, LLC

By:

/s/ Charles E. Blue

Name:

Title:

Charles E. Blue

President

KEYSTONE INTERNET SERVICES, LLC

By:

/s/ Charles E. Blue

Name: Title:

Charles E. Blue

Vice President

THE COMPANY STORE GROUP, LLC

By:

/s/ Charles E. Blue

Name:

Title:

Charles E. Blue

President

DOMESTICATIONS, LLC

By:

/s/ Charles E. Blue

Name:

Title:

Charles E. Blue

Vice President

SILHOUETTES, LLC

By:

/s/ Charles E. Blue

Name:

Title:

Charles E. Blue

President

THE COMPANY OFFICE, INC.

By:

/s/ David Pipkorn

Name:

Title:

David Pipkorn

President

THE COMPANY STORE FACTORY, INC.

By:

/s/ David Pipkorn

Name:

Title:

David Pipkorn

President

EX-10.05 6 exhibit10_05.htm

Exhibit 10.05

SECOND AMENDMENT TO LOAN AND SECURITY AGREEMENT

THIS SECOND AMENDMENT TO LOAN AND SECURITY AGREEMENT (this “Amendment”), dated as of December 30, 2004, is entered into by and among CHELSEY FINANCE, LLC, a Delaware limited liability company (“Lender”), BRAWN OF CALIFORNIA, INC., a California corporation (“Brawn”), GUMP’S BY MAIL, INC., a Delaware corporation (“GBM”), GUMP’S CORP., a California corporation (“Gump’s”), HANOVER REALTY, INC., a Virginia corporation (“Hanover Realty”), THE COMPANY STORE FACTORY, INC., a Delaware corporation (“TCS Factory”), THE COMPANY OFFICE, INC., a Delaware corporation (“TCS Office”), SILHOUETTES, LLC, a Delaware limited liability company (“Silhouettes LLC”), HANOVER COMPANY STORE, LLC, a Delaware limited liability company (“HCS LLC”), DOMESTICATIONS, LLC, a Delaware limited liability company (“Domestications LLC”), KEYSTONE INTERNET SERVICES, LLC, a Delaware limited liability company (“KIS LLC”), and THE COMPANY STORE GROUP, LLC, a Delaware limited liability company (“CSG LLC” and, together with Brawn, GBM, Gump’s, Hanover Realty, TCS Factory, TCS Office, Silhouettes LLC, HCS LLC, Domestications LLC and KIS LLC, collectively, “Existing Borrowers” and each, individually, an “Existing Borrower”), BRAWN, LLC, a Delaware limited liability company (“Brawn LLC” as hereinafter further defined, and together with Existing Borrowers, collectively, “Borrowers” and each, individually, a “Borrower”), HANOVER DIRECT, INC., a Delaware corporation (“Hanover”), HANOVER HOME FASHIONS GROUP, LLC, a Delaware limited liability company (“HHFG LLC”), CLEARANCE WORLD OUTLETS, LLC, a Delaware limited liability company (“Clearance World”), SCANDIA DOWN, LLC, a Delaware limited liability company (“Scandia Down LLC”), LACROSSE FULFILLMENT, LLC, a Delaware limited liability company (“LaCrosse LLC”), D.M. ADVERTISING, LLC, a Delaware limited liability company (“DM Advertising LLC”), AMERICAN DOWN & TEXTILE, LLC, a Delaware limited liability company (“ADT LLC”), and HANOVER GIFTS, INC., a Virginia corporation (“Hanover Gifts” and, together with Hanover, HHFG LLC, Clearance World, Scandia Down LLC, LaCrosse LLC, DM Advertising LLC and ADT LLC, collectively, “Guarantors” and each, individually, a “Guarantor”).

W I T N E S S E T H:

WHEREAS, Existing Borrowers, Guarantors and Lender are parties to the Loan and Security Agreement, dated as of July 8, 2004, as amended (as so amended, the “Loan Agreement”), pursuant to which Lender has made loans and advances to Borrowers;

WHEREAS, Lender is willing to agree to provide such consents and make such amendments, subject to the terms and conditions and to the extent set forth herein;

1.	Definitions.

(i) “Brawn LLC” shall mean Brawn, LLC, a Delaware limited liability company, and its successors and assigns.

(ii) “Brawn/Brawn LLC Merger” shall mean the merger of Brawn with and into Brawn LLC, with Brawn LLC as the surviving limited liability company.

(iii) “Hanover 2004 Reorganization” shall mean, individually and collectively, the mergers, reorganization steps and transactions effected under the Hanover 2004 Reorganization Agreements.

(v) “HHFG LLC /CSG LLC Merger” shall mean the merger of HHFG LLC with and into CSG LLC, with CSG LLC as the surviving limited liability company.

(b)	Amendment to Definitions.

(i) Brawn. All references to the term “Brawn” in the Loan Agreement and the other Financing Agreements shall be deemed and each such reference is hereby amended to mean “Brawn LLC”.

owns any assets in excess of Ten Thousand Dollars ($10,000), other than Non-Guarantor Subsidiaries, and each of their respective successors and assigns.

(c) Interpretation. All capitalized terms used herein and not defined herein shall have the meanings given to such terms in the Loan Agreement.

2. Consent to Hanover 2004 Reorganization. Subject to the terms and conditions contained herein and in the Loan Agreement and in the other Financing Agreements, and notwithstanding anything to the contrary contained in Sections 6.2, 6.5, 6.6 or 6.9 of the Loan Agreement, Lender consents, effective upon the earlier of the date hereof or the effective date of the applicable transaction of the Hanover 2004 Reorganization, to the following transactions:

(a) the formation by CSG LLC of Brawn LLC as a Delaware limited liability company in accordance with the applicable Hanover 2004 Reorganization Agreements;

(b) Each of the respective Guarantys made by the Existing Borrowers as of that date in their capacities as Guarantors, as heretofore amended (collectively, the “Borrower Guarantees”) shall be deemed further amended to include Brawn LLC as an additional Guarantor party signatory thereto. Brawn LLC hereby expressly (i) assumes and agrees to be directly liable to Lender, jointly and severally with the other Borrowers signatories thereto and the Guarantors,

for all Obligations as defined in the Borrower Guarantees, (ii) agrees to perform, comply with and be bound by all terms, conditions and covenants of the Borrower Guarantees with the same force and effect as if Brawn LLC had originally executed and been an original party signatory to each of the Borrower Guarantees, and (iii) agrees that Lender shall have all rights, remedies and interests with respect to Brawn LLC and its properties under the Borrower Guarantees with the same force and effect as if Brawn LLC had originally executed and been an original party signatory to each of the Borrower Guarantees.

4. Acknowledgments with respect to Mergers pursuant to the Hanover 2004 Reorganization.

(iii) Assuming that Lender has made all appropriate filings of UCC financing statements or amendments thereto, Lender shall continue to have valid and perfected security interests, liens and rights in and to all of the assets and properties owned and acquired (A) by

Brawn LLC, as the surviving limited liability company of the Brawn/Brawn LLC Merger, and (B) by CSG LLC, as the surviving limited liability company of the HHFG LLC/CSG LLC Merger, and all such assets and properties shall be deemed included in the Collateral or the Guarantor Collateral, as the case may be, and such security interests, liens and rights and their perfection and priorities have continued and shall continue in all respects in full force and effect;

(a) This Amendment and each other agreement or instrument to be executed and delivered by Borrowers or Guarantors hereunder have been duly authorized, executed and delivered by all necessary action on the part of Borrowers and Guarantors which are parties hereto and thereto and, if necessary, their respective stockholders (with respect to any corporation) or members (with respect to any limited liability company), and is in full force and effect as of the date hereof, as the case may be, and the agreements and obligations of Borrowers or Guarantors, as the case may be, contained herein and therein constitute legal, valid and binding obligations of Borrowers and Guarantors, as the case may be, enforceable against them in accordance with their terms.

(c) None of the membership interests in Brawn LLC have been evidenced by a membership certificate or other certificate, document, instrument or security. All of the membership interests in Brawn LLC (i) are noted in the respective books and records of such company, (ii) have been duly authorized and validly issued to CSG LLC and (iii) are fully paid and non-assessable, free and clear of all claims, liens, pledges and encumbrances of any kind, except those security interests existing in favor of Congress Financial Corporation and Lender.

(f) The assets and properties of Brawn LLC are owned by it, free and clear of all security interests, liens and encumbrances of any kind, nature or description, as of the date hereof, except those security interests existing in favor of Congress Financial Corporation and Lender and those granted to Congress Financial Corporation pursuant to the Thirty-Second Amendment to Loan and Security Agreement by and among the Borrowers, the Guarantors and Congress Financial Corporation, dated as of the date hereof, and pursuant hereto in favor of Lender, and except for Liens (if any) permitted under Section 6.4 of the Loan Agreement or the other Financing Agreements.

therein contemplated, nor compliance with the provisions thereof before the date hereof or upon the effectiveness of such mergers (i) has violated or will violate any Federal or State securities laws, any State corporation law, or any other law or regulation or any order or decree of any court or governmental instrumentality in any respect, (ii) does or will conflict with or result in the breach of, or constitute a default in any respect under any material mortgage, deed of trust, security agreement, agreement or instrument to which any existing or former Guarantor or Borrower is a party or may be bound, other than conflicts or defaults under certain real estate leases, intellectual property licenses and equipment leases, (iii) does or will violate any provision of the Certificate of Incorporation or Certificate of Formation, as applicable, or By-Laws or Operating Agreement, as applicable, of any Borrower or Guarantor, or has resulted in or if consummated or effected after the date hereof shall result in the creation or imposition of any lien, claim, charge or encumbrance upon any of the Collateral or Guarantor Collateral, except in favor of Lender.

(k) No action of, or filing with, or consent of any governmental or public body or authority, other than the filing of a UCC financing statement naming Brawn LLC as debtor and Lender as secured party, and no approval or consent of any other party, other than Congress Financial Corporation, is required to authorize, or is otherwise required in connection with, the execution, delivery and performance of this Amendment and each other agreement or instrument to be executed and delivered pursuant hereto.

6. Conditions Precedent. Concurrently with the execution and delivery hereof (except to the extent otherwise indicated below), and as a further condition to the effectiveness of this

Amendment and the agreement of Lender to the modifications and amendments set forth in this Amendment:

(b) as soon as possible, but in any event by no later than December 31, 2004, in the case of the HHFG LLC/CSG LLC Merger, and by no later than March 31, 2005, in the case of the Brawn/Brawn LLC Merger, Lender shall have received, in form and substance satisfactory to Lender, (i) true, correct and complete photocopies of all of the Hanover 2004 Reorganization Agreements, (ii) evidence that (A) the Hanover 2004 Reorganization Agreements have been duly executed and delivered by and to the appropriate parties thereto and (B) the transactions contemplated by the Hanover 2004 Reorganization have been consummated as set forth herein, and (iii) evidence that the certificates of merger with respect to the Brawn/Brawn LLC Merger and the HHFG LLC/CSG LLC Merger have been filed with the Secretary of State of the appropriate States of formation or incorporation or formation of each constituent corporation or limited liability company;

(c) Lender shall have received all information with respect to Brawn LLC and CSG LLC necessary for Lender to file UCC financing statements and UCC amendments to the existing UCC financing statements previously filed by Lender against Brawn and HHFG LLC to change either or both of the debtor’s name or mailing address to that of Brawn LLC and CSG LLC, respectively, and other documents and instruments which Lender in its sole discretion has determined are necessary to perfect the security interests of Lender in all Collateral or Guarantor Collateral now or hereafter owned by Brawn LLC, CSG LLC and all other Borrowers and Guarantors;

(d) Lender shall have received from Brawn LLC, (i) a copy of its Certificate of Formation, and all amendments thereto, certified by the Secretary of State of the State of Delaware as of the most recent practicable date certifying that each of the foregoing documents remains in full force and effect and has not been modified or amended, except as described therein, (ii) a copy of its Operating Agreement, certified by the Secretary or Assistant Secretary of the company, and (iii) a certificate from its Secretary or Assistant Secretary dated the date hereof certifying that each of the foregoing documents remains in full force and effect and has not been modified or amended, except as described therein;

(e) Lender shall have received, in form and substance satisfactory to Lender, for each Borrower and Guarantor that is a limited liability company (i) a Management and Incumbency Certificate of each such company identifying all managers, officers or other persons authorized to act on behalf of such company, (ii) Company Resolutions of each such company, evidencing the adoption and subsistence of company resolutions approving the execution, delivery and performance by each Borrower and Guarantor that is a limited liability company of this Amendment and the agreements, documents and instruments to be delivered pursuant to this Amendment, in each case signed by all members of each such company, and (iii) Certificates of the Secretary or Assistant Secretary of each such company identifying all members of such company;

(f) Lender shall have received, in form and substance satisfactory to Lender, for each Borrower and Guarantor that is a corporation, a Secretary’s or Assistant Secretary’s Certificate of Directors’ Resolutions with Shareholders’ Consent (other than in respect of Hanover) evidencing the adoption and subsistence of corporate resolutions approving the execution, delivery and performance by such Borrower and Guarantor of this Amendment and the agreements, documents and instruments to be delivered pursuant to this Amendment;

(g) each Borrower and Guarantor shall deliver, or cause to be delivered, to Lender a true and correct copy of any consent, waiver or approval to or of this Amendment, which any Borrower or Guarantor is required to obtain from any other Person, including without limitation Congress Financial Corporation, and such consent, approval or waiver shall be in a form reasonably acceptable to Lender; and

(h) prior to the effectiveness of the Hanover 2004 Reorganization, no court of competent jurisdiction shall have issued any injunction, restraining order or other order which prohibits the consummation of the Hanover 2004 Reorganization or any part thereof, and no governmental action or proceeding shall have been threatened or commenced, seeking any injunction, restraining order or other order which seeks to void or otherwise modify the transactions described in the Hanover 2004 Reorganization Agreements.

9. Governing Law. The validity, interpretation and enforcement of this Amendment in any dispute arising out of the relationship between the parties hereto, whether in contract, tort, equity or otherwise shall be governed by the internal laws of the State of New York, without regard to any principle of conflict of laws or other rule of law that would result in the application of the law of any jurisdiction other than the State of New York.

10. Binding Effect. This Amendment shall be binding upon and inure to the benefit of each of the parties hereto and their respective successors and assigns.

11. Counterparts. This Amendment may be executed in any number of counterparts, but all of such counterparts shall together constitute but one and the same agreement. In making

proof of this Amendment, it shall not be necessary to produce or account for more than one counterpart thereof signed by each of the parties hereto.

[REMAINDER OF THIS PAGE INTENTIONALLY LEFT BLANK]

IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be executed on the day and year first written.

CHELSEY FINANCE, LLC
By:	/s/ William Wachtel
Name:	William Wachtel
Title:	Manager

BRAWN OF CALIFORNIA, INC.
By:	/s/ Charles E. Blue
Name:	Charles E. Blue
Title:	Vice President

GUMP’S BY MAIL, INC.
By:	/s/ Charles E. Blue
Name:	Charles E. Blue
Title:	Secretary

GUMP’S CORP.
By:	/s/ Charles E. Blue
Name:	Charles E. Blue
Title:	Secretary

HANOVER REALTY, INC.
By:	/s/ Charles E. Blue
Name:	Charles E. Blue
Title:	Vice President

THE COMPANY STORE FACTORY, INC.
By:	/s/ Charles E. Blue
Name:	Charles E. Blue
Title:	Vice President

[SIGNATURES CONTINUE ON FOLLOWING PAGE]

(ii)

[SIGNATURES CONTINUED FROM PREVIOUS PAGE]

THE COMPANY OFFICE, INC.
By:	/s/ Charles E. Blue
Name:	Charles E. Blue
Title:	Vice President

SILHOUETTES, LLC
By:	/s/ Charles E. Blue
Name:	Charles E. Blue
Title:	Vice President

HANOVER COMPANY STORE, LLC
By:	/s/ Charles E. Blue
Name:	Charles E. Blue
Title:	President

DOMESTICATIONS, LLC
By:	/s/ Charles E. Blue
Name:	Charles E. Blue
Title:	Vice President

KEYSTONE INTERNET SERVICES, LLC
By:	/s/ Charles E. Blue
Name:	Charles E. Blue
Title:	Vice President

THE COMPANY STORE GROUP, LLC
By:	/s/ Charles E. Blue
Name:	Charles E. Blue
Title:	President

BRAWN, LLC
By:	/s/ Charles E. Blue
Name:	Charles E. Blue
Title:	Vice President

[SIGNATURES CONTINUE ON FOLLOWING PAGE]

(iii)

[SIGNATURES CONTINUED FROM PREVIOUS PAGE]

By their signatures below, the

undersigned Guarantors acknowledge

and agree to be bound by the

applicable provisions of this

Amendment:

HANOVER DIRECT, INC.
By:	/s/ Charles E. Blue
Name:	Charles E. Blue
Title:	Senior Vice President and Chief Financial Officer

HANOVER HOME FASHIONS GROUP, LLC
By:	/s/ Charles E. Blue
Name:	Charles E. Blue
Title:	Vice President

CLEARANCE WORLD OUTLETS, LLC
By:	/s/ Charles E. Blue
Name:	Charles E. Blue
Title:	President

SCANDIA DOWN, LLC
By:	/s/ Charles E. Blue
Name:	Charles E. Blue
Title:	President

LA CROSSE FULFILLMENT, LLC
By:	/s/ Charles E. Blue
Name:	Charles E. Blue
Title:	President

[SIGNATURES CONTINUE ON FOLLOWING PAGE]

(v)

(iv)

[SIGNATURES CONTINUED FROM PREVIOUS PAGE]

D.M. ADVERTISING, LLC
By:	/s/ Charles E. Blue
Name:	Charles E. Blue
Title:	President

AMERICAN DOWN & TEXTILE, LLC
By:	/s/ Charles E. Blue
Name:	Charles E. Blue
Title:	Vice President

HANOVER GIFTS, INC.
By:	/s/ Charles E. Blue
Name:	Charles E. Blue
Title:	Vice President

EX-10.06 7 exhibit10_06.htm

Exhibit 10.06

THIRD AMENDMENT TO LOAN AND SECURITY AGREEMENT

THIS THIRD AMENDMENT TO LOAN AND SECURITY AGREEMENT (this “Amendment”), dated as of July 29, 2005, is entered into by and among CHELSEY FINANCE, LLC, a Delaware limited liability company (“Lender”), BRAWN, LLC, a Delaware limited liability company (“Brawn LLC”), HANOVER REALTY, INC., a Virginia corporation (“Hanover Realty”), THE COMPANY STORE FACTORY, INC., a Delaware corporation (“TCS Factory”), THE COMPANY OFFICE, INC., a Delaware corporation (“TCS Office”), SILHOUETTES, LLC, a Delaware limited liability company (“Silhouettes LLC”), HANOVER COMPANY STORE, LLC, a Delaware limited liability company (“HCS LLC”), DOMESTICATIONS, LLC, a Delaware limited liability company (“Domestications LLC”), KEYSTONE INTERNET SERVICES, LLC, a Delaware limited liability company (“KIS LLC”), and THE COMPANY STORE GROUP, LLC, a Delaware limited liability company (“CSG LLC” and, together with Brawn, Brawn LLC, Hanover Realty, TCS Factory, TCS Office, Silhouettes LLC, HCS LLC, Domestications LLC and KIS LLC, collectively, “Borrowers” and each, individually, a “Borrower”), HANOVER DIRECT, INC., a Delaware corporation (“Hanover”), CLEARANCE WORLD OUTLETS, LLC, a Delaware limited liability company (“Clearance World”), SCANDIA DOWN, LLC, a Delaware limited liability company (“Scandia Down LLC”), LACROSSE FULFILLMENT, LLC, a Delaware limited liability company (“LaCrosse LLC”), D.M. ADVERTISING, LLC, a Delaware limited liability company (“DM Advertising LLC”), AMERICAN DOWN & TEXTILE, LLC, a Delaware limited liability company (“ADT LLC”), and HANOVER GIFTS, INC., a Virginia corporation (“Hanover Gifts” and, together with Hanover, Clearance World, Scandia Down LLC, LaCrosse LLC, DM Advertising LLC and ADT LLC, collectively, “Guarantors” and each, individually, a “Guarantor”).

W I T N E S S E T H:

WHEREAS, Borrowers, Guarantors and Lender are parties to the Loan and Security Agreement, dated as of July 8, 2004, as amended (as so amended, the “Loan Agreement”), pursuant to which Lender has made loans and advances to Borrowers;

WHEREAS, Borrowers and Guarantors have requested that Lender(a) consent to the private label credit card program of Hanover with World Financial Network National Bank (“WFNNB” as hereinafter further defined) as set forth in the Private Label Credit Card Agreement (as hereinafter defined), (b) conditionally waive certain Events of Default that have occurred and are continuing or still exist, (c) amend the minimum amounts of Consolidated Working Capital and Consolidated Net Worth that Hanover and its Subsidiaries are required to maintain, (d) consent to the license by Silhouettes LLC to Branded, LLC (“Tweeds Licensee” as hereinafter further defined) of the “Tweeds” trademark with an option in favor of Tweeds Licensee to purchase the “Tweeds” trademark, together with the goodwill symbolized thereby, and (e) to make certain other amendments to the Loan Agreement and the other Financing Agreements;

WHEREAS, Lender is willing to agree to provide such consents and make such amendments, subject to the terms and conditions and to the extent set forth herein.

1.	Definitions.

(ii) “Existing Defaults” shall have the meaning set forth in Section 11(a) hereof.

(iii) “Hanover Private Label Credit Card Program” shall mean the private label program of Hanover as set forth in the Private Label Credit Card Agreement.

(vii) “Tweeds Licensee” shall mean Branded, LLC, a Georgia limited liability company, and its successors and assigns.

(viii) “Tweeds Licensing Agreement” shall mean the License-to-Purchase Agreement, dated as of April 18, 2005, between Silhouettes LLC and Tweeds Licensee, as the

same now exists or may hereafter be amended, modified, supplemented, extended, renewed, restated or replaced.

(ix) “WFNNB” shall mean World Financial Network National Bank, a chartered national bank, and its successors and assigns.

(xi) “WFNNB Credit Card Accounts” shall mean, collectively, the Co-Brand Accounts and the Private Label Accounts.

(b)	Amendment to Definitions.

Interpretation. All capitalized terms used herein and not defined herein shall have the meanings given to such terms in the Loan Agreement.(c)

2. Indebtedness. Section 6.3 of the Loan Agreement is hereby amended by deleting the word “and” appearing at the end of Section 6.3(f), replacing the period with a semicolon and the word “and” appearing at the end of Section 6.3(g) and adding a new Section 6.3(h) immediately thereafter as follows:

“(h) Indebtedness of Borrowers and Hanover to WFNNB for chargebacks and fees payable by Hanover to WFNNB and Indebtedness arising out of the contingent obligation of Borrowers and Hanover to repurchase Private Label

Accounts in accordance with the terms and conditions of the Private Label Credit Card Agreement; provided, that:

(i) such Indebtedness is incurred in accordance with and to the extent permitted by Section 6.4(f) hereof;

(ii) Borrowers and Guarantors shall not terminate the Private Label Credit Card Agreement without the prior written consent of Lender;

and substance acceptable to Lender;

(F) after giving effect to such Repurchase Financing, no Incipient Default or an Event of Default shall exist or have occurred and be continuing,

3. Encumbrances. Section 6.4 of the Loan Agreement is hereby amended by deleting the word “and” appearing at the end of Section 6.4(g), replacing the period with a semicolon and the word “and” appearing at the end of Section 6.4(h) and adding new Section 6.4(i) immediately thereafter, as follows:

“(i) right of WFNNB to purchase the Private Label Receivables sold by any Borrower or Hanover to WFNNB pursuant to the Private Label Credit Card Agreement, subject to the terms and conditions of the WFNNB Credit Card Acknowledgment and Section 6.3(d) hereof.”

4. Sale of Assets. Section 6.9 of the Loan Agreement is hereby amended by adding the number “(i)” after the words “provided, however,” and replacing the period with a semicolon and the word “and” appearing at the end of clause (i) of such proviso and adding new clause (ii) immediately thereafter, as follows:

“(ii) the foregoing shall not restrict the sale by any Borrower or Hanover to WFNNB of the Private Label Receivables of such Borrower in accordance with the terms and conditions of the Private Label Credit Card Agreement so long as each of the following conditions shall have been satisfied as determined by

Lender in good faith:

(A) all sales of the Private Label Receivables by any Borrower or Hanover to WFNNB shall be subject to the lien and security interest of Lender, subject to the terms and conditions of the WFNNB Credit Card Acknowledgment, and Section 9 of the Third Amendment to Loan and Security Agreement, dated as of July 29, 2005, and

(B) at the time of each such sale, the Private Label Credit Card Agreement shall be in full force and effect and no default or event of default shall exist thereunder by any of the parties thereto.”

5. Inventory Covenants. Section 6.13(b) of the Loan Agreement is hereby amended by adding the following at the end of such Section:

6. Consolidated Working Capital. Section 6.18 of the Loan Agreement is hereby deleted and replaced with the following:

“6.18

Consolidated Working Capital

Hanover shall, commencing with the fiscal month ending July 2005, and for each fiscal month thereafter in any fiscal year thereafter, maintain Consolidated Working Capital, calculated on a consolidated basis for Hanover and its Subsidiaries, of not less than the following amounts as at the end of each such fiscal month:

Period	Amount
January	$ 4,500,000
February	$ 6,300,000
March	$ 2,700,000
April	$ 5,400,000
May	$ 5,400,000
June	$ 5,400,000
July	$ 5,400,000
August	$ 6,300,000
September	$ 8,100,000
October	$ 6,300,000
November	$ 4,500,000
December	$ 7,200,000”

7. Consolidated Net Worth. Section 6.19 of the Loan Agreement is hereby deleted in its entirety and replaced with the following:

“6.19

Consolidated Net Worth.

Hanover shall, commencing with the fiscal month ending July 2005 and for each fiscal month thereafter in any fiscal year thereafter, maintain Consolidated Net Worth, calculated on a consolidated basis for Hanover and its Subsidiaries, of not less than the following amounts as at the end of each such fiscal month:

Period	Amount
January	($49,350,000)
February	($50,400,000)
March	($48,300,000)
April	($48,300,000)
May	($48,300,000)
June	($47,250,000)
July	($46,200,000)
August	($45,150,000)
September	($44,100,000)
October	($44,100,000)
November	($40,950,000)
December	($38,850,000)”

8. EBITDA. Sections 6.28(b) and (c) of the Loan Agreement are hereby deleted in their entirety and replaced with the following:

“(b) Hanover and its Subsidiaries shall not, commencing with the second fiscal quarter of Hanover and its Subsidiaries ending June 25, 2005 and for each fiscal quarter thereafter during the fiscal year 2005, permit EBITDA of Hanover and its Subsidiaries commencing on the first day of such fiscal year and ending on the last day of the applicable fiscal quarter set forth below on a cumulative YTD basis to be less than the respective amount set forth below opposite such fiscal quarter end YTD period:

Fiscal Quarter End YTD Periods for Fiscal Year 2005	Cumulative Minimum EBITDA

(ii) December 26, 2004 through June 25, 2005	$4,950,000
(iii) December 26, 2004 through September 24, 2005	$8,640,000
(iv) December 26, 2004 through December 31, 2005	$13,950,000”

Fiscal Quarter

End YTD Periods

for Fiscal Year 2006

Cumulative

Minimum EBITDA

(i) January 1, 2006 through

April 1, 2006

$2,520,000

(ii) January 1, 2006 through

July 1, 2006

$4,950,000

(iii) January 1, 2006 through

September 30, 2006

$8,640,000

(iv) January 1, 2006 through

December 30, 2006

$13,950,000”

9.	Release of Security Interest in Certain Collateral.

10.	Consent to Tweeds Licensing Agreement.

(a) Notwithstanding anything to the contrary contained in the Trademark Collateral Assignment and Security Agreement, dated July 8, 2004, among Borrowers that are signatory parties thereto and Lender, as heretofore amended, or Section 6.7 of the Loan Agreement, subject to the terms and conditions contained herein, Silhouettes LLC may enter into the Tweeds Licensing Agreement with Tweeds Licensee to provide for the license of the “Tweeds” trademark and option in favor of Tweeds Licensee to purchase the “Tweeds” trademark and the goodwill symbolized thereby, as set forth in the Tweeds Licensing Agreement so long as Borrowers and Guarantors remit all payments and other amounts due to Silhouettes LLC under the Tweeds Licensing Agreement to a Blocked Account in accordance with the terms and conditions of the Loan Agreement;

(b) Borrowers and Guarantors represent, warrant and covenant with, to and in favor of Lender the following:

11.	Conditional Waiver of Events of Default.

(a) It has come to the attention of Lender that certain Events of Default have occurred and are continuing or exist as set forth on Schedule 11(a) hereto (the “Existing Defaults”) and in the absence of this conditional waiver, entitle Lender to cease making Loans and to exercise its other rights and remedies under the Financing Agreements, applicable law or otherwise. In reliance upon the representations, warranties and covenants of Borrowers and Guarantors contained herein, and subject to the terms and conditions contained herein, Lender agrees to waive the Existing Defaults so long as Borrowers and Guarantors take the actions set forth on Schedule 11(a) hereto within the time periods and in accordance with the terms and conditions set forth on Schedule 11(a) hereto (collectively, the “Existing Default Cure Actions”).

Lender may thereafter immediately enforce its rights and remedies in accordance with the terms and conditions of the Financing Agreements, including, without limitation, ceasing making any Loans or providing any Letter of Credit Accommodations.

(c) Lender has not waived, is not by this Amendment waiving, and has no intention of waiving, any Event of Default which may have occurred on or prior to the date hereof, whether or not continuing on the date hereof, or which may occur after the date hereof (whether the same or similar to the Existing Defaults or otherwise), other than the specific Existing Defaults subject to the terms and conditions of Section 11(b) hereof. The foregoing waiver shall not be construed as a bar to or a waiver of any other or further Event of Default on any future occasion, whether similar in kind or nature to the Existing Defaults or otherwise and shall not constitute a waiver, express or implied, of any of the rights and remedies of Lender arising under the terms of the Loan Agreement or any other Financing Agreements on any future occasion or otherwise, including, without limitation, the failure of Borrowers or Guarantors to implement the Existing Default Cure Actions.

12. Representations, Warranties and Covenants. Borrowers and Guarantors represent, warrant and covenant with and to Lender as follows, which representations, warranties and covenants are continuing and shall survive the execution and delivery hereof, the truth and accuracy of, or compliance with each, together with the representations, warranties and covenants in the other Financing Agreements, being a condition of the effectiveness of this Amendment and a continuing condition of the making or providing of any Revolving Loans or Letter of Credit Accommodations by Lender to Borrowers:

any court or governmental instrumentality in any respect, or (ii) does, or shall conflict with or result in the breach of, or constitute a default in any respect under any mortgage, deed of trust, security agreement, agreement or instrument to which any Borrower or Guarantor is a party or by which it or any of its assets may be bound, or (iii) does or shall violate any provision of the Certificate of Incorporation, Certificate of Formation, By-Laws or Operating Agreement of any Borrower or Guarantor.

(e) After giving effect to the waivers and consents set forth in this Amendment, no Incipient Default or Event of Default exists or has occurred on the date hereof.

13. Conditions Precedent. Concurrently with the execution and delivery hereof (except to the extent otherwise indicated below), and as a further condition to the effectiveness of this Amendment and the agreement of Lender to the modifications and amendments set forth in this Amendment:

(b)	Lender shall have received, in form and substance satisfactory to Lender,

(i) the WFNNB Credit Card Acknowledgment, duly authorized, executed and delivered by WFNNB and Hanover; and

(c) Lender shall have received, in form and substance satisfactory to Lender, the consent of all Participants to this Amendment and the transactions contemplated hereby;

(f) Each Borrower and Guarantor shall deliver, or cause to be delivered, to Lender a true and correct copy of any consent, waiver or approval to or of the transactions contemplated by the Private Label Credit Card Agreement, which any Borrower or Guarantor is required to obtain from any other Person and such consent, approval or waiver shall be in a form reasonably acceptable to Lender; and

(g) As of the date of this Amendment and after giving effect hereto, no Incipient Default or Event of Default shall exist or have occurred, other than the Existing Defaults.

14. Effect of this Amendment. This Amendment constitutes the entire agreement of the parties with respect to the subject matter hereof, and supersedes all prior oral or written communications, memoranda, proposals, negotiations, discussions, term sheets and commitments with respect to the subject matter hereof. Except as expressly provided herein, no other changes or modifications to the Loan Agreement or any of the other Financing Agreements, or waivers of or consents under any provisions of any of the foregoing, are intended or implied by this Amendment, and in all other respects the Financing Agreements are hereby specifically ratified, restated and confirmed by all parties hereto as of the effective date hereof. To the extent that any provision of the Loan Agreement or any of the other Financing Agreements conflicts with any provision of this Amendment, the provision of this Amendment shall control.

15. Further Assurances. Borrowers and Guarantors shall execute and deliver such additional documents and take such additional action as may be reasonably requested by Lender to effectuate the provisions and purposes of this Amendment.

16. Governing Law. The validity, interpretation and enforcement of this Amendment in any dispute arising out of the relationship between the parties hereto, whether in contract, tort, equity or otherwise shall be governed by the internal laws of the State of New York, without regard to any principle of conflict of laws or other rule of law that would result in the application of the law of any jurisdiction other than the State of New York.

17. Binding Effect. This Amendment shall be binding upon and inure to the benefit of each of the parties hereto and their respective successors and assigns.

18. Counterparts. This Amendment may be executed in any number of counterparts, but all of such counterparts shall together constitute but one and the same agreement. In making proof of this Amendment, it shall not be necessary to produce or account for more than one counterpart thereof signed by each of the parties hereto.

[REMAINDER OF THIS PAGE INTENTIONALLY LEFT BLANK]

IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be executed on the day and year first written.

CHELSEY FINANCE, LLC
By:	/s/ William Wachtel
Name:	William Wachtel
Title:	Manager

THE COMPANY STORE FACTORY, INC. THE COMPANY OFFICE, INC.
By:	/s/ John Swatek
Name:	John Swatek
Title:	Senior Vice President & Chief Financial Officer

BRAWN, LLC SILHOUETTES, LLC HANOVER COMPANY STORE, LLC DOMESTICATIONS, LLC KEYSTONE INTERNET SERVICES, LLC THE COMPANY STORE GROUP, LLC
By:	/s/ John Swatek
Name:	John Swatek
Title:	Senior Vice President & Chief Financial Officer

By their signatures below, the

undersigned Guarantors acknowledge

and agree to be bound by the

applicable provisions of this

Amendment:

HANOVER DIRECT, INC.
By:	/s/ Wayne P. Garten
Name:	Wayne P. Garten
Title:	Chief Executive Officer

[SIGNATURES CONTINUED FROM PREVIOUS PAGE]

CLEARANCE WORLD OUTLETS, LLC SCANDIA DOWN, LLC LA CROSSE FULFILLMENT, LLC D.M. ADVERTISING, LLC AMERICAN DOWN & TEXTILE, LLC
By:	/s/ Wayne P. Garten
Name:	Wayne P. Garten
Title:	Manager

HANOVER GIFTS, INC.
By:	/s/ Wayne P. Garten
Name:	Wayne P. Garten
Title:	Chairman

(i)

EX-10.07 8 exhibit10-07.htm

Exhibit 10.07

CO-BRAND AND PRIVATE LABEL CREDIT CARD PROGRAM AGREEMENT

BETWEEN

HANOVER DIRECT, INC.

AND

WORLD FINANCIAL NETWORK NATIONAL BANK

DATED AS OF FEBRUARY 22, 2005

TABLE OF CONTENTS

Page

	SECTION 1. DEFINITIONS
1.1	Certain Definitions
1.2	Rules of Interpretation

	SECTION 2. THE PROGRAM
2.1	Establishment and Operation of the Program
2.2	Applications for Credit Under the Program; Billing Statements
2.3	Operating Procedures
2.4	Program Documents
2.5	Marketing
2.6	Credit Decision
2.7	Ownership of Accounts and Mailing Lists, Reporting Requirements
2.8	Protection Programs and Enhancement Marketing Services
2.9	Ownership of Hanover Direct Name and Licensing
2.10	Cardholder Loyalty Program

	SECTION 3. OPERATION OF THE PROGRAM
3.1	Honoring Accounts
3.2	Additional Operating Procedures
3.3	Cardholder Disputes Regarding Goods or Services
3.4	No Special Agreements
3.5	Cardholder Disputes Regarding Violations of Applicable Law
3.6	Payment to Hanover Direct; Ownership of Accounts; Fees; Accounting
3.7	Insertion of Hanover Direct’s Promotional Materials
3.8	Payments
3.9	Chargebacks
3.10	Assignment of Title in Charged Back Purchases
3.11	Promotion of Program and Card Program; Non-Competition
3.12	Postage
3.13	Reports

TABLE OF CONTENTS

Page

	SECTION 4. REPRESENTATIONS AND WARRANTIES OF HANOVER DIRECT
4.1	Organization, Power and Qualification
4.2	Authorization, Validity and Non-Contravention
4.3	Accuracy of Information
4.4	Validity of Charge Slips
4.5	Compliance with Applicable Law
4.6	Hanover Direct’s Name, Trademarks and Service Marks
4.7	Intellectual Property Rights

	SECTION 5. COVENANTS OF HANOVER DIRECT
5.1	Notices of Changes
5.2	Financial Statements
5.3	Inspection
5.4	Hanover Direct’s Business
5.5	Hanover Direct’s Employees
5.6	Insurance

	SECTION 6. REPRESENTATIONS AND WARRANTIES OF BANK
6.1	Organization, Power and Qualification
6.2	Authorization, Validity and Non-Contravention
6.3	Accuracy of Information
6.4	Compliance with Applicable Law
6.5	Intellectual Property Rights

	SECTION 7. COVENANTS OF BANK
7.1	Notices of Changes
7.2	Financial Statement
7.3	Inspection
7.4	Bank’s Business
7.5	Insurance

	SECTION 8. INDEMNIFICATION
8.1	Indemnification Obligations
8.2	LIMITATION ON LIABILITY
8.3	NO WARRANTIES
8.4	Notification of Indemnification; Conduct of Defense

TABLE OF CONTENTS

Page

	SECTION 9. TERM AND TERMINATION
9.1	Term
9.2	Termination with Cause by Bank; Bank Termination Events
9.3	Termination with Cause by Hanover Direct; Hanover Direct Termination Events
9.4	Termination by Mutual Agreement
9.5	Termination of Particular State
9.6	Sale or Transfer of a Business
9.7	Purchase of Accounts
9.8	Termination of Program Participation
9.9	Wind Down of Operations

	SECTION 10. MISCELLANEOUS
10.1	Entire Agreement
10.2	Coordination of Public Statements
10.3	Amendment
10.4	Successors and Assigns
10.5	Waiver
10.6	Severability
10.7	Notices
10.8	Captions and Cross-References
10.9	GOVERNING LAW
10.10	Counterparts
10.11	Force Majeure
10.12	Relationship of Parties
10.13	Survival
10.14	Mutual Drafting
10.15	Independent Contractor
10.16	No Third Party Beneficiaries
10.17	Confidentiality and Security Controls
10.18	Taxes

	Schedules
1.1	Discount Rate and Promotional Programs
2.1(a)	Service Standards
2.5	Marketing
2.8	Monthly Master File Information
2.8(b)(ii)	Competitive Products and Services
3.6	Initial Account Terms and Features
3.13	Bank Reports

iii

CREDIT CARD PROGRAM AGREEMENT

THIS CREDIT CARD PROGRAM AGREEMENT is made as of this 22nd day of February, 2005 (the “Effective Date”) by and between Hanover Direct, Inc., on behalf of itself and its Merchant Affiliates (as defined below), with its principal office at 1500 Harbor Blvd., Weehawken, New Jersey 07087, and WORLD FINANCIAL NETWORK NATIONAL BANK, with its principal office at 800 Tech Center Drive, Gahanna, Ohio 43230.

RECITALS

WHEREAS, Bank is a member of various Card Associations and is an issuer of both general-purpose credit cards and private label credit cards throughout the United States;

WHEREAS, Hanover Direct has determined that offering its Customers both co-brand credit cards and private label credit cards will provide Hanover Direct’s Customers with benefits;

WHEREAS, Hanover Direct wishes to participate in a Hanover Direct-branded Program involving the issuance by Bank of both general purpose co-brand credit cards and private label credit cards to Hanover Direct’s Customers and other qualified applicants, and Bank is willing to issue such cards and perform related services to support the Program on terms and conditions set forth herein;

NOW, THEREFORE, in consideration of the foregoing promises, and for other good and valuable consideration, the receipt and sufficiency of which is acknowledged, the parties agree as follows:

SECTION 1. DEFINITIONS

1.1 Certain Definitions. As used herein and unless otherwise required by the context, the following terms shall have the following respective meanings.

“Account” shall mean either a Co-Brand Account or Private Label Account.

“Address Verification Service” shall mean an adjunct process to the credit authorization process where the Cardholder’s reported billing address is verified against the Bank’s address on file for such Cardholder.

“Affiliate” shall mean with respect to either Bank or Hanover Direct any entity that is owned by, owns, or is under common control with such party; provided, however, that in the case of Hanover Direct, the term shall not include Gump’s Corp. and Gump’s by Mail Inc.

“Agreement” shall mean this Credit Card Program Agreement with all of its schedules as may be modified, altered, supplemented, or amended from time to time by the mutual written agreement of the parties.

“Applicable Law” shall mean any law, ordinance, statute, treaty, regulation, written regulatory guidance, order or directive, final rule, or other determination or finding of any court, arbitrator or governmental authority applicable or binding upon the party or to which that party is subject, or otherwise applicable to the Program, whether federal, state, county, local or otherwise.

“Applicant” shall mean a consumer who has submitted an application for an Account.

“Automated Telephone Application” shall mean an application procedure designed to process applications and open Accounts at the point of sale or order entry, in which an application for credit is processed without a paper application being completed by an Applicant and the Applicant’s information is keyed into the telephone.

“Average Accounts Receivable” shall mean the sum of the trailing twelve (12) month-end accounts receivable divided by the number twelve. The accounts receivable contain Purchases, Protection Programs and Enhancement Marketing Services charges, finance charges, late fees and other miscellaneous Cardholder charges and fees.

“Bank” shall mean World Financial Network National Bank.

“Bank’s Total Direct Expenses” shall mean those direct expenses of Bank related to the Program, Cardholders, debt cancellation claims, and direct marketing, and specifically allocable thereto, and shall be limited to: (i) talk time (ii) third-party processing fees, (iii) debt cancellation claims and (iv) other out of pocket expenses related to specific and definable aspects of a program.

“Batch Prescreen Application” shall mean a process where Bank’s offer of credit is made to certain Customers prequalified by Bank, in a batch mode typically within a catalog environment.

“Business” shall mean the following businesses owned and operated by Hanover Direct, Inc.: Domestications, Silhouettes, The Company Store, International Male, and Undergear, whether brick-and-mortar, websites, or direct marketing vehicles such as print catalogs.

“Business Day” shall mean any day, except Saturday, Sunday or a day on which banks in Ohio are required to be closed.

“Card Association” shall mean a nationwide payment clearing network such as MasterCard International, Inc. Visa U.S.A. Inc., Discover Bank or American Express Company in which the co-brand Accounts participate.

“Cardholder” shall mean any natural person to whom an Account has been issued by Bank pursuant to the Program and/or any authorized user of the Account.

“Charge Slip” shall mean a sales receipt, register receipt tape, invoice or other documentation, whether in hard copy or electronic form, in each case evidencing a Purchase that is to be charged to a Cardholder’s Account.

“Co-Brand Account” shall mean a general purpose open-end revolving line of credit account that may be accessed through a Credit Card established by Bank for a Customer pursuant to the terms of a Credit Card Agreement and in accordance with Card Association rules and regulations and marketed with the trade names and/or logos of Hanover Direct and a Card Association.

“Credit Card” shall mean a Hanover Direct-branded credit card which may be either a Private Label Account or Co-Brand Account credit card issued by Bank to access such Account pursuant to this Agreement.

“Credit Card Agreement” shall mean the agreement between a Cardholder and Bank governing the Account and Cardholder’s use of the Account, together with any modifications or amendments which may be made to such agreement. Bank may develop different versions of the Credit Card Agreement as appropriate for the co-brand Accounts and the private label Accounts.

“Credit Sales Day” shall mean any day, whether or not a Business Day, on which Goods and/or Services are sold by Hanover Direct.

“Credit Slip” shall mean a sales credit receipt or other documentation, whether in hard copy or electronic form, evidencing a return or exchange of Goods or a credit on an Account as an adjustment by Hanover Direct for goodwill or for Services rendered or not rendered by Hanover Direct to a Cardholder.

“Customer” shall mean a consumer who has purchased Goods and/or Services from Hanover Direct’s Merchant Affiliates or a consumer who receives marketing materials about the Program, and includes any person on the customer list of a Business.

“Direct Settlement” shall mean the processing of Hanover Direct Co-Brand Account Purchases outside of the Card Associations’ authorization and settlement networks in a manner consistent with or similar to the Bank’s Private Label Account Purchases as outlined in Section 3.6.

“Discount Fee” shall mean, for all Private Label Account Account Purchases and for those certain Co-Brand Account Purchases that are Direct Settlement transactions, an amount to be charged by Bank for such Purchases equal to Net Sales multiplied by the Discount Rate.

“Discount Rate” shall have the meaning set forth in Schedule 1.1.

“Effective Date” shall mean the date set forth in the first paragraph on page one of this Agreement.

“Electronic Bill Presentment and Payment” shall mean a procedure where Cardholders can elect to receive their Account billing statements electronically and that also allows them an opportunity to remit their Account payment to Bank electronically.

“Enhancement Marketing Services” shall have the meaning set forth in Section 2.9(b).

“Equal Payment Purchases” shall mean Purchases subject to a minimum purchase amount set by Bank for which Bank sets equal monthly payments over a specified term to collect the balance related to the Purchase.

“Forms” shall have the meaning set forth in Section 2.4.

“Goods and/or Services” shall mean those goods and/or services sold by Hanover Direct’s Merchant Affiliates through stores, catalog, Internet or otherwise to the general public for individual, personal, family or household use.

“Hanover Direct” shall mean Hanover Direct, Inc. and the Merchant Affiliates.

“Hanover Direct Deposit Account” shall mean a deposit account maintained by Hanover Direct as set forth in Section 3.6 (a).

“Hanover Direct’s Marks” shall mean the trademarks and/or service marks owned by or licensed (and capable of being sublicensed) to the Businesses of Hanover Direct and designated by Hanover Direct and/or the Businesses to Bank for use in connection with the Program.

“Hanover Direct’s Stores” shall mean those certain retail locations selling Goods and/or Services, which are owned and operated by Hanover Direct’s Merchant Affiliates.

“Initial Term” shall have the meaning set forth in Section 9.1.

“Instant Credit Application” shall mean an in store, Internet or catalog application procedure designed to open Accounts at point of sale or order entry whereby an application for credit is communicated to Bank either verbally at point of sale or systemically during the catalog order entry process according to Bank’s Operating Procedures.

“Loyalty Program” shall have the meaning set forth in Section 2.11.

“Marketing Fund” shall have the meaning set forth in Section 2.5(b).

“Merchant Affiliates” shall mean those certain Affiliates of Hanover Direct, Inc. which operate the Businesses.

“Name Rights” shall have the meaning set forth in Section 2.10.

“Net Proceeds” shall mean Purchases less: (i) credits to Accounts for the return or exchange of Goods or a credit on an Account as an adjustment by Hanover Direct for goodwill or for Services rendered or not rendered by Hanover Direct to a Cardholder, all as shown in the Transaction Records (as corrected by Bank in the event of any computational error), calculated each Business Day; (ii) any applicable Discount Fees in effect on the date of calculation; and (iii) any other fees or charges imposed by Bank pursuant to this Agreement.

“Net Sales” shall mean Purchases, less credits or refunds for Goods and/or Services, all as shown in the Transaction Records (as corrected by Bank in the event of any computational error), calculated each Business Day.

“On-Line Prescreen” shall mean a process where a pre-screened offer of credit is made to Customers meeting Bank’s credit criteria in a real-time pre-approved process according to Bank’s Operating Procedures. The process utilizes traditional order entry data elements to build Customer records. The Customer records are pre-screened by a credit bureau using Bank’s established criteria to determine if an offer of credit is appropriate. Customer records passing the Bank’s pre-screening credit criteria are returned to the point of order entry where the pre-approved offer to open an Account is made. Records not passing the credit criteria are not returned and no offer is made.

“Operating Procedures” shall mean Bank’s written instructions and procedures provided to Hanover Direct, Inc. to be followed by Hanover Direct and Hanover Direct’s employees in connection with implementation of the Program.

“Prescreen Acceptance” shall mean a point of sale procedure designed to recognize and activate Bank’s pre-approved offers for Accounts for Customers.

“Private Label Account” shall mean an individual open-end revolving line of credit account that may be accessed through a Credit Card established by Bank for a Customer pursuant to the terms of a Credit Card Agreement, marketed with the trade names and/or logos of Hanover Direct, and for which the Credit Cards are accepted exclusively by Hanover Direct pursuant to this Agreement.

“Program” shall mean the Co-Brand Account and Private Label Account credit card program established and administered by Bank for Customers of Hanover Direct by virtue of this Agreement.

“Program Commencement Date” shall mean the date on which Bank commences operation of the Program. Bank shall be deemed to have commenced operation of the Program on the earlier of the date on which Bank begins to issue new Accounts or the date on which Bank notifies Hanover Direct in writing that Bank has commenced operation of the Program.

“Program Year” shall mean each consecutive twelve (12) month period commencing on the Program Commencement Date or the first day of the first full calendar month following the Program Commencement Date if the Program

Commencement Date is not the first day of a calendar month and each anniversary thereof.

“Promotional Programs” shall mean any special Cardholder payment terms approved by Bank for certain Purchases, including without limitation deferred finance charges, deferred payments and subject to any terms and conditions set forth in writing by Bank. Equal Payment Purchases shall be deemed to be Promotional Programs. Promotional Programs shall not have a promotional period (e.g. deferral period) greater than six (6) months.

“Protection Programs” shall have the meaning set forth in Section 2.9(a).

“Purchase” shall mean a purchase of Goods and/or Services, including without limitation all applicable taxes and shipping costs, with a specific extension of credit by Bank to a Cardholder using an Account as provided for under this Agreement.

“Quick Credit” shall mean an in-store application procedure designed to open Accounts as expeditiously as possible at point of sale, whereby an application for an Account is processed without a paper application being completed by an Applicant. An Applicant’s credit card (Visa, MasterCard, American Express, Discover Bank or other Bank approved private label card) is electronically read by a terminal that captures the Applicant’s name and credit card Account number. Other data shall be entered into that same terminal by the Hanover Direct’s Store associate as specified in the Operating Procedures. This data is used by Bank to request a credit bureau report and make a decision whether to approve or decline the Applicant.

“Regular Revolving Purchases” shall mean Purchases which are not subject to any Promotional Programs.

“Renewal Term” shall have the meaning set forth in Section 9.1.

“Roll to Revolve Rate” shall mean, for each Promotional Program subject to a deferred period, the total dollar amount of the Accounts Receivable for the Promotional Program that is not paid in full prior to the end of the deferral period divided by the total dollar amount of the Purchases for the particular Promotional Program, and expressed as a percentage.

“Statemented Account” shall mean each Account for which a billing statement is generated (whether or not actually sent to the Cardholder) within a particular billing cycle.

“Term” shall mean the Initial Term and any Renewal Terms.

“Transaction Record” shall mean, with respect to each Purchase of Goods or Services by a Cardholder from Hanover Direct, each credit or return applicable to a Purchase of Goods or Services: (a) the Charge Slip or Credit Slip

corresponding to the Purchase, credit or return; or (b) a computer readable tape/cartridge or electronic transmission containing the following information: the Account number of the Cardholder, the particular Hanover Direct Business at which the Purchase, credit or return was made (identified as mutually agreed by Bank and Hanover Direct), the total of (i) the Purchase price of Goods or Services purchased or amount of the credit, as applicable, plus (ii) the date of the transaction, a description of the Goods or Services purchased, credited or returned and the authorization code, if any, obtained by Hanover Direct prior to completing the transaction; or (c) electronic record whereby Hanover Direct or Hanover Direct’s Store electronically transmits the information described in subsection (b) hereof to a network provider (selected by Hanover Direct at its expense), which in turn transmits such information to Bank by a computer tape/cartridge or electronic tape or transmission.

1.2 Rules of Interpretation. Except as otherwise expressly provided in this Agreement, the following rules will apply: (i) the singular includes the plural and the plural includes the singular; (ii) “include” and “including” are not limiting; (iii) a reference to any agreement or other contract includes any permitted modifications supplements, amendments and replacements.

SECTION 2. THE PROGRAM

2.1	Establishment and Operation of the Program.

(a) Hanover Direct and Bank shall use reasonable efforts to commence the Program on or before April 1, 2005, or such other date as the parties mutually agree upon in writing. Subject to the terms and conditions set forth in this Agreement, commencing on the Program Commencement Date, Bank shall originate Accounts and issue Credit Cards to Customers. Bank shall open an Account for all qualified Applicants approved by Bank and establish a credit line in an amount to be determined by Bank in its discretion for each individual Applicant. Subject to Section 3.6 (d), applicable Card Association rules and regulations and Applicable Law, Bank shall determine the terms and conditions of the Account to be contained in a Credit Card Agreement. Bank shall service the Accounts in accordance with the terms set forth in Schedule 2.1(a).

(b) When Hanover Direct internally develops or acquires a new business owned and operated by Hanover Direct, Inc. or an Affiliate of Hanover Direct, Inc. (including but not limited to new Affiliates, divisions, catalogues, Internet sites and other entities) for the sale of consumer goods and/or services, not specifically identified as a “Business” or “Merchant Affiliate” in Section 1.1 (referred to as a “New Business”), Hanover Direct shall notify Bank of such New Business. Bank shall have a right of first refusal to add such New Business to the Plan and if Bank desires to do so, then Hanover Direct and Bank shall negotiate in good faith the pricing and other terms that shall apply to Bank issuing Accounts to Customers of the New Business, and the parties shall execute an addendum to this Agreement defining the terms and conditions that will apply to the New Business, which addendum shall be incorporated into this Agreement. Each time an addendum is executed by the parties, the New Business shall be

considered a Business for the purposes of this Agreement, and all of the terms of this Agreement shall be deemed to cover the New Business and the Affiliate operating such New Business shall be deemed to be a Merchant Affiliate, unless otherwise specifically agreed to by the parties in the addendum adding the New Business to this Agreement.

(c) The Bank shall designate a Program manager and Hanover Direct shall designate a Program manager (collectively the “Managers”). The Managers shall be available as contact persons for purposes of facilitating the on-going Program management, contractually required consultations and the resolution of disputes. The Managers or their respective designees, shall confer periodically in order to review the implementation, administration, and performance of the Program and to review and plan the marketing of the Program in accordance with Section 2.5 hereto.

2.2 Applications for Credit Under the Program; Billing Statements. (a) Customers who wish to apply for an Account under the Program must submit a completed application on a form or in an electronic or telephonic format approved by Bank, and Bank shall grant or deny the request for credit based solely upon Bank’s credit criteria. Bank or Hanover Direct shall provide a copy of the applicable Credit Card Agreement to the Applicant to be retained for the Applicant’s records. The application shall be submitted to Bank by the Applicant or submitted by Hanover Direct on behalf of the Applicant, as set forth in the Operating Procedures. If Bank opens an Account for an Applicant, Bank shall issue a Credit Card to the Applicant which accesses the individual line of credit in an amount determined by Bank for the Account.

(a) Bank shall make available to Hanover Direct and Hanover Direct shall utilize an Instant Credit application procedure, as well as Batch Prescreen and On-Line Prescreen application procedures. Bank shall also make available to Hanover Direct Instant Credit and Automated Telephone Application procedures that may be used by Hanover Direct.

(b) Hanover Direct will protect and keep confidential the application information and, except as may otherwise be required by Applicable Law, shall not disclose the information to anyone other than authorized representatives of Bank.

(c) Cardholders will receive from Bank a periodic statement (the “Billing Statement”) listing the transaction information for a billing cycle and other information, as deemed desirable by Bank and in accordance with the requirements of Applicable Law.

(d) Bank shall make available to Hanover Direct and its Customers Internet application procedures, Charge Slip processing, and Cardholder Account customer service. Hanover Direct shall be responsible for integrating and maintaining on its website at its sole expense a link to the Bank’s Internet website. The style and content of the link shall be subject to Bank’s prior approval. Hanover Direct represents and warrants that, to integrate and maintain the link, and to ensure access to the Bank’s Internet website and reduce technical errors, its software providing the link will function, and continue to function, in a sound technical manner. Hanover Direct shall regularly monitor the link to ensure proper functioning. Bank represents and warrants to ensure

that Bank’s Cardholder Internet website will function and continue to function in a sound technical manner. In the event Bank changes or otherwise modifies the website address for Bank’s Internet site for the Program, Hanover Direct will promptly update or modify the link, as directed by Bank. In providing the link, Hanover Direct shall make it clear and conspicuous that the Customer is leaving Hanover Direct’s website and is being directed to Bank’s website for the exclusive purpose of accessing Bank’s website.

(e) Hanover Direct agrees that, in connection with the link, it will only use Bank’s name, or any logo, statements or any other information that is related to Bank, only as directed by Bank, or as approved in advance and in writing by Bank. Without limiting the generality of the scope of required approvals, but by way of example, Hanover Direct shall seek Bank’s approval not only with respect to content, but also with respect to any typestyle, color, or abbreviations used in connection with the link. Hanover Direct will promote to its Customers the Bank’s Electronic Bill Presentment and Payment.

2.3 Operating Procedures. With Respect to the Program, Hanover Direct and Hanover Direct’s employees shall observe and comply with the Operating Procedures and such other reasonable procedures as Bank may prescribe on not less than forty-five (45) days’ prior notice to Hanover Direct or otherwise required by Applicable Law or Card Association rules and regulations, if applicable. Hanover Direct shall ensure that Hanover Direct’s employees are trained regarding the Operating Procedures and shall ensure their compliance with them. The Operating Procedures may be amended or modified by Bank from time to time in its reasonable discretion; provided, however, unless such changes are required by Applicable Law or Card Association rules and regulations (if applicable), a copy of any such amendment or modification shall be provided to Hanover Direct at least forty-five (45) Business Days before its effective date, and for those changes required by Applicable Law or Card Association rules and regulations (if applicable), notice shall be given as soon as practicable.

2.4	Program Documents.

(a) Forms. Subject to and in compliance with the requirements of Applicable Law and Section 2.10 hereof, Bank shall design and provide the form of the Credit Card Agreement, applications, Credit Card, card mailers, billing statements, letters, and other documents and forms (collectively, “Forms”) to be used under the Program which (i) relate to the Program, (ii) relate to Bank’s and/or the Cardholder’s obligations (excluding any obligations Hanover Direct may have with respect to such Cardholder, such as providing the form of Charge Slips and Credit Slips), or (iii) are required by Applicable Law. Bank shall solely determine the terms and conditions of the Forms, subject to the provisions of Section 3.6(d). Bank will provide Hanover Direct with copies of the form of the Credit Card Agreement, applications, billing statement, card mailers, and the template of any Forms which are to be provided by Bank for marketing purposes in a mass mailing or distribution to all Cardholders as a whole or to all Cardholders in a particular state. Bank shall provide, at Bank’s expense, reasonable and appropriate quantities of the Credit Card Agreements, Credit Card plastics, card mailer, and billing statements; provided, that all quantities shall be reviewed with Hanover Direct and provided further that all quantities shall be so limited as not to cause Hanover Direct to

incur extraordinary costs related to any reissuances requested under this Section, but in no event shall such quantities be less than a ninety (90) days’ supply unless otherwise agreed by Bank and Hanover Direct. Hanover Direct shall pay the costs of all Credit Card plastics, including embossing and encoding, card mailers, envelopes, Credit Card Agreements and postage related to any reissuances requested by Hanover Direct for any reissuance of Credit Cards to Cardholders (other than replacements made by Bank from time to time at a Cardholder’s request on a case by case basis and regular reissuances by Bank of expiring Credit Cards). If Hanover Direct’s requirements for any form, plastics or other related collateral (Program documents) associated with the Program vary from the specifications provided by Bank, Bank will advise Hanover Direct of the variance and provide an estimate for the difference, then Hanover Direct shall pay any additional cost associated with the Program documents. In the event any Forms become obsolete as a result of changes requested by Hanover Direct, Hanover Direct shall reimburse Bank for the costs associated with any unused obsolete Forms. Only one (1) design shall be used for each Form. The Businesses may have separate designs for each of the Co-Brand Accounts and Private Label Accounts, as follows:

Private Label Accounts (4 separate designs):

Domestications

Silhouettes

The Company Store/Company Kids (combined)

Co-Brand Accounts (3 separate designs):

Domestications

Silhouettes

The Company Store/Company Kids (combined)

(b) Customer Marketing. Bank and Hanover Direct shall jointly design the Customer marketing aspects of the Forms (except for Cardholder letters, Credit Card Agreements, billing statement backers and other documents and forms used by Bank in maintaining and servicing the Accounts, which Bank shall solely design), subject to and in compliance with the requirements of Applicable Law and Section 2.10. Hanover Direct may design and produce promotional material, direct mail pieces, catalog, newspaper, radio and Internet advertisements, and other collateral documents (collectively, “Collateral”) which reference the Program and shall submit the same to Bank for its review and approval of the Co-brand disclosures and references to the Program and Bank. Hanover Direct will ensure all changes requested by Bank pursuant to the review and approval process are made to the Collateral.

(c) Review & Approval of Promotion Copy. Each party’s Manager (defined in Section 2.1(c) above) shall cause all drafts of all Customer marketing aspects of Forms and Collateral promoting or advertising the Program containing promotional copy, as well as notification of all modifications (collectively “Promotion Copy”), to be delivered to the other party’s Manager for review, comment, and approval or disapproval by the appropriate person at least five (5) Business Days in advance of a comment deadline imposed by or upon such party’s Manager and also in the case of HDI, with an additional copy to Attention: Lisa Green, Esq., Corporate Counsel, Hanover Direct, Inc.,

1500 Harbor Boulevard, Weehawken, NJ 07087, Telecopier 201-272-3498; E-mail lgreen@hanoverdirect.com.

2.5 Marketing. (a) Hanover Direct agrees to prominently advertise and actively promote the Program wherever Customers can purchase Goods and/or Services in accordance with the Operating Procedures or as otherwise provided by Bank. Hanover Direct and Bank will jointly agree upon programs to market the Program, both initially and on a continuing basis. Bank must approve in advance Hanover Direct’s use of Bank’s and/or the Card Association’s name and any references to the Program and Card Association.

(a) Bank shall contribute the amounts set forth in Schedule 2.5 to apply to marketing and promotion expenses associated with the Program in each Program Year (such funds to be made available at the beginning of the applicable Program Year). All of such funds shall be referred to herein as the “Marketing Fund.” If the Marketing Fund is not used in the Program Year, up to twenty-five percent (25%) of the funds may be rolled over to the first six (6) months of the next Program Year, but in no event shall the funds have any cash value. Hanover Direct shall pay marketing and promotion expenses directly as they are incurred, and shall send Bank an invoice for the aggregate amount of the expenditures mutually agreed upon by the parties together with copies of paid invoices or other supporting documentation reasonably satisfactory to Bank for such expenses and Bank shall reimburse Hanover Direct within thirty (30) days after receipt of such invoice until Bank’s maximum contribution amount for the applicable Program Year has been met. In the last Program Year of the Initial Term, Bank shall have the right to cease the availability of the Marketing Fund contributed by Bank for any future marketing or promotions, however, if the Term is renewed by Hanover Direct prior to the end of the Term, then Bank shall continue to contribute any unused Marketing Fund for such Program Year on a retroactive basis.

(b) Administration of Accounts. Bank shall perform, in compliance with Applicable Law and Card Association rules and regulations (if applicable), all functions necessary to administer and service the Accounts, including but not limited to: making all necessary credit investigations; notifying Applicants in writing of acceptance or rejection of credit under the Program; preparing and mailing billing statements; making collections; handling Cardholder inquiries; processing payments, sending Cardholder privacy notices and maintaining Cardholder opt-out information in accordance with Bank’s policies.

2.6 Credit Decision. The decision to extend credit to any Applicant under the Program shall be Bank’s decision. Bank will work in good faith with Hanover Direct to develop business strategies with respect to the issuance of Accounts which are intended to maximize the potential of the Program, and which are mutually beneficial to Hanover Direct and Bank. Hanover Direct may from time to time request Bank to consider offering certain types of special credit programs. Bank shall reasonably consider Hanover Direct’s requests and negotiate with Hanover Direct in good faith. However, Bank shall, in its sole discretion, subject to Applicable Laws, Card Association rules and regulations (as applicable) and safety and soundness considerations, determine whether or not to offer any of such programs. In the event Bank agrees to

any special credit program, Hanover Direct and Bank shall mutually agree upon any special terms and fees associated with the special credit program.

2.7 Ownership of Accounts and Mailing Lists, Reporting Requirements. The Customer’s names and addresses and other Customer information collected by Hanover Direct independent of Bank and set forth in Hanover Direct’s records, shall be the exclusive property of Hanover Direct, but Hanover Direct shall during the Term of this Agreement as requested by Bank make the names and addresses of such Customers available to Bank, as permitted by Applicable Law and by the privacy policies of the Businesses, to be used only for purposes of solicitation of such Customers for Accounts and in connection with the administration of the Program in accordance with the terms of this Agreement. Bank shall provide to Hanover Direct monthly one (1) master file extract initially containing the information set forth on Schedule 2.7 to the extent such information is available to Bank, but subject to change by Bank at any time, and any other information agreed to by Hanover Direct and Bank, to the extent permitted by Applicable Law and Bank’s privacy and security policies, which Hanover Direct may use solely in connection with maintaining and servicing the Accounts and for the purpose of marketing its Goods and/or Services to the Cardholders, as permitted by Applicable Law. Hanover Direct shall keep such Cardholder information confidential and shall not sell, lease, transfer or disclose such information to any third party without Bank’s prior written consent. The Accounts and all information related to the Accounts, Cardholders and Applicants including without limitation the receivables, names, addresses, credit and transaction information of Cardholders, as set forth in Bank’s records shall be the exclusive property of Bank during and after the Term of this Agreement unless the Accounts are purchased by Hanover Direct, or its designee, pursuant to Section 9. Bank shall have the right to take a security interest in the Goods purchased with an Account until such time as the balance with respect to the Goods is paid in full.

2.8 Protection Programs and Enhancement Marketing Services. (a) Hanover Direct and Bank agree that Bank will have the exclusive right to make available to Cardholders debt cancellation programs (collectively referred to herein as “Protection Programs”) offered by Bank and/or its vendors or Affiliates. Such Protection Programs may include, but are not limited to, debt cancellation programs. Bank shall, prior to offering any Protection Programs to Cardholders, review the proposed solicitations and offerings with Hanover Direct. Bank may make up to six (6) offers for such Protection Programs per Program Year, up to two (2) of which may be statement inserts. The fees for Protection Programs shall be charged to the applicable Cardholder’s Account. Hanover Direct will assist Bank’s effort to offer Protection Programs so long as such assistance will not require Hanover Direct to incur any direct expense or cost or would not result in Hanover Direct’s violation of any third party agreement. During the first Program Year, Bank shall pay Hanover Direct fifty percent (50%) of the net profit (Bank’s revenues, commissions and other incentives minus Bank’s Total Direct Expenses generated by Protection Programs, payment to be made on a monthly basis, together with a statement setting forth the revenues, expenses and profits in reasonable detail. In the second Program Year, and each Program Year thereafter, Bank shall review the actual number of Enhancement Marketing Services offers approved by

Hanover Direct for the prior Program Year, and if such number is less than three (3), then Bank shall have the right to reduce the amount of percentage of net profit payable by Bank to Hanover Direct for Protection Programs for the current Program Year to zero percent (0%) and to reduce the amount of percentage of net profit payable by Bank to Hanover Direct for Enhancement Marketing Services (pursuant to Section 2.9(a) below) for the current Program Year to thirty percent (30%).

(b) Hanover Direct and Bank agree that Bank will have the right from time to time, at Hanover Direct’s invitation, to make available to Cardholders various types of other products and services (collectively referred to herein as “Enhancement Marketing Services”) through solicitations made in connection with their Accounts.

(i)	Such Enhancement Marketing Services may include, but are not limited, to travel services, legal services, card registration programs and merchandise products which are non-”competitive” with Hanover Direct Affiliates; provided, however that all Enhancement Marketing Services shall be subject to the prior approval of Hanover Direct (which may be withheld in its sole discretion), and provided, further that Enhancement Marketing Services shall not include and the following shall be expressly prohibited hereunder: any program or service where discounts, information and/or benefits are proposed to be delivered to a Cardholder in exchange for a recurring fee on a negative option, positive option or similar basis, including, but not limited to, programs or services similar to loyalty programs or clubs, notwithstanding that the fee is not labeled by the program, service, or plan provider as a “membership” or “annual” fee. Such Enhancement Marketing Services will be offered through various direct marketing channels including but not limited to direct mail, inbound telemarketing, call transfer, call to confirm, statement inserts, statement messaging and IVR, but shall expressly exclude outbound telemarketing to Customers;
(ii)	Enhancement Marketing Services which offer merchandise products shall not directly compete with Hanover Direct’s products and services. “Competitive products and services” shall be as defined on Schedule 2.8(b)(ii) attached hereto and made a part hereof and as amended from time to time;
(iii)	For all combined Enhancement Marketing Services, if such offers are invited and permitted by Hanover Direct, Bank shall have the right to utilize for each Credit Card in statement inserts each month during a Program Year if Hanover Direct has not already reserved such space. . Except for Enhancement Marketing Services offered by IVR, call to confirm, call transfer and call center sales, Bank will notify Hanover Direct of the proposed offer prior to its execution and obtain Hanover Direct’s prior written consent, which shall not be unreasonably withheld. The charges for the products and

services will be billed to the applicable Cardholder’s Account when appropriate.

(b) Bank shall pay Hanover Direct fifty percent (50%) of the net profit (Bank’s revenues, commissions and other incentives minus Bank’s Total Direct Expenses) generated by Enhancement Marketing Services, payment to be made on a monthly basis, together with a statement setting forth the revenues, expenses and profits in reasonable detail.

2.9 Ownership of Hanover Direct Name and Licensing. (a) Subject to the other provisions of this Agreement, Hanover Direct hereby grants to Bank a non-exclusive, non-transferable license to use the Hanover Direct’s Marks solely in satisfaction of its duties, rights and obligations described in this Agreement, including without limitation, using same in any and all promotional materials, Account documentation, advertising, marketing and solicitations related to the Program, during the Term. Bank shall use the trademark designations “®” or “TM” or such other designation as Hanover Direct may specify or approve in connection with the Hanover Direct’s Marks on the Credit Cards, Account documentation and promotional materials. Bank agrees it will not use the Hanover Direct’s Marks on or in connection with any products or services or for any other purpose other than as explicitly described in this Agreement except as required by Applicable Law.

(b) Anything in this Agreement to the contrary notwithstanding, Hanover Direct shall retain all rights in and to Hanover Direct’s Mark pertaining to such names and all goodwill associated with the use of Hanover Direct’s Marks whether under this Agreement or otherwise shall inure to the benefit of the Hanover Direct. Hanover Direct shall have the right, in its sole and absolute discretion, to prohibit the use of any of Hanover Direct’s Marks in any Forms, advertisements or other materials proposed to be used by Bank which Hanover Direct in its reasonable business judgment deems objectionable or improper. Bank shall cease all use of Hanover Direct’s Marks upon the termination of this Agreement for any reason unless Bank retains the Accounts after termination of the Agreement, in which case Bank may use Hanover Direct’s Marks solely in connection with the administration and collection of the balance due on the Accounts. During the term, Hanover Direct grants Bank the right to use Hanover Direct’s Marks in connection with Bank and its Affiliates’ business client lists in Bank and Bank’s Affiliates’ product marketing and promotional materials, in written and electronic form.

2.10 Cardholder Loyalty Program. At Hanover Direct’s request, Bank will provide Hanover Direct with system functionality tied to the Accounts to support Hanover Direct’s Cardholder loyalty program (the “Loyalty Program”), at no additional charge, to the extent Hanover Direct’s Loyalty Program is consistent with Bank’s existing or future functionality offered to other Bank clients and is facilitated using monthly billing statements to active Accounts and does not include stand-alone mailings. Provided, however, that Bank will support stand-alone Cardholder mailings and zero-balance statements in conjunction with the Loyalty Program at Hanover Direct’s expense. Bank will, at Hanover Direct’s request, upon the terms, conditions and fees mutually agreed upon in writing by the parties, provide back office servicing and administration support for Hanover Direct’s Loyalty Program. The Loyalty Program will

provide for loyalty point accumulation, tracking, lookup/reporting, and redemption where coupon is part of the billing statement, at no additional charge to Hanover Direct, consistent with Bank’s existing or future functionality offered to other Bank clients. Hanover Direct is the owner of the Loyalty Program and will be responsible for determining and funding the reward related to the Loyalty Program and for ensuring that the Loyalty Program complies with all Applicable Laws.

SECTION 3. OPERATION OF THE PROGRAM

3.1 Honoring Accounts. Hanover Direct agrees that Hanover Direct will honor any Account properly issued and currently authorized by Bank pursuant to the Program, and shall deliver to Bank all Transaction Records evidencing transactions made under the Program for Goods and/or Services, in accordance with the provisions of this Agreement and the Operating Procedures.

3.2 Additional Operating Procedures. In addition to the procedures, instructions and practices contained in the Operating Procedures, Hanover Direct agrees that Hanover Direct will comply with the following procedures:

(a) In each Account transaction by Hanover Direct, such entity must obtain all the information contained in clause (b) of the definition of Transaction Record. The date which appears on the Charge Slip or Credit Slip will be prima facie evidence of the transaction date, and Hanover Direct shall be required to transmit all Transaction Records relating to such Charge Slip and/or Credit Slip so that Bank receives such Transaction Records no later than the second Business Day after the transaction date. The “Cardholder Copy” of each Charge Slip shall be delivered to the Cardholder at the time of the transaction if the Cardholder is in the store.

(b) All Charge Slips will evidence the total price of the sale minus any cash down payment. Hanover Direct shall retain the “Merchant Copy” of all Hanover Direct and Hanover Direct’s Store generated Charge Slips and Credit Slips for each transaction for a period of twelve (12) months from the date of presentation to Bank or in the case of Promotional Programs, twelve (12) months from the end of the applicable Promotional Program.

(c) Hanover Direct will maintain a fair policy for the exchange and return of Goods and adjustment for Services rendered and for that purpose will give credit to Accounts upon such exchange, return or adjustment. Hanover Direct will not make cash refunds to Cardholders on Credit Card Purchases. If any Goods are returned, price adjustment is allowed, or debt for Services is adjusted, Hanover Direct will notify the Bank and provide appropriate documentation thereof to the Cardholder. Upon receipt of Transaction Records reflecting a credit to which there has been a corresponding debit, Bank will net against amounts payable by Bank to Hanover Direct the total shown on the Credit Slip, and credit the Cardholder’s Account in the amount of such Credit Slip. If the Hanover Direct Deposit Account contains insufficient funds, Hanover Direct shall remit the amount of such Credit Slips, or any unpaid portion thereof, to Bank immediately upon written demand.

(d) Hanover Direct’s Stores shall not, when the Cardholder or authorized user is present in the store, accept a transaction to be charged to an Account without presentation of a Credit Card or proper identification as outlined in the Operating Procedures.

3.3 Cardholder Disputes Regarding Goods or Services. Hanover Direct shall act promptly to investigate and work to resolve disputes with Cardholders regarding Goods and/or Services obtained through Hanover Direct pursuant to the Program. Hanover Direct shall timely process credits or refunds for Cardholders utilizing the Program.

3.4 No Special Agreements. Hanover Direct will not extract any special agreement, condition or security from Cardholders in connection with their use of an Account, unless approved in advance by Bank in writing.

3.5 Cardholder Disputes Regarding Violations of Applicable Law. Hanover Direct shall assist Bank in further investigating and using its reasonable efforts to help resolve any Applicant or Cardholder claim, dispute, or defense which may be asserted under Applicable Law or Card Association rules or regulations (for Co-Brand Accounts) in connection with purchases from a Business.

3.6 Payment to Hanover Direct; Ownership of Accounts; Fees; Accounting. (a)Hanover Direct shall electronically transmit all Transaction Records from Hanover Direct to Bank in a format acceptable to Bank. Upon receipt, Bank shall use commercially reasonable efforts to promptly verify and process such Transaction Records, and in the time frames specified herein, Bank will remit to Hanover Direct an amount equal to the Net Proceeds indicated by such Transaction Records for the Credit Sales Day(s) for which such remittance is made. In the event Bank discovers any discrepancies in the amount of Transaction Records submitted by Hanover Direct or paid by Bank to Hanover Direct, Bank shall notify Hanover Direct in detail of the discrepancy, and credit Hanover Direct, or net against amounts owed to Hanover Direct, as the case may be, in a subsequent daily settlement. Bank will transfer funds via wire transfer to an account designated in writing by Hanover Direct to Bank (the “Hanover Direct Deposit Account”). If Transaction Records are received by Bank’s processing center before 12 noon Eastern time on a Business Day, Bank will initiate such wire transfer by 5 p.m. Eastern time on the next Business Day thereafter. In the event that the Transaction Records are received after 12 noon Eastern time on a Business Day, then Bank will initiate such wire transfer no later than 5 p.m. Eastern time on the second Business Day thereafter. Bank shall remit funds to one (1) Hanover Direct designated account and shall not remit funds to individual Hanover Direct Stores. Bank shall, if requested by Hanover Direct, Inc., negotiate in good faith with Hanover Direct, Inc. and its secured lender to enter into an agreement which provides, among other things, for Bank to transfer the Net Proceeds owed to Hanover Direct, Inc. pursuant to this Section into a blocked account and once transferred, such funds are without recourse to the lender by Bank and acknowledge that the secured lender of Hanover Direct has a first priority lien on Hanover Direct’s inventory and accounts (not including Bank’s Accounts pursuant to this Agreement).

(a) Bank shall own all the Accounts under the Program from the time of establishment, and except as otherwise provided herein, Hanover Direct shall not have any right to any indebtedness on an Account or to any Account payment from a Cardholder arising out of or in connection with any Purchases under the Program. Effective upon the delivery of each Charge Slip by Hanover Direct to Bank and payment to Hanover Direct by Bank pursuant to Section 3.6(a), Hanover Direct shall be deemed to have transferred, conveyed, assigned and surrendered to Bank all right, title or interest in all such Charge Slips and in all other rights and writings evidencing such Purchases, if any, subject to Hanover Direct’s right to use and retain copies, whether electronic or otherwise, of all such records for purposes not inconsistent with this

Agreement (for example, general records related to sales, sales tax obligations, etc.).

(b) All Transaction Records are subject to review and acceptance by Bank. In the event of a computational or similar error of an accounting or record keeping nature with respect to such Transaction Records, Bank may credit to the Hanover Direct’s Deposit Account or net against the Net Proceeds (as the case may be) the proper amount as corrected. If the Net Proceeds are insufficient, Hanover Direct shall remit the proper amount to Bank immediately upon written demand. Upon any such correction Bank shall give prompt notice thereof to Hanover Direct.

(c) The Accounts shall initially have the terms and features set forth in Section I. of Schedule 3.6. Bank may make any changes in the terms of the Credit Card Agreement at any time, or as required by Applicable Law or the Card Association, and will notify Hanover Direct of such changes with notice to Hanover Direct as reasonable under the circumstances. In addition, Bank may make changes in the terms of a Credit Card Agreement on an individual Account basis in connection with its servicing of the Accounts without notice to Hanover Direct. With respect to any other changes in the terms of the Credit Card Agreement affecting the credit repayment terms or fees charged by Bank, Bank will, at least ninety (90) days prior to making any changes, notify Hanover Direct of such changes and discuss such changes with Hanover Direct.

(d) Hanover Direct shall obtain and maintain at their own expense such point of sale terminals, cash registers, software, hardware and other items of equipment as are necessary for it to request and receive authorizations, transmit Charge Slip and Credit Slip information, process Credit Card Applications and perform its obligations under this Agreement; provided, however, that all network (electronic communication interchange system for communication between Hanover Direct and Bank), telephone or other communication lines and other items necessary for such processing between Hanover Direct and Bank shall be ordered by Bank, caused to be installed by Bank, and maintained, and Hanover Direct shall pay the first ten thousand dollars ($10,000) of expenses related to such network (electronic communication interchange system), telephone or other communication lines and other items necessary for such processing and the remaining costs shall all be at Bank’s expense. The hardware and software and any computer programs and telecommunications protocols necessary to facilitate communications between Bank and Hanover Direct may be changed from time to time by Bank, provided Bank provides reasonable advance notice to Hanover Direct with respect to any such change and provided further that the written consent of Hanover Direct is obtained with respect to any change that is reasonably likely to involve

expenditures on the part of Hanover Direct in excess of ten thousand dollars ($10,000) (other than for changes that are required by Applicable Law or by Card Association Rules).

(e) Hanover Direct may from time to time offer Promotional Programs to Cardholders. Hanover Direct shall be responsible for ensuring that all Purchases subject to any Promotional Programs are properly designated as such on the Transaction Record in accordance with Bank’s instructions.

(f) Bank may if Hanover Direct fails to pay Bank any amounts (and not subject to a good faith dispute) due to Bank pursuant to this Agreement for more than thirty (30) days after the date of invoice by Bank, upon five (5) Business Days prior notice to Hanover Direct, offset such amounts against the Net Proceeds or any other amounts owed by Bank to Hanover Direct under this Agreement.

(g) Bank will pay to Hanover Direct the Initial Plan Compensation and Co-Brand Account compensation set forth in Section III. of Schedule 1.1.

3.7 Insertion of Hanover Direct’s Promotional Materials. Bank may from time to time insert Hanover Direct’s promotional materials for Hanover Direct’s Goods and/or Services, which are provided by Hanover Direct at Hanover Direct’s expense or from the Marketing Fund, into the Account billing statements, new Credit Card mailers, and PIN mailers so long as the materials: (a) are provided to Bank at least fifteen (15) Business Days prior to the scheduled mailing date of such statements or notices; (b) if they reference Bank or the Program in any manner, are approved by Bank as to content, in Bank’s reasonable discretion; (c) meet all size, weight, or other specifications for such inserts as shall be reasonably set by Bank from time to time; (d) there is sufficient space in Bank’s standard envelope for the insert in addition to any legally required material, Cardholder notices and other materials which Bank is including in the mailing; and (e) Hanover Direct pays any and all additional postage costs caused by Bank’s insertion of materials provided by Hanover Direct, if instructed by Hanover Direct to insert regardless of the additional postage costs.

3.8 Payments. All payments to be made by Cardholders with respect to any amounts outstanding on the Accounts shall be made in accordance with the instructions of Bank and at the location or address specified by Bank. Hanover Direct hereby authorizes Bank, or any of its employees or agents, to endorse “WORLD FINANCIAL NETWORK NATIONAL BANK” upon all or any checks, drafts, money orders or other evidence of payment, made payable to Hanover Direct, a Merchant Affiliate or Business, and intended as payment on an Account, that may come into Bank’s possession from Cardholders and to credit said payment against the appropriate Cardholder’s Account. Bank has the sole right to receive and retain all payments made with respect to all Accounts and to pursue collection of all amounts outstanding, unless an Account or Purchase is charged back to Hanover Direct pursuant to the provisions of Sections 3.9 and 3.10 hereof.

3.9 Chargebacks. Bank shall have the right to demand immediate purchase by Hanover Direct of any Purchase and charge back to Hanover Direct the unpaid

balance (including all amounts related to the Purchase) and any Discount Fee paid by Bank to Hanover Direct, relating to any such Purchase, as more fully described below, if and whenever:

(a) Any Applicant or Cardholder claim, defense or dispute is asserted against Bank with respect to such Purchase or the Account as a result of an action or inaction by Hanover Direct pursuant to and within the time limits under Applicable Law or the Card Association rules and regulations (as applicable);

(b) Bank determines that with respect to such Purchase or the Account: (i) there is a breach of any warranty or representation made by or with respect to Hanover Direct under this Agreement and such breach has or may have a material adverse impact on the Bank’s ability to collect unpaid amounts directly related to the Purchase; or (ii) there is a failure by Hanover Direct to comply with any term or condition of this Agreement, which failure shall not have been cured within fifteen (15) days after receipt of written notice thereof from Bank and which failure has a material adverse impact on the Bank’s ability to collect unpaid amounts directly related to the Purchase;

(c) For or any chargeback reason as set forth in the Operating Procedures (as may be amended from time to time pursuant to Section 2.3), or the Card Association rules and regulations (as applicable).

3.10 Assignment of Title in Charged Back Purchases. With respect to any amount of a Purchase to be charged back to and to be purchased by Hanover Direct, Hanover Direct shall either pay such amount directly to Bank in immediately available funds or Bank will offset such amount as part of the Net Proceeds to be paid to Hanover Direct, to the extent the balance thereof is sufficient. Upon payment of such amount by Hanover Direct to Bank, or off-setting, as the case may be, Bank shall assign and transfer to Hanover Direct, without recourse, all of Bank’s right, title and interest in and to such Purchase and deliver all documentation (or copies) in Bank’s possession with respect thereto. Hanover Direct further consents to all extensions or compromises given any Cardholder with respect to any such Purchase, and agrees that such shall not affect any liability of Hanover Direct hereunder or right of Bank to charge back any Purchase as provided in this Agreement; provided, however, that Bank shall not have the right to charge back for any Purchase the amount of any reductions, or compromises of amounts owed by a Cardholder to Bank. Hanover Direct shall not resubmit or re-transmit any charged back Purchases to Bank, without Bank’s prior written consent.

3.11 Promotion of Program and Card Program; Non-Competition. (a) Hanover Direct agrees to actively and consistently market, promote, participate in and support the Program as set forth in this Agreement. During the Term of this Agreement, Hanover Direct and its Affiliates shall not without Bank’s prior written consent, by itself or in conjunction with others, directly or indirectly enter into a letter of intent or agreement or otherwise establish with any financial institution, credit card issuer or processor to provide or process on its own behalf, any credit card, charge card or debit card, consumer, revolving credit or any other credit or charge account or product that utilizes a plastic or provides promotional billing options to its customers; provided, however, that during the Term, Hanover Direct may solicit or enter into a letter of intent

or agreement with another credit card issuer/processor/provider, if activities with such third party shall only become effective on or after the expiration or termination of this Agreement Furthermore, during the Term of this Agreement, Hanover Direct and its Affiliates shall not participate in any rewards program, incentive program, or other loyalty program offered, sponsored or otherwise promoted by any card issuer or any card-related program which Bank reasonably believes encourages the use of a payment card other than a Credit Card, unless Hanover Direct offers substantially equal promotions and/or incentives to Customers to use the Credit Cards.

(a) Notwithstanding the foregoing, nothing contained in this Agreement will be construed to prohibit or prevent Hanover Direct from: (i) accepting as payment any major general purpose credit card (including without limitation, American Express Card, MasterCard, Visa, or Discover/NOVUS), or any form of general purpose debit card, as a means of payment by Cardholders for purchase of Goods and/or Services, or (ii) accepting as payment any fixed payment (closed end) credit programs for Applicants declined by Bank as a means of payment by Cardholders for purchase of Goods and/or Services; or (iii) entering into a contract with another credit card provider for a particular state after Bank has terminated the operation of the Program in such state pursuant to Section 9.4.

(b) Hanover Direct, Inc. shall be entitled to negotiate with and enter into an agreement with any third party with respect to the issuance of private label and co-branded bank credit cards for any New Business for which Bank has declined to issue Accounts pursuant to its right of first refusal under Section 2.1, however, such credit cards shall not be accepted by any of the Businesses as payment for Goods and/or Services during the Term of this Agreement.

3.12 Postage. Any increase(s) in the cost of mailing Account billing statements, form letters or new Credit Cards due to an increase in the first class pre-sort cost of postage from the United States Postal Service which increase occurs on or after the date of execution of this Agreement shall be shared equally by Hanover Direct and Bank. Adjustments will also be made for any subsequent decreases in the cost of postage. Bank will use commercially reasonable efforts to obtain the best bulk rate discount.

3.13 Reports. Bank will deliver to Hanover Direct the reports set forth in Schedule 3.13 attached hereto as specified therein. Bank may provide any additional reports requested by Hanover Direct upon such terms and at the costs mutually agreed to by the parties.

SECTION 4. REPRESENTATIONS AND WARRANTIES OF HANOVER DIRECT

Hanover Direct hereby represents and warrants to Bank as follows:

4.1 Organization, Power and Qualification. Hanover Direct, Inc. is a corporation duly organized, validly existing and in good standing under the laws of the state of Delaware and has full corporate power and authority to enter into this Agreement and to carry out the provisions of this Agreement. Hanover Direct, Inc. is

duly qualified and in good standing to do business in all jurisdictions where Hanover Direct, Inc. is located, except where the failure to so qualify would not have a material adverse effect on the business of the Hanover Direct, Inc. or where the failure to so qualify would not have a material adverse effect on Hanover Direct’s or Bank’s ability to continue operation of the Program.

4.2 Authorization, Validity and Non-Contravention. (a) This Agreement has been duly authorized by all necessary corporate proceedings, has been duly executed and delivered by Hanover Direct, Inc. on behalf of itself and its Merchant Affiliates and is a valid and legally binding agreement of Hanover Direct, Inc. and its Merchant Affiliates duly enforceable in accordance with its terms (except as such enforcement may be limited by bankruptcy, insolvency, reorganization, moratorium and other laws relating to or affecting creditors’ rights generally and by general equity principles).

(a) No consent, approval, authorization, order, registration or qualification of or with any court or regulatory authority or other governmental body having jurisdiction over Hanover Direct is required for, and the absence of which would adversely affect, the legal and valid execution and delivery of this Agreement, and the performance of the transactions contemplated by this Agreement. However, Hanover Direct, Inc. must obtain the written consent of its senior secured lender, Wachovia National Bank, N.A. (“Wachovia”) to this Agreement. Hanover Direct shall use reasonable commercial efforts to obtain such consent as soon as reasonably practicable. Hanover Direct, Inc. agrees to reimburse Bank for its direct out of pocket expenses incurred in connection with this Agreement if Hanover Direct, Inc. does not obtain Wachovia’s consent for any reason. Hanover Direct, Inc. shall give Bank written notification when such consent has been obtained.

(b) The execution and delivery of this Agreement by Hanover Direct, Inc. hereunder and the compliance by Hanover Direct with all provisions of this Agreement: (i) will not conflict with or violate any Applicable Law; and (ii) subject to the written consent of Hanover Direct, Inc.’s senior secured lender, Wachovia National Bank, N.A. (pursuant to Section 4.2 (c) above) will not conflict with or result in a breach of or default under any of the terms or provisions of any indenture, loan agreement or other contract or agreement under which Hanover Direct is an obligor or by which its property is bound where such conflict, breach or default would have a material adverse effect on Hanover Direct, nor will such execution, delivery or compliance violate or result in the violation of the Articles of Incorporation or By-Laws of Hanover Direct.

4.3 Accuracy of Information. All factual information furnished by Hanover Direct to Bank in writing at any time pursuant to any requirement of, or furnished in response to any written request of Bank under this Agreement or any transaction contemplated hereby has been, and all such factual information hereafter furnished by Hanover Direct to Bank will be, to Hanover Direct’s best knowledge and belief, true and accurate in every respect material to the transactions contemplated hereby on the date as of which such information was or will be stated or certified.

4.4 Validity of Charge Slips. (a) As of the date any Transaction Records are presented to Bank in accordance with the provisions of this Agreement, each Charge

Slip relating to such Transaction Records shall represent the obligation of a Cardholder in the respective amount set forth therein for Goods sold or Services rendered, together with applicable taxes, if any, and shall not involve any element of credit for any other purpose.

(a) As of the date any Transaction Records are presented to Bank in accordance with the provisions of this Agreement, Hanover Direct has no knowledge or notice of any fact or matter which would immediately or ultimately impair the validity of any Charge Slip relating to such Transaction Records, the transaction evidenced thereby, or its collectibility.

4.5 Compliance with Applicable Law. Any action or inaction taken by Hanover Direct, Hanover Direct’s employees (where Hanover Direct has a duty to act) in connection with the Program, the Loyalty Program, and the sales of Goods and/or Services shall be in compliance with all Applicable Law except where the failure to comply does not or will not have an adverse effect on Hanover Direct, the Bank or the Program.

4.6 Hanover Direct’s Name, Trademarks and Service Marks. Hanover Direct has the legal right to use and to permit the Bank to use, to the extent set forth herein, Hanover Direct’s Marks.

4.7 Intellectual Property Rights. In the event Hanover Direct provides any software, technology or hardware to Bank, Hanover Direct has the legal right to such software, technology or hardware and the right to permit Bank to use such software, technology or hardware, and such use shall not violate any intellectual property rights of any third party. Any software or other technology developed by Hanover Direct or its Affiliates or developed for Hanover Direct or its Affiliates at Hanover Direct’s expense, to facilitate the Program, including but not limited to, software and software modifications developed in response to Bank’s request or to accommodate Bank’s special requirements and all derivative works, regardless of the developer thereof, will remain the exclusive property of Hanover Direct and/or its Affiliates. Nothing in this Agreement shall be deemed to convey a proprietary interest to Bank or any third party in any of the software, hardware, technology or any of the derivative works thereof which are owned or licensed by Hanover Direct and/or its Affiliates.

SECTION 5. COVENANTS OF HANOVER DIRECT

Hanover Direct hereby covenants and agrees as follows:

5.1 Notices of Changes. Hanover Direct will as soon as reasonably possible notify Bank of any: (a) change in the name or form of business organization of Hanover Direct, change in the location of its chief executive office or the location of the office where its records concerning the Program are kept; (b) merger or consolidation of Hanover Direct or the sale of a significant portion of its stock or of any substantial amount of its assets not in the ordinary course of business or any change in the control of Hanover Direct; (c) material adverse change in its financial condition or operations or the commencement of any litigation which would have a material adverse effect on

Hanover Direct; (d) the planned opening or closing of any Business, location or Hanover Direct Store; or (e) any change in business practices of Hanover Direct that would have a material adverse effect on this Agreement or the Program. Hanover Direct will furnish such additional information with respect to any of the foregoing as Bank may request for the purpose of evaluating the effect of such change on the financial condition and operations of Hanover Direct and on the Program.

5.2 Financial Statements. Hanover Direct, Inc. shall furnish to Bank as soon as available the following information pertaining to Hanover Direct, Inc.: (a) a consolidated balance sheet as of the close of each fiscal year; (b) a consolidated statement of income, retained earnings and paid-in capital to the close of each fiscal year; (c) a consolidated statement of cash flow to the close of each such period; and (d) a copy of the opinion submitted by Hanover Direct, Inc.’s independent certified public accountants in connection with such of the financial statements as have been audited. Hanover Direct, Inc. may satisfy the requirements of this Section by filing its annual report on Form 10-K with the SEC.

5.3 Inspection. Hanover Direct will permit, once per Program Year, unless Bank has reasonable cause to do so more frequently, authorized representatives designated by Bank, at Bank’s expense, to visit and inspect, to the extent permitted by Applicable Law, Hanover Direct’s books and records pertaining to Transaction Records and the Program and to make copies and take extracts there from, and to discuss the same with its officers and independent public accountants, all at reasonable times during normal business hours.

5.4 Hanover Direct’s Business. Hanover Direct shall do or cause to be done all things necessary to preserve and keep in full force and effect its corporate existence and to comply with all Applicable Laws in connection with its business and the sale of Goods and/or Services. Hanover Direct shall discuss with Bank annually its estimated forecast of Hanover Direct’s total sales and estimated forecasted number of stores, for the next year. Bank acknowledges and agrees that all such discussions shall contain non-public highly confidential information, that this information may constitute “insider information” for purposes of securities laws, and that this information may not be used or disclosed by Bank other than in furtherance of Bank obligations under this Agreement.

5.5 Hanover Direct’s Employees. Hanover Direct shall cause all of Hanover Direct’s employees to comply with the obligations, restrictions and limitations of this Agreement as such are applicable at the point of sale of the Goods and/or Services.

5.6 Insurance. Hanover Direct shall maintain insurance policies with insurers and in such amounts and against such types of loss and damage as are customarily maintained by other companies within Hanover Direct’s industry engaged in similar businesses as Hanover Direct.

SECTION 6. REPRESENTATIONS AND WARRANTIES OF BANK

Bank hereby represents and warrants to Hanover Direct as follows:

6.1 Organization, Power and Qualification. Bank is a national banking association duly organized, validly existing and in good standing under the laws of the United States of America and has full corporate power and authority to enter into this Agreement and to carry out the provisions of this Agreement. Bank is duly qualified and in good standing to do business in all jurisdictions where such qualification is necessary for Bank to carry out its obligations under this Agreement.

6.2 Authorization, Validity and Non-Contravention. (a) This Agreement has been duly authorized by all necessary proceedings, has been duly executed and delivered by Bank and is a valid and legally binding agreement of Bank duly enforceable in accordance with its terms (except as such enforcement may be limited by bankruptcy, insolvency, reorganization, moratorium and other laws relating to or affecting creditors’ rights generally and by general equity principles).

(b) The execution and delivery of this Agreement by Bank hereunder and the compliance by Bank with all provisions of this Agreement: (i) will not conflict with or violate any Applicable Law; (ii) will not conflict with or result in a breach of the terms or provisions of any indenture, loan agreement or other contract or agreement under which Bank is an obligor or by which its property is bound where such conflict, breach or default would have a material adverse effect on Bank, nor will such execution, delivery or compliance violate or result in the violation of the Charter or By-Laws of Bank.

6.3 Accuracy of Information. All factual information furnished by Bank to Hanover Direct in writing at any time pursuant to any requirement of, or furnished in response to any written request of Hanover Direct under this Agreement or any transaction contemplated hereby has been, and all such factual information hereafter furnished by Bank to Hanover Direct will be, to Bank’s best knowledge and belief, true and accurate in every respect material to the transactions contemplated hereby on the date as of which such information has or will be stated or certified.

6.4 Compliance with Applicable Law. Any action or inaction taken by Bank (where Bank has a duty to act) in connection with the Program shall be in compliance with all Applicable Law except where the failure to so comply does not or will not have an adverse effect on the Bank, Hanover Direct or the Program.

6.5 Intellectual Property Rights. In the event Bank provides any software or hardware to Hanover Direct, Bank has the legal right to such software or hardware and the right to permit Hanover Direct to use such software or hardware, and such use shall

not violate any intellectual property rights of any third party. Any software or other technology developed by Bank or its Affiliates or developed for Bank or its Affiliates at Bank’s expense, to facilitate the Program, including but not limited to, software and software modifications developed in response to Hanover Direct’s request or to accommodate Hanover Direct’s special requirements and all derivative works, regardless of the developer thereof, will remain the exclusive property of Bank and/or its Affiliates. Nothing in this Agreement shall be deemed to convey a proprietary interest to Hanover Direct or any third party in any of the software, hardware, technology or any of the derivative works thereof which are owned or licensed by Bank and/or its Affiliates.

SECTION 7. COVENANTS OF BANK

Bank hereby covenants and agrees as follows:

7.1 Notices of Changes. Bank will as soon as reasonably possible notify Hanover Direct of any: (a) change in the name or form of business organization of Bank, change in the location of its chief executive office or the location of the office where its records concerning the Program are kept; (b) merger or consolidation of Bank or the sale of a significant portion of its stock or of any substantial amount of its assets not in the ordinary course of business or any change in the control of Bank; (c) material adverse change in its financial condition or operations or the commencement of any litigation which would have a material adverse effect on the Program. Bank will furnish such additional information with respect to any of the foregoing as Hanover Direct may request for the purpose of evaluating the effect of such transaction on the financial condition and operations of Bank and on the Program.

7.2 Financial Statement. Bank shall furnish to Hanover Direct upon request by Hanover Direct and as soon as available the following information pertaining to Bank: (a) a consolidated balance sheet as of the close of each fiscal year; (b) a consolidated statement of income, retained earnings and paid-in capital to the close of each fiscal year; (c) a consolidated statement of cash flow to the close of each such period; and (d) a copy of the opinion submitted by Bank’s independent certified public accountants in connection with such of the financial statements as have been audited.

7.3 Inspection. Bank will permit, once per Program Year unless Hanover Direct has reasonable cause to do so more frequently, authorized representatives designated by Hanover Direct, at Hanover Direct’s expense, to visit and inspect, to the extent permitted by Applicable Law, any of Bank’s books and records pertaining to the Discount Fees, Purchases, and Enhancement Marketing Services revenues and expenses set forth in Section 2.9, and to make copies and take extracts there from, and to discuss the same with its officers and independent public accountants, all at reasonable times during normal business hours. Bank shall permit Hanover Direct, once per Program Year, during normal business hours and upon reasonable notice, and in a manner which does not disrupt the operations, to visit the offices at which services relating to the Program are provided, to monitor the activities of Bank and its subcontractors.

7.4 Bank’s Business. Bank shall do or cause to be done all things necessary to preserve and keep in full force and effect its corporate existence and to comply with all Applicable Laws in connection with its business and the issuance of credit by Bank.

7.5 Insurance. Bank shall maintain insurance policies with insurers and in such amounts and against such types of loss and damage as are customarily maintained by other banks engaged in similar businesses as Bank.

SECTION 8. INDEMNIFICATION

8.1 Indemnification Obligations. (a) Hanover Direct shall be liable to and shall indemnify and hold Bank and its Affiliates and their respective officers, directors, employees, subcontractors and their successors and assigns, harmless from any and all Losses (as hereinafter defined) incurred by reason of: (i) Hanover Direct’s breach of any representation, warranty or covenant hereunder; (ii) Hanover Direct’s failure to perform its obligations hereunder; (iii) any damage caused by or related to Goods or Services charged to an Account; and (iv) any action or failure to act by Hanover Direct (where Hanover Direct has a duty to act) and their respective officers, directors and employees which results in a claim against Bank, its officers, employees, Affiliates, unless the proximate cause of any such claim is an act or failure to act by Bank, its officers, directors or employees.

(a) Bank shall be liable to and shall indemnify and hold Hanover Direct and its Affiliates and their respective officers, directors, employees, sub-contractors and their successors and assigns, harmless from any and all Losses (as hereinafter defined) incurred by reason of: (i) Bank’s breach of any representation, warranty or covenant hereunder; (ii) Bank’s failure to perform its obligations hereunder; and (iii) any action or failure to act by Bank (where Bank has a duty to act) and its officers, directors, and employees which results in a claim against Hanover Direct, its officers, employees, Affiliates, unless the proximate cause of any such claim is an act or failure to act by Hanover Direct and its respective officers, directors or employees.

(b) For purposes of this Section 8.1 the term “Losses” shall mean any liability, damage, costs, fees, losses, judgments, penalties, fines, and expenses, including without limitation, any reasonable attorneys’ fees, disbursements, settlements (which require the other party’s consent which shall not be unreasonably withheld), and court costs, reasonably incurred by Bank or Hanover Direct, as the case may be, without regard to whether or not such Losses would be deemed material under this Agreement except that Losses may not include any overhead costs that either party would normally incur in conducting its everyday business.

8.2 LIMITATION ON LIABILITY. (a) IN NO EVENT SHALL EITHER PARTY BE LIABLE TO THE OTHER PARTY FOR ANY INCIDENTAL, INDIRECT, SPECIAL OR CONSEQUENTIAL DAMAGES ARISING OUT OF THIS AGREEMENT, PROVIDED, HOWEVER, THAT THIS LIMITATION SHALL NOT APPLY WITH RESPECT TO A PARTY’S INTENTIONAL BREACH OF THIS AGREEMENT.

(a) BANK’S TOTAL ANNUAL LIABILITY TO HANOVER DIRECT FOR ALL DAMAGES FOR ANY CAUSE WHATSOEVER DURING ANY YEAR OF THE TERM OF THIS AGREEMENT, SHALL NOT EXCEED ONE MILLION DOLLARS ($1,000,000). BANK’S TOTAL CUMULATIVE LIABILITY TO HANOVER DIRECT FOR ALL DAMAGES FOR ANY CAUSE WHATSOEVER, SHALL NOT EXCEED FIVE MILLION DOLLARS ($5,000,000) PROVIDED, HOWEVER, THAT THIS LIMITATION SHALL NOT APPLY WITH RESPECT TO BANK’S INTENTIONAL BREACH OF THIS AGREEMENT.

(b) HANOVER DIRECT’S TOTAL ANNUAL LIABILITY TO BANK FOR ALL DAMAGES FOR ANY CAUSE WHATSOEVER DURING ANY YEAR OF THE TERM OF THIS AGREEMENT, SHALL NOT EXCEED ONE MILLION DOLLARS ($1,000,000). HANOVER DIRECT’S TOTAL CUMULATIVE LIABILITY TO BANK FOR ALL DAMAGES FOR ANY CAUSE WHATSOEVER, SHALL NOT EXCEED FIVE MILLION DOLLARS ($5,000,000) PROVIDED, HOWEVER, THAT THIS LIMITATION SHALL NOT APPLY WITH RESPECT TO HANOVER DIRECT’S INTENTIONAL BREACH OF THIS AGREEMENT.

8.3 NO WARRANTIES. EXCEPT AS PROVIDED HEREIN, THERE ARE NO EXPRESS OR IMPLIED WARRANTIES, INCLUDING THE IMPLIED WARRANTIES OF MERCHANTABILITY AND FITNESS FOR A PARTICULAR PURPOSE, RESPECTING THE SERVICES AND/OR OTHER PRODUCTS SOLD OR PROVIDED BY BANK PURSUANT TO THIS AGREEMENT.

8.4 Notification of Indemnification; Conduct of Defense. (a) In no case shall the indemnifying party be liable under Section 8.1 of this Agreement with respect to any claim or claims made against the indemnified party or any other person so indemnified unless it shall be notified in writing of the nature of the claim within a reasonable time after the assertion thereof, but failure to so notify the indemnifying party shall not relieve it from any liability which it may have under other provisions of this Agreement.

(a) The indemnifying party shall be entitled to participate, at its own expense, in the defense, or, if it so elects, within a reasonable time after receipt of such notice, to assume the defense of any suit brought against the indemnified party which gives rise to a claim against the indemnifying party, but, if the indemnifying party so elects to assume the defense, such defense shall be conducted by counsel chosen by it and approved by the indemnified party or the person or persons so indemnified, who are the defendant or defendants in any suit so brought, which approval shall not be unreasonably withheld. If the indemnifying party elects to assume the conduct of the defense of any suit brought to enforce any such claim and retains counsel to do so, the indemnified party or the person or persons so indemnified who are the defendant or defendants in the suit, shall bear the fees and expenses of any additional counsel thereafter retained by the indemnified party or such other person or persons.

SECTION 9. TERM AND TERMINATION

9.1 Term. This Agreement shall become effective as of the Effective Date when executed by authorized officers of each of the parties and shall remain in effect for

seven (7) years from the Program Commencement Date plus any additional calendar days needed to end the Term on the last day of a calendar month (the “Initial Term”) and shall automatically renew for successive two (2) year terms (each a “Renewal Term”) thereafter unless either party provides the other with at least one hundred eighty (180) days’ written notice of its intention to terminate the Agreement prior to the expiration of the Initial or then current Renewal Term, or unless otherwise terminated as provided herein.

9.2 Termination with Cause by Bank; Bank Termination Events. Any of the following conditions or events shall constitute a “Bank Termination Event” hereunder, and Bank may terminate this Agreement immediately without further action if such Bank Termination Event occurs:

(a) If Hanover Direct shall: (i) generally not pay its debts as they become due; (ii) file, or consent by answer or otherwise to the filing against it, of a petition for relief, reorganization or arrangement or any other petition in bankruptcy, for liquidation or to take advantage of any bankruptcy or insolvency law of any jurisdiction; (iii) make an assignment for the benefit of its creditors; (iv) consent to the appointment of a custodian, receiver, trustee or other officer with similar powers of itself or of any substantial part of its property; (v) be adjudicated insolvent or be liquidated; (vi) take corporate action for the purpose of any of the foregoing and such event shall materially adversely affect the ability of Hanover Direct to perform under this Agreement or the Program; (vii) have a materially adverse change in its financial condition, including, but not limited to receiving a material bond downgrade or being downgraded by a rating agency to a rating below an investment grade rating; or (viii) receive an adverse opinion by its auditors or accountants as to its viability as a going concern; or (ix) breach or fail to perform or observe any material covenant or other material term contained in any creditor loan agreement, debt instrument or any other material agreement to which it is bound, which breach or failure, if left uncured could result in a default of such agreement and which breach or failure would materially adversely affect the ability of Hanover Direct to perform under this Agreement or the Program; or

(b) If a court or government authority of competent jurisdiction shall enter an order appointing, without consent by Hanover Direct, a custodian, receiver, trustee or other officer with similar powers with respect to it or with respect to any substantial part of its property, or if an order for relief shall be entered in any case or proceeding for liquidation or reorganization or otherwise to take advantage of any bankruptcy or insolvency law of any jurisdiction, or ordering the dissolution, winding up or liquidation of Hanover Direct, or if any petition for any such relief shall be filed against Hanover Direct and such petition shall not be dismissed within sixty (60) days; or

(c) If Hanover Direct shall default in the performance of or compliance with any term or violates any of the covenants, representations, warranties or agreements contained in this Agreement and Hanover Direct shall not have remedied such default within thirty (30) days after written notice thereof shall have been received by Hanover Direct from Bank;

(d) If at anytime the type of Goods and/or Services sold by Hanover Direct materially changes from the type of Goods and/or Services sold by Hanover Direct on the date of execution of this Agreement;

(e) If there are any changes in business practices of Hanover Direct that would have a material adverse effect on this Agreement or the Program; or

(f) If Hanover Direct, Inc. does not obtain the written consent of Wachovia pursuant to Section 4.2(b).

9.3 Termination with Cause by Hanover Direct; Hanover Direct Termination Events. Any of the following conditions or events shall constitute a “Hanover Direct Termination Event” hereunder, and Hanover Direct may terminate this Agreement immediately without further action if such Hanover Direct Termination Event occurs:

(a) If Bank shall: (i) generally not be paying its debts as they become due; (ii) file or consent by answer or otherwise to the filing against it, of a petition for relief, reorganization or arrangement or any other petition in bankruptcy, for liquidation or to take advantage of any bankruptcy or insolvency law of any jurisdiction; (iii) make an assignment for the benefit of its creditors; (iv) consent to the appointment of a custodian, receiver, trustee or other officer with similar powers for itself or of any substantial part of its property; (v) be adjudicated insolvent or be liquidated; or (vi) take corporate action for the purpose of any of the foregoing and such event shall materially adversely affect the ability of Bank to perform under this Agreement or the operation of the Program and such event shall materially adversely affect the ability of Bank to perform under this Agreement or the Program; or (vii) have a materially adverse change in its financial condition, including, but not limited to being downgraded by a rating agency to a rating below an investment grade rating; or (viii) receive an adverse opinion by its auditors or accountants as to its viability as a going concern; or (ix) breach or fail to perform or observe any material covenant or other material term contained in any creditor loan agreement, debt instrument or any other material agreement to which it is bound, which breach or failure, if left uncured could result in a default of such agreement and which breach or failure would materially adversely affect the ability of Bank to perform under this Agreement or the Program; or

(b) If a court or government authority of competent jurisdiction shall enter an order appointing, without consent by Bank, a custodian, receiver, trustee or other officer with similar powers with respect to it or with respect to any substantial part of its property, or if an order for relief shall be entered in any case or proceeding for liquidation or reorganization or otherwise to take advantage of any bankruptcy or insolvency law of any jurisdiction, or ordering the dissolution, winding up or liquidation of Bank, or if any petition for any such relief shall be filed against Bank and such petition shall not be dismissed within sixty (60) days; or

(c) Except with respect to the Service Standards, if Bank shall default in the performance of or compliance with any term or violates any of the covenants, representations, warranties or agreements contained in this Agreement and Bank shall not have remedied such default within thirty (30) days (ten (10) days in the case of

failure to pay Hanover Direct pursuant to Section 3.6(a)) after written notice of the default thereof shall have been received by Bank from Hanover Direct; or

(d) If Bank fails for three (3) consecutive months to perform any one (1) of the same Service Standards in a Service Factor Category, and such failure is not the result of an act of Hanover Direct, or as a result of a force majeure event specified in Section 10.11, and Bank fails to remedy such failure within thirty (30) days after receipt of written notice from Hanover Direct; or

(e) In the event Bank assigns the Agreement to a third party pursuant to Section 10.4 and within the first twelve (12) months after the assignment the assignee materially changes any of the credit underwriting standards or Cardholder credit repayment terms or fees from the credit underwriting standards and/or Cardholder credit repayment terms or fees in effect by Bank prior to the assignment of the Agreement by Bank and assignee fails to revise, amend or correct the changes, within thirty (30) days after receiving written notice from Hanover Direct (which notice must be given by Hanover Direct within the first twelve (12) months after the assignment by Bank), in such a manner that the change will no longer result in a material change, then Hanover Direct shall have the right to terminate this Agreement upon thirty (30) days’ prior written notice to Bank’s assignee; or

(f) If Hanover Direct, Inc. does not obtain the written consent of Wachovia pursuant to Section 4.2(b).

9.4 Termination By Mutual Agreement. The parties agree that they may terminate the operation of the Program, by mutual written agreement, in the event that both parties determine that the Program is not profitable.

9.5 Termination of Particular State. In addition, Bank may terminate the operation of the Program in a particular state or jurisdiction if the Applicable Law of the state or jurisdiction is amended or interpreted in such a manner so as to render all or any part of the Program illegal or unenforceable, and in such event Bank will, if requested, (i) assist Hanover Direct with finding a new credit provider for such state or jurisdiction and will permit Hanover Direct or its designee with the option to purchase all unpaid and outstanding Accounts belonging to Cardholders with billing addresses in such state at a purchase price equal to the fair market value of the Account which shall be a function of the receivables related thereto, including without limitation all accrued finance charges and fees, whether or not billed or posted to the Accounts; or (ii) wind down the Program in the particular state and continue to own and service the receivables for Cardholders with billing addresses in such state.

9.6 Sale or Transfer of a Business. In the event Hanover Direct sells or otherwise transfers its ownership interest in all or substantially all of the assets of or relating to any Business to an un-Affiliated party, Hanover Direct shall use commercially reasonable efforts to assist the party acquiring such ownership interests or assets to enter into a new private label agreement with Bank, upon approval by Bank of the acquiring party, such approval not to be unreasonably withheld or delayed, governing continuation of the Plan for the related Business on substantially the same terms and

conditions as set forth in this Agreement, including, without limitation, a term for the new private label agreement which is equal to the balance of the Initial Term or any Renewal Term then in effect.

9.7 Purchase of Accounts. Upon the termination of this Agreement by either party, Hanover Direct, Inc. or its designated new credit provider shall purchase from Bank all unpaid and outstanding Accounts and the listing of names and addresses of such Cardholders at purchase price equal to the fair market value of the Account and receivables related thereto, including without limitation all accrued and unpaid finance charges and fees, whether or not billed or posted to the Accounts. Notwithstanding the foregoing, Hanover Direct shall not be required to purchase from Bank all unpaid and outstanding Accounts in the case of a termination by Hanover Direct for a Hanover Direct Termination Event pursuant to Section 9.3 (a), (b), (c), (d) or (e).

9.8 Termination of Program Participation. In the case of either termination of the Agreement or termination of the Program in a particular state and upon payment of the purchase price to Bank, (a) Bank shall assign to Hanover Direct or its designee, without recourse, all of its right, title and interest in and to the Accounts and receivables related thereto being transferred and will deliver all related documentation. For purposes of this section, “without recourse” shall not be construed as a limitation on the survival of the Bank’s obligations pursuant to Section 10.13 below; and (b) Bank shall cooperate with Hanover Direct and its designee, if any, to effect the transfer of Accounts and receivables, and shall bear the reasonable expense of its own transition costs therefor.

9.9 Wind Down of Operations. At the date of expiration of this Agreement or earlier termination, as the case may be, all fulfillment obligations of Hanover Direct and Bank with respect to credit card transactions processed until the earlier to occur of the date of termination or date of termination advertised to Cardholders, as mutually agreed-upon, shall continue with regard to orders received prior to and through the close of business on the termination date, including all items on backorder, in compliance with the Federal Trade Commission’s Mail and Telephone Merchandise Order Rule.

SECTION 10. MISCELLANEOUS

10.1 Entire Agreement. This Agreement constitutes the entire Agreement and supersedes all prior agreements and understandings, whether oral or written, among the parties hereto with respect to the subject matter hereof and merges all prior discussions between them.

10.2 Coordination of Public Statements. Bank is a subsidiary of Alliance Data Systems Corporation which, as a public company, may issue a news release disclosing this Agreement between Hanover Direct and Bank, however, such news release shall be approved by both parties prior to its issuance. In all other cases, except as required by Applicable Law, neither party will make any public announcement of the Program or provide any information concerning the Program to any representative of any news, trade or other media without the prior approval of the other party, which approval will not

be unreasonably withheld. Neither party will respond to any inquiry from any public or governmental authority, except as required by Applicable Law, concerning the Program without prior consultation and coordination with the other party. Upon Bank’s reasonable request from time to time, and with Hanover Direct’s prior written approval, Hanover Direct shall provide references or participate in marketing campaigns or testimonial initiatives for Bank regarding the services provided by Bank in connection with the Program.

10.3 Amendment. Except as otherwise provided for in this Agreement, the provisions herein may be modified only upon the mutual agreement of the parties, however, no such modification shall be effective until reduced to writing and executed by both parties.

10.4 Successors and Assigns. This Agreement and all obligations and rights arising hereunder shall be binding upon and inure to the benefit of the parties hereto and their respective successors, transferees and assigns. Either party may assign its rights and obligations under this Agreement.

10.5 Waiver. No waiver of the provisions hereto shall be effective unless in writing and signed by the party to be charged with such waiver. No waiver shall be deemed to be a continuing waiver in respect of any subsequent breach or default either of similar or different nature unless expressly so stated in writing. No failure or delay on the part of either party in exercising any power or right under this Agreement shall be deemed to be a waiver, nor does any single or partial exercise of any power or right preclude any other or further exercise, or the exercise of any other power or right.

10.6 Severability. If any of the provisions or parts of the Agreement are determined to be illegal, invalid or unenforceable in any respect under any applicable statute or rule of law, such provisions or parts shall be deemed omitted without affecting any other provisions or parts of the Agreement which shall remain in full force and effect, unless the declaration of the illegality, invalidity or unenforceability of such provision or provisions substantially frustrates the continued performance by, or entitlement to benefits of, either party, in which case this Agreement may be terminated by the affected party, without penalty.

10.7 Notices. All communications and notices pursuant hereto to either party shall be in writing and addressed or delivered to it at its address shown below, or at such other address as may be designated by it by notice to the other party, and shall be deemed given when delivered by hand, or two (2) Business Days after being mailed (with postage prepaid) or when received by receipted courier service:

If to Bank:

World Financial Network National Bank

800 Tech Center Drive

Gahanna, OH 43230

Attn.: Daniel T. Groomes, President

With a Copy to:

ADS Alliance Data Systems, Inc.

800 Tech Center Drive

Gahanna, OH 43230

Attn.: Karen A. Morauski, VP and Counsel

If to Hanover Direct:

Hanover Direct, Inc.

1500 Harbor Blvd.

Weehawken, NJ 07086
Attn.: Mike Contino,
Chief Operating Officer

With a Copy to:

Hanover Direct, Inc.

1500 Harbor Blvd.
Weehawken, NJ 07086

Attn: Legal Department

10.8 Captions and Cross-References. The table of contents and various captions in this Agreement are included for convenience only and shall not affect the meaning or interpretation of any provision of this Agreement. References in this Agreement to any Section are to such Section of this Agreement.

10.9 GOVERNING LAW. THIS AGREEMENT SHALL BE A CONTRACT MADE UNDER AND GOVERNED BY THE INTERNAL LAWS OF THE STATE OF OHIO, REGARDLESS OF THE DICTATES OF OHIO CONFLICT OF LAWS.

10.10 Counterparts. This Agreement may be signed in one (1) or more counterparts, all of which shall be taken together as one (1) agreement.

10.11 Force Majeure. Neither party will be responsible for any failure or delay in performance of its obligations under this Agreement because of circumstances beyond its reasonable control, and not due to the fault or negligence of such party, including, but not limited to, acts of God, flood, criminal acts, fire, riot, computer viruses or hackers where such party has utilized commercially reasonable means to prevent the same, accident, strikes or work stoppage, embargo, sabotage, inability to obtain material, equipment or phone lines, government action (including any laws, ordinances, regulations or the like which restrict or prohibit the providing of the services contemplated by this Agreement), and other causes whether or not of the same class or kind as specifically named above. In the event a party is unable to perform substantially for any of the reasons described in this Section, it will notify the other party promptly of its inability so to perform, and if the inability continues for at least one-hundred eighty (180) consecutive days (thirty (30) days in the cases of credit authorizations and processing of new Accounts and sixty (60) days in the cases of failures related to Bank’s Account billing system or Account payment processing system), the party so notified may then terminate this Agreement forthwith. This provision shall not, however, release the party unable to perform from using its best efforts to avoid or remove such circumstance and such party unable to perform shall continue performance hereunder with the utmost dispatch whenever such causes are removed.

10.12 Relationship of Parties. This Agreement does not constitute the parties as partners, joint venturers nor any other form of business organization and neither party will so represent itself.

10.13 Survival. No termination of this Agreement shall in any way affect or impair the powers, obligations, duties, rights, indemnities, liabilities, covenants or warranties and/or representations of the parties with respect to times and/or events occurring prior to such termination. No powers, obligations, duties, rights, indemnities, liabilities,

covenants or warranties and/or representations of the parties with respect to times and/or events occurring after termination shall survive termination except for the following Sections: Section 2.10, Section 3.3, Section 3.5, Section 3.6, Section 3.8, Section 3.9, Section 3.10, Section 8, Section 9. 7, Section 9. 8, Section 9.9, Section 10.7, Section 10.9, Section 10.11, Section 10.17 and Section 10.18.

10.14 Mutual Drafting. This Agreement is the joint product of Hanover Direct and Bank and each provision hereof has been subject to mutual consultation, negotiation and agreement of Hanover Direct and Bank; therefore to the extent any language in this Agreement is determined to be ambiguous, it shall not be construed for or against any party based on the fact that either party controlled the drafting of the document.

10.15 Independent Contractor. The parties hereby declare and agree that Bank is engaged in an independent business, and shall perform its obligations under this Agreement as an independent contractor; that any of Bank’s personnel performing the services hereunder are agents, employees, Affiliates, or subcontractors of Bank and are not agents, employees, Affiliates, or subcontractors of Hanover Direct; that Bank has and hereby retains the right to exercise full control of and supervision over the performance of Bank’s obligations hereunder and full control over the employment, direction, compensation and discharge of any and all of the Bank’s agents, employees, Affiliates, or subcontractors, including compliance with workers’ compensation, unemployment, disability insurance, social security, withholding and all other federal, state and local laws, rules and regulations governing such matters; that Bank shall be responsible for Bank’s own acts and those of Bank’s agents, employees, Affiliates, and subcontractors; and that except as expressly set forth in this Agreement, Bank does not undertake by this Agreement or otherwise to perform any obligation of Hanover Direct, whether regulatory or contractual, or to assume any responsibility for Hanover Direct’s business or operations.

10.16 No Third Party Beneficiaries. The provisions of this Agreement are for the benefit of the parties hereto and not for any other person or entity.

10.17 Confidentiality and Security Controls. (a) Neither party shall disclose any information not of a public nature concerning the business or properties of the other party which it learns as a result of negotiating or implementing this Agreement, including, without limitation, the terms and conditions of this Agreement, Customer names, Cardholder personal or Account information, sales volumes, test results, and results of marketing programs, Program reports generated by Bank, trade secrets, business and financial information, source codes, business methods, procedures, know-how and other information of every kind that relates to the business of either party except to the extent disclosure is required by applicable law, is necessary for the performance of the disclosing party’s obligation or realization of rights under this Agreement, or is agreed to in writing by the other party; provided that: (i) prior to disclosing any confidential information to any third party, the party making the disclosure shall give notice to the other party of the nature of such disclosure and of the fact that such disclosure will be made; and (ii) prior to filing a copy of this Agreement with any governmental authority or agency, the filing party will consult with the other party with respect to such filing and shall redact such portions of this Agreement which the other

party requests be redacted, unless, in the filing party’s reasonable judgment based on the advice of its counsel (which advice shall have been discussed with counsel to the other party), the filing party concludes that such request is inconsistent with the filing party’s obligations under applicable laws. Neither party shall acquire any property or other right, claim or interest, including any patent right or copyright interest, in any of the systems, procedures, processes, equipment, computer programs and/or information of the other by virtue of this Agreement. Neither party shall use the other party’s name for advertising or promotional purposes without such other party’s written consent.

(a) For purposes of clarity, each party agrees that, during the Term and for a period of two (2) years thereafter, it shall not make public or disclose to any third party, except as required by Applicable Law, the terms or substance of this Agreement, including pricing.

(b) The obligations of this Section, shall not apply to any information, (except for consumer personal information):

(i)	which is generally known to the trade or to the public at the time of such disclosure; or
(ii)	which becomes generally known to the trade or the public subsequent to the time of such disclosure; provided, however, that such general knowledge is not the result of a disclosure in violation of this Section; or
(iii)	which is obtained by a party from a source other than the other party, without breach of this Agreement or any other obligation of confidentiality or secrecy owed to such other party or any other person or organization; or
(iv)	which is independently conceived and developed by the disclosing party and proven by the disclosing party through tangible evidence not to have been developed as a result of a disclosure of information to the disclosing party, or any other person or organization which has entered into a confidential arrangement with the non-disclosing party; or
(v)	which Bank is required to report to a Card Association by such Card Association’s applicable rules and regulations.

(c) If any disclosure is made pursuant to the provisions of this Section, to any Affiliate or third party, the disclosing party shall be responsible for ensuring that such Affiliate or third party keeps all such information in confidence and that any third party executes a confidentiality agreement provided by the non-disclosing party. Each party covenants that at all times it shall have in place procedures designed to assure that each of its employees who is given access to the other party’s confidential information shall protect the privacy of such information. Each party acknowledges that any breach of the confidentiality provisions of this Agreement by it will result in irreparable damage

to the other party and therefore in addition to any other remedy that may be afforded by law any breach or threatened breach of the confidentiality provisions of this Agreement may be prohibited by restraining order, injunction or other equitable remedies of any court. The provisions of this Section will survive termination or expiration of this Agreement.

(d) Each party shall establish commercially reasonable controls to ensure the confidentiality of Cardholder and other confidential information and to ensure that Cardholder and other confidential information is not disclosed contrary to the provisions of this Agreement, or any applicable privacy, security or other laws, rules and regulations. Without limiting the foregoing, each party shall implement such physical and other security measures as are necessary to (i) ensure the security and confidentiality of Cardholder and other confidential information, (ii) protect against any threats or hazards to the security and integrity of Cardholder and other confidential information, and (iii) protect against any unauthorized access to or use of Cardholder and other confidential information.

(e) Hanover Direct shall notify Bank in the event it believes, or has reason to believe, that either a confidentiality or security breach, or any other unauthorized intrusion, has occurred with respect to Cardholder information and shall estimate the intrusion’s affect on Bank and shall specify the corrective action taken by it. Bank shall notify Hanover Direct in the event it believes, or has reason to believe, that either a confidentiality or security breach, or any other unauthorized intrusion, has occurred (1) with respect to Hanover Direct’s Customer information, or (2) with respect to Bank’s Cardholder Personal Information and requires notification to Cardholders by Bank under Applicable Law (Notice of Security Breach) or impacts more than 25% of the Cardholders, and Bank is not prohibited from notifying Hanover Direct of such event. For purposes of this section 10.17(f), “Cardholder Personal Information” means a Cardholder’s first name or first initial and last name in combination with any one or more of the following data elements, when either the name or the data elements are not encrypted: (1) social security number; (2) driver’s license number or other government identification number; (3) account number, credit or debit card number, in combination with any required security code, access code, or password that would permit access to an individual’s financial account; (4) address; or (5) date of birth; provided, however, that it shall not be deemed a confidentiality or security breach if the name is encrypted but data element (5) is unencrypted. With respect to Hanover Direct’s Customer information, Bank shall estimate the intrusion’s effect on Hanover Direct and Customers and shall specify the corrective action taken by it.

10.18 Taxes. Hanover Direct will be responsible for, and agrees to pay, all sales, use, excise, and value-added taxes, or taxes of a similar nature (excluding personal property taxes and taxes based on Bank’s income, net worth or capital stock which shall be borne by Bank), imposed by the United States, any state or local government, or other taxing authority, on all services provided by Bank under this Agreement. The parties agree to cooperate with each other to minimize any applicable sales, use, or similar tax and, in connection therewith, the parties shall provide each other with any relevant tax information as reasonably requested (including without limitation, resale or exemption certificates, multi-state exemption certificates, information concerning the

use of assets, materials and notices of assessments). All amounts set forth in this Agreement are expressed and shall be paid in lawful U.S. dollars.

(Signature block on following page.)

IN WITNESS WHEREOF, the parties hereto have executed this Agreement in manner and form sufficient to bind them as of the date first above written.

HANOVER DIRECT, INC.

on behalf of itself and its

Merchant Affiliates

By: /s/ Wayne P. Garten

Title: Chief Executive Officer

Date: September 22, 2005

WORLD FINANCIAL NETWORK

NATIONAL BANK

By: /s/ Ivan M. Szeftel

Title: Chief Executive Officer

Date: September 25, 2005

EX-10.08 9 exhibit10_08.htm

Exhibit 10.08

AMENDMENT NUMBER ONE TO

CREDIT CARD PROGRAM AGREEMENT

THIS AMENDMENT NUMBER ONE TO CREDIT CARD PROGRAM AGREEMENT (this “Amendment”) is made as of this 30^th day of March 2005, by and between Hanover Direct, Inc. (“Hanover Direct”), on behalf of itself and its Merchant Affiliates, with its principal office at 1500 Harbor Blvd., Weehawken, New Jersey 07086, and WORLD FINANCIAL NETWORK NATIONAL BANK (“Bank”), with its principal office at 800 Tech Center Drive, Gahanna, Ohio 43230.

RECITALS

WHEREAS, Hanover and Bank executed the Co-Brand and Private Label Credit Card Program Agreement (the “Agreement”), dated as of February 22, 2005 (all defined terms not otherwise defined shall have the same meaning as in the Agreement; Section references are to the sections of the Agreement);

WHEREAS, the parties wish to amend the Agreement as provided for herein;

NOW, THEREFORE, in consideration of the foregoing promises, and for other good and valuable consideration, the receipt and sufficiency of which is acknowledged, the parties agree as follows:

1.	Amendment to Section 3.9(c)

Section 3.9(c) is hereby deleted in its entirety and the following substituted therefor:

“(c) For or any chargeback reason as set forth in the Operating Procedures (as may be amended from time to time pursuant to Section 2.3), or the Card Association rules and regulations (as applicable) but only to the extent such chargeback is for Purchases.”

2.	Amendment of Section 9.2(a)(ix)

Section 9.2(a)(ix) is hereby deleted in its entirety and the following substituted therefor:

“(ix) breach or fail to perform or observe any material covenant or other material term contained in any creditor loan agreement, debt instrument or any other material agreement to which it is bound, (A) which breach or failure results in a default or event of default by Hanover Direct that continues for more than the applicable cure period, if any, or is not waived in writing by the parties thereto, (B) such default or event of default materially adversely affects the ability of Hanover Direct to perform under this Agreement or the Program, (C) in the case of any creditor loan agreement or debt instrument, the creditor under such loan agreement or debt instrument exercise its rights to accelerate the debt and to commence an action to collect the debt of Hanover Direct, and (D) in the case of

any material agreement that is not a creditor loan agreements or debt instrument, the other party terminates such material agreement; or”

2.	Amendment of Section 9.2(e)

Section 9.2(e) is hereby deleted in its entirety and the following substituted therefor:

“(e) If there are any material changes in Hanover Direct's business practices with respect to the delivery channels of its Goods and/or Services that would have a material adverse effect on this Agreement or the Program; or”

3.	Amendment of Section 9.3(a)(ix)

Section 9.3(a)(ix) is hereby deleted in its entirety and the following substituted therefor:

“(ix) breach or fail to perform or observe any material covenant or other material term contained in any creditor loan agreement, debt instrument or any other material agreement to which it is bound, (A) which breach or failure results in a default or event of default by Bank that continues for more than the applicable cure period, if any, or is not waived in writing by the parties thereto, (B) such default or event of default materially adversely affects the ability of Hanover Direct to perform under this Agreement or the Program, (C) in the case of any creditor loan agreement or debt instrument, the creditor under such loan agreement or debt instrument exercise its rights to accelerate the debt and to commence an action to collect the debt of Bank, and (D) in the case of any material agreement that is not a creditor loan agreement or debt instrument, the other party terminates such material agreement; or”

4.	Amendment of Section 9.7.

Section 9.7 is hereby deleted in its entirety and the following substituted therefor:

“9.7	Purchase of Accounts.

(a) Upon the expiration or termination of this Agreement by either party for any reason other than a Hanover Direct Termination Event, Hanover Direct or its designated new credit provider shall purchase from Bank all unpaid and outstanding Private Label Accounts and the listing of names and addresses of such Cardholders at a purchase price equal to the fair market value of the Private Label Account and receivables related thereto, including, without limitation, all accrued and unpaid finance charges and fees due and owing by the Cardholder with respect to the Private Label Accounts. Such purchase must be completed upon the termination of the Agreement.

(b) Upon the expiration or termination of this Agreement by either party for any reason, Hanover shall have the option, upon 180 days prior written notice to

Bank (upon 60 days written notice to Bank after the occurrence of a Hanover Direct Termination Event or Bank Termination Event), to require that Bank sell to the replacement private label credit provider all unpaid and outstanding Co-Brand Accounts and the listing of names and addresses of such Cardholders at purchase price equal to the fair market value of the Co-Brand Account and receivables related thereto, including, without limitation, all accrued and unpaid finance charges and fees due and owing by the Cardholder with respect to the Co-Brand Accounts. Such purchase must be completed within 60 days after the termination of the Agreement.

(c) For purposes of this Section 9.7, the fair market value of an Account shall be the price that an unrelated third party is willing to pay for such Account.”

5.	No Other Modifications

Except as otherwise modified herein, the Agreement shall remain in full force and effect. To the extent that any provision of the Agreement conflicts with any provision of this Amendment, the provision of this Amendment shall control.

[signatures on following page]

IN WITNESS WHEREOF, the parties hereto have executed this First Amendment to Credit Card Program Agreement in manner and form sufficient to bind them as of the date first above written.

HANOVER DIRECT, INC.

on behalf of itself and its

Merchant Affiliates

By: /s/ Wayne P. Garten

Title: President and Chief Executive Officer

Date: March 30, 2005

WORLD FINANCIAL NETWOR

NATIONAL BANK

By: /s/ Daniel T. Groomes

Title: President

Date: March 31, 2005

EX-99.01 10 exhibit99_01.htm

Exhibit 99.01

KPMG LLP

345 Park Avenue

New York, NY 10154

September 22, 2005

Mr. Wayne Garten

Chief Executive Officer

Hanover Direct, Inc.

1500 Harbor Boulevard

Weehawken, NJ 07086

Dear Wayne:

As you requested, I have summarized for you below the additional work that KPMG will need to perform. Please remember that this summary is by no means all inclusive and, depending on the results of this work, could lead to additional procedures.

Due to the nature of the items causing the restatement adjustments, as well as consideration of the three material weaknesses noted in our draft letter to the Audit Committee, we need to re-assess the nature and extent of audit procedures performed on the December 29, 2001 balance sheet audited by Arthur Andersen (any further issues in this balance sheet could potentially impact the 2002 income statement), in addition to the nature and extent of the audit procedures performed by KPMG for the 2003 and 2002 audits. After this re-assessment, in all likelihood we will need to perform additional procedures in certain areas for each of these periods (inclusive of the balance sheet at December 29, 2001).

I cannot estimate for you when these procedures will be completed nor the extent of our additional work, and therefore I can only provide you with a wide range of estimated additional fees. I currently believe that these additional fees, inclusive of additional time incurred to date, will range from $300,000 to $450,000. At a minimum, I foresee a minimum of at least one month of additional work, inclusive of review.

If you have any questions, please give me a call.

Sincerely,

/s/ Mark Slosberg

Mark Slosberg

Partner

EX-99.02 11 exhibit99_02.htm

DRAFT

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

_______________

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For The Fiscal Year Ended December 25, 2004

Commission File Number 1-08056

_______________

HANOVER DIRECT, INC.

(Exact Name of Registrant as Specified in Its Charter)

Delaware	13-0853260
(State or Other Jurisdiction of Incorporation or Organization)	(IRS Employer Identification No.)

1500 Harbor Boulevard, Weehawken, New Jersey	07086
(Address of Principal Executive Offices)	(Zip Code)

(201) 863-7300

(Registrant’s Telephone Number, Including Area Code)

Securities registered pursuant to Section 12(b) of the Act: Common Stock, $0.01 Par Value

Securities registered pursuant to Section 12(g) of the Act: None

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 (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes o No x

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).

Yeso No x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)

Yeso No x

As of June 25, 2005, the last business day of the registrant’s most recently completed second fiscal quarter, the aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant was $6,200,166 (based on the closing price of the Common Stock on the Pink Sheets on June 25, 2005 of $0.88 per share; shares of Common Stock owned by directors and officers of the Company are excluded from this calculation; such exclusion does not represent a conclusion by the Company that all of such directors and officers are affiliates of the Company).

As of October 17, 2005, the registrant had 22,426,296 shares of Common Stock outstanding.

_______________

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EXPLANATORY NOTE

As explained herein, we have restated the consolidated financial statements for the fiscal years ended December 27, 2003 and December 28, 2002 in this Annual Report on Form 10-K. We have also restated the quarterly financial information for fiscal 2003 and the first two quarters of fiscal 2004. See Note 2 to the accompanying consolidated financial statements (collectively, the “Restatement”). By way of summary, the Restatement also affects periods prior to fiscal 2002. The Restatement’s impact on periods prior to fiscal 2002 has been reflected as an adjustment to accumulated deficit as of December 29, 2001 in the accompanying Consolidated Statements of Shareholders’ Deficiency as well as the Selected Financial Data in Part 1, Item 6 of this Form 10-K. The Restatement corrects a revenue recognition issue that resulted in revenue being recorded in advance of the actual shipment of merchandise to the customer and the correction of an accounting policy to recognize revenue when the merchandise is received by the customer as opposed to when the merchandise is shipped, corrects an error in the accounting treatment of discounts obligations for certain of the Company’s buyers’ club programs, corrects two errors in the accounting treatment of a reserve for post-employment benefits including correcting the premature reversal of the reserve and other adjustments and recording legal fees in the proper periods that were inappropriately recorded related to the matter. The Restatement also records certain customer prepayments and credits inappropriately released and records other liabilities relating to certain miscellaneous catalog costs and other miscellaneous costs that were inappropriately not accrued in the appropriate periods. In addition we have made adjustments to the deferred tax asset and liability to reflect the effect of the Restatement adjustments. For a more complete description of the Restatement, refer to Note 2 to the attached consolidated financial statements. We have not amended our previously filed Annual Reports on Form 10-K or Quarterly Reports on Form 10-Q for the Restatement. As previously disclosed in our Current Report on Form 8-K filed with the Securities and Exchange Commission (“SEC”) on November 10, 2004, the consolidated financial statements and related financial information contained in such reports for the fiscal years ended December 25, 1999, December 30, 2000, December 29, 2001, December 28, 2002 and December 27, 2003 and the fiscal quarters ended March 29, 2003, June 28, 2003, September 27, 2003, March 27, 2004 and June 26, 2004 should no longer be relied upon. Throughout this Form 10-K all referenced amounts for prior periods and prior period comparisons reflect the balances and amounts after giving effect to the Restatement.

As a result of the Restatement, we were unable to timely file the Form 10-K for the fiscal year ended December 25, 2004.

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PART I

Item 1. Business

This Annual Report on Form 10-K, contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The use of words such as “anticipates,” “estimates,” “expects,” “projects,” “intends,” “plans,” and “believes,” among others, generally identify forward-looking statements. Forward-looking statements are predictions of future trends and events and as such, there are substantial risks and uncertainties associated with forward-looking statements, many of which are beyond management’s control. Some of the more material risks and uncertainties are identified in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Risk Factors.” We do not intend, and disclaim any obligation, to update any forward-looking statements.

General

Hanover Direct, Inc. (collectively with its subsidiaries, referred to as the “Company,” “we” or “us” in this Form 10-K) is a direct marketer of quality, branded merchandise through a portfolio of catalogs and websites. We also manufacture comforters and pillows that we sell in two of our catalogs and our retail outlet stores and manufacture Scandia Down branded comforters, pillows and featherbeds that we sell through specialty retailers. In addition, we provide product fulfillment, telemarketing, information technology and e-commerce services to third party businesses involved in the direct marketing business.

Our direct marketing operations consist of a portfolio of catalogs and associated websites in the home fashions, men’s and women’s apparel and gift categories that included during 2004, Domestications, The Company Store, Company Kids, Silhouettes, International Male and Undergear. Each catalog can be accessed on the Internet individually by name. We also owned and operated the Gump’s retail store in San Francisco and the Gump’s By Mail catalog and website until March 14, 2005, when we sold them to an unrelated third party. In addition, we manufacture high quality pillows and comforters for sale in The Company Store and Domestications catalogs and websites, through our retail outlet stores and super-premium down comforters, pillows and featherbeds under the Scandia Down brand name, which we sell through third party luxury retailers in North and South America.

Leveraging our in-house expertise in product fulfillment and utilizing our excess capacity, we provide third party, end-to-end, fulfillment, logistics, telemarketing and information technology services to businesses formerly owned by the Company and select third party companies involved in the direct marketing business.

The Company is incorporated in Delaware and our executive offices are located at 1500 Harbor Boulevard, Weehawken, New Jersey 07086. The Company’s telephone number is (201) 863-7300. The Company is the successor of the 1993 merger between The Horn & Hardart Company, a restaurant company that traces its origins to 1888 and Hanover House Industries, Inc., which was founded in 1934.

At the Company’s 2004 Annual Meeting of Shareholders held on August 12, 2004, the Company’s shareholders approved a one-for-ten reverse stock split of the Company’s common stock (“Common Stock”), which became effective at the close of business on September 22, 2004. In this Annual Report on Form 10-K, the number of shares of Common Stock outstanding, per share amounts, stock warrants, stock option and exercise price data relating to the Company’s Common Stock for periods prior to the reverse stock split have been restated to reflect the effect of the reverse stock split. See Note 9 to the accompanying consolidated financial statements for more information regarding the reverse stock split and additional amendments to the Company’s Certificate of Incorporation.

Restatement of Prior Financial Information and Related Matters

We have restated the consolidated financial statements for the fiscal years ended December 27, 2003 and December 28, 2002 in this Annual Report on Form 10-K. We have also restated the quarterly financial information for fiscal 2003 and the first two quarters of fiscal 2004. See Note 2 to the accompanying consolidated financial statements (collectively, the “Restatement”). The Restatement also affects periods prior to fiscal 2002. The Restatement’s impact on periods prior to fiscal 2002 have been reflected as an adjustment to accumulated deficit as of December 29, 2001 in the accompanying Consolidated Statements of Shareholders’ Deficiency.

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We have also restated the applicable financial information for fiscal 2000, fiscal 2001, fiscal 2002 and fiscal 2003 in “Item 6. Selected Consolidated Financial Data.”

The Restatement corrects a revenue recognition issue that resulted in revenue being recorded in advance of the actual receipt of merchandise by the customer, corrects an error in the accounting treatment of discounts obligations for certain of the Company’s buyers’ club programs, corrects two errors in the accounting treatment of a reserve, including re-establishing a reserve balance prematurely released based on a summary judgment decision which could be and was appealed, and recording legal fees in the proper periods that were inappropriately recorded related to the matter. The Restatement also records certain customer prepayments and credits prematurely released, and records other liabilities relating to certain miscellaneous catalog costs and other miscellaneous costs that were inappropriately not accrued in the appropriate periods. In addition, we have made adjustments to the deferred tax asset and liability to reflect the effect of the Restatement adjustments. We did not amend our previously filed Annual Reports on Form 10-K or Quarterly Reports on Form 10-Q for the Restatement. As previously disclosed in our Current Report on Form 8-K filed with the Securities and Exchange Commission (“SEC”) on November 10, 2004, the consolidated financial statements and related financial information contained in such reports for the fiscal years ended December 25, 1999, December 30, 2000, December 29, 2001, December 28, 2002 and December 27, 2003 and the fiscal quarters ended March 29, 2003, June 28, 2003, September 27, 2003, March 27, 2004 and June 26, 2004 should no longer be relied upon. Throughout this Form 10-K all referenced amounts for prior periods and prior period comparisons reflect the balances and amounts after giving effect to the Restatement.

As a result of the Restatement, we were unable to timely file our Quarterly Report on Form 10-Q for the fiscal quarter ended September 27, 2004 or this Form 10-K. As a result of our not filing our Quarterly Report on Form 10-Q for the fiscal quarter ended September 27, 2004 on a timely basis and our inability to meet the continued listing requirements of the American Stock Exchange (“AMEX”), trading in our Common Stock on the AMEX was halted and ultimately the Common Stock was delisted by the AMEX on February 16, 2005.

In response to the discovery of certain of the matters leading up to the Restatement, the Audit Committee of the Board of Directors launched an investigation in November 2004 relating to the restatement of the Company’s consolidated financial statements and other accounting-related matters and engaged the law firm of Wilmer Cutler Pickering Hale and Dorr LLP (“Wilmer Cutler”) as its independent outside counsel to assist with the investigation. In March 2005, the Audit Committee concluded its investigation and, with the assistance of Wilmer Cutler, reported its findings to the Board of Directors. The Audit Committee, again with the assistance of Wilmer Cutler, formulated a series of recommendations to the Company and the Board of Directors concerning potential improvements in the Company’s internal controls and procedures for financial reporting. The Board of Directors and management have begun implementing these recommendations.

The Company was notified in January 2005 by the SEC that the SEC was conducting an informal inquiry relating to the Company’s financial results and financial reporting since 1998. The SEC indicated in its letter to the Company that the inquiry should not be construed as an indication by the SEC that there has been any violation of the federal securities laws. The Company is cooperating fully with the SEC in connection with the inquiry and has directed Wilmer Cutler to brief the SEC and the Company’s former independent registered public accounting firm, KPMG LLP (“KPMG”) on the results of its investigation. The Company intends to continue to cooperate with the SEC in connection with its informal inquiry concerning the Company’s financial reporting.

We hired a new Chief Executive Officer in May 2004 who, together with current management, identified the issues leading to the Restatement. Based on recommendations of the Audit Committee concerning potential improvements in the Company’s internal controls and procedures for financial reporting, management has responded to the weaknesses in internal controls exposed by the Restatement by revamping and augmenting the Company’s accounting and finance functions, hiring a new Chief Financial Officer, strengthening the Company’s internal controls, hiring an internal general counsel and replacing the Company’s external counsel, and instituting a corporate culture that demands ethical behavior of all employees, the highest level of compliance and encourages free communication up and down the ranks. See “Controls and Procedures” for more information regarding these and other initiatives.

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Significant Shareholder

After its January 10, 2005 purchase of an aggregate of 3,799,735 shares of Common Stock formerly held by Regan Partners, L.P., Regan International Fund Limited and Basil Regan, Chelsey Direct, LLC and related affiliates (“Chelsey”) beneficially own approximately 69.0% of the issued and outstanding Common Stock and approximately 75.0% of the Common Stock after giving effect to the exercise of all outstanding options and warrants to purchase Common Stock beneficially owned by Chelsey. In addition, Chelsey is holder of all of the Company’s Series C Participating Preferred Stock (“Series C Preferred”). Including the Series C Preferred and outstanding options and warrants beneficially owned by Chelsey, Chelsey maintains approximately 91.0% of the voting rights of the Company (after giving effect to the exercise of all outstanding options and warrants). Chelsey made its initial investment in the Company on May 19, 2003 by acquiring 2,944,688 shares of Common Stock and 1,622,111 shares of Series B Participating Preferred Stock (“Series B Preferred”) from Richemont Finance S.A (“Richemont”). Stuart Feldman, a Chelsey affiliate, held 16,090 shares of Common Stock when Chelsey acquired Richemont’s shares. Chelsey’s Common Stock ownership has increased since its initial investment as a result of three transactions:

•	The recapitalization of the Company on November 30, 2003 whereby the Series B Preferred was exchanged for 564,819 shares of Series C Preferred which has, in general, 100 votes per share and, as part of this transaction, the Company’s issuance of 8,185,783 shares of Common Stock to Chelsey.
•	On July 8, 2004, Chelsey Finance, LLC, (“Chelsey Finance”), a Chelsey affiliate, provided us with a $20.0 million junior secured credit facility, of which the entire $20.0 million was borrowed by the Company (the “Chelsey Facility”). As part of this transaction, the Company issued to Chelsey 434,476 shares of Common Stock in payment of a waiver fee and Chelsey Finance received a 10-year warrant to purchase 30.0% of the fully diluted shares of Common Stock (then equal to 10,259,366 shares of Common Stock). The terms of the Chelsey Facility are described in greater detail in Note 7 to the consolidated financial statements in Part II.
•	On January 10, 2005, Chelsey purchased an aggregate of 3,799,735 shares of Common Stock from Basil Regan, Regan International Fund Ltd. and Regan Partners, L.P, constituting all of the Common Stock held by them. Basil Regan had previously resigned from the Board of Directors on July 30, 2004.

Chelsey has designated four of the seven members of the Company’s Board of Directors including its Chairman.

Direct Commerce

General. We are a leading specialty direct marketer with a diverse portfolio of home fashions, men’s and women’s apparel and gift products marketed via direct mail-order catalogs, websites and retail outlets (“direct commerce”). All of these categories utilize our centralized purchasing and inventory management functions and our common systems platform and our telemarketing, fulfillment, distribution and administrative functions. We mailed approximately 172.0 million, 180.0 million and 191.0 million catalogs for the fiscal years ended 2004, 2003 and 2002, respectively. Although the past three years indicate a downward trend in catalog circulation and sales revenues, we began to reverse this trend during the second half of 2004 when catalog circulation increased by 6% compared with the second half of 2003, and revenue trends began to rise due to several factors including improved customer service levels which were made possible by enhanced liquidity provided by the Chelsey Facility. The enhanced liquidity also allowed us to increase inventory levels and realize a stronger catalog performance.

Sales revenues generated by our websites continue to increase, both in dollar terms and as a percentage of our net revenues. Website sales comprised 32.0% of combined Internet and catalog net revenues for the year ended December 25, 2004 compared with 27.9% for the comparable period in 2003, and have increased by approximately $11.6 million, or 10.8%, to $118.7 million for the year ended December 25, 2004 from $107.1 million for the comparable period in 2003.

We continually review our portfolio of catalogs and websites. On March 14, 2005, we completed the sale of the Gump’s By Mail catalog and Gump’s retail store located in San Francisco, California to an unrelated third party in part because the Gump’s operations, which were based primarily on the retail operation, did not fit within the Company’s direct marketing core competency.

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While our back-end/fulfillment functions are centralized, we operate merchandising, purchasing and catalog production separately for each of The Company Store/Company Kids, Domestications, Silhouettes and International Male/Undergear catalogs and websites. Previously, we operated The Company Store/Company Kids and Domestications as a single unit. During 2004, after a review of the management structure of the catalogs, we determined that we would better served by having separate management teams to guide each of the catalogs because of the diversity of the target customer base and sales volumes of the catalogs.

Each of our specialty catalogs targets its market by offering a focused assortment of merchandise designed to meet the needs and preferences of each catalog’s customers. Through market research and ongoing testing of new products and concepts, each catalog has its own merchandise strategy, including appropriate price points, mailing plans and presentation of its products. We are continuing our development of exclusive or private label products for a number of our catalogs to further differentiate the catalog’s identities.

Our catalogs range in size from approximately 48 to 108 pages with 9 to 27 editions per year depending on the seasonality and fashion content of the products offered. Each edition may be mailed several times each season with variations in format and content. The Company employs the services of outside creative agencies or has its own creative staff that is responsible for the designs, layout, copy, feel and theme of the catalogs. Generally, the initial sourcing of new merchandise for a catalog begins six to nine months before the catalog is mailed. The Company has created commerce-enabled websites for each of its catalogs. The websites offer all of a particular catalog’s merchandise and more extensive offerings than any single issue of a print catalog. Customers can request catalogs and place orders for not only website merchandise, but also from any print catalog already mailed.

The following is a description of our catalogs:

The Company Store is an upscale home fashions catalog focused on high quality products that we manufacture and other private label and branded home furnishings. Basic bedding lines produced at our LaCrosse, Wisconsin factory accounts for approximately 27.0% of The Company Store product in 2004.

Exclusive designs and vibrant colors, along with a unique and sophisticated catalog presentation, gives The Company Store a strong identity within its market. Even as The Company Store website continued to grow with an increasing percentage of its revenue coming through this channel, catalogs remained the biggest catalyst for driving website orders.

Company Kids is a catalog developed from a category offered in The Company Store catalogs and now accounts for approximately 17% of the total Company Store volume and has grown over the past three years to nine exclusive Company Kids mailings. The unique themes and full room views, gives the Company Kids customer the opportunity to purchase the “entire room” including bed, bedding, storage, wall hangings, lamps and rugs.

Creative design and varied color pallets for the complete bed ensemble are developed by The Company Store’s own design staff and sourced around the world. These exclusive designs and vibrant color pallets remain the signature identity for this quality oriented, better-priced catalog and position both The Company Store and Company Kids as strong competitors in the direct home textile market.

Domestications is “America’s Authority in Home Fashions®.” Celebrating our 20th anniversary in 2004, we continue to be the value minded customer’s top-of-mind choice when shopping for the latest in home furnishings. Domestications targets the mid-tier marketplace with its primary focus on bedding for every taste and lifestyle, featuring unique and novel ideas, hard to find problem solvers, and exclusive designs found nowhere else. We also offer a wide range of fashion and seasonal products for every other room of the house and even have great ideas for the backyard.

2004 was a turnaround year for Domestications as new management began to reposition the business to a more promotional strategy that focuses on new merchandising and creative marketing initiatives.

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Silhouettes is a moderate-to-better priced fashion catalog dedicated to woman’s styles starting at size 12W. The catalog carries the current trends in fashion along with core classics, seasonal favorites and Silhouettes® exclusives. Silhouettes carries a full range of apparel from boots to bathing suits, sleepwear to swimwear, and everything in between.

Silhouettes core strengths include exclusive designs and manufacturing sourced around the world. Utilizing key manufacturing plants allows Silhouettes to control costs and ensure the quality of these designs, offering the customer a product of style and value.

The Silhouettes catalog and website create a virtual department store, carrying something for every 12W plus-sized woman. The catalog continues to be the primary driver for website orders. In each of the past four years Silhouettes® has enjoyed significant Internet sales growth. Improved on-site search capabilities and navigations have taken the tedium and frustration out of the search and have created a better virtual shopping experience, getting Silhouettes® closer to its goal of being the customer’s best friend.

International Male offers contemporary men’s fashions and accessories at reasonable prices. As we celebrate International Male’s 30^th Anniversary, the Company has relocated the business to its headquarters in Weehawken, New Jersey and hired a new management team for the catalog, which is in the process of repositioning International Male to return it to its roots as a young men’s “lifestyle” fashion leader. This merchandising shift will be evident in catalogs commencing in the fourth quarter of 2005.

International Male carries a full line of apparel, from sportswear to swimwear, underwear, shoes and accessories, offering a merchandise mix that is both exciting and eclectic.

Undergear was launched in 1985 as a “handbook of men’s underwear” from around the world. It is a market leader in the men’s underwear catalog and Internet business.

Core strengths include the production of our many exclusive styles, interpreted by our merchandising team using key manufacturing sources, allowing us to control costs and ensure quality.

Over the years, the names International Male and Undergear have become synonymous with our merchandise - from top vendors to our signature collections - as well as our world-famous catalogs, sparking the imaginations of countless readers ever since their inception.

Gump’s By Mail and Gump’s are luxury sources for discerning customers of jewelry, gifts and home furnishings, and are market leaders in offering Asian inspired products. On March 14, 2005, we sold both the Gump’s By Mail catalog and the Gump’s San Francisco retail store to an unrelated third party.

Catalog Sales. Net sales, including delivery and service charges, through the Company’s catalogs were $252.3 million for the fiscal year ended December 25, 2004, a decrease of $24.6 million, or 8.9%, compared with the prior fiscal year. Overall circulation in fiscal year 2004 decreased by 4.2% primarily stemming from our decision to reduce circulation during the first half of the year due to liquidity issues facing the Company that constrained inventory levels and restricted catalog circulation. However, increased working capital provided by the Chelsey Facility starting in the third quarter allowed the Company to begin increasing its inventory levels and investing in catalog circulation to strengthen its customer files and grow its catalog business. These steps took hold during the second half of 2004 as catalog circulation increased by 6.0% compared with the second half of 2003, which resulted in an upward trend in revenues in the fourth quarter of 2004.

Internet Sales. The Internet continues to grow in importance as a source of new customers. Net sales, including delivery and service charges, through the Internet improved to $118.7 million for the fiscal year ended December 25, 2004, an increase of $11.6 million or 10.8%, over Internet sales in the prior fiscal year. For the year ended December 25, 2004, Internet sales had reached 32.0% of combined catalog and Internet net revenues. Customers can order catalogs and place orders for not only website merchandise but also for merchandise from any print catalog already mailed. The website for each catalog is prominently promoted within each catalog and on third-party websites.

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During November 2002, Amazon.com began to offer Silhouettes, International Male and Undergear merchandise within Amazon.com’s Apparel & Accessories store under a multi-year strategic alliance between the Company and Amazon.com. During 2003, Company Kids, Domestications, The Company Store and Gump’s were also made available on Amazon.com. All orders resulting from this alliance are electronically transferred to and fulfilled by the Company. Amazon.com charges us a commission on orders placed through its website.

We utilize other on-line marketing opportunities by posting our catalog merchandise and accepting orders on third-party websites for which we are charged a commission. We also enter into affiliate marketing agreements with third-party website operators and pay for “click thrus” to our websites. In addition to the Amazon.com arrangements, we have entered into third party affiliate marketing agreements with ArtSelect.com, CatalogCity, Decorative Product Source, Google, MSN, NexTag, Overture, Shopping.com, Linkshare and GiftCertificates.com.

Scandia Down. Scandia Down manufactures luxury European down comforters, pillows and featherbeds from its LaCrosse, Wisconsin facility and distributes these products together with proprietary branded sheeting, towels and related accessories through its network of over 90 high end retailers in North and South America. Scandia Down’s core growth strategy is focused on expanding distribution in select markets with key retailers, expanding product lines and categories, and developing sales and marketing support programs for licensed retailers.

Divestitures.

Improvements. On June 29, 2001, we sold certain assets and liabilities of our Improvements business to HSN, a division of USA Networks, Inc.’s Interactive Group, for approximately $33.0 million. In conjunction with the sale, we agreed to provide telemarketing and fulfillment services for the Improvements business under a services agreement with a three year term that was later extended for an additional two years. To secure our performance, $3.0 million of the purchase price was held in escrow. A portion of the escrow was released in 2002 and the balance was released in 2003. The services agreement for Improvements expires in 2006.

Gump’s and Gump’s By Mail. On March 14, 2005, we sold all of the stock of Gump’s Corp. and Gump’s By Mail, Inc. (collectively, “Gump’s”) to Gump’s Holdings, LLC, an unrelated third party (“Purchaser”) for $8.9 million, including a $0.4 million purchase price adjustment pursuant to the terms of a February 11, 2005 Stock Purchase Agreement. The Company recognized a gain of approximately $3.6 million in its quarter ended March 26, 2005. Chelsey, as the holder of all of the Series C Preferred, consented to the application of the sales proceeds to reduce the outstanding balance of the senior secured credit facility (“Wachovia Facility”) provided by Wachovia National Bank, as successor by a merger with Congress Financial Corporation (“Wachovia”), in lieu of using the available proceeds to redeem the Series C Preferred (the number of shares to be redeemed would have been based on the available sales proceeds and the then current redemption price per share of the Series C Preferred). This waiver provided us with additional credit resources under the Wachovia Facility. Chelsey expressly retained its right to require redemption of approximately $6.9 million (the Gump’s sales proceeds available for redemption) of the Series C Preferred subject to Wachovia’s approval.

After the sale, we continue as the guarantor of one of the two leases for the San Francisco building where the store is located (we were released from liability on the other lease). The Purchaser is required to use its commercially reasonable efforts to secure the Company’s release from the guarantee within a year of the closing. If the Purchaser cannot secure our release within a year of the closing, an affiliate of the Purchaser will either (i) transfer a percentage interest in its business so that we will own, indirectly, 5.0% interest of the Purchaser’s common stock, or (ii) provide us with a $2.5 million stand-by letter of credit or other form of compensation acceptable to the Company to reimburse us for any liabilities we incur under the guarantee until we are released from the guarantee or the lease is terminated.

We entered into a Direct Marketing Services Agreement with the Purchaser to provide telemarketing and fulfillment services for the Gump’s catalog and direct marketing businesses for eighteen months. We have the option to extend the term for an additional eighteen months.

Membership Services

Vertrue. In March 2001, we entered into a five-year marketing services agreement with MemberWorks, Incorporated (now known as “Vertrue”) under which our catalogs market and offer a variety of Vertrue

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membership programs to our catalog customers when they call to place an order. Vertrue membership programs offer members discounts on a wide variety of goods and services. Vertrue has the exclusive rights to the first up-sell position on all merchandise order calls made to our call centers, after any cross-sells that the catalogs may make for their own primary (or catalog-based) products. Initially, prospective members participate in a thirty-day trial period that, unless canceled, is automatically converted into a full membership term, which is one year in duration. Memberships are automatically renewed at the end of each year unless canceled by the member. Vertrue pays us commissions that vary based on the actual number of offers and sales made and whether the membership is an initial sale or a renewal. In 2004, we began offering Vertrue programs on our websites. The Vertrue programs are offered to customers when a customer reaches the order confirmation page after placing an order.

The Vertrue agreement expires in March 2006 and we are evaluating proposals from membership program providers to market membership programs to our customers after the Vertrue agreement expires. We expect the terms of any new membership marketing agreement to be no less favorable than those under the current agreement with Vertrue.

We also received commission revenue related to our solicitation of the Magazine Direct subscription program until the program was discontinued in May 2003. We were paid commissions based on a per-solicitation basis according to the number of solicitations made, with additional revenue recognized if the customer accepted the solicitation.

Buyers’ Club. Customers may purchase memberships in a number of our catalogs’ Buyers’ Club programs for an annual fee. The Buyers’ Clubs offer members merchandise discounts or free delivery and service charge, advance notice of sales and other benefits. We use Buyers’ Club programs to promote catalog loyalty, repeat business and to increase sales.

In the past, certain of the Buyers’ Club programs contained a guarantee whereby the customer would receive discounts or savings, at least equal to the cost of his or her membership or we would refund the difference with a merchandise credit at the end of the membership period. This guarantee was offered during the following periods: Silhouettes from July 1998 through March 2004; Domestications from April 2002 through March 2004; and Men’s Apparel from April 2003 through March 2004. We do not offer the guarantee currently.

In the first quarter of 2004, former management identified a potential issue with the accounting treatment for Buyers’ Club memberships that contained a guarantee related to discount obligations. At that time, an inappropriate conclusion regarding the accounting treatment was reached and during the third quarter of 2004, the issue was re-evaluated and we determined that an error in the accounting treatment had occurred. The cumulative impact of the error for which the Company restated resulted in the overstatement of revenues and the omission of the liability related to the guarantee of these discount obligations that aggregated $2.4 million as of June 26, 2004 (the end of the second quarter of 2004). The Company has developed a plan to satisfy its obligation to those Buyers’ Club members entitled to benefits as a result of the guarantee which will be implemented by the end of the first quarter of 2006. As reflected in the Restatement, for memberships purchased during those periods when the Buyers’ Club memberships contained a guarantee, revenue net of actual cancellations is recognized on a monthly basis over the membership period, commencing after the thirty-day cancellation period, with the revenue recognized equal to the lesser of the cumulative amount determined using the straight-line method or the actual benefit received by each customer as of the end of each period. At the end of the membership period, a liability equal to the residual guarantee is recorded on the Company’s Consolidated Balance Sheets.

For Buyers’ Club memberships that did not contain a guarantee, we recognize revenue net of actual cancellations on a monthly basis commencing after the thirty-day cancellation period, over the membership period using the straight-line method.

Collectively, we reported revenues from membership services of $10.3 million, or 2.5% of net revenues, $9.3 million or 2.2% of net revenues, and $10.3 million or 2.2% of net revenues for fiscal years 2004, 2003 and 2002, respectively. We continue to consider opportunities to offer new and different goods and services to our customers on inbound order calls and on our websites.

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Marketing and Database Management. We maintain a proprietary customer list currently containing approximately 5.6 million names of customers who have purchased from one of our catalogs or websites within the past thirty-six months (including 0.2 million names relating to Gump’s By Mail). Approximately 2.2 million of the names on the list represent customers who have made purchases from at least one of our catalogs within the last twelve months (including 0.1 million names relating to Gump’s By Mail). We also maintain a proprietary list of e-mail addresses totaling approximately 2.8 million addresses (including 0.2 million addresses relating to Gump’s By Mail). We consider our customer lists one of our most valuable assets.

We utilize modeling and segmentation analysis to devise catalog marketing and circulation strategies that are intended to maximize customer contribution by catalog. This analysis is the basis used by our catalogs to determine which of our catalogs will be mailed and how frequently to a particular customer, as well as the promotional incentive content of the catalog(s) that a customer receives.

We utilize name lists rented from other mailers and compilers as a primary source of new customers for our catalogs. Many of our catalogs participate in a consortium database of catalog buyers whereby new customers are obtained by the periodic submission of desired customer buying behavior and interests to the consortium and the subsequent rental of non-duplicative names from the consortium. Other sources of new customers include traditional print space advertisements and promotional inserts in outbound merchandise packages.

On the Internet, our main sources of new customers are from our catalogs, through affiliate marketing arrangements, search engines, and a variety of contractual Internet affiliate marketing arrangements.

Purchasing. Our large sales volume permits us to achieve a variety of purchasing efficiencies, including the ability to obtain prices and terms that are more favorable than those available to smaller companies or than would be available to our individual catalogs were they to operate independently. We use major goods and services that are purchased or leased from selected suppliers by our central buying staff. These goods and services include paper, catalog printing and printing related services such as order forms and color separations, communication systems including telephone time and switching devices, packaging materials, expedited delivery services, computers and associated network software and hardware.

We contract for our telemarketing phone service costs (both inbound and outbound calls) under multi-year agreements. In February 2004, we entered into a twenty-six month call center service agreement with AT&T Corp. that includes a one year renewal option at our election. We are required to pay AT&T a minimum of at least $1.0 million for each of the two twelve-month periods following an initial transitional ramp-up period. To date and because of our call volume, our payments have exceeded the minimum $1.0 million threshold for the first twelve-month period. The commitment is subject to a reduction based on certain events including but not limited to business downturn, corporate divestiture, or significant restructuring.

We generally enter into annual arrangements for paper and printing services with a limited number of suppliers. These arrangements permit periodic price increases or decreases based on prevailing market conditions, changes in supplier costs and continuous productivity improvements. For 2004, paper costs approximated 5.0% of the Company’s net revenues. The Company experienced 3.0% to 5.0% increases in paper prices during 2004 and projects that paper prices will continue to increase in 2005 due to tight market conditions. The Company normally experiences increased costs of sales and operating expenses as a result of the general rate of inflation and commodity price fluctuations. Operating margins are generally maintained through internal cost reductions and operating efficiencies, and then through selective price increases where market conditions permit.

Inventory Management. Our inventory management strategy is designed to maintain inventory levels that provide optimum in-stock positions while maximizing inventory turnover rates and minimizing the amount of unsold merchandise at the end of each season. We manage inventory levels by monitoring sales and fashion trends, making purchasing adjustments as necessary and by promotional sales. Additionally, we sell excess inventory through special sale catalogs, sales/liquidation postings in catalog websites, e-auctions, our outlet stores, off-price merchants and jobbers.

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We acquire products for resale in our catalogs from numerous domestic and foreign vendors. Over recent years, the Company has trended more towards obtaining goods from foreign as opposed to domestic vendors. No single third party source supplied more than 10.0% of our products in 2004. Our vendors are selected based on their ability to reliably meet our production and quality requirements, as well as their financial strength and willingness to meet our needs on an ongoing basis.

At the end of fiscal 2004, we had received approximately $4.7 million in combined catalog and Internet orders that had not been shipped and were not included in the net revenues of the Company. This amount was a decrease of $1.0 million compared with the approximately $5.7 million of unshipped orders existing at the end of fiscal 2003. These amounts consisted mainly of backorders, orders awaiting credit card authorization, open dropship orders and orders physically in the warehouse awaiting shipment to customers. The Company fulfilled substantially all of these orders within the first ninety days of 2005.

Because we import a large portion of our merchandise, we have, in the past, been subject to delays in merchandise availability and shipments due to customs, quotas, duties, inspections and other governmental regulation of international trade. We continue to monitor development in this area in an effort to minimize delays in international merchandise shipments that adversely impact our business.

Telemarketing and Distribution. During 2004, we received approximately 58.0% of our orders through our toll-free telephone service as compared with 62.0% in 2003. As the migration to the Internet continues to increase, we expect to see the trend of decreased percentages of toll-fee telephone orders continue. Customers can access our call centers seven days per week, twenty-four hours per day. In addition, we answered more than 5.5 million customer service/order calls and processed and shipped 6.2 million packages to customers during 2004 (including our third party Business-to-Business processing).

We mail our catalogs through the United States Postal Service (“USPS”) utilizing pre-sort, bulk mail and other discounts. We ship most of our packages through the USPS (93.0%). Overall, catalog mailing and package-shipping costs approximated 19.2% of our net revenues in 2004 as compared with 19.6% in 2003. There were no USPS rate increases during 2004 though one is scheduled for 2006. We also utilize United Parcel Service (1.0%) and other delivery services, including Federal Express (6.0%). In January 2004 and 2005, United Parcel Service increased its rates by 2.9% for each year. The increase did not have a material adverse effect on our 2004 results of operations and we do not expect a material adverse effect in 2005. We examine alternative shipping services with competitive rate structures from time to time.

Order Processing and Product Fulfillment

Telemarketing. The Company operates telemarketing facilities in Hanover, Pennsylvania, York, Pennsylvania and LaCrosse, Wisconsin. Our telemarketing facilities utilize state-of-the-art telephone switching equipment that enables us to route calls between telemarketing centers, balancing loads and providing prompt customer service.

We train our telemarketing service representatives to be courteous, efficient and knowledgeable about our products and those of our third party customers. Telemarketing service representatives generally receive forty hours of training in selling products, services, systems and communication skills through simulated as well as actual phone calls. A substantial portion of the evaluation of telemarketing service representatives’ performance is based on how well the representative meets customer service standards. While primarily trained with product knowledge to serve customers of one or more specific catalogs, telemarketing service representatives also receive cross training that enables them to take overflow calls from other catalogs. We utilize customer surveys as an important measure of customer satisfaction.

Distribution. We currently operate a distribution center in Roanoke, Virginia and until June 2005, operated a smaller distribution center and storage facility in LaCrosse, Wisconsin. The distribution centers handled merchandise distribution for our catalogs and websites as well as select third party clients. On June 30, 2004 we announced our plan to consolidate the operations of the LaCrosse, Wisconsin fulfillment center and storage facility into the Roanoke, Virginia fulfillment center by June 30, 2005. The LaCrosse fulfillment center and the storage facility were closed in June 2005 and August 2005, upon the expiration of their respective leases. These facilities were consolidated because of excess capacity at the Roanoke, Virginia fulfillment center, space constraints at the LaCrosse facilities and to realize the enhanced efficiencies afforded by our state-of-the-art Roanoke facility. We

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took a charge of $0.7 million in the fourth quarter of 2004 because of staff reductions at the LaCrosse facility and the costs of relocating inventory to Roanoke. In addition, the Company leases a 302,900 square foot warehouse and fulfillment facility located in Salem, Virginia for additional storage for the Roanoke distribution center. The lease originally commenced on March 28, 2005 and was amended in June 2005 and again in September 2005 to increase the initial 91,000 square feet of leased space to the current 302,900 square feet. The lease expires on September 30, 2006 except for the portion that pertains to the additional 90,900 square feet added in September 2005 which is on a month-to-month basis. See “Properties.”

Management Information Systems. All of our catalogs are part of our integrated mail order and catalog system operating on mid-range computer systems. Additionally, our fulfillment centers are part of our warehouse management system. These systems have been designed to meet our requirements as a high volume publisher of multiple catalogs and provider of back-end fulfillment services. We continue to devote resources to improving our systems.

Our software system is an on-line, real-time system, which is used in managing all phases of our operations and includes order processing, fulfillment, inventory management, list management and reporting. The software provides us with a flexible system that offers data manipulation and in-depth reporting capabilities. The management information systems are designed to permit us to achieve efficiencies in the way our financial, merchandising, inventory, telemarketing, fulfillment and accounting functions are performed.

Business-to-Business Services. In 1998 we began offering product fulfillment services to other direct marketers. We later expanded our service offerings to include e-commerce solutions. Currently we do not actively market these services, however, we do provide them to the purchasers of Improvements and Gump’s By Mail as part of those purchase transactions and to select other direct marketers, including National Geographic. While the primary mission of our order processing and product fulfillment services is to support our catalogs, our third party services business allows us to productively leverage our expertise and utilize our excess infrastructure capacity thereby defraying a portion of our fixed expenses. Revenues recorded from the Company’s B-to-B services were $20.8 million, or 5.2% of net revenues, $20.0 million, or 4.8% of net revenues, and $20.1 million, or 4.4% of net revenues, for 2004, 2003 and 2002, respectively.

Credit Management

On February 22, 2005, and as amended by Amendment Number One on March 30, 2005, we entered into a seven year co-brand and private label credit card agreement with World Financial Network National Bank (“WFNNB”) under which WFNNB will issue private label and co-brand (Visa and MasterCard) credit cards to our catalog customers. We began a phased roll out of our private label credit card program in April 2005 across our catalogs offering pre-approved credit to our core customers. In general the program extends credit to our customers at no credit risk to the Company. WFNNB provides a marketing fund to support our promotion of the program.

Financing

Our business is dependent on having adequate financial resources to fund our operations, catalog circulation and maintain appropriate inventory levels to meet customer demands. In the past, the Company has experienced periods of constrained liquidity, which has adversely affected our financial performance. Our results for the second half of 2004 were positively impacted by the increased liquidity provided by the closing on July 8, 2004 of the new $20.0 million Chelsey Facility and the concurrent amendment of the terms of the Wachovia Facility, which increased our capital availability under that facility. This increased liquidity enabled us to restore inventory to adequate levels for the second half of 2004, which resulted in substantial declines in backorder levels and higher initial customer order fill rates, reversing the trend experienced during the first six months of 2004. The improved inventory levels also increased our borrowing availability under the Wachovia Facility and alleviated constraints on vendor credit that we had previously experienced.

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As described more fully in Note 7, Debt to the consolidated financial statements contained in Part II, we have two credit facilities: the Wachovia Facility and the $20.0 million Chelsey Facility provided by Chelsey Finance. The Wachovia Facility includes a revolving credit facility with a maximum loan amount of $34.5 million and a $5.0 million term loan. The Wachovia Facility expires on July 8, 2007 and bears interest at 0.5% over the Wachovia prime rate. The interest rate on December 25, 2004 was 5.5%.

The Chelsey Facility is a $20.0 million junior secured credit facility and has a three-year term. At December 25, 2004, the amount recorded as debt relating to the Chelsey Facility on the Consolidated Balance Sheet is $8.2 million, net of the remaining, un-accreted debt discount of $11.8 million. The Chelsey Facility bears interest at 5.0% over the Wachovia prime rate. The stated interest rate on December 25, 2004 was 10.0%. The annual effective interest rate of this debt instrument is approximately 62.7%, inclusive of the accretion of the debt discount arising from the issuance of common stock warrants to Chelsey Finance in connection with the Chelsey Facility. See Note 6 to the consolidated financial statements for more information regarding the Chelsey Facility and the common stock warrant . We used approximately $4.9 million of the proceeds of the Chelsey Facility to retire a term loan under the Wachovia Facility that bore interest at a 13.0% rate. As a result of this prepayment and the concurrent amendment of the Wachovia Facility, Wachovia provided us with an additional $10.0 million of availability on the Wachovia Facility. There is no additional availability on the Chelsey Facility.

Total recorded borrowings as of December 25, 2004, including financing under capital lease obligations, aggregated $27.9 million, of which $11.2 million is classified as long term, excluding the Series C Preferred of $72.7 million, as reflected on the Company’s Consolidated Balance Sheet, and the remaining, un-accreted debt discount on the Chelsey Facility of $11.8 million. Remaining availability under the Wachovia Facility as of December 25, 2004 was $14.0 million. We believe that we have adequate capital resources to continue to operate our business for at least the next twelve months.

Preferred Stock

Chelsey holds all 564,819 outstanding shares of Series C Preferred, the only series of preferred stock currently outstanding. Chelsey acquired the Series C Preferred by first acquiring all of the Series B Participating Preferred Stock (“Series B Preferred”) and Common Stock held by Richemont on May 19, 2003. Prior to the Chelsey acquisition, Richemont was the Company’s second largest single stockholder. The transaction with Richemont, the recapitalization in which the Company exchanged the Series B Preferred for the Series C Preferred and the terms of the Series C Preferred are summarized in greater detail in Note 8, Preferred Stock to the Financial Statements contained in Part II.

In general, the Series C Preferred holders are entitled to one hundred votes per share on any matter on which the Common Stock votes. If the Company liquidates, dissolves or is wound up, the holders of the Series C Preferred are entitled to a liquidation preference of $100 per share, or an aggregate of approximately $56.5 million based on the shares of Series C Preferred currently owned by Chelsey, plus all accrued and unpaid dividends on the Series C Preferred. As described further below, commencing January 1, 2006, dividends will be payable quarterly on the Series C Preferred at the rate of 6.0% per annum, but such dividends may be accrued at the Company’s option. Effective October 1, 2008 and assuming the Company has elected to accrue all dividends from January 1, 2006 through such date, the maximum aggregate amount of the liquidation preference plus accrued and unpaid dividends on the Series C Preferred will be approximately $72.7 million.

Commencing January 1, 2006, dividends will be payable quarterly on the Series C Preferred at the rate of 6.0% per annum, with the preferred dividend rate increasing by 1 1/2% per annum on each anniversary of the dividend commencement date until redeemed. At the Company’s option, in lieu of paying cash dividends, the Company may accrue dividends that will compound at a rate 1.0% higher than the applicable cash dividend rate. The Series C Preferred is mandatorily redeemable on January 1, 2009. The Company is also obligated to redeem the maximum number of shares of Series C Preferred as possible with the net proceeds of certain asset and equity sales not required to be used to repay the Wachovia Facility. The proceeds from the sale of Gump’s would have required redemption of some of the Series C Preferred. At the Company’s request, Chelsey agreed to permit the Company to apply the Gump’s sales proceeds to reduce the revolving credit facility under the Wachovia Facility. Chelsey expressly retained its right to require redemption of approximately $6.9 million (the Gump’s sales proceeds available for redemption) of the Series C Preferred subject to Wachovia’s approval.

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Employees

As of December 25, 2004, we employed approximately 1,800 full-time employees and approximately 400 part-time employees. The number of part-time employees at December 25, 2004 reflects a temporary increase in headcount necessary to fill the increase in orders during the holiday season. Approximately 164 employees employed by one of our subsidiaries are represented by The Union of Needletrades, Industrial and Textile Employees (UNITE!). We entered into a new union agreement in March 2003 that expires on February 26, 2006.

We believe our relations with our employees are good.

During the fiscal year ended December 25, 2004, we eliminated a total of approximately 200 full-time equivalent positions, including approximately eight positions at or above the level of director, which included open positions that were eliminated. All separations were made in accordance with normal pay practices, excluding those individuals who were terminated under a compensation continuation agreement, which provided for payment in the form of a lump sum.

Seasonality

Our business is subject to moderate variations in demand. Historically, a larger portion of our revenues have been realized during the fourth quarter compared to each of the first three quarters of the year. The percentage of annual revenues for the first, second, third and fourth quarters recognized by the Company were as follows: 2004 — 22.4%, 24.0%, 23.4% and 30.2%; 2003 — 23.5%, 25.4%, 23.4% and 27.7%; and 2002 — 22.8%, 24.5%, 23.3% and 29.4%.

Competition

We believe that the principal bases upon which we compete in our direct commerce business are quality, value, service, proprietary product offerings, catalog design, website design, convenience, speed and efficiency. Our catalogs compete with other mail order catalogs, both specialty and general catalogs and bricks and mortar stores. Competitors in each of our catalog specialty areas of home fashions, women’s apparel, and men’s apparel include Linen Source, Pottery Barn and BrylaneHome in the home fashions, Lane Bryant, Roaman’s, Jessica London and Spiegel in the women’s apparel category and J. Crew, Blair and Bachrach, in the men’s apparel category. Our catalogs also compete with bricks and mortar department stores, specialty stores and discount stores including JC Penney, Wal-Mart, Target, Bed, Bath & Beyond and Bloomingdale’s and Pottery Barn. Many of our competitors have substantially greater financial, distribution and marketing resources than we do.

We maintain an active e-commerce enabled Internet website presence for all of our catalogs. A substantial number of each of our catalogs’ competitors maintain active e-commerce enabled Internet website presences as well. A number of these competitors have substantially greater financial, distribution and marketing resources than we do. In addition, we have entered into third party website affiliate marketing arrangements, including one with Amazon.com, as described above under “Direct Commerce — Internet Sales.” We believe the Internet and online commerce will continue to be an ever increasing portion of our business and we plan to continue to explore additional marketing opportunities in this medium.

Trademarks

Each of our catalogs has its own federally registered trademarks that are owned directly by the catalog company subsidiaries. These subsidiaries also own numerous trademarks, copyrights and service marks on logos, products and catalog offerings. We have also protected various trademarks internationally. We believe our trademarks, copyrights, service marks and other intellectual property are valuable assets and we continue to vigorously protect these marks.

Government Regulation

The Company is subject to Federal Trade Commission regulations governing its advertising and trade practices, Consumer Product Safety Commission regulations governing the safety of the products it sells and other regulations

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relating to the sale of merchandise to its customers. We are also subject to the Department of Treasury — Customs regulations with respect to any goods we directly import.

The imposition of a sales and use tax collection obligation on out-of-state catalog companies in states to which they ship products was the subject of a case decided in 1994 by the United States Supreme Court. While the Court reaffirmed an earlier decision that allowed direct marketers to make sales into states where they do not have a physical presence without collecting sales taxes with respect to such sales, the Court further noted that Congress has the power to change this law. We believe that we collect sales tax in all jurisdictions where we are currently required to do so.

Listing Information

The Common Stock was listed on the AMEX. Because of the Restatement, we could not file our Form 10-Q for the fiscal quarter ended September 25, 2004, a condition of continued AMEX listing. Trading in our Common Stock on the AMEX was halted on November 16, 2004, formally suspended on February 2, 2005 and delisted effective February 16, 2005. Current trading information about the Common Stock can be obtained from the Pink Sheets (www.pinksheets.com) under the trading symbol HNVD.PK.

Website Access to Information

Our corporate Internet address is www.hanoverdirect.com. Our catalogs operate the following websites:

•	www.thecompanystore.com
•	www.companykids.com
•	www.domestications.com
•	www.silhouettes.com
•	www.internationalmale.com
•	www.undergear.com

The website for Keystone Internet Services, LLC (“Keystone”) which provides business to business services is www.keystoneinternet.com and Scandia Down’s is www.scandiadown.com.

We make available free of charge on or through our corporate website our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports and press releases as soon as reasonably practicable after these filings are electronically filed with or furnished to the Securities and Exchange Commission or in the case of press releases, released to the wire services. We will continue to provide electronic or paper copies of our filings free of charge upon request.

Item 2. Properties

The Company’s subsidiaries own and operate the following properties:

•	A 775,000 square foot warehouse and fulfillment facility located in Roanoke, Virginia;
•	A 48,000 square foot administrative and telemarketing facility located in LaCrosse, Wisconsin; and
•	A 150,000 square foot home fashion manufacturing facility located in LaCrosse, Wisconsin used to manufacture comforters, pillows and featherbeds for sale under “The Company Store” and “Scandia Down” names.

Each of these properties is subject to a mortgage in favor of Wachovia and a second mortgage in favor of Chelsey Finance.

In addition, the Company or its subsidiaries lease the following properties:

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•	An 85,000 square foot corporate headquarters and administrative offices located in Weehawken, New Jersey. On February 12, 2005, we entered into a 10-year lease extension and modification, effective June 2005, for 50,000 square feet of the 85,000 square feet that was previously leased. All catalog operations are based in the Weehawken facility as of the end of May 2005. In addition, we leased approximately 5,000 square feet in a storage facility in Jersey City, New Jersey, under a lease that expired in May 2005. We did not renew this lease, however we did secure a new lease expiring May 31, 2010, for a 6,900 square foot storage facility in Secaucus, New Jersey.
•	A 28,700 square foot office formerly used for corporate headquarters, administration and Silhouettes operations located in Edgewater, New Jersey under a lease that expired in May 2005. The Company has vacated this facility and has consolidated these functions into the Weehawken facility.
•	Five properties currently used as outlet stores located in Pennsylvania and Wisconsin having approximately 49,200 square feet of space in the aggregate, with leases running through December 2005. The Company decided to close and not renew the leases of three of these stores. Two of these closures were located in Wisconsin and were vacated by July 31, 2005. The remaining location is located in Pennsylvania and will be vacated no later than December 31, 2005.
•	A 65,100 square foot retail and office facility which includes the Gump’s retail store in San Francisco, California under two leases that expire in April 2010, of which approximately 37,800 square feet was occupied by the Company and the remaining 27,300 square feet are subleased. On March 14, 2005, the Company sold its Gump’s retail store operation. After the sale, the Company continued as the guarantor of one of the two leases. The Purchaser is required to use its commercially reasonable efforts to secure the Company’s release from the guarantee within a year of the closing.
•	A 151,000 square foot warehouse and fulfillment facility located in LaCrosse, Wisconsin under a lease that expired in June 2005. The Company also leased a 34,000 square foot facility, located in LaCrosse, Wisconsin that was used for storage under a lease extension that expired in August 2005. As part of the consolidation of the distribution function to the Roanoke facility, the Company vacated these facilities upon their lease expirations.
•	A 117,900 square foot telemarketing, customer service and administrative facility located in Hanover, Pennsylvania, under a lease extension expiring on June 30, 2006.
•	An 11,000 square foot satellite telemarketing facility in York, Pennsylvania under a lease expiring July 31, 2006.
•	A 30,000 square foot administrative facility in San Diego, California for the men’s apparel business under a lease that expired February 28, 2005. At the end of the lease, the Company vacated this space in conjunction with the relocation of the men’s apparel business to the Weehawken facility.
•	A 302,900 square foot warehouse and fulfillment facility located in Salem, Virginia for additional storage for the Roanoke distribution center under a lease commencing March 28, 2005. The lease was initially for 91,000 square feet and was amended in June 2005 and September 2005 to increase the leased space to the current 302,900 square feet. The lease expires on September 30, 2006 except for the portion that pertains to the additional 90,900 square feet added in September 2005 which is on a month-to-month basis.

Item 3. Legal Proceedings

Rakesh K. Kaul v. Hanover Direct, Inc., No. 04-4410(L)-CV, 2nd Cir.S.D.N.Y., on appeal from 296 F. Supp.2d (S.D. NY 2004). On June 28, 2001, Rakesh K. Kaul, the former President and Chief Executive Officer of the Company, filed a five-count complaint in the Federal District Court in New York seeking relief stemming from his separation of employment from the Company including short-term bonus and severance payments of $2,531,352, attorneys’ fees and costs, and damages due to the Company’s failure to pay him a “tandem bonus” as well as Kaul’s alleged rights to benefits under a change in control plan and a long-term incentive plan. The Company filed a Motion for Summary Judgment and in July 2004, the Court entered a final judgment dismissing most of Mr. Kaul’s claims with prejudice and awarded Mr. Kaul $45,946 in vacation pay and $14,910 in interest which the Company paid in July 2004. In August 2004, Kaul filed an appeal on three issues: severance and short-term bonus, tandem bonus and legal fees. On June 28, 2005 the Second Circuit Court of Appeals denied Kaul’s appeal, affirming the Summary Judgment decision in the Company’s favor. Mr. Kaul’s rights to appeal the Second Circuit’s decision expired in August 2005.

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As of December 25, 2004, the Company had accrued $4.5 million related to this matter. This accrual remained on the Company’s Consolidated Balance Sheet until the third fiscal quarter of 2005 when Kaul’s rights to pursue this claim expired.

SEC Informal Inquiry:

See Note 18 to the consolidated financial statements for a discussion of the informal inquiry being conducted by the SEC relating to the Company’s financial results and financial reporting since 1998.

Class Action Lawsuits:

The Company was a party to four class action/ representative lawsuits that all involved allegations that the Company’s charges for insurance were invalid, unfair, deceptive and/or fraudulent. As described in greater detail below, the Company has resolved all of these class action lawsuits.

Jacq Wilson v. Brawn of California, Inc. , Case No. CGC-02-404454 (Supp. Ct. San Francisco, CA 2002) (“Wilson Case”). On February 13, 2002, Jacq Wilson, suing on behalf of himself and other similarly situated persons, filed a representative suit in the Superior Court of the State of California, City and County of San Francisco, against the Company alleging that the Company charged an unlawful, unfair, and fraudulent insurance fee on orders, was engaged in untrue, deceptive and misleading advertising and unfair competition under the state’s Business and Professions Code. The plaintiffs sought relief including restitution and disgorgement of all monies wrongfully collected by defendants, including interest, an order enjoining defendants from imposing insurance on its order forms, and compensatory damages, attorneys’ fees, pre-judgment interest and costs of the suit. In November, 2003, the Court, after a trial the previous April, entered judgment for the plaintiffs, requiring defendants to refund insurance charges collected from consumers for the period from February 13, 1998 through January 15, 2003, with interest. In April, 2004, the Court awarded plaintiff’s counsel approximately $445,000 of attorneys’ fees.

The Company appealed the Court’s decision and the order to pay attorneys’ fees, which appeals were consolidated. Enforcement of the judgment for insurance fees and the award of attorneys’ fees was stayed pending resolution of the appeal. On September 2, 2005 the California Court of Appeals reversed both the Court’s findings on the merits and its award of attorneys’ fees and awarded the Company its cost on the appeal.

Teichman v. Hanover Direct, Inc. et. al., No. 3L641 (Supp. Ct. San Francisco, CA 2001). On August 15, 2001, Randi Teichman filed a summons and four-count complaint in the Superior Court for the City and County of San Francisco seeking damages and other relief for herself and a class of similarly situated persons arising out of the insurance fee charged by catalogs and Internet sites operated by Company subsidiaries. This case had been stayed since May 2002 pending resolution of the Wilson Case.

The plaintiffs in both Wilson and Teichman were represented by the same counsel and the plaintiffs in both cases agreed to dismiss the cases with prejudice in exchange for the Company’s agreement to not seek reimbursement of costs in the Wilson case.

John Morris, individually and on behalf of all other similarly situated person and entities similarly situated v. Hanover Direct, Inc. and Hanover Brands, Inc., No. L 8830-02 (Sup. Ct. Bergen Co. – Law Div., NJ) October 28, 2002, John Morris, individually and on behalf of other similarly situated persons in New Jersey filed a class action alleging that (1) the Company improperly added a charge for “insurance” and (2) the Company’s conduct was in violation of the New Jersey Consumer Fraud Act as otherwise deceptive, misleading and unconscionable. Morris sought relief including damages equal to the amount of all insurance charges, interest, treble and punitive damages, injunctive relief, costs, and reasonable attorneys’ fees. On February 14, 2005, the Court denied class certification which limited the damages being litigated, absent an appeal of the denial of class certification, to Plaintiff’s individual injury of the $1.48 he paid for insurance which could be trebled pursuant to the New Jersey consumer protection statute plus attorney’s fees. This case was settled effective as of August 29, 2005 and the Company paid $39,500 in the aggregate for a nominal amount of damages and legal fees.

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Martin v. Hanover Direct, Inc., et. al., No. CJ-2000 (D.C. Sequoyah Co., Ok.) (“Martin Case”). On March 3, 2000, Edwin L. Martin filed a class action lawsuit against the Company claiming breach of contract, unjust enrichment, recovery of money paid absent consideration, fraud and a claim under the New Jersey Consumer Fraud Act. The allegations stem from “insurance charges” paid to the Company by consumers who had placed orders from catalogs published by indirect subsidiaries of the Company over a number of years. Martin sought relief including (i) a declaratory judgment as to the validity of the delivery insurance, (ii) an order directing the Company to return to the plaintiff and class members the “unlawful revenue” derived from the insurance charges, (iii) threefold damages for each class member, and (iv) attorneys’ fees and costs. In July 2001, the Court certified the class and the Company filed an appeal of the class certification. On October 25, 2005, the class certification was reversed. The Company believes that it is remote that the plaintiff will pursue the matter further.

The Company established a $0.5 million reserve during the third quarter of 2004 for the class action lawsuits described above for settlements and the Company’s current estimate of future legal fees to be incurred. The balance of the reserve as of December 25, 2004 remained at $0.5 million.

Claims for Post-Employment Benefits

The Company is involved in two lawsuits involving claims by former employees for change in control benefits under compensation continuation plans. The Company believes it has meritorious defenses in both cases.

In addition, in March 2005 the Company terminated the employment of two former officers, Charles Blue, the former Chief Financial Officer and the former Vice President of Treasury Operations and Risk Management. Both sought change in control benefits which the Company denied in accordance with the respective plans. On October 14, 2005 Charles Blue filed an action seeking compensatory and punitive damages and attorneys’ fees. The other officer has indicated that he intends to commence an action against the Company. The Company plans to vigorously defend its denial of benefits which it believes was proper.

In addition, the Company is involved in various routine lawsuits of a nature that is deemed customary and incidental to its businesses. In the opinion of management, the ultimate disposition of these actions will not have a material adverse effect on the Company’s financial position, results of operations, or cash flows.

Item 4. Submission of Matters to a Vote of Security Holders

None.

PART II

Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters

The Common Stock was delisted from the AMEX effective February 16, 2005 as a result of the Company’s inability to timely file its periodic SEC reports and its failure to comply with the AMEX’s continued listing standards. Current trading information about our Common Stock can be obtained from the Pink Sheets under the trading symbol “HNVD.PK.”

The following table sets forth, for the periods shown, the high and low sale prices of our Common Stock (as adjusted for the reverse stock split). As of October 17, 2005, we had 22,426,296 shares of Common Stock outstanding. Of these, 15,380,413 shares were held directly or indirectly by Chelsey and its affiliates. As a result, 7,045,883 shares of Common Stock were held by other public shareholders. There were approximately 548 holders of record of Common Stock.

	High	Low
Fiscal 2004
First Quarter (Dec. 28, 2003 to March 27, 2004)	$ 3.00	$ 2.00
Second Quarter (March 28, 2004 to June 26, 2004)	$ 2.50	$ 1.30
Third Quarter (June 27, 2004 to Sept. 25, 2004)	$ 1.80	$ 1.20
Fourth Quarter (Sept. 26, 2004 to Dec. 25, 2004)	$ 1.59	$ 1.26

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Fiscal 2003
First Quarter (Dec. 29, 2002 to March 29, 2003)	$ 2.70	$ 1.90
Second Quarter (March 30, 2003 to June 28, 2003)	$ 2.80	$ 1.80
Third Quarter (June 29, 2003 to Sept. 27, 2003)	$ 2.90	$ 2.20
Fourth Quarter (Sept. 28, 2003 to Dec. 27, 2003)	$ 3.00	$ 2.00

The Company is restricted from paying dividends on its Common Stock or from acquiring its Common Stock by certain debt covenants contained in the loan agreements for the Wachovia Facility and the Chelsey Facility. See Note 7 to the Notes to the consolidated financial statements for additional information regarding the certain debt covenants and loan agreements.

Reverse Stock Split. At our 2004 Annual Meeting of Shareholders held on August 12, 2004, our shareholders approved a one-for-ten reverse stock split of the Common Stock, which became effective at the close of business on September 22, 2004. In this Annual Report on Form 10-K, the number of shares of Common Stock outstanding, per share amounts, stock warrants, stock option and exercise price data relating to the Company’s Common Stock, for periods prior to the reverse stock split, have been restated to reflect the effect of the reverse stock split.

Amendments to the Company’s Certificate of Incorporation. On September 22, 2004, we filed a Certificate of Amendment to the Company’s Amended and Restated Certificate of Incorporation (1) reducing the par value of the Common Stock from $0.66-2/3 to $0.01 per share and reclassifying the outstanding shares of Common Stock into such lower par value shares; (2) increasing the number of authorized shares of additional Preferred Stock from 5,000,000 shares to 15,000,000 shares and making a corresponding change to the aggregate number of authorized shares of all classes of preferred stock; and (3) after giving effect to the reverse stock split, increasing the authorized number of shares of Common Stock from 30,000,000 shares to 50,000,000 shares and making a corresponding change to the aggregate number of authorized shares of all classes of common stock.

Equity Compensation Plan Information Table

The following table provides information about the securities authorized for issuance under the Company’s equity compensation plans as of December 25, 2004:

	(a)	(b)	(c)
Plan category	Number of securities to be issued upon exercise of outstanding options, warrants and rights	Weighted-average exercise price of outstanding options, warrants and rights	Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column(a))
Equity compensation plans approved by security holders	1,048,883	$ 6.23	1,871,117
Equity compensation plans not approved by security holders	270,000	2.50	270,000
Total	1,318,883	$ 5.47	2,141,117

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Item 6. Selected Financial Data

The following table presents selected financial data for each of the fiscal years indicated:

	2004	2003	2002	2001	2000
		As Restated	As Restated	As Restated	As Restated
	(In thousands of dollars, except per share data )
Income Statement Data:
Net revenues	$ 403,160	$ 414,283	$ 456,990	$ 533,630	$ 606,430
Special charges	1,536	1,308	4,398	11,277	19,126
Income (loss) from operations	10,742	1,445	(2,211)	(24,926)	(69,686)
Gain on sale of Improvements	--	(1,911)	(570)	(23,240)	--
Gain on sale of Kindig Lane Property	--	--	--	(1,529)	--
Income (loss) before interest and income taxes	10,742	3,356	(1,641)	(157)	(69,686)
Interest expense, net	5,567	12,088	5,477	6,529	10,083
Provision for income taxes	174	11,328	3,791	120	165
Net income (loss)	5,001	(20,060)	(10,909)	(6,806)	(79,934)
Preferred stock dividends and accretion	--	7,922	15,556	10,745	4,015
Net income (loss) applicable to common stockholders	$ 4,877	$ (27,982)	$ (26,465)	$ (17,551)	$ (83,949)

Net Income (Loss) Per Common Share:
Basic	$ 0.22	$ (1.94)	$ (1.91)	$ (0.83)	$ (3.94)
Diluted	$ 0.18	$ (1.94)	$ (1.91)	$ (0.83)	$ (3.94)

Weighted Average Number of Shares
Outstanding (in thousands):
Basic	22,220	14,439	13,828	21,054	21,325
Diluted	27,018	14,439	13,828	21,054	21,325


		2004	2003	2002	2001	2000
			As Restated	As Restated	As Restated	As Restated
	(In thousands of dollars)
Balance Sheet Data (End of Period):
Working capital (deficit)		$ 10,767	$ (10,399)	$ (6,200)	$ 658	$ (5,138)
Total assets		130,354	116,547	145,274	161,032	208,379
Total debt, excluding Preferred Stock		27,886	22,510	25,129	29,710	39,036
Series A Participating Preferred Stock		--	--	--	--	71,628
Series B Participating Preferred Stock		--	--	92,379	76,823	--
Series C Participating Preferred Stock		72,689	72,689	--	--	--
Shareholders’ deficiency		(37,652)	(56,339)	(63,011)	(38,119)	(25,882)

There were no cash dividends declared on the Common Stock in any of the periods presented. See Note 2 of Notes to consolidated financial statements for more information regarding the Restatement.

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Item 7. Management’s Discussion and Analysis of Consolidated Financial Condition and Results of Operations

The following table sets forth, for the fiscal years indicated, the percentage relationship to net revenues of certain items in the Company’s Consolidated Statements of Income (Loss):

	Fiscal Year
	2004	2003 As Restated	2002 As Restated
Net revenues	100.0%	100.0%	100.0%
Cost of sales and operating expenses	60.3	63.1	63.5
Special charges	0.4	0.3	1.0
Selling expenses	24.9	24.1	23.1
General and administrative expenses	10.7	11.0	11.7
Depreciation and amortization	1.0	1.1	1.2
Gain on sale of Improvements	—	(0.4)	(0.1)
Income (loss) before interest and income taxes	2.7	0.8	(0.4)
Interest expense, net	1.4	2.9	1.2
Provision for Federal and state income taxes	0.0	2.7	0.8
Net income (loss)	1.2%	(4.8)%	(2.4)%

Restatement of Prior Year Financial Information and Related Matters

During the second quarter of 2004, the Company identified a revenue recognition cut-off issue that resulted in revenue being recorded in advance of the actual shipment of merchandise to the customer. The practice was stopped immediately. Subsequently, the Company determined that revenue should be recognized when merchandise is received by the customer rather than when shipped because the Company routinely replaces customer merchandise damaged or lost in transit as a customer service matter (even though risk of loss, as a legal matter, passes on shipment). As a consequence, the Company has restated all periods presented to recognize revenue when merchandise is received by the customer.

In the first quarter of 2004, former management identified a potential issue with the accounting treatment for Buyers’ Club memberships that contained a guarantee. At that time, an inappropriate conclusion regarding the accounting treatment was reached and during the third quarter of 2004, the issue was re-evaluated and we determined that an error in the accounting treatment had occurred. The impact of the error resulted in an overstatement of revenues and the omission of a liability related to the guarantee for discount obligations. The proper accounting treatment has been applied to all periods impacted including a calculation of the cumulative impact on previously reported periods.

Starting in fiscal 2001, the Company inappropriately reduced the liability for certain customer prepayments and credits. The impact of the inappropriate reduction of this liability resulted in the understatement of general and administrative expenses and the omission of the related liability. During the fourth quarter of 2004, the Company re-evaluated the accounting treatment for these customer prepayments and credits. As a consequence, the Company has applied the proper accounting treatment to all periods impacted including recording a liability in each respective previously reported period equivalent to the cumulative impact of the error.

The Company also corrected its accounting for an accrual related to a claim for post-employment benefits by a former CEO. See “Legal Proceedings—Rakesh Kaul v. Hanover Direct, Inc.”

In addition, the Company has recorded other liabilities relating primarily to certain miscellaneous catalog costs and other miscellaneous costs that were inappropriately not accrued in the necessary periods and has made adjustments to the deferred tax asset and liabilities to reflect the effect the Restatement.

The Audit Committee of the Board of Directors conducted an investigation related to these issues (except for the revenue recognition issue based on receipt of merchandise by the customer which was addressed by the Company subsequent to the conclusion of the investigation) and other accounting-related matters with the assistance of independent outside counsel. The Company’s inability to timely file its financial statements as well as its non-compliance with several of the AMEX’s listing criteria resulted in the AMEX halting trading in the Company’s common stock on November 16, 2004 and later delisting the common stock as of February 16, 2005.

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See Item 9A. “Controls and Procedures” for management’s evaluation and conclusions relating to this investigation. In addition, the SEC is currently conducting an informal inquiry relating to the Company’s financial results and financial reporting since 1998. We intend to continue our cooperation with the SEC with its informal inquiry concerning our financial reporting.

See Note 2 to the consolidated financial statements for additional information regarding the Restatement.

Executive Summary

Hanover Direct is a direct marketer owning a portfolio of catalogs and associated websites. During the first six months of 2004, the Company operated in a very challenging environment due to our liquidity constraints. The inability to maintain levels of inventory adequate to service demand created increased backorder levels, reduced initial customer order fill rates as well as higher order cancellation rates all of which contributed to lower net revenues. On May 5, 2004, the Board of Directors appointed a new chief executive officer (“CEO”), Wayne P. Garten, who quickly obtained the Chelsey Facility, a $20.0 million junior secured credit facility. The Company borrowed the entire $20.0 million and paid off the remaining outstanding balance ($4.9 million) of a term loan, which was part of the Wachovia Facility. As part of a concurrent amendment to the Wachovia Facility, the Chelsey Facility freed up $10.0 million of availability under the Wachovia Facility that had previously been blocked. The increased liquidity enabled us to increase inventory to more adequate levels for the second half of 2004, which resulted in substantial declines in backorder levels and higher initial customer order fill rates, reversing the trend experienced during the first six months of 2004. The improved inventory levels increased the Company’s borrowing availability under the Wachovia Facility and alleviated constraints on vendor credit previously experienced. In addition, the increased working capital allowed the Company to invest in catalog circulation in order to strengthen the customer name file base for the future as well as producing strong fourth quarter revenues of $121.6 million, which were an increase of $6.9 million, or 6.0%, over the comparable prior year period. Income from operations increased $9.3 million to $10.7 million for the year ended December 25, 2004 from $1.4 million in 2003. Although a significant improvement, certain items incurred during 2004 hindered income from operations from achieving a greater increase over 2003 and 2002. A summary of these expense / (income) items incurred during 2004, 2003 and 2002 are as follows (in thousands):

		2004		2003		2002
Severance and Termination Costs	$	2,607	$	725	$	356
Special Charges		1,536		1,308		4,398
Class Action Litigation Reserve		535		--		--
Facility Exit Costs		201		--		--
Rakesh Kaul Accrual		196		24		3,648
Compensation Continuation Agreement Costs		--		3,083		--
Change in Vacation and Sick Policy		--		(1,634)		--
	$	5,075	$	3,506	$	8,402

We also began developing and implementing strategies to reduce the infrastructure of the Company. These strategies included the consolidation of the operations of the LaCrosse, Wisconsin fulfillment center and storage facility into the Roanoke, Virginia fulfillment center, which was substantially completed by the end of June 2005; the relocation of the International Male and Undergear catalog operations from San Diego, California to the corporate headquarters in Weehawken, New Jersey, which was completed February 28, 2005; and the consolidation of the Edgewater facility into the Weehawken, New Jersey premises, which was completed by May 31, 2005. The projected annual savings from the consolidation of the San Diego, California and the Edgewater, New Jersey facilities into the Weehawken, New Jersey facility is approximately $2.1 million.

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Results of Operations

2004 Compared with 2003

Net Income (Loss). The Company reported net income applicable to common shareholders of $4.9 million, or $0.22 basic and $0.18 diluted income per share, for the year ended December 25, 2004 compared with a net loss applicable to common shareholders of $28.0 million, or a loss of $1.94 basic and diluted income per share, in fiscal 2003.

In addition to improved operating results, the increase in net income applicable to common shareholders was the result of the following:

•	A favorable impact of $11.3 million due to a deferred Federal income tax provision recorded during the year ended December 27, 2003 to increase the valuation allowance and fully reserve the net deferred tax asset;
•	A favorable impact of $7.9 million on preferred stock dividends due to the June 2003 implementation of SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” (“SFAS 150”). The accretion of the Series B Participating Preferred Stock (“Series B Preferred”) was recorded as dividends through the June 2003 implementation of SFAS 150, and as interest expense thereafter;
•	A favorable impact of $6.5 million on net interest expense as the Series C Participating Preferred Stock (“Series C Preferred”) was recorded as of its November 30, 2003 issuance date at its maximum potential cash payments in accordance with SFAS No. 15, “Accounting by Debtors and Creditors for Troubled Debt Restructurings;” thus, we are currently not required to record accretion of the Series C Preferred. In 2003, the Series B Preferred dividends and accretion were recorded as interest expense after the implementation of SFAS 150; and
•	A favorable impact of $3.1 million due to Compensation Continuation Agreement costs incurred during the year ended December 27, 2003. These costs included payments made to various executives and non-employee directors of the Company.

Partially offset by:

•	An unfavorable impact due to the establishment of a 0.5 million reserve for risks of litigation related to all class action lawsuits including the Company’s current estimate of future legal fees to be incurred;
•	An unfavorable impact of $2.1 million due to severance, termination and facility exit costs associated with the implementation of strategies to reduce the Company’s infrastructure;
•	An unfavorable impact of $1.9 million due to the recognition of the deferred gain related to the 2001 sale of our Improvements business during the year ended December 27, 2003;
•	An unfavorable impact of $1.6 million due to a benefit recognized during 2003 from the revision of our vacation and sick policy; and
•	An unfavorable impact of $0.2 million of special charges due to facility exit costs associated with the consolidation of the LaCrosse and Roanoke operations.

Net Revenues. Net revenues decreased by approximately $11.1 million (2.7%) for the year ended December 25, 2004 to $403.2 million from $414.3 million in 2003. The decrease was primarily due to a 15.6% decline in Domestications revenue on a 19.2% reduction in circulation. During 2004, management purposely reduced circulation in Domestications during the first six months due to liquidity restraints and during the final six months due to the newly appointed President of Domestications assembling a team to stabilize and reposition the catalog. The impact of the decline in circulation and demand from Domestications was partially offset by increases in circulation for Silhouettes and The Company Store resulting in an increase in net revenues for these catalogs. Certain catalogs benefited from increased fill rates and reductions in backorders and lower order cancellations due to the additional capital secured through the Chelsey Facility and the amended Wachovia Facility. In addition, revenue relating to our membership programs increased by approximately $1.0 million for the year ended December 25, 2004 to $10.3 million from $9.3 million in 2003. Internet sales revenue comprised 32.0% of combined Internet and catalog net revenues for the year ended December 25, 2004 compared with 27.9% in 2003, and have increased by

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approximately $11.6 million, or 10.8%, to $118.7 million for the year ended December 25, 2004 from $107.1 million in 2003.

Cost of Sales and Operating Expenses. Cost of sales and operating expenses decreased by $18.1 million to $243.2 million for the year ended December 25, 2004 as compared with $261.3 million in 2003. Cost of sales and operating expenses decreased to 60.3% of net revenues for the year ended December 25, 2004 as compared with 63.1% of net revenues in 2003. As a percentage of net revenues, this decrease was primarily due to a decline in merchandise costs associated with a shift from domestic to foreign-sourced goods (1.3%). The balance of the decline was attributable to a combination of factors including a decline in inventory write-downs due to reduced slow moving inventory and increased sales of clearance merchandise through the Internet resulting in lower variable costs as compared with utilizing catalogs as the clearance avenue and other cost reductions.

Special Charges. In December 2000, the Company began a strategic business realignment program that resulted in the recording of special charges for severance, facility exit costs and fixed asset write-offs. The actions related to this strategic business realignment program were taken in an effort to direct our resources primarily towards a loss reduction strategy and a return to profitability. On June 30, 2004, we decided to consolidate the operations of the LaCrosse, Wisconsin fulfillment center and storage facility into the Roanoke Virginia fulfillment center by June 30, 2005. The LaCrosse fulfillment center and the LaCrosse storage facility were closed in June 2005 and August 2005 upon the expiration of their leases. This plan was prompted by excess capacity at our Roanoke facility and the lack of sufficient warehouse space in the leased Wisconsin facilities to support the growth of The Company Store and to reduce the overall cost structure of the Company. In addition, on November 9, 2004, we decided to relocate the International Male and Undergear catalog operations to our Corporate offices in New Jersey. The relocation was effected to consolidate operations and reduce costs while leveraging our catalog expertise in New Jersey. The relocation was completed on February 28, 2005.

Total special charges increased by approximately $0.2 million to $1.5 million for the year ended December 25, 2004 as compared with $1.3 million in 2003. During the year ended December 25, 2004, the Company recorded $0.5 million and $0.9 million in severance and related costs associated with the consolidation of the LaCrosse operations and the relocation of the International Male and Undergear catalog operations to New Jersey, respectively. In addition, we recorded an additional $0.3 million in severance and related costs during the fourth quarter of 2004 associated with the elimination of 15 full-time company-wide positions. These costs were partially offset by $0.2 million of reductions in the special charges reserve primarily due to decreases in estimated losses on the sublease arrangements for the Gump’s office facility in San Francisco, California. During the year ended December 27, 2003, we recorded $1.3 million of additional severance costs and charges incurred to revise estimated losses related to the sublease arrangements for the Gump’s office facility in San Francisco. The increase in anticipated losses on the sublease arrangements for the San Francisco office space resulted from the loss of a subtenant, coupled with declining real estate values in that area of the country.

Selling Expenses. Selling expenses increased by $0.5 million to $100.5 million for the year ended December 25, 2004 as compared with $100.0 million in 2003. Selling expenses increased to 24.9% of net revenues for the year ended December 25, 2004 from 24.1% in 2003. As a percentage of net revenues, this change was due primarily to an increase in Internet marketing and catalog paper costs, partially offset by reduced circulation during 2004.

General and Administrative Expenses. General and administrative expenses decreased approximately $2.3 million to $43.2 million for the year ended December 25, 2004 from $45.5 million in 2003. As a percentage of net revenues, general and administrative expenses decreased to 10.7% of net revenues for the year ended December 25, 2004 compared with 11.0% of net revenues in 2003. This decrease of $2.3 million was due primarily to the net

impact of certain items during 2004 and 2003, the largest of which was the higher payments for compensation continuation agreements in 2003 offset by items such as the establishment of a reserve of $0.5 million related to class action lawsuits in 2004. See “Executive Summary.”

Depreciation and Amortization. Depreciation and amortization decreased approximately $0.7 million to $4.0 million for the year ended December 25, 2004 from $4.7 million in 2003. The decrease was primarily due to property and equipment that have become fully depreciated, partially offset by the depreciation of newly purchased property and equipment.

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Income from Operations. The Company’s income from operations increased by $9.3 million to $10.7 million for the year ended December 25, 2004 from income from operations of $1.4 million in 2003.

Gain on Sale of the Improvements Business. During the year ended December 27, 2003, the Company recognized the remaining deferred gain of $1.9 million consistent with the terms of the March 27, 2003 amendment made to the asset purchase agreement relating to the sale of the Improvements business. Effective March 28, 2003, the remaining $2.0 million escrow balance was received by the Company, thus terminating the escrow agreement. See Note 4 of Notes to the consolidated financial statements.

Interest Expense, Net. Interest expense, net, decreased $6.5 million to $5.6 million for the year ended December 25, 2004 from $12.1 million in 2003. The decrease in interest expense, net was due to the recording of $7.6 million of Series B Preferred dividends and accretion as interest expense for the year ended December 27, 2003 based upon the treatment of the Series B Preferred as a liability as a result of the implementation of SFAS 150 and lower average cumulative borrowings relating to the Wachovia Facility. In November 2003, we exchanged the Series B Preferred for the Series C Preferred, which was accounted for in accordance with SFAS No. 15, “Accounting by Debtors and Creditors for Troubled Debt Restructurings.” Accordingly, the Series C Preferred was recorded at its total maximum potential cash payments including dividends and other contingent amounts, and thus no dividends or interest expense on this stock has been recorded for the year ended December 25, 2004. In addition, the decrease was due to lower amortization of deferred costs as a result of the amendments to the Wachovia Facility, which have lengthened the life of the facility and therefore the amortization period. These decreases were partially offset by increases in interest expense and amortization of deferred issuance costs relating to the Chelsey Facility. See Note 7 of Notes to the consolidated financial statements.

Income Taxes. The Company’s income tax provision decreased by approximately $11.1 million to $0.2 million for the year ended December 25, 2004 as compared with $11.3 million in 2003. The Company had sufficient net operating loss carryovers (“NOLs”) and its taxable income was below its §382 limit to eliminate its entire 2004 regular Federal income tax. The 2004 Federal income tax provision of $0.1 million is comprised of the Federal alternative minimum tax (“AMT”). The Company has AMT net operating loss carryovers for which utilization is limited to a maximum of 90% of AMT taxable income. See Note 12 of Notes to the consolidated financial statements for further discussion of the Company’s income taxes. In addition, during the third quarter of 2003, due to a number of factors, management lowered its projections of taxable income for 2003 and 2004, which resulted in a decision to fully reserve the remaining net deferred tax asset and accordingly increased the valuation allowance by $11.3 million.

Preferred Stock Dividends. Through the end of the second quarter of 2003, the Company recorded preferred stock dividends relating to the Series B Preferred. Upon the implementation of SFAS 150 beginning in the third quarter of 2003, we were required to begin recording the preferred stock dividends as interest expense. Additionally, the Series C Preferred was recorded at the maximum amount of the liquidation preference of $72.7 million, thus no preferred stock dividends were recorded. Therefore, during the year ended December 25, 2004, no preferred stock dividends were recorded. See Note 8 of Notes to the consolidated financial statements for an explanation regarding the Company’s accounting treatment of the Series C Preferred.

2003 Compared with 2002

Net Loss. The Company reported a net loss applicable to common shareholders of $28.0 million, or $1.94 basic and diluted income per share, for the year ended December 27, 2003 compared with a net loss applicable to common shareholders of $26.5 million, or $1.91 basic and diluted income per share, for the comparable period in the 2002.

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The increase in net loss applicable to common shareholders was primarily the result of the following:

•	An increase of $7.6 million in the deferred Federal income tax provision incurred to increase the valuation allowance and fully reserve the remaining net deferred tax asset. Due to a number of factors, including the continued softness in the demand for our products, management lowered its projections of future taxable income for fiscal years 2003 and 2004. As a result of lower projections of future taxable income, the future utilization of our net operating losses were no longer “more-likely-than-not” to be achieved;
•	$7.6 million of additional interest expense incurred on the Series B Preferred as a result of the implementation of SFAS 150. Effective June 29, 2003, SFAS 150 required us to reclassify our Series B Preferred as a liability and reflect the accretion of the preferred stock balance as interest expense. However, this then reduced the preferred stock dividends by $7.6 million;
•	A favorable impact of $3.1 million due to the reduction of special charges recorded;
•	An unfavorable impact of $3.1 million due to Compensation Continuation Agreement costs incurred for the year ended December 27, 2003. These costs included payments made to various executives and non-employee directors of the Company;
•	A favorable impact of $3.6 million due to reduced legal expenses related to the ongoing litigation with Rakesh Kaul;
•	A favorable impact of $1.3 million due to recognition of the deferred gain related to the 2001 sale of the Company’s Improvements business; and
•	A favorable impact of $1.6 million due to the implementation of the revised vacation and sick benefit policy.

The increase in net loss applicable to common shareholders was partially offset by improved operating results of the Company.

Net Revenues. Net revenues decreased $42.7 million, or 9.3% for the year ended December 27, 2003 to $414.3 million from $457.0 million in 2002. The decreases were due to a number of factors including softness in the economy and demand for our products during the first six months of the year. In addition, our strategy of reducing unprofitable circulation contributed to the decline throughout the year. Circulation decreased by 5.9% from the prior year period. Internet sales accounted for 27.9% of combined Internet and catalog revenues and have improved by $20.8 million, or 24.2%, to $107.1 million from $86.3 million in 2002. Catalog sales declined by $53.7 million, or 16.3%, for the year ended December 27, 2003 to $276.9 million from $330.6 million in 2002.

Cost of Sales and Operating Expenses. Cost of sales and operating expenses decreased to 63.1% of net revenues for the year ended December 27, 2003 as compared with 63.5% of net revenues in 2002. As a percentage of net revenues, this decrease from the prior year was caused primarily by a reduction of total merchandise cost of 0.9% due to a more cost-efficient merchandise sourcing strategy. This decline was partially offset by increased product shipping costs of 0.5% related to an increase in rates charged by third party shipping companies. Fixed distribution and telemarketing costs as a percentage of net revenues were constant during 2003 and 2002.

Special Charges. In December 2000, the Company began a strategic business realignment program that resulted in the recording of special charges for severance, facility exit costs and asset write-offs. Special charges recorded in 2003 and 2002 relating to the strategic business realignment program were $1.3 million and $4.4 million, respectively. The actions related to the strategic business realignment program were taken in an effort to direct our resources primarily towards a loss reduction strategy and a return to profitability.

In the first quarter of 2003, special charges were recorded in the amount of $0.3 million. These charges consisted primarily of additional severance costs associated with our strategic business realignment program. During the second, third and fourth quarters of 2003, we recorded special charges of $0.2 million, $0.2 million and $0.6 million, respectively. These charges were incurred primarily to revise estimated losses related to sublease arrangements for the Gump’s office facility in San Francisco, California. For 2002, $4.4 million of special charges were recorded relating to the strategic business realignment program. These costs consisted of approximately $1.8 million in severance costs and $2.6 million in facility lease and exit costs.

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Selling Expenses. Selling expenses decreased $5.5 million to $100.0 million for the year ended December 27, 2003 from $105.5 million in 2002. Selling expenses increased to 24.1% of net revenues for the year ended December 27, 2003 from 23.1% for the comparable period in 2002. This increase was due primarily to a combined increase of 1.1% in postage, catalog preparation and printing costs, which was partially offset by a 0.1% decline in paper prices.

General and Administrative Expenses. General and administrative expenses decreased by $7.8 million to $45.5 million for the year ended December 27, 2003 from $53.3 million in 2002. This decrease was primarily due to reductions in incentive compensation programs of $3.5 million, a reduction of legal costs of $3.0 million which had been incurred in the prior year and related to litigation pertaining to the Company’s former Chief Executive Officer, benefits recognized from the implementation of our new vacation and sick policy of $0.8 million, and other payroll related cost reductions.

Depreciation and Amortization. Depreciation and amortization decreased to 1.1% of net revenues for the year ended December 27, 2003 from 1.2% in 2002. The decrease was primarily due to capital expenditures that have become fully amortized, partially offset by the depreciation of newly purchased property and equipment.

Income from Operations. The Company’s income from operations increased $3.6 million to $1.4 million for the year ended December 27, 2003 from a loss of $2.2 million in 2002. The increase was principally due to reductions in special charges, general and administrative expenses, and depreciation and amortization, which were partially offset by increased costs in selling expenses.

Gain on Sale of the Improvements Business. During 2003, the Company recognized the remaining approximately $1.9 million of deferred gain consistent with the terms of the escrow agreement relating to the Improvements sale. Effective March 28, 2003, the remaining $2.0 million escrow balance was received by the Company, thus terminating the agreement (see Note 4 to the Company’s consolidated financial statements).

Interest Expense, Net. Interest expense, net increased $6.6 million to $12.1 million for the year ended December 27, 2003 from $5.5 million in 2002. The increase in interest expense was due to the recording of $7.6 million of Series B Preferred dividends and accretion as interest expense based upon the implementation of SFAS 150. Effective June 29, 2003, SFAS 150 required us to reclassify our Series B Preferred as a liability and reflect the accretion as interest expense. The increase in interest expense was partially offset by a decrease in amortization of deferred financing costs relating to our amendments to the Wachovia Facility, which lengthened the facility.

Income Taxes. The Company’s income tax provision increased by approximately $7.5 million to $11.3 million for the year ended December 27, 2003 as compared with $3.8 million in 2002. During the year ended December 27, 2003, the Company made a decision to fully reserve the remaining net deferred tax asset by increasing the valuation allowance by recording a $11.3 million deferred Federal income tax provision as compared with a $3.7 million provision incurred in 2002. During the quarter ended September 27, 2003, management lowered its projections of future taxable income for 2003 and 2004 due to a number of factors, including the continued softness in the demand for our products at that time and the impact of the May 19, 2003 change in control (see Note 12 to the Company’s consolidated financial statements). Partially offsetting this $7.6 million increase was a $0.1 million decrease in the provision for state income taxes for the year ended December 27, 2003.

Preferred Stock Dividends. Preferred stock dividends decreased by approximately $7.7 million to $7.9 million for the year ended December 27, 2003 as compared with $15.6 million in 2002. Through the end of the second quarter of 2003, the Company recorded Preferred stock dividends relating to the Series B Preferred, however, upon the implementation of SFAS 150 beginning in the third quarter of 2003, we were required to begin recording the preferred stock dividends as interest expense. Additionally, the Series C Preferred, which was exchanged on November 30, 2003 for the Series B Preferred, was recorded at the maximum amount of the liquidation preference of $72.7 million, thus no preferred stock dividends were recorded.

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Liquidity and Capital Resources

Overview

By the end of 2004, the Company’s liquidity significantly improved as compared with its position at the end of 2003. Our working capital at December 25, 2004 was $10.8 million, as compared with a working capital deficit of $10.4 million at December 27, 2003. As a result of securing the $20.0 million Chelsey Facility on July 8, 2004 and concurrently amending the terms of the Wachovia Facility, our liquidity increased by approximately $25.0 million. The additional working capital has provided us the ability to restore inventory to more adequate levels in order to more effectively fulfill demand, reduce existing backorder levels, and increase initial customer order fill rates. In addition, the funding has eliminated substantially all vendor restrictions involving our credit arrangements. With lower than expected inventory levels in the fourth quarter of 2003 and the interruptions in the flow of merchandise, which prevented inventories from reaching adequate levels in the first half of 2004, we experienced a significant negative impact on revenues and cash flow in the first half of 2004. These lower inventory levels resulted in large part from tighter vendor credit and borrowing restrictions under our Wachovia Facility. This had a compounding effect on the business as a whole; lower levels of inventory reduced the amount of the financing available under the Wachovia Facility as well as the ability to meet customer demand, which resulted in a significant increase in our backorder position and cancellation of customer orders. During the second quarter of 2004, management determined that this inventory position was not sustainable for the long term, as we were experiencing a significant negative impact on second quarter net revenues due to the decreased inventory levels. Management’s primary objective became the formulation and execution of a plan to address the liquidity issue facing the Company. After reviewing available alternatives, the Company entered into the Chelsey Facility and concurrently negotiated an amendment of the terms of the Wachovia Facility.

Net cash used by operating activities. For the year ended December 25, 2004, net cash used by operating activities was $17.3 million. This was due primarily to increased inventory levels, payments to vendors to reduce accounts payable and increases in accounts receivable and prepaid catalog costs. These uses of cash were partially offset by $13.0 million of operating cash provided by net income, when adjusted for depreciation, amortization, special charges and other non cash items.

Net cash used by investing activities. For the year ended December 25, 2004, net cash used by investing activities was $0.8 million. This amount comprised capital expenditures, consisting primarily of purchases and upgrades to various information technology hardware and software throughout the Company and purchases of equipment for the Company’s Lacrosse, Wisconsin and Roanoke, Virginia locations.

Net cash provided by financing activities. For the year ended December 25, 2004, net cash provided by financing activities was $16.3 million, which was primarily due to the receipt of $20.0 million from the Chelsey Facility and a $0.3 million refund relating to withholding taxes remitted on behalf of Richemont Finance S.A. for estimated taxes due related to the Series B Preferred. These receipts were partially offset by net payments of $2.1 million under the Wachovia Facility, debt issuance costs of $1.2 million relating to the Chelsey Facility transaction and the amendment of the Wachovia Facility, and payments of $0.7 million for obligations under capital leases.

Financing Activities

Wachovia Facility. Wachovia and the Company are parties to a Loan and Security Agreement dated November 14, 1995 (as amended by the First through Thirty-Fourth Amendments, the “Wachovia Loan Agreement”) pursuant to which Wachovia provided the Company with the Wachovia Facility which has included, since inception, one or more term loans and a revolving credit facility (“Revolver”). The Wachovia Facility expires on July 8, 2007.

Prior to obtaining the Chelsey Facility, there were two term loans outstanding, Tranche A and Tranche B, under the Wachovia Facility. The Tranche B term loan had a principal balance of approximately $4.9 million and bore interest at 13% when the Company used a portion of the proceeds of the Chelsey Facility to repay this loan on July 8, 2004. The Tranche A term loan had a principal balance of approximately $5.0 million as of December 25, 2004, of which approximately $2.0 million was classified as short term and approximately $3.0 million was classified as long term on the Consolidated Balance Sheet. The Tranche A term loan bears interest at 0.5% over the Wachovia prime rate and requires monthly principal payments of approximately $166,000.

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The Revolver has a maximum loan limit of $34.5 million, subject to inventory and accounts receivable sublimits that limit the credit available to the Company’s subsidiaries, that are borrowers under the Revolver. The interest rate on the Revolver is currently 0.5% over the Wachovia prime rate. As of December 25, 2004, the interest rate on the Revolver was 5.5%.

The Wachovia Facility is secured by substantially all of the assets of the Company and contains certain restrictive covenants, including a restriction against the incurrence of additional indebtedness and the payment of Common Stock dividends. In addition, all of the real estate owned by the Company is subject to a mortgage in favor of Wachovia and a second mortgage in favor of Chelsey Finance. The Wachovia Loan Agreement contains affirmative and negative covenants typical for loan agreements for asset-based lending of this type including financial covenants requiring the Company to maintain specified levels of Consolidated Net Worth, Consolidated Working Capital and EBITDA, as those terms are defined in the Wachovia Loan Agreement.

Due to, among other things, the restatements which resulted in the Company violating several financial covenants and the Company’s inability to timely file its periodic reports with the SEC, the Company was in technical default under the Wachovia and Chelsey Facilities. The Company has obtained waivers from both Wachovia and Chelsey Finance for such defaults.

2004 Amendments to Wachovia Loan Agreement. On March 25, 2004, the Company and Wachovia amended the Wachovia Loan Agreement to adjust the levels of Consolidated Net Worth and Consolidated Working Capital as defined in the agreement, that the Company must maintain during each month commencing January 2004, and amend the EBITDA covenant to specify minimum levels of EBITDA that the Company must achieve on a quarterly basis during 2004, 2005 and 2006. In addition, the definition of “Event of Default” was amended by changing an Event of Default from the occurrence of a material adverse change in the business, assets, liabilities or condition of the Company and its subsidiaries to the occurrence of certain specific events such as a decrease in consolidated net revenues beyond certain specified levels or aging of inventory or accounts payable beyond certain specified levels.

Concurrent with the closing of the Chelsey Facility on July 8, 2004, the Company and Wachovia amended the Wachovia Loan Agreement in several respects including: (1) releasing certain existing availability reserves and removing the excess loan availability covenant, which increased the Company’s availability by approximately $10.0 million, (2) reducing the amount of the maximum credit, the revolving loan limit and the inventory and accounts sublimits of the borrowers, and (3) permitting Chelsey Finance to have a junior secured lien on the Company’s assets. In addition, Wachovia consented to (a) the Company’s issuance to Chelsey Finance of the Common Stock Warrant and the Common Stock as described below, (b) the proposed reverse stock split of the Common Stock and the Company making cash payments to repurchase fractional shares, (c) certain amendments to the Company’s Certificate of Incorporation, and (d) the issuance by the Company of Common Stock to Chelsey as payment of a waiver fee. The Company paid Wachovia a $400,000 fee in connection with this amendment. This fee was recorded as a deferred charge on the Company’s Consolidated Balance Sheets and is being amortized over the three-year term of the amended Wachovia Facility.

2005 Amendments to Wachovia Loan Agreement. On March 14, 2005, Wachovia consented to the sale of Gump’s and Gump’s By Mail. On March 11, 2005 the Wachovia Loan Agreement was amended to temporarily increase the amount of letters of credit that the Company could issue from $10.0 million to $13.0 million through June 30, 2005. The Company paid Wachovia a $25,000 fee in connection with this amendment.

Effective July 29, 2005 the Company and Wachovia amended the Wachovia Loan Agreement (“Thirty-Fourth Amendment”) to provide the terms under which the Company could enter into the World Financial Network National Bank (“WFNNB”) Credit Card Agreement which, among other things, prohibits the use of the proceeds of the Wachovia Facility to repurchase private label and co-brand accounts created under the WFNNB Credit Card Agreement should the Company become obligated to do so, prohibits the Company from terminating the WFNNB Credit Card Agreement without Wachovia’s consent and restricts the Company from borrowing on receivables generated under the WFNNB Credit Card Agreement. The amendment also waives enumerated defaults, resets the financial covenants, reallocates the availability that was previously allocated to Gump’s among other Company subsidiaries and, retroactive to June 30, 2005, increases the amount of letter of credits that the Company can issue to $15.0 million. The Company paid Wachovia a $60,000 fee in connection with this amendment.

On July 29, 2005 the Company and Chelsey Finance entered into a similar amendment of the Chelsey Facility.

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Based on the provisions of EITF 95-22, “Balance Sheet Classification of Borrowings Outstanding under Revolving Credit Agreements that Include Both a Subjective Acceleration Clause and a Lock-Box Arrangement,” and certain provisions in the Wachovia Loan Agreement, the Company is required to classify its Revolver as short-term debt.

Remaining availability under the Wachovia Facility was $14.0 million and the interest rate was 5.5% as of December 25, 2004.

Chelsey Facility. On July 8, 2004, the Company closed on the Chelsey Facility, the $20.0 million junior secured credit facility with Chelsey Finance that was recorded net of a debt discount at $7.1 million at issuance. The Chelsey Facility has a three-year term, subject to earlier maturity upon the occurrence of a change in control or sale of the Company (as defined), and carries an interest rate of 5.0% above the prime rate publicly announced by Wachovia. The financial and non-financial covenants contained in the Chelsey Facility mirror those in the Wachovia Facility except that the quantitative measures for the consolidated working capital and EBITDA covenants are 10.0% less restrictive and the consolidated net worth covenant is 5.0% less restrictive than the comparable financial covenants in the Wachovia Facility. The Chelsey Facility is secured by a second priority lien on substantially of the assets of the Company. As part of this transaction, Chelsey Finance entered into an intercreditor and subordination agreement with Wachovia. At December 25, 2004, the amount recorded as debt on the Consolidated Balance Sheet is $8.2 million, net of the un-accreted debt discount of $11.8 million.

Under the original terms of the Chelsey Facility, the Company was obligated to make payments of principal of up to the full outstanding amount of the Chelsey Facility in each quarter, provided, among other things that: (1) the aggregate amount of availability under the Wachovia Facility is at least $7.0 million, (2) the cumulative EBITDA for the four fiscal quarters immediately preceding the quarter in which the payment is made is at least $14.0 million, and (3) the aggregate amount of principal prepayments is no more than $2.0 million in any quarter. Subsequent to the closing of the Chelsey Facility, the Company and Chelsey Finance amended the Chelsey Facility to provide that the Company was not obligated to make principal payments prior to July 8, 2007, except in the event of a change in control or sale of the Company. This resulted in the recorded amount of the Chelsey Facility plus the accreted cost of the debt discount (as described below) being classified as long term on the Company’s Consolidated Balance Sheet as of December 25, 2004.

In consideration for providing the Chelsey Facility to the Company, Chelsey Finance received a closing fee of $200,000 and a warrant (the “Common Stock Warrant”) valued at $12.9 million, exercisable immediately and for a period of ten years to purchase 30.0% of the fully diluted shares of Common Stock of the Company (equal to 10,259,366 shares of Common Stock) at an exercise price of $0.01 per share. The closing fee of $200,000 was recorded as a deferred charge within Other Assets on the Company’s Consolidated Balance Sheets and is being amortized over the three-year term of the Chelsey Facility. Because the issuance of the Common Stock Warrant was subject to shareholder approval, the Company initially issued a warrant to Chelsey Finance to purchase newly-issued Series D Participating Preferred Stock (“Series D Preferred”) that was automatically exchanged for the Common Stock Warrant on September 23, 2004 following receipt of shareholder approval. See Note 7 to the Company’s consolidated financial statements for further information on the Chelsey Facility and the Common Stock Warrant.

Other Activities

Consolidation of New Jersey Office Facilities. The Company entered into a 10-year extension of the lease for its Weehawken, New Jersey premises and has relocated its executive offices to that facility in 2005. We consolidated all of our New Jersey operations into the Weehawken facility when the Edgewater, New Jersey facility closed upon the expiration of the lease on May 31, 2005.

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costs and leverage its catalog expertise in New Jersey. We accrued $0.9 million in severance and related costs during the fourth quarter of 2004 associated with the elimination of 33 California-based full-time equivalent positions. The payment of these costs began in February 2005 and continued through August 2005.

The projected annual savings from the consolidation of the San Diego, California and the Edgewater, New Jersey facilities into the Weehawken, New Jersey facility is approximately $2.1 million.

Consolidation of Fulfillment Centers. On June 30, 2004 the Company announced plans to consolidate the operations of the LaCrosse, Wisconsin fulfillment center and storage facility into the Roanoke, Virginia fulfillment center by June 30, 2005. The LaCrosse fulfillment center and the LaCrosse storage facility were closed in June 2005 and August 2005 upon the expiration of their respective leases. The plan to consolidate operations was prompted by excess capacity at the Roanoke facility and the lack of sufficient warehouse space in the leased Wisconsin facilities to support the growth of The Company Store and reduce the overall cost structure of the Company. The Company substantially completed the consolidation into the Roanoke, Virginia fulfillment center by the end of June 2005. We accrued $0.7 million in severance and related costs and incurred $0.2 million of facility exit costs during 2004 associated with the consolidation of the LaCrosse operations and the elimination of 149 full and part-time positions. The payment of these costs began in January 2005 and is expected to continue into the fourth quarter of 2005.

Pursuant to and in conjunction with the above actions to reduce overhead costs, the Company eliminated an additional 15 full-time positions Company-wide, for which we accrued $0.3 million in severance and related costs during the fourth quarter of 2004.

Sale of Improvements Business. On March 27, 2003, the Company and HSN, a division of USA Networks, Inc.’s Interactive Group and purchaser of certain assets and liabilities of the Company’s Improvements business on June 29, 2001, amended the asset purchase agreement to provide for the release of the remaining $2.0 million

balance of the escrow fund and to terminate the escrow agreement. The asset purchase agreement had provided that if Keystone failed to perform its obligations during the first two years of the services contract, HSN could receive a reduction in the original purchase price of up to $2.0 million. By agreeing to the terms of the amendment, HSN forfeited its ability to receive a reduction in the original purchase price. In consideration for the release, Keystone issued a credit to HSN for $100,000, which could be applied by HSN against any invoices of Keystone to HSN. This credit was utilized by HSN in March 2003. On March 28, 2003, the remaining $2.0 million escrow balance was received by the Company, thus terminating the escrow agreement.

During 2002, the Company recognized approximately $0.6 million of the deferred gain consistent with the terms of the escrow agreement. Proceeds related to the deferred gain were received on July 2, 2002 and December 30, 2002 for $0.3 million and $0.3 million, respectively. We recognized the remaining net deferred gain of $1.9 million upon the receipt of the escrow balance on March 28, 2003. This gain was reported net of the costs incurred to provide the credit to HSN of approximately $0.1 million.

Delisting of Common Stock. The Common Stock was delisted from the AMEX on February 16, 2005 ultimately because of the Restatement that prevented us from filing our Form 10-Q for the fiscal quarter ended September 25, 2004, a condition of continued AMEX listing. Trading in our Common Stock on the AMEX was halted on November 16, 2004 and formally suspended on February 2, 2005.

Initially the Company was notified by the AMEX on May 21, 2004 that the Company was not in compliance with the continued listing standards as set forth in Part 10 of the AMEX’s Company Guide because of insufficient shareholders equity and a series of losses from continuing operations. The Company submitted a plan to the AMEX to regain compliance with the continued listing standards which the AMEX accepted and granted the Company an extension until November 21, 2005 to regain compliance with the continued listing standards. Because the Company could not timely file its Form 10-Q for the fiscal quarter ended September 25, 2004, a condition for the Company’s continued listing on the AMEX, the AMEX began the delisting proceedings that culminated in the February 16, 2005 delisting.

Current trading information about the Company’s Common Stock can be obtained from the Pink Sheets (www.pinksheets.com) under the trading symbol HNVD.PK.

General. At December 25, 2004, the Company had $0.5 million in cash and cash equivalents compared with

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$2.3 million at December 27, 2003. Working capital and current ratio at December 25, 2004 were $10.8 million and 1.13 to 1, respectively. Total recorded borrowings, net of the un-accreted debt discount of $11.8 million and the Series C Preferred, as of December 25, 2004, aggregated $27.9 million, $11.2 million of which is classified as long term. Remaining availability under the Revolver as of December 25, 2004 was $14.0 million.

At December 25, 2004, the aggregate annual principal payments required on debt instruments (including capital lease obligations) are as follows (in thousands): 2005 — $16,690; 2006 — $2,039; 2007 — $20,998.

Management believes that the Company has sufficient liquidity and availability under its credit agreements to fund its planned operations through at least the next twelve months. See “Risk Factors” below.

Use of Estimates and Other Critical Accounting Policies

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and revenues and expenses during the period. Significant accounting policies employed by the Company, including the use of estimates, are presented in the Notes to consolidated financial statements.

Critical accounting policies are those that are most important to the portrayal of the Company’s financial condition and results of operations, and require management’s most difficult, subjective or complex judgments, as a result of the need to make estimates about the effect of matters that are inherently uncertain. The Company’s most critical accounting policies, discussed below, pertain to revenue recognition, inventory valuation, catalog costs, reserves related to the Company’s strategic business realignment program and other accrued liabilities, reserves related to employee health, welfare and benefit plans, and the net deferred tax asset.

Revenue Recognition

Direct Commerce — The Company recognizes revenue for catalog and Internet sales at the time merchandise is received by the customer, net of estimated returns. Delivery and service charges billed to customers are also recognized as revenue at the time merchandise is received by the customer. The Company’s revenue recognition policy includes the use of estimates for the time period between shipment of merchandise by the Company and receipt of merchandise by the customer and the future amount of returns to be received on the current period’s sales. These estimates of future returns are determined using historical measures including the amount of time between the shipment of a product and its return, the overall rate of return, and the average product margin associated with the returned products. The Company’s total returns reserve at the end of 2004 and 2003 was $2.0 million. For the year ended December 25, 2004, the Company’s return rate decreased 0.6% to 10.5% from 11.1% in 2003. A contributing factor to this decrease was the modification of our return policy in October 2003, which previously allowed unlimited returns, to limit returns to a maximum of 90 days after the sale of the merchandise.

Membership Services — Customers may purchase memberships in a number of the Company’s Buyers’ Club programs for an annual fee. For memberships purchased during the following periods, certain of the Buyers’ Club programs contained a guarantee that the customer would receive discounts or savings, at least equal to the cost of his or her membership or the Company would refund the difference with a merchandise credit at the end of the membership period: Silhouettes from July 1998 through March 2004; Domestications from April 2002 through March 2004; and Men’s Apparel from April 2003 through March 2004. For memberships purchased during the periods in which the Buyers’ Club memberships contained a guarantee, revenue net of actual cancellations was recognized on a monthly basis over the membership period subsequent to the end of the thirty-day cancellation period, with the revenue recognized equal to the lesser of the cumulative amount determined using the straight-line method or the actual benefit received by each customer as of the end of each period. For the Buyers’ Club memberships that did not contain a guarantee, revenue net of actual cancellations was recognized on a monthly basis over the membership period subsequent to the end of the thirty-day cancellation period, using the straight-line method. We receive commission revenue related to our solicitation of the Vertrue membership programs. The Company receives a monthly commission based on the number of memberships sold with additional revenue recognized if certain program performance levels are attained for each fiscal year. Through May 2003, we received commission revenue from the Magazine Direct magazine subscription program. The commission revenue we recognized for the Magazine Direct magazine program was on a per-solicitation basis according to the number of

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solicitations made, with additional revenue recognized if the customer accepted the solicitation. Collectively, the amount of revenues the Company received from these sources was $10.3 million, or 2.5% of net revenues, $9.3 million or 2.2% of net revenues, and $10.3 million, or 2.2% of net revenues for 2004, 2003 and 2002, respectively. In May 2003, we discontinued our solicitation of the Magazine Direct program.

Inventory Valuation — The Company’s inventory valuation policy includes the use of estimates regarding the future loss on in-transit and on-hand inventory that will be sold at a price less than the cost of the inventory (inventory write-downs), plus the amount of freight-in expense associated with the inventory on-hand (capitalized freight). These amounts are included in Inventories, as recorded on the Company’s Consolidated Balance Sheets. Our inventory write-downs are determined for each individual catalog using the estimated amount of overstock inventory that will need to be sold below cost and an estimate of the method of liquidating this inventory (each method generates a different level of cost recovery). Any incremental gross margin that would result in inventory being sold at a higher amount after a write-down is recorded is not realized until that inventory is ultimately sold. The estimated amount of overstock inventory is determined using current and historical sales trends for each category of inventory as well as the content of future merchandise offers that will be produced by the Company. An estimate of the percentage of freight-in expense associated with each dollar of inventory received is used in calculating the amount of freight-in expense to include in our inventory value. Different percentage estimates are developed for each catalog and for inventory purchased from foreign and domestic sources. The estimates used to determine our inventory valuation affect the balance of Inventories on the Company’s Consolidated Balance Sheets and Cost of sales and operating expenses on the Company’s Consolidated Statements of Income (Loss).

Catalog Costs — In accordance with Statement of Position 93-7, “Reporting on Advertising Costs,” catalog costs are deferred and amortized over the estimated period in which the sales related to such advertising are generated. An estimate of the future sales dollars to be generated from each individual catalog drop is used in the implementation of the Company’s catalog cost amortization policy. The estimate of future sales is calculated for each catalog drop using historical trends for similar catalog drops mailed in prior periods as well as the overall current sales trend for the catalog. On a monthly basis, this estimate is evaluated and adjusted as necessary and then is compared with the actual sales generated to-date for the catalog drop to determine the percentage of total catalog costs to be classified as prepaid catalog costs on the Company’s Consolidated Balance Sheets. The costs for each catalog drop are completely amortized, regardless of actual sales generated by the catalog drop, when the catalog has been in circulation for six months or the amount of the costs remaining to be amortized decreases below 3.0% of the catalog drop’s total cost. Our Prepaid catalog costs at the end of 2004, 2003 and 2002 were $15.6 million, $12.5 million and $14.3 million, respectively. Prepaid catalog costs on the Consolidated Balance Sheets and Selling expenses on the Consolidated Statements of Income (Loss) are affected by these estimates.

Reserves related to the Company’s strategic business realignment program and other Accrued Liabilities — Generally, the Company records severance in accordance with the Financial Accounting Standards Board (“FASB”) Statement No. 112, “Employers’ Accounting for Postemployment Benefits,” (“SFAS 112”) and reserves for leased properties were accounted in accordance with Emerging Issues Task Force No. 94-3 (“EITF 94-3”), “Liability Recognition for Certain Employee Termination Benefits & Other Costs to Exit an Activity (Including Certain Costs Incurred in Restructuring).” The reserves established by the Company related to its strategic business realignment program include employee severance and related costs, facility exit costs and estimates primarily associated with the potential subleasing of leased properties that have been vacated by the Company. Subsequent to December 25, 2004, the Gump’s business was sold as described in Part I of this Form 10-K. The overall reserves for leased properties that have been vacated by the Company are developed using estimates that include the potential ability to sublet leased but unoccupied properties, the length of time needed to obtain suitable tenants and the amount of rent to be received for the sublet. Real estate broker representations regarding current and future market conditions are sometimes used in estimating these items. Accrued liabilities and Other Non-current liabilities on the Company’s Consolidated Balance Sheets and Special charges on the Company’s Consolidated Statements of Income (Loss) are impacted by these estimates. See Note 5 and Note 6 to the Company’s consolidated financial statements.

The most significant estimates involved in evaluating our accrued liabilities are used in the determination of the accrual for legal liabilities or those liabilities that will be resolved through litigation. We accrue for potential litigation losses when management determines that it is probable that an unfavorable outcome will result and the loss is reasonably estimable. Our policy is to accrue an amount equal to the estimated potential loss and associated legal fees. For the year ended December 30, 2000, the Company used estimates to determine the liability related to Rakesh Kaul’s claims regarding benefits as a result of his resignation on December 5, 2000. As part of the

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Restatement, the Company corrected two accounting errors related to the Rakesh Kaul liability. The first error identified was the premature reversal of the reserve in the fourth quarter of 2003 based upon the summary judgment decision in January 2004. As noted above, this decision could be, and subsequently was, appealed. Due to this fact, management has now determined that the reversal was premature. The second error identified was the accounting for legal fees associated with litigating this claim. Due to the fact that the Kaul reserve was recorded prior to the initiation of litigation, the Company has determined that the appropriate basis of accounting for the legal fees related to the litigation would have been to treat such fees as period costs and, therefore, expensed as incurred. However, the Company had inappropriately recorded certain of these fees against the reserve as opposed to recording them as an expense in the income statement. See Note 2 of Notes to the consolidated financial statements for additional information pertaining to this restatement adjustment. In addition, the Company recorded a $0.5 million reserve during the third quarter of 2004 for estimated costs associated with the Class Action Lawsuits the Company is currently litigating. See Note 15 of Notes to the consolidated financial statements for additional information pertaining to this reserve.

Reserves related to employee health, welfare and benefit plans — The Company maintains a self-insurance program related to losses and liabilities associated with employee health and welfare claims. Stop-loss coverage is held on both an aggregate and individual claim basis thereby limiting the amount of losses we will experience. Losses are accrued based upon estimates of the aggregate liability for claims incurred using our experience patterns. General and administrative expenses on the Consolidated Statement of Income (Loss) and Accrued liabilities on the Consolidated Balance Sheets are affected by these estimates. At December 25, 2004 and December 27, 2003, the Company had an accrued liability recorded in the amount of $0.6 million.

Deferred Tax Asset - In determining the Company’s net deferred tax asset (gross deferred tax asset net of a valuation allowance and the deferred tax liability), projections concerning the future utilization of the Company’s net operating loss carryforwards are employed. These projections involve evaluations of our future operating plans and ability to generate taxable income, as well as future economic conditions and our future competitive environment. For the year ended December 27, 2003, the carrying value of the deferred tax asset was adjusted based on a reassessment of the Company’s ability to utilize certain net operating losses prior to their expiration and our history of losses. The deferred tax asset and deferred tax liability on the Company’s Consolidated Balance Sheets and the Provision for deferred income taxes on the Company’s Consolidated Statements of Income (Loss) are impacted by these projections.

New Accounting Pronouncements

On March 31, 2004, the Financial Accounting Standards Board (“FASB”) issued Emerging Issues Task Force Issue No. 03-6 (“EITF 03-6”), “Participating Securities and the Two-Class Method under FASB Statement No. 128.” SFAS 128 defines earnings per share (“EPS”) as “the amount of earnings attributable to each share of common stock” and indicates that the objective of EPS is to measure the performance of an entity over the reporting period. SFAS 128 addresses conditions under which a participating security requires the use of the two-class method of computing EPS. The two-class method is an earnings allocation formula that treats a participating security as having rights to earnings that otherwise would have been available to common shareholders, but does not require the presentation of basic and diluted EPS for securities other than common stock. The Company’s Series C Preferred is a participating security and, therefore, we calculate EPS utilizing the two-class method, however, have chosen not to present basic and diluted EPS for its preferred stock.

In November 2004, the FASB issued SFAS No. 151, “Inventory Costs, an Amendment of ARB No. 43, Chapter 4” (“SFAS 151”), which clarifies the accounting for abnormal amounts of idle facility expense, freight, handling costs and spoilage. We are required to adopt the provisions of SFAS 151 effective January 1, 2006; however, early adoption is permitted. We are currently in the process of determining the impact of the adoption of this Statement on our financial statements.

In December 2004, the FASB issued SFAS No. 123R, “Share Based Payment” (“SFAS 123R”). SFAS 123R requires measurement and recording of compensation expense for all employee share-based compensation awards using a fair value method. The Company currently accounts for its stock-based compensation to employees using the fair value-based methodology under SFAS 123. We are currently assessing the impact of the adoption of this Statement.

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In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Correction” (“SFAS 154”), which changes the requirements for the accounting for and reporting of a change in accounting principle. We are required to adopt the provisions of SFAS 154 effective January 1, 2006; however, early adoption is permitted. The Company is currently assessing the impact of the adoption of this Statement.

Off-Balance Sheet Arrangements and Contractual Obligations

The Company has entered into no “off-balance sheet arrangements” within the meaning of the Securities Exchange Act of 1934, as amended, and the rules thereunder other than operating leases in the normal course of business.

Provided below is a tabular disclosure of contractual obligations as of December 25, 2004, as required by Item 303(a)(5) of SEC Regulation S-K. In addition to obligations recorded on the Company’s Consolidated Balance Sheets as of December 25, 2004, the schedule includes purchase obligations, which are defined as legally binding and enforceable agreements to purchase goods or services that specify all significant terms (quantity, price, and timing of transaction).

Payment Due by Period (in thousands)

Contractual Obligations	Total	Less Than 1 Year	1-3 Years	3-5 Years	More Than 5 Years
Debt Obligations, excluding the Series C Participating Preferred Stock (a)	$ 39,384	$ 16,400	$ 22,984	$ —	$ —
Total Minimum Lease Payments Under Capital Lease Obligations (Including interest)	358	304	54	—	—
Operating Lease Obligations- excluding Gump’s (e)	2,164	1,735	421	8	—
Operating Lease Obligations- Gump’s (e)	8,680	1,659	3,383	3,360	278
Operating Lease Obligations — Restructuring/ Discontinued Operations- excluding Gump’s (e)	1,051	979	72	—	—
Operating Lease Obligations — Restructuring/ Discontinued Operations- Gump’s (e)	5,179	1,002	2,004	2,006	167
Contractual Obligations (b)	1,478	1,289	189	—	—
Purchase Obligations- excluding Gump’s (c) (e)	27,661	27,661	—	—	—
Purchase Obligations- Gump’s (c) (e)	1,088	1,088	—	—	—
Other Long-Term Liabilities Reflected on the Registrant’s Balance Sheet under GAAP (d)	72,689	—	—	72,689	—
Total	$ 159,732	$ 52,117	$ 29,107	$ 78,063	$ 445

(a)

Represents the Company’s debt obligations, including the $20.0 million Chelsey Facility principal amount due Chelsey Finance, recorded as $8.2 million on the Consolidated Balance Sheet. See Note 7 of Notes to the consolidated financial statements for additional detail regarding the Chelsey Facility.

(b)

The Company’s contractual obligations consist primarily of a total commitment of $2,000,000 to purchase telecommunication services during the period from May 1, 2004 through April 30, 2006, of which approximately $1,246,000 had been fulfilled as of December 25, 2004, and of which $754,000 should be fulfilled during the next 12 months; a total commitment of approximately $487,000 to purchase catalog photography services during the period from September 11, 2003 through September 10, 2005, of which approximately $265,000 had been fulfilled as of December 25, 2004, and of which an additional $161,000 had

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been fulfilled by September 10, 2005, and of which approximately $61,000 remains unpaid; a total commitment of $375,000 for list processing services representing the maximum exposure for a service contract that requires a three-month notice of termination for services costing $125,000 per month; and several commitments totaling approximately $127,000 to purchase various packaging materials from several vendors during the next 12 months, under contracts wherein the vendors warehouse varying minimum and maximum levels of materials to ensure immediate availability.

(c) The Company’s purchase obligations represent the estimated commitments at year-end to purchase inventory and raw materials in the normal course of business to meet operational requirements. The Company’s purchase orders are not unconditional commitments, but rather represent executory contracts requiring performance by vendors/suppliers. As such the Company has an absolute and unconditional right to cancel the Purchase Order if the vendor/supplier is unable to arrange for the products listed thereon to be delivered to the destination by the date shown. The purchase obligations presented above include all such open orders and agreed upon raw material commitments that are not otherwise included in the Company’s recorded liabilities.

(d)

Represents Series C Participating Preferred Stock as disclosed in Note 8 to the Company’s consolidated financial statements. In March 2005 at the Company’s request, Chelsey agreed to permit the Company to apply the sales proceeds from the sale of Gump’s to reduce the Wachovia Facility. Chelsey retained the right to require redemption of approximately $6.9 million (the Gump’s sales proceeds available for redemption) of the Series C Preferred subject to Wachovia’s approval. Since the redemption of approximately $6.9 million is subject to Wachovia’s approval the payment due period is presented as January 1, 2009.

(e)	Operating lease and purchase obligation amounts for Gump’s are being shown separately due to the Company’s sale of Gump’s on March 14, 2005.

Risk Factors

Factors That May Affect Future Results.

There are many risks and uncertainties relating to our business; we have described some of the more important ones below. Additional risks and uncertainties not currently known to us or that we currently do not deem material may also become important factors that may harm our business. The success of our business could be impacted by any of these risks and uncertainties.

We have experienced several years of operating losses.

We had a history of losses prior to the 2004 fiscal year. As of December 25, 2004, our accumulated deficit was $498.6 million. We may not be able to sustain or increase profitability on an annual basis in the future. If we are unable to maintain and increase profitability our financial condition could be adversely affected.

We are dependent on having sufficient financing to meet our requirements.

Our business is dependent upon our access to adequate financing from our senior lender, Wachovia and our junior lender, Chelsey Finance, so that we can support normal operations, purchase inventory, and secure letters of credit and other financial accommodations required to operate our business. Our credit facilities contain financial and other covenants and we have not been in compliance with these covenants at all times. In the past Wachovia and Chelsey Finance have granted us waivers and agreed to amendments to the Wachovia and Chelsey Facilities, though there can be no assurances that they will continue to do so. Our ability to borrow is also limited by the value of our inventory which is reappraised from time to time. Were either Wachovia or Chelsey Finance to deny or curtail the Company’s access to capital, our business would be adversely affected. Both lenders have liens on our assets and were we to default, they could commence foreclosing on our assets.

We are also dependent on our vendors or suppliers providing us with trade credit. If certain trade creditors were to deny us credit or convert the Company to a cash basis or otherwise change credit terms, or require the Company to provide letters of credit or cash deposits to support its purchase of inventory, paper, printing and other items essential to its business, our costs would be increased and we might have inadequate liquidity to operate our business or operate profitably.

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The Restatement, the delay in filing financial statements and the commencement of an informal SEC inquiry have adversely affected us and may continue to do so in the future.

We have restated our financial results as a result of various errors identified in 2004. This has led to our inability to file financial information for several quarters, the commencement of an investigation by the Audit Committee of the Board of Directors, the delisting of our Common Stock from the AMEX, the commencement of an informal SEC inquiry. We dismissed our former independent auditors, who had identified material weaknesses in our internal controls, after they informed us that they needed to perform additional audit procedures on our prior period financial statements. We engaged new auditors which further delayed the filing of our financial statements. As a consequence of the foregoing, our business has been and will continue to be adversely affected as a result of the increased professional expenses, the diversion of senior management’s attention to resolving these matters and the damage to our Company’s reputation. There can be no assurances that the consequences of these events will not continue to adversely affect our business for the foreseeable future.

The SEC inquiry is ongoing and we cannot predict the outcome at this time. Were the SEC to convert the informal inquiry into a formal investigation, we would likely incur significant professional fees in addressing such investigation, and our relationships with our lenders, vendors, customers and other third parties could be adversely affected. Should the SEC find wrongdoing on our part, we may be subject to a censure or penalty that could adversely affect our results of operations, our relationships with our lenders, vendors, customers and other third parties, our reputation and our business in general.

There is limited liquidity in our shares of Common Stock.

The AMEX halted trading in our Common Stock during the fourth quarter of 2004 and delisted it on February 16, 2005. Current trading information about our Common Stock is available on the Pink Sheets. There is very little liquidity in our Common Stock at this point in time which adversely affects its price. There can be no assurances that an active market in our Common Stock will develop at any time in the foreseeable future.

There can be no assurance that we will be able to successfully remedy material weaknesses in our internal controls.

In connection with its audit of the Company’s consolidated financial statements for the year ended December 25, 2004, material weaknesses in internal control over financial reporting and other matters relating to the Company’s internal controls were identified. Although the Company has taken actions to enhance its internal controls, there can be no assurance that such actions will be effective in remedying the identified material weaknesses or that additional weaknesses will not develop or be discovered in the future.

Our success depends on our ability to publish the optimal number of catalogs to the correct target customer with merchandise that our target customers will purchase.

Historically our catalogs have been the primary drivers of our sales. We must create, design, publish and distribute catalogs that offer and display merchandise that our customers want to purchase at prices that are attractive. Our future success depends on our ability to anticipate, assess and react to the changing demands of the customer-base of our catalogs and to design and publish catalogs that appeal to our customers. If we fail to anticipate fashion trends, select the right merchandise assortment, maintain appropriate inventory levels and creatively present merchandise in a way that is appealing to our customer-base on a consistent basis, our sales could decline significantly. We must also accurately determine the optimal number of issues to publish for each catalog and the contents thereof and the optimal circulation for each of our catalogs to maximize sales at an appropriate cost level to achieve profitability while growing our customer base. Correctly determining the universe of catalog recipients also directly impacts our results. We can provide no assurance that we will be able to identify and offer merchandise that appeals to our customer-base or that the introduction of new merchandise categories will be successful or profitable or that we will mail the optimal number of catalogs to the appropriate target customer base.

Our catalogs are in highly competitive markets.

Our catalogs are in a highly competitive markets. Many of our competitors are considerably larger and have substantially greater financial, marketing and other resources, and we can provide no assurance that we will be able to compete successfully with them in the future.

We must effectively manage our inventories.

We must manage our inventories to track customer preferences and demand. We order merchandise based on our best projection of consumer tastes and anticipated demand in the future, but we cannot guarantee that our

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projections of consumer tastes and the demand for our merchandise will be accurate. It is critical to our success that we stock our product offerings in appropriate quantities. If demand for one or more products outstrips our available supply, we may have large backorders and cancellations and lose sales. On the other hand, if one or more products do not achieve projected sales levels, we may have surplus or un-saleable inventory that would force us to take significant inventory markdowns, which could reduce our net sales and gross margins.

We may have difficulty sourcing our products, especially those sourced overseas.

Most of our products are manufactured by third-party suppliers. Some of these products are manufactured exclusively for us using our designs. If any of these manufacturers were to stop supplying us with merchandise or go out of business, it would take several weeks to secure a new manufacturer and there could be a disruption in our supply of merchandise. If we are unable to provide our customers with continued access to popular merchandise manufactured exclusively for us, our operating results could be harmed.

We also source many of our products overseas. While products sourced overseas typically have lower costs, our product margins may be slightly offset by an increase in inbound freight costs. As security measures around shipping ports increase, these additional costs may result in higher inbound freight costs. As we increase our overseas sourcing, we face the risk of these delays which could harm our business and results of operations. We cannot predict whether any of the countries in which our merchandise currently is manufactured or may be manufactured in the future will be subject to additional trade restrictions imposed by the U.S. and other foreign governments, including the likelihood, type or effect of any such restrictions. Trade restrictions, including increased tariffs or quotas, embargoes, and customs restrictions, against items that we offer or intend to offer to our customers, as well as U.S. or foreign labor strikes, work stoppages or boycotts, could increase the cost or reduce the supply of items available to us and adversely affect our business, financial condition and results of operations. Our sourcing operations also may be adversely affected by political and financial instability resulting in the disruption of trade from exporting countries, significant fluctuation in the value of the U.S. dollar against foreign currencies, restrictions on the transfer of funds and/or other trade disruptions. Any disruption or delays in, or increased costs of, importing our products could have an adverse effect on our business, financial condition and operating results.

Our success is dependent on the performance of our vendors and service providers.

Our business depends on the performance of third parties, including merchandise manufacturers and foreign buying agents, telecommunications service providers, the United States Postal Service (“USPS”), shipping companies, printers, professionals, photographers, creative designers and models, credit card processing companies and the service bureau that maintains our customer database.

Any interruptions or delays in the provision of these goods and services could materially and adversely affect our business and financial condition. Although we believe that, in general, the goods and services we obtain from third parties could be purchased from other sources, identifying and obtaining substitute goods and services could result in delays and increased costs. If any significant merchandise vendor or buying agent were to suddenly discontinue its relationship with us, we could experience temporary delivery delays until a substitute supplier could be found.

Our business is subject to a number of external costs that we are unable to control.

Our business is subject to a number of external costs that we are unable to control, including labor costs, insurance costs, printing, paper and postage expenses, shipping charges associated with distributing merchandise to our customers and inventory acquisition costs, including product costs, quota and customs charges. In particular, the paper market is extremely tight at this time and we are experiencing increased costs for our paper needs for 2005. We also ship a majority of our merchandise by USPS and we anticipate an increase in postal rates in 2006. Increases in these or other external costs could adversely affect our financial position, results of operations and cash flows unless we are able to pass these increased costs along to our customers.

We have a new management team that is critical to our success.

Our success depends to a significant extent upon our ability to attract and retain key personnel. Moreover, four members of our senior management team, the new CEO, the new CFO, the General Counsel and the president of one of our catalogs, have each been with the Company for less than two years. Our success is dependent on the ability of our senior management and catalog presidents to successfully integrate into and manage our business and the individual catalogs. The loss of the services of one or more of our current members of senior management, or our failure to attract talented new employees, could have a material adverse effect on our business.

We are dependent on the continued growth of Internet sales.

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We derive an increasing portion of our revenue from our websites. While we continue to believe that our catalogs are the primary sales drivers of our merchandise, e-commerce is an important part of our business. Factors which could reduce the widespread use of the Internet include actual or perceived lack of privacy protection, actual or perceived lack of security of credit card information. possible disruptions or other damage to the Internet or telecommunications infrastructure, increased governmental regulation and taxation and decreased use of personal computers. Our business would be harmed by any decrease or less than anticipated growth in Internet usage.

We have a majority shareholder who controls the Board and is also a secured lender.

Chelsey and Chelsey Finance, a Chelsey affiliate, control over 90.0% of the voting power (after giving effect to the exercise of all outstanding options and warrants to purchase Common Stock beneficially owned by Chelsey) and hold over 68.0% of the Company’s issued and outstanding Common Stock (including the January 10, 2005 purchase of 3,799,735 shares). Chelsey has appointed a majority of our Board of Directors including our Chairman, and Chelsey Finance is the Company’s junior secured lender. The interests of Chelsey and Chelsey Finance as the majority owners of the Common Stock, the holders of all of the Series C Preferred and as a secured lender may be in conflict with that of our other Common Stock holders, which may adversely affect their investment in the Common Stock. In addition, Chelsey has sufficient voting power to cause an extraordinary transaction (such as a merger or other business combination, a sale of all or substantially all of the Company’s assets or a going private transaction) to take place without the vote of any other shareholders.

Our Series C Preferred Stock begins to accrue dividends in 2006 and is subject to mandatory redemption in 2009.

Commencing January 1, 2006, dividends will be payable quarterly on the Series C Preferred at the rate of 6.0% per annum, with the preferred dividend rate increasing by 1 1/2% per annum on each anniversary of the dividend commencement date until redeemed. At the Company’s option, in lieu of cash dividends, the Company may accrue dividends that will compound at a rate 1.0% higher than the applicable cash dividend rate. The Wachovia Loan Agreement currently prohibits the payment of cash dividends. The Series C Preferred, if not redeemed earlier, must be redeemed by the Company on January 1, 2009 for the liquidation preference and all accrued and unpaid dividends. Assuming the Company has elected to accrue all dividends from and after January 1, 2006, the maximum aggregate amount of the liquidation preference plus accrued and unpaid dividends on the Series C Preferred will be approximately $72.7 million.

We have not fully assessed the effectiveness of our internal controls over financial reporting.

We are in the process of assessing the effectiveness of our internal controls over financial reporting in connection with the rules adopted by the Securities and Exchange Commission under Section 404 of the Sarbanes-Oxley Act of 2002. The SEC delayed implementation of Section 404 for companies with a market capitalization of less than $75.0 million such as the Company. Under the current rules and the Company’s current market capitalization, Section 404 would apply to our 2007 financial statements. There can be no assurance that management will not identify significant deficiencies that would result in one or more material weaknesses in our internal controls over financial reporting. We cannot provide any assurance that testing of our internal controls will not uncover significant deficiencies that would result in a material weakness in our internal controls over financial reporting.

If we fail to comply in a timely manner with the requirements of Section 404 of the Sarbanes-Oxley Act of 2002 or to remedy any material weaknesses in our internal controls that we may identify, such failure could result in material misstatements in our financial statements and cause a default under the Company’s credit facilities, cause investors to lose confidence in our reported financial information and have a negative effect on the trading price of our common stock.

For those material weaknesses previously identified and those that may be identified in the future, we will adopt and implement policies and procedures to remediate such material weaknesses. Designing and implementing effective internal controls is a continuous process that requires us to anticipate and react to changes in our business and the economic environment in which we operate, and to expend significant resources to maintain a system of internal controls that is adequate to satisfy our reporting obligations as a public company. We cannot assure you that the measures we will take will remediate any material weaknesses that we may identify, or that we will implement and maintain adequate controls over our financial process and reporting in the future.

Any failure to complete our assessment of our internal controls over financial reporting, to remediate any material weaknesses that we may identify, or to implement new or improved controls, could harm our operating results, cause us to fail to meet our reporting obligations, or result in material misstatements in our financial

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statements and cause a default under the Company’s credit facilities. Any such failure also could adversely affect the results of the periodic management evaluations and, in the case of a failure to remediate any material weaknesses that we may identify, would adversely affect the annual auditor attestation reports regarding the effectiveness of our internal control over financial reporting that are required under Section 404 in 2007. Inferior internal controls could also cause investors to lose confidence in our reported financial information, which could have a negative effect on the trading price of our common stock.

We receive a material portion of our operating profits from our sale of third party membership services and derive a material portion of our revenues by providing fulfillment services to third parties.

In 2004, we received approximately $7.0 million in revenues from our sale of Vertrue membership programs, which generates a material portion of our operating profit. Our agreement with Vertrue continues through March 2006 and we are evaluating proposals from membership program providers to market membership programs to our customers after the Vertrue agreement expires. Were we to lose this revenue stream, our operating results would be adversely affected.

We also derive a material portion of our revenues by providing order processing and product fulfillment services to third parties. These revenues offset some of our fixed costs associated with operating our distribution facility and our call centers and were we to lose this revenue stream, our results would be adversely affected unless our direct marketing operations made up for the lost revenues.

In light of these risks and uncertainties and others not mentioned above, the forward-looking statements contained in this Annual Report may not occur. Accordingly, readers should not place undue reliance on these forward-looking statements, which only reflect the views of the Company management as of the date of this report. The Company is not under any obligation and does not intend to publicly update or review any of these

forward-looking statements, whether as a result of new information, future events or otherwise, even if experience or future events make it clear that any expected results expressed or implied by those forward-looking statements will not be realized.

Item 7A. Quantitative and Qualitative Disclosures about Market Risk

Interest Rates: The Company’s exposure to market risk relates to interest rate fluctuations for borrowings under the Wachovia Facility, including the term loans, which bear interest at variable rates, and the Chelsey Facility, which bears interest at 5.0% above the prime rate publicly announced by Wachovia. At December 25, 2004, outstanding principal balances under the Wachovia Facility and Chelsey Facility subject to variable rates of interest were approximately $19.4 million and $20.0 million, respectively. If interest rates were to increase by one percent from current levels, the resulting increase in interest expense, based upon the amount outstanding at December 25, 2004, would be approximately $0.4 million on an annual basis.

In addition, the Company’s exposure to market risk relates to customer response to the Company’s merchandise offerings and circulation changes, effects of shifting patterns of e-commerce versus catalog purchases, costs associated with printing and mailing catalogs and fulfilling orders, effects of potential slowdowns or other disruptions in postal service, dependence on customers’ seasonal buying patterns, fluctuations in foreign currency exchange rates, and the ability of the Company to reduce unprofitable circulation and effectively manage its customer lists.

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Item 8. Financial Statements and Supplementary Data — Report of Independent Registered Public Accounting Firm

[TO BE PROVIDED AFTER COMPLETION OF THE AUDIT BY NEW AUDITORS]

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CONSOLIDATED BALANCE SHEETS

As of December 25, 2004 and December 27, 2003

	December 25, 2004	December 27, 2003 As Restated
	(In thousands of dollars,
	Except share amounts)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents	$ 510	$ 2,282
Accounts receivable, net of allowance for doubtful accounts of $1,367 in 2004 and $1,105 in 2003	17,819	14,335
Inventories	53,147	42,806
Prepaid catalog costs	15,644	12,485
Other current assets	4,482	4,239
Total Current Assets	91,602	76,147
PROPERTY AND EQUIPMENT, AT COST:
Land	4,361	4,361
Buildings and building improvements	18,221	18,210
Leasehold improvements	10,156	10,108
Furniture, fixtures and equipment	53,792	53,212
	86,530	85,891
Accumulated depreciation and amortization	(61,906)	(58,113)
Property and equipment, net	24,624	27,778
Goodwill	9,278	9,278
Deferred tax asset	2,034	1,769
Other non-current assets	2,816	1,575
Total Assets	$ 130,354	$ 116,547
LIABILITIES AND SHAREHOLDERS’ DEFICIENCY
CURRENT LIABILITIES:
Short-term debt and capital lease obligations	$ 16,690	$ 13,468
Accounts payable	29,544	42,742
Accrued liabilities	20,535	17,088
Customer prepayments and credits	12,032	11,479
Deferred tax liability	2,034	1,769
Total Current Liabilities	80,835	86,546
NON-CURRENT LIABILITIES:
Long-term debt	11,196	9,042
Series C Participating Preferred Stock, authorized, issued and outstanding 564,819 shares at December 25, 2004 and December 27, 2003; liquidation preference was $56,482 at December 25, 2004 and December 27, 2003	72,689	72,689
Other	3,286	4,609
Total Non-current Liabilities	87,171	86,340
Total Liabilities	168,006	172,886
SHAREHOLDERS’ DEFICIENCY:
Common Stock, $0.01 par value, authorized 50,000,000 shares at December 25, 2004 and 30,000,000 shares at December 27, 2003; 22,426,296 shares issued and outstanding at December 25, 2004; 22,229,456 shares issued and 22,017,363 shares outstanding at December 27, 2003	225	222
Capital in excess of par value	460,744	450,407
Accumulated deficit	(498,621)	(503,622)
	(37,652)	(52,993)
Less:
Treasury stock, at cost (0 shares at December 25, 2004 and 212,093 shares at December 27, 2003)	--	(2,996)
Notes receivable from sale of Common Stock	--	(350)
Total Shareholders’ Deficiency	(37,652)	(56,339)
Total Liabilities and Shareholders’ Deficiency	$ 130,354	$ 116,547

See notes to Consolidated Financial Statements.

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CONSOLIDATED STATEMENTS OF INCOME (LOSS)

For the Years Ended December 25 2004, December 27, 2003 and December 28, 2002


	2004	2003 As Restated	2002 As Restated
	(In thousands of dollars, except
	per share amounts)
NET REVENUES	$ 403,160	$ 414,283	$ 456,990

OPERATING COSTS AND EXPENSES:
Cost of sales and operating expenses	243,215	261,297	290,383
Special charges	1,536	1,308	4,398
Selling expenses	100,460	99,971	105,448
General and administrative expenses	43,213	45,543	53,322
Depreciation and amortization	3,994	4,719	5,650
	392,418	412,838	459,201

INCOME (LOSS) FROM OPERATIONS	10,742	1,445	(2,211)
Gain on sale of Improvements, net	--	(1,911)	(570)

INCOME (LOSS) BEFORE INTEREST AND INCOME TAXES	10,742	3,356	(1,641)
Interest expense, net	5,567	12,088	5,477

INCOME (LOSS) BEFORE INCOME TAXES	5,175	(8,732)	(7,118)
Provision for Federal income taxes	146	11,300	3,700
Provision for state income taxes	28	28	91
Provision for income taxes	174	11,328	3,791

NET INCOME (LOSS) AND COMPREHENSIVE INCOME (LOSS)	5,001	(20,060)	(10,909)
Preferred stock dividends	--	7,922	15,556
Earnings Applicable to Preferred Stock	124	--	--

NET INCOME (LOSS) APPLICABLE TO COMMON SHAREHOLDERS	$ 4,877	$ (27,982)	$ (26,465)
NET INCOME (LOSS) PER COMMON SHARE:
Net income (loss) per common share – basic	$ 0.22	$ (1.94)	$ (1.91)
Net income (loss) per common share – diluted	$ 0.18	$ (1.94)	$ (1.91)

Weighted average common shares outstanding – basic (thousands)	22,220	14,439	13,828
Weighted average common shares outstanding – diluted (thousands)	27,018	14,439	13,828

See notes to Consolidated Financial Statements.

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CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Years Ended December 25, 2004, December 27, 2003 and December 28, 2002

	2004	2003 As Restated	2002 As Restated
	(In thousands of dollars)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)	$ 5,001	$ (20,060)	$ (10,909)
Adjustments to reconcile net income (loss) to net cash provided (used) by operating activities:
Depreciation and amortization, including deferred fees	4,538	5,715	7,203
Provision for doubtful accounts	609	378	304
Special charges	1,536	1,308	4,398
Provision for deferred tax	—	11,300	3,700
Gain on the sale of Improvements	—	(1,911)	(570)
Gain on the sale of property and equipment	(11)	(4)	(167)
Interest expense related to Series B Participating Preferred Stock redemption price increase	—	7,235	—
Compensation expense related to stock options	184	1,141	1,332
Accretion of debt discount	1,098	—	—
Changes in assets and liabilities: Accounts receivable	(4,093)	2,232	2,207
Inventories	(10,341)	11,700	5,997
Prepaid catalog costs	(3,159)	1,801	1,075
Accounts payable	(13,198)	(666)	(3,151)
Accrued liabilities	1,911	(11,434)	(2,345)
Customer prepayments and credits	553	1,478	433
Other, net	(1,893)	(2,140)	(4,848)
Net cash (used) provided by operating activities	(17,265)	8,073	4,659
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisitions of property and equipment	(840)	(1,895)	(639)
Proceeds from sale of Improvements	—	2,000	570
Costs related to early release of escrow funds	—	(89)	—
Proceeds from sale of property and equipment	14	78	169
Net cash (used) provided by investing activities	(826)	94	100
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings (payments) under Wachovia revolving loan facility	5,411	179	(4,704)
Borrowings under Wachovia Tranche B term loan facility	—	—	3,500
Payments under Wachovia Tranche A term loan facility	(1,493)	(1,991)	(1,991)
Payments under Wachovia Tranche B term loan facility	(6,011)	(1,800)	(1,314)
Borrowings under the Chelsey Facility	7,061	—	—
Issuance of Common Stock Warrant to related party	12,939	—	—
Payments of capital lease obligations	(690)	(466)	(104)
Payments of Series C Participating Preferred Stock financing costs	—	(1,334)	—
Payments of debt issuance costs	(1,045)	(910)	(722)
Payment of debt issuance costs to related party	(200)	—	—
Refund (payment) of estimated Richemont tax obligation on Series B Participating Preferred Stock accretion	347	(347)	—
Proceeds from issuance of common stock	—	—	25
Series B Participating Preferred Stock transaction cost adjustment	—	—	215
Other, net	—	(1)	—
Net cash provided (used) by financing activities	16,319	(6,670)	(5,095)
Net (decrease) increase in cash and cash equivalents	(1,772)	1,497	(336)
Cash and cash equivalents at the beginning of the year	2,282	785	1,121
Cash and cash equivalents at the end of the year	$ 510	$ 2,282	$ 785

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Supplemental Disclosures of Cash Flow Information
Cash paid during the year for:
Interest	$ 3,340	$ 3,325	$ 3,405
Income taxes	$ 9	$ 705	$ 193
Non-cash investing and financing activities:
Issuance of Common Stock to related party as payment of waiver fee	$ 563	$ —	$ —
Series B Participating Preferred Stock redemption price increase	$ —	$ 7,575	$ 15,556
Redemption of Series B Participating Preferred Stock	$ —	$ 107,536	$ —
Issuance of Series C Participating Preferred Stock	$ —	$ 72,689	$ —
Gain on issuance of Series C Participating Preferred Stock	$ —	$ 13,867	$ —
Tandem share expirations	$ 350	$ —	$ 54
Retirement of Treasury Stock	$ 3,346	$ —	$ —
Capital lease obligations	$ —	$ 1,459	$ 32

See notes to Consolidated Financial Statements.

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CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ DEFICIENCY

For the Years Ended December 25, 2004, December 27, 2003 and December 28, 2002

								Notes Receivable from Sale of Common Stock
				Capital in Excess of Par Value
	Common Stock
	$0.01 Par Value				Accumulated Deficit	Treasury Stock
	Shares	Amount			Accumulated Deficit	Shares	Amount		Total
	(In thousands of dollars and shares)

Restated Balance at December 29, 2001	14,033	$ 140	$ 444,976		$(479,888)	(210)	$ (2,942)	$ (405)	$(38,119)

Net loss applicable to common shareholders					(26,465)				(26,465)
Series B Participating Preferred stock liquidation preference accrual			(15,556)		15,556				—
Stock options expensed			1,332						1,332
Issuance of Common Stock for employee stock plan	10		25						25
Tandem share expirations						(2)	(54)	54	—
Series B Preferred Stock issuance cost adjustment			215					1	216

Restated Balance at December 28, 2002	14,043	$ 140	$ 430,992		$(490,797)	(212)	$ (2,996)	$ (350)	$(63,011)

Net loss applicable to common shareholders					(27,982)				(27,982)
Series B Participating Preferred Stock liquidation preference accrual			(15,157)		15,157				—
Stock options expensed			1,141						1,141
Gain on Recapitalization, net of issuance costs of $1,334			13,867						13,867
Issuance of Common Stock in conjunction with Recapitalization	8,186	82	19,564						19,646

Restated Balance at December 27, 2003	22,229	$ 222	$ 450,407		$(503,622)	(212)	$ (2,996)	$ (350)	$(56,339)

Net income applicable to common shareholders					4,877				4,877
Earnings applicable to Series C Preferred Stock					124				124
Stock options expensed			184						184
Issuance of Common Stock for Chelsey Facility waiver fee	434	4	559						563
Issuance of Chelsey Common Stock Warrants			12,939						12,939
Tandem share expirations	(14)					(11)	(350)	350	—
Retirement of Treasury Stock	(223)	(1)	(3,345)			223	3,346		—

Balance at December 25, 2004	22,426	$ 225	$460,744		$(498,621)	—	—	—	$(37,652)

See notes to Consolidated Financial Statements.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years Ended December 25, 2004, December 27, 2003 and December 28, 2002

1. BACKGROUND OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Nature of Operations — Hanover Direct, Inc., (the “Company” or we), a Delaware corporation, is a specialty direct marketer, that markets a diverse portfolio of home fashions, men’s and women’s apparel, and gift products, through mail-order catalogs, retail stores and connected Internet websites directly to the consumer (“direct commerce”). The Company also manufactures super-premium down comforters, pillows and featherbeds under the Scandia Down brand name, which are sold through third party luxury retailers in North and South America. In addition, as excess capacity exists within its operating centers, the Company provides third party clients with business-to-business (B-to-B) e-commerce transaction services including a full range of order processing, customer care, customer information, and shipping and distribution services. The Company utilizes these services provided to third party clients as a mechanism to absorb certain fixed costs of the Company.

Basis of Presentation — The consolidated financial statements include all subsidiaries of the Company, and all intercompany transactions and balances have been eliminated. The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. All references in these consolidated financial statements to the number of shares outstanding, per share amounts, stock warrants, and stock option data relating to the Company’s common stock have been restated, as appropriate, to reflect the one-for-ten reverse stock split occurring at the close of business on September 22, 2004. See Note 9 for more information regarding the reverse stock split and additional amendments to the Company’s Certificate of Incorporation.

Fiscal Year — The Company operates on a 52 or 53-week fiscal year, ending on the last Saturday in December. The years ended December 25, 2004, December 27, 2003 and December 28, 2002 were reported as 52-week years.

Cash and Cash Equivalents — Cash includes cash equivalents consisting of highly liquid investments with an original maturity of ninety days or less.

Allowance for Doubtful Accounts — An allowance for doubtful accounts is calculated for the Company’s accounts receivable. A combination of historical and rolling bad debt rates are applied to the various receivables maintained by the Company to determine the amount of the allowance to be recorded. The Company also records additional specific allowances deemed necessary by management, based on known circumstances related to the overall receivable portfolio.

Inventories — Inventories consist principally of merchandise held for resale and are stated at the lower of cost or market. Cost, which is determined using the first-in, first-out (FIFO) method, includes the cost of the product as well as capitalized freight-in charges. Raw materials and work in process represented approximately 7% and 5% of the inventory balance as of December 25, 2004 and December 27, 2003, respectively. The Company considers slow moving inventory to be surplus and calculates a loss on the impairment as the difference between an individual item’s cost and the net proceeds anticipated to be received upon disposal. The Company utilizes various liquidation vehicles to dispose of aged inventory including special sale catalogs, sale sections within main catalogs, sale sections on the Company’s Internet websites, outlet stores and liquidations through off-price merchants. Such inventory is written down to its net realizable value if the expected proceeds of disposal are less than the cost of the merchandise.

Prepaid Catalog Costs — Prepaid catalog costs consist of direct response advertising costs related to catalog production and mailing. In accordance with Statement of Position 93-7, “Reporting on Advertising Costs,” these costs are deferred and amortized as selling expenses over the estimated period in which the sales related to such advertising are generated. Total catalog expense was $99.4 million, $99.0 million and $104.3 million for 2004, 2003 and 2002, respectively. These costs are included in Selling expenses in the Company’s Consolidated Statements of Income (Loss).

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Depreciation and Amortization — Depreciation and amortization of property and equipment is computed on the straight-line method over the following lives: buildings and building improvements, 30-40 years; furniture, fixtures and equipment, 3-10 years; and leasehold improvements, over the estimated useful lives or the terms of the related leases, whichever is shorter. Repairs and maintenance are expensed as incurred.

Assets Held under Capital Leases — Assets held under capital leases are recorded at the lower of the net present value of the minimum lease payments or the fair value of the leased asset at the inception of the lease. Amortization expense is computed using the straight-line method over the shorter of the estimated useful lives of the assets or the period of the related lease.

Goodwill — The Company accounts for goodwill in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” which requires that goodwill no longer be amortized but reviewed for impairment if impairment indicators arise and, at a minimum, annually. The Company performs its annual impairment review during its second quarter each fiscal year. The fair value is determined using a combination of market and discounted cash flow approaches.

Impairment of Long-lived Assets — In accordance with SFAS No.144, “Accounting for the Impairment or Disposal of Long-lived Assets” (“SFAS 144”), the Company reviews long-lived assets, other than goodwill, for impairment whenever events indicate that the carrying amount of such assets may not be fully recoverable. The Company performs a review, at a total company-wide level since the Company is viewed as one segment, of long-lived assets using a fair-value approach utilizing appraisals to determine if impairment exists. If impairment is determined to exist, any related impairment loss is calculated based on fair value, which is generally based on discounted future cash flows.

Reserves and accruals related to loss contingencies, litigation and legal expenses — The Company accrues for potential litigation losses when management determines that it is probable that an unfavorable outcome will result and the loss is reasonably estimable in accordance with SFAS No. 5, “Accounting for Contingencies.” In addition, when a loss contingency is accrued pursuant to SFAS 5, the Company’s policy is to accrue for all of the related legal fees as contemplated in EITF D-77, “Accounting for Legal Costs Expected to Be Incurred in Connection with a Loss Contingency.” For the year ended December 30, 2000, the Company used estimates to determine the liability related to Rakesh Kaul’s claims regarding benefits to which he was entitled as a result of his resignation as CEO on December 5, 2000, which resulted in an accrual of $5.0 million. As part of the restatement as discussed in Note 2, the Company corrected two accounting errors related to the Rakesh Kaul liability.

Reserves related to the Company’s strategic business realignment program — The reserves established by the Company related to its strategic business realignment program include employee severance and related costs, facility exit costs and estimates primarily associated with the potential subleasing of leased properties which have been vacated by the Company. The overall reserves for leased properties that have been vacated by the Company are developed using estimates that include the potential ability to sublet leased but unoccupied properties, the length of time needed to obtain suitable tenants and the amount of rent to be received for the sublet. Real estate broker representations regarding current and future market conditions are sometimes used in estimating these items. See Note 5 for additional information regarding the reserves.

Reserves related to employee health and welfare claims — The Company maintains a self-insurance program related to losses and liabilities associated with employee health and welfare claims. Stop-loss coverage is held on both an aggregate and individual claim basis; thereby, limiting the amount of losses the Company will experience. Losses are accrued based upon estimates of the aggregate liability for claims incurred using the Company’s experience patterns. At December 25, 2004 and December 27, 2003, the Company had an accrued liability recorded in the amount of $0.6 million.

Employee Benefits — Vacation and Sick Compensation — During June 2003, the Company established and issued a new Company-wide vacation and sick policy to better administer vacation and sick benefits. For purposes of the policy, employees were converted to a fiscal year for earning vacation and sick benefits. Under the new policy, vacation and sick benefits are deemed earned and thus accrued ratably throughout the fiscal year and employees must utilize all vacation and sick earned by the end of the same year. Generally, any unused vacation and sick benefits not utilized by the end of a fiscal year will be forfeited. Before the establishment of this new policy, employees earned vacation and sick in the twelve months prior to the year that it would be utilized. The policy has

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been modified in certain locations to comply with state and local laws or written agreements. As a result of the transition to this new policy, the Company recognized a benefit of approximately $1.6 million in 2003. Approximately $0.8 million of both general and administrative expenses and operating expenses was reduced as a result of the recognition of this benefit for the year ended December 27, 2003.

Cost of Sales and operating expenses — Cost of sales and operating expenses in the Consolidated Statements of Income (Loss) include the cost of merchandise sold and merchandise delivery expenses in addition to fulfillment, telemarketing and information technology expenses. Merchandise delivery expenses consist of the cost to ship packages to the customer utilizing a variety of shipping services, as well as the cost of packaging the merchandise for shipment. Total merchandise postage expense for 2004, 2003 and 2002 was $36.5 million, $39.9 million and $41.6 million, respectively. These costs are recognized upon receipt of delivery by the customer and are included in Cost of sales and operating expenses in the Company’s Consolidated Statements of Income (Loss). The total costs deferred for shipments in transit for 2004 and 2003 were $1.8 million and $1.3 million, respectively.

General and administrative expenses — General and administrative expenses in the Consolidated Statements of Income (Loss) reflect payroll and benefit expenses for the catalog and corporate management personnel, costs associated with the New Jersey facilities as well as professional fees and other corporate expenses.

Stock-Based Compensation — The Company accounts for its stock-based compensation to employees using the fair value-based methodology under SFAS No. 123, “Accounting for Stock-Based Compensation.”

Income Taxes — The Company accounts for income taxes in accordance with SFAS No. 109, “Accounting for Income Taxes.” SFAS No. 109 requires an asset and liability approach for financial accounting and reporting of income taxes. The provision for income taxes is based on income after adjustment for those temporary and permanent items that are not considered in the determination of taxable income. The gross deferred tax asset is the total tax benefit available from net operating loss carryovers and temporary differences. A valuation allowance is calculated, based on the Company’s projections of its future taxable income, to establish the amount of deferred tax asset that the Company is expected to utilize on a “more-likely-than-not” basis. A deferred tax liability represents future taxes that may be due arising from the reversal of temporary differences. In 2003, due to a number of factors, including the annual limitation on utilization of net operating losses caused by the Chelsey Direct, LLC (“Chelsey”) purchase of Richemont Finance, S.A.’s (“Richemont”) stockholdings in the Company during the year (see Note 8), and lower projections of taxable income for future years, the Company made a decision to fully reserve the remaining net deferred tax asset (the gross deferred tax asset net of the then existing valuation allowance and deferred tax liability) by increasing the valuation allowance and recorded an $11.3 million deferred income tax provision. At December 25, 2004, the Company’s net deferred tax asset remains fully reserved with no additional deferred income tax provision required.

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Net Income (Loss) Per Share — Net income (loss) per share is computed using the weighted average number of common shares outstanding in accordance with the provisions of SFAS No. 128, “Earnings Per Share.” Basic net income (loss) per common share is calculated by dividing net income (loss) available to common shareholders, reduced for participatory interests, by the weighted average number of common shares outstanding during the period. Diluted net income (loss) per common share is calculated using the weighted average number of common shares outstanding adjusted to include the potentially dilutive effect of stock options and stock warrants. The computations of basic and diluted net income (loss) per common share are as follows (in thousands except per share amounts):

	December 25, 2004	December 27, 2003 As Restated	December 28, 2002 As Restated

Net income (loss)	$ 5,001	$ (20,060)	$ (10,909)
Less:
Preferred stock dividends	--	7,922	15,556
Earnings applicable to preferred stock	124	--	--
Net income (loss) applicable to common shareholders	$ 4,877	$ (27,982)	$ (26,465)
Basic net income (loss) per common share	$ 0.22	$ (1.94)	$ (1.91)

Weighted-average common shares outstanding	22,220	14,439	13,828

Diluted net income (loss)	$ 4,877	$ (27,982)	$ (26,465)
Diluted net income (loss) per common share	$ 0.18	$ (1.94)	$ (1.91)

Weighted-average common shares outstanding	22,220	14,439	13,828
Effect of Dilution:
Stock options	12	--	--
Stock warrants	4,786	--	--
Weighted-average common shares outstanding assuming dilution	27,018	14,439	13,828

Diluted net loss per common share excluded incremental weighted-average shares 20,979 and 93,318 for the years ended December 27, 2003 and December 28, 2002, respectively. These incremental weighted-average shares were related to employee stock options and were excluded due to their anti-dilutive effect.

Revenue Recognition

— Direct Commerce: The Company recognizes revenue for catalog and Internet sales at the time merchandise is received by the customer, net of estimated returns in accordance with the provisions of Staff Accounting Bulletin (“SAB”) No. 101, “Revenue Recognition in Financial Statements,” as amended by SAB No. 104, “Revenue Recognition.” Delivery and service charges billed to customers are also recognized as revenue at the time merchandise is received by the customer. The Company’s revenue recognition policy includes the use of estimates for the time period between shipment of merchandise by the Company and receipt of merchandise by the customer and the future amount of returns to be received on the current period’s sales. The Company accrues for expected future returns that relate to sales prior to the balance sheet date utilizing a combination of historical and current trends. During October 2003, the Company modified its returns policy, which previously allowed unlimited returns, by adopting a policy that limits returns to a maximum of ninety days after the sale of the merchandise.

— Membership Services: Customers may purchase memberships in a number of the Company’s Buyers’ Club programs for an annual fee. For memberships purchased during the following periods, certain of the Buyers’ Club programs contained a guarantee that the customer would receive discounts or savings, at least equal to the cost of his or her membership or we would refund the difference with a merchandise credit at the end of the membership period Silhouettes from July 1998 through March 2004; Domestications from April 2002 through March 2004; and Men’s Apparel from April 2003 through March 2004. In the first quarter of 2004, we identified a potential issue with the

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accounting treatment for Buyers’ Club memberships that contained a guarantee. At that time, an inappropriate conclusion was reached and during the third quarter of 2004, the issue was re-evaluated and we determined an error in the accounting treatment had occurred. The Company identified guarantee obligations to members of certain of the Company’s Buyers’ Club programs for its catalogs. The impact of the error resulted in the overstatement of revenues and the omission of the related liability for guarantee obligations. The proper accounting treatment was applied to all periods impacted including a calculation of the cumulative impact of the error on previously reported periods. See Note 2 for further explanation and amounts. Currently, and as reflected by the restatement of the Company’s consolidated financial statements, for memberships purchased during the periods in which the Buyers’ Club memberships contained a guarantee, revenue net of actual cancellations was recognized on a monthly basis over the membership period subsequent to the end of the thirty-day cancellation period, with the revenue recognized equal to the lesser of the cumulative amount determined using the straight-line method or the actual benefit received by each customer as of the end of each period. For the Buyers’ Club memberships that did not contain a guarantee, revenue net of actual cancellations was recognized on a monthly basis over the membership period subsequent to the end of the thirty-day cancellation period, using the straight-line method. We also receive commission revenue related to our solicitation of the Vertrue membership programs. The Company receives a monthly commission based on the number of memberships sold with additional revenue recognized if certain program performance levels are attained for each fiscal year. The additional revenue is not recognized until the performance level is attained. We received commission revenue from the Magazine Direct magazine subscription program through May 2003 when the program was discontinued. The commission revenue recognized by the Company for the Magazine Direct magazine program was on a per-solicitation basis according to the number of solicitations made, with additional revenue recognized if the customer accepted the solicitation. Collectively, the amount of revenues the Company received from these sources was $10.3 million, or 2.5% of net revenues, $9.3 million, or 2.2% of net revenues, and $10.3 million, or 2.2% of net revenues in 2004, 2003 and 2002, respectively.

— B-to-B Services: Revenues from the Company’s e-commerce transaction services are recognized as the related services are provided. Customers are charged on an activity unit basis, which applies a contractually specified rate according to the type of transaction service performed. Revenues recorded from the Company’s B-to-B services were $20.8 million, or 5.2% of net revenues, $20.0 million, or 4.8% of net revenues, and $20.1 million, or 4.4% of net revenues, for 2004, 2003 and 2002, respectively.

— Financial Instruments: The carrying amounts for cash and cash equivalents, accounts receivable, accounts payable, short- and long-term debt (including the Wachovia Facility and excluding the Chelsey Facility) and capital lease obligations approximate fair value due to the short maturities of these instruments. The carrying amounts for long-term debt related to the Chelsey Facility are net of the remaining un-accreted debt discount of $11.8 million. The fair value of the long-term debt related to the Chelsey Facility is approximately equal to the gross amount outstanding under the facility of $20.0 million since the interest rate on this loan is a floating rate of 5.0% above the prime rate publicly announced by Wachovia.

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” (“SFAS 150”). SFAS 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability, many of which had been previously classified as equity or between the liabilities and equity sections of the Consolidated Balance Sheet. The provisions of SFAS 150 were effective for financial instruments entered into or modified after May 31, 2003, and otherwise were effective at the beginning of the first interim period beginning after June 15, 2003. The Company adopted the provisions of SFAS 150, which resulted in the reclassification of its Series B Participating Preferred Stock (“Series B Preferred”) to a liability rather than between the liabilities and equity sections of the Consolidated Balance Sheet. Based upon the requirements set forth by SFAS 150, this reclassification was subject to implementation beginning on June 29, 2003. Upon implementation of SFAS 150, the Company reflected subsequent increases in liquidation preference of the Series B Preferred as an increase in Total Liabilities with a corresponding reduction in capital in excess of par value, because the Company has an accumulated deficit. Accretion was recorded as interest expense. Net Income (Loss) Applicable to Common Shareholders and Net Income (Loss) Per Common Share remains unchanged in comparison with the Company’s classification of the instrument prior to June 29, 2003. On November 30, 2003, the Company and Chelsey consummated the transactions contemplated by a Recapitalization Agreement, dated as of November 18, 2003 under which the Company recapitalized, completed the reconstitution of its Board of Directors and outstanding litigation between the Company and Chelsey was settled (the “Recapitalization”). As part of the Recapitalization, the Company exchanged the Series B Preferred for Series C Preferred Stock, which was

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recorded at its maximum amount of the liquidation preference. Therefore, there have been no preferred stock dividends recorded since November 30, 2003. See Note 8 for additional information regarding the Recapitalization.

New Accounting Pronouncements

In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections” (“SFAS 154”), which changes the requirements for the accounting for and reporting of a change in accounting principle. We are required to adopt the provisions of SFAS 154 effective January 1, 2006; however, early adoption is permitted. The Company is currently assessing the impact of the adoption of this Statement.

2. RESTATEMENT OF FINANCIAL STATEMENTS AND OTHER RELATED MATTERS

Buyers’ Club Program. In the first quarter of 2004, former management identified a potential issue with the accounting treatment of discount obligations due to members of certain of the Company’s buyers’ club programs, and at that time, an inappropriate conclusion regarding the accounting treatment was reached. During the third quarter of 2004, the issue was re-evaluated and we determined that an error in the accounting treatment had occurred. The impact of the error resulted in the overstatement of revenues and the omission of a liability related to the guarantee for discount obligations. The proper accounting treatment has been applied to all periods impacted including a calculation of the cumulative impact of the error on previously reported periods.

Revenue Recognition Issues. During the second quarter of 2004, the Company identified a revenue recognition cut-off issue that resulted in revenue being recorded in advance of the actual shipment of merchandise to the customer. The practice was stopped immediately. Subsequently, the Company determined that revenue should be recognized when merchandise is received by the customer rather than when shipped because the Company routinely replaces customer merchandise damaged or lost in transit as a customer service matter (even though risk of loss, as a legal matter, passes on shipment). As a consequence, the Company has restated all periods presented to recognize revenue when merchandise is received by the customer.

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Kaul Accrual. During the year ended December 30, 2000, the Company estimated its liability related to Rakesh Kaul’s claims regarding benefits to which he was entitled as a result of his resignation as CEO on December 5, 2000. The accompanying consolidated financial statements contain a restatement related to the Kaul reserve that corrects two errors in the accounting treatment of the reserve. The first error identified was the premature reversal of the reserve in the fourth quarter of 2003 based upon the summary judgment decision in January 2004. As noted above, because this decision could be, and subsequently was, appealed, management has determined that the reversal was premature. The second error identified was the accounting for legal fees associated with litigating this claim. Due to the fact that the Kaul reserve was recorded prior to the initiation of litigation, the Company has determined that the appropriate basis of accounting for the legal fees related to the litigation would have been to treat such fees as period costs and, therefore, expensed as incurred. However, the Company had inappropriately recorded certain of these fees against the reserve as opposed to recording them as an expense in the income statement. As of December 25, 2004, the Company had accrued $4.5 million related to this matter. This accrual will remain on the Company’s Consolidated Balance Sheet until the third fiscal quarter of 2005 when Kaul’s rights to pursue this claim expired.

Customer Prepayments and Credits. Starting in fiscal 2001, the Company inappropriately reduced the liability for certain customer prepayments and credits. The impact of the inappropriate reduction of this liability resulted in the understatement of general and administrative expenses and the omission of the related liability. During the fourth quarter of 2004, the Company re-evaluated the accounting treatment for these customer prepayments and credits. As a consequence, the Company has applied the proper accounting treatment to all periods impacted including recording a liability in each respective previously reported period equivalent to the cumulative impact of the error.

Other Accruals. The Company has recorded other liabilities relating primarily to certain miscellaneous catalog costs and other miscellaneous costs that were inappropriately not accrued in the appropriate periods.

The summary of the effects of the Restatement, inclusive of any tax implications, on the Company’s annual consolidated financial statements is as follows:

	Year ended December 27, 2003
	As Previously Reported	Buyers’ Club Adjustment	Revenue Recognition Adjustments	Kaul Accrual Adjustment	Customer Prepayments and Credit Adjustments	Other Accrual Adjustments	As Restated
	(In thousands, except per share amounts)
Inventories	$ 41,576	--	1,230	--	--	--	$ 42,806
Prepaid catalog costs	$ 11,808	--	677	--	--	--	$ 12,485
Other current assets	$ 3,951	--	288	--	--	--	$ 4,239
Total current assets	$ 73,952	--	2,195	--	--	--	$ 76,147
Deferred tax asset	$ 1,453	--	316	--	--	--	$ 1,769
Accounts payable	$ 41,880	--	--	--	--	862	$ 42,742
Accrued liabilities	$ 12,918	--	(184)	4,354	--	--	$ 17,088
Customer prepayments and credits	$ 5,485	1,897	3,230	--	867	--	$ 11,479
Deferred tax liability	$ 1,453	--	316	--	--	--	$ 1,769
Total current liabilities	$ 75,204	1,897	3,362	4,354	867	862	$ 86,546
Accumulated deficit	$ ( 494,791)	(1,897)	(851)	(4,354)	(867)	(862)	$ (503,622)
Total shareholders’ deficiency	$ (47,508)	(1,897)	(851)	(4,354)	(867)	(862)	$ (56,339)
Net revenues	$ 414,874	(899)	308	--	--	--	$ 414,283
Cost of sales and operating expenses	$ 261,118	--	179	--	--	--	$ 261,297
Selling expenses	$ 99,543	--	150	--	--	278	$ 99,971
General and administrative expenses	$ 42,080	--	4	3,297	114	48	$ 45,543
Income before interest and income taxes	$ 8,017	(899)	(25)	(3,297)	(114)	(326)	$ 3,356
Net loss and comprehensive loss	$ (15,399)	(899)	(25)	(3,297)	(114)	(326)	$ (20,060)
Net loss applicable to common shareholders	$ (23,321)	(899)	(25)	(3,297)	(114)	(326)	$ (27,982)
Net loss per share-basic and diluted	$ (1.62)	(0.06)	(0.00)	(0.23)	(0.01)	(0.02)	$ (1.94)

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	Year ended December 28, 2002
	As Previously Reported	Buyers’ Club Adjustment	Revenue Recognition Adjustments	Kaul Accrual Adjustment	Customer Prepayments and Credit Adjustments	Other Accrual Adjustments	As Restated
	(In thousands, except per share amounts)
Accumulated deficit	$ (486,627)	(998)	(826)	(1,057)	(753)	(536)	$ (490,797)
Total shareholders’ deficiency	$ (58,841)	(998)	(826)	(1,057)	(753)	(536)	$ (63,011)
Net revenues	$ 457,644	(306)	(348)	--	--	--	$ 456,990
Cost of sales and operating expenses	$ 290,531	--	(148)	--	--	--	$ 290,383
Selling expenses	$ 105,239	--	(86)	--	--	295	$ 105,448
General and administrative expenses	$ 52,258	--	(4)	777	261	30	$ 53,322
Income (loss) before interest and income taxes	$ 138	(306)	(110)	(777)	(261)	(325)	$ (1,641)
Net loss and comprehensive loss	$ (9,130)	(306)	(110)	(777)	(261)	(325)	$ (10,909)
Net loss applicable to common shareholders	$ (24,686)	(306)	(110)	(777)	(261)	(325)	$ (26,465)
Net loss per share-basic and diluted	$ (1.79)	(0.02)	(0.01)	(0.05)	(0.02)	(0.02)	$ (1.91)

	Year ended December 29, 2001
	As Previously Reported	Buyers’ Club Adjustment	Revenue Recognition Adjustments	Kaul Accrual Adjustment	Customer Prepayments and Credit Adjustments	Other Accrual Adjustments	As Restated
	(In thousands)
Accumulated deficit	$ (477,497)	(692)	(716)	(280)	(492)	(211)	$ (479,888)
Total shareholders’ deficiency	$ (35,728)	(692)	(716)	(280)	(492)	(211)	$ (38,119)

The Restatement did not result in a change to the Company’s cash flows during the restated periods.

As further discussed below in Note 18, as a result of the Restatement, the Audit Committee of the Board of Directors hired independent outside counsel to assist with an investigation of certain of the matters relating to the restatements of the Company’s consolidated financial statements and other accounting-related matters. The Securities and Exchange Commission (“SEC”) also informed the Company that it was conducting an informal inquiry.

3. DIVIDEND RESTRICTIONS

The Company is restricted from paying dividends on its Common Stock or from acquiring its Common Stock by covenants contained in loan agreements to which the Company is a party.

4. DIVESTITURES

On March 27, 2003, the Company and HSN, a division of USA Networks, Inc.’s Interactive Group and purchaser of certain assets and liabilities of the Company’s Improvements business on June 29, 2001, amended the asset purchase agreement to provide for the release of the remaining $2.0 million balance of the escrow fund and to terminate the escrow agreement. The asset purchase agreement had provided that if the Company’s subsidiary, Keystone Internet Services LLC (“Keystone”) failed to perform its obligations during the first two years of the services contract, HSN could receive a reduction in the original purchase price of up to $2.0 million. By agreeing to the terms of the amendment, HSN forfeited its ability to receive a reduction in the original purchase price. In consideration for the release, Keystone issued a credit to HSN for $100,000, which could be applied by HSN against any invoices of Keystone to HSN. This credit was utilized by HSN during March 2003. On March 28, 2003, the remaining $2.0 million escrow balance was received by the Company, thus terminating the escrow agreement.

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During 2002, the Company recognized approximately $0.6 million of the deferred gain consistent with the terms of the escrow agreement. Proceeds related to the deferred gain were received on July 2, 2002 and December 30, 2002 for $0.3 million and $0.3 million, respectively. The Company recognized the remaining net deferred gain of $1.9 million upon the receipt of the escrow balance on March 28, 2003. This gain was reported net of the costs incurred to provide the credit to HSN of approximately $0.1 million.

5. SPECIAL CHARGES

2004 Plan

On June 30, 2004 the Company announced its plan to consolidate the operations of the LaCrosse, Wisconsin fulfillment center and storage facility into the Roanoke, Virginia fulfillment center by June 30, 2005. The LaCrosse fulfillment center and storage facility were closed in June 2005 and August 2005 upon the expiration of their respective leases. The plan to consolidate operations was prompted by excess capacity at the Roanoke facility and the lack of sufficient warehouse space in the leased Wisconsin facilities to support the growth of The Company Store and reduce the overall cost structure of the Company. The Company substantially completed the consolidation of the Roanoke, Virginia fulfillment center by the end of June 2005. The Company has incurred approximately $0.6 million in facility exit costs through June 25, 2005. The Company accrued $0.5 million in severance and related costs during 2004 associated with the LaCrosse operations and the elimination of 149 full and part-time positions, of which 96 employees will be provided severance benefits by the Company.

On November 9, 2004, the Company decided to relocate its International Male and Undergear catalog operations to its offices in New Jersey. The Company completed the relocation on February 28, 2005. The relocation was done primarily to consolidate operations, reduce costs, and leverage its catalog expertise in New Jersey. The Company accrued $0.9 million in severance and related costs during the fourth quarter associated with the elimination of 32 California-based full-time equivalent positions.

Pursuant to and in conjunction with the above actions to reduce overhead costs, the Company eliminated an additional 15 full-time positions Company-wide, for which the Company accrued $0.3 million in severance and related costs during the fourth quarter of 2004.

2000 Plan

In December 2000, the Company began a strategic business realignment program that resulted in the recording of special charges for severance, facility exit costs and fixed asset write-offs. The actions related to the strategic business realignment program were taken in an effort to direct the Company’s resources primarily towards a loss reduction strategy and return to profitability.

In May 2002, the Company entered into an agreement with the landlord and the sublandlord to terminate its sublease of the Company’s closed 746,000 square foot warehouse and telemarketing facility located in Maumelle, Arkansas. The agreement provided for the payment by the Company to the sublandlord of $1.8 million. The Company’s previously established reserves for Maumelle, Arkansas were adequate based upon the terms of the final settlement agreement.

In 2002, special charges relating to the strategic business realignment program were recorded in the amount of $4.4 million. These charges consisted of $1.8 million of severance costs related to the Company’s strategic business realignment program, and $1.3 million of additional facility exit costs resulting from the integration of The Company Store and Domestications divisions. The remaining $1.3 million consisted primarily of a $0.4 million credit reflecting the reduction of the deferred rental liabilities applicable to the portions of the facilities previously included in the Company’s strategic business realignment program, and a $1.7 million charge in order to properly reflect the current marketability of such facilities in the rental markets.

In 2003, special charges were recorded in the amount of $1.3 million primarily for additional severance costs associated with the Company’s strategic business realignment program and to revise estimated losses related to sublease arrangements for Gump’s office facility in San Francisco, California, as a result of the loss of a subtenant, coupled with declining market values in that area of the country.

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During 2004, special charge credits were recorded in the amount of $0.1 million. These credits consisted principally of reductions of estimated losses on the sublease arrangements for the office facility in San Francisco due to the acquisition of additional subtenants for the vacant space.

Plan Summary

At December 25, 2004, a current liability of approximately $2.5 million was included within Accrued Liabilities and a long-term liability of approximately $2.4 million was included within Other Non-Current Liabilities relating to future payments in connection with the Company’s 2000 and 2004 plans. They are expected to be satisfied no later than February 2010 and consist of the following (in thousands):

	Severance & Personnel Costs		Real Estate Lease & Exit Costs	Information Technology Leases
	2004 Plan	2000 Plan	2000 Plan	2000 Plan	Total

Balance at December 29, 2001	$ --	$ 2,546	$ 8,137	$ 373	$ 11,056
2002 expenses	--	1,817	2,952	--	4,769
Paid in 2002	--	(2,911)	(4,672)	(210)	(7,793)
Balance at December 28, 2002	$ --	$ 1,452	$ 6,417	$ 163	$ 8,032
2003 expenses	--	291	1,013	--	1,304
Paid in 2003	--	(1,538)	(1,841)	(163)	(3,542)
Balance at December 27, 2003	$ --	$ 205	$ 5,589	$ --	$ 5,794
2004 expenses	1,664	--	--	--	1,664
2004 revisions of previous estimate	--	(31)	(97)	--	(128)
Paid in 2004	(146)	(174)	(2,132)	--	(2,452)
Balance at December 25, 2004	$ 1,518	$ --	$ 3,360	$ --	$ 4,878

The following is a summary of the liability related to real estate lease and exit costs, by location, as of December 25, 2004 and December 27, 2003 and includes lease and exit costs related to the Gump’s operations that were sold on March 14, 2005 (in thousands):

	December 25, 2004	December 27, 2003

Gump’s facility, San Francisco, CA	$ 2,885	$ 3,788
Corporate facility, Weehawken, NJ	386	1,447
Corporate facility, Edgewater, NJ	68	261
Administrative and telemarketing facility, San Diego, CA	21	93
Total Real Estate Lease and Exit Costs	$ 3,360	$ 5,589

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6. ACCRUED LIABILITIES

Accrued liabilities consist of the following (in thousands):

	December 25, 2004	December 27, 2003 As Restated
Special charges	$ 2,460	$ 2,362
Reserve for future sales returns	1,985	1,981
Compensation and benefits	5,670	4,341
Income and other taxes	470	258
Litigation and other related accruals	5,023	4,554
Other	4,927	3,592
Total	$ 20,535	$ 17,088

7. DEBT

The Company has two credit facilities: a senior secured credit facility (the “Wachovia Facility”) provided by Wachovia National Bank, as successor by merger to Congress Financial Corporation (“Wachovia”) and a $20.0 million junior secured facility (the “Chelsey Facility”), provided by Chelsey Finance, LLC (“Chelsey Finance”), of which the entire $20.0 million was borrowed by the Company. Chelsey Finance is an affiliate of Chelsey, the Company’s principal shareholder.

Debt consists of the following (in thousands):

	December 25,	December 27,
	2004	2003
Wachovia facility:
Tranche A term loans – Current portion, interest rate of 5.5% in 2004 and 4.75% in 2003	$ 1,992	$ 1,992
Tranche B term loan – Current portion, interest rate of 13.0% in 2003	--	1,800
Revolver, interest rate of 5.5% in 2004 and 4.5% in 2003	14,408	8,997
Capital lease obligations – Current portion	290	679
Short-term debt	$ 16,690	$ 13,468

Wachovia facility:
Tranche A term loans – interest rate of 5.5% in 2004 and 4.75% in 2003	$ 2,985	$ 4,478
Tranche B term loan – interest rate of 13.0% in 2003	--	4,211
Chelsey facility – stated interest rate of 10.0% (5.0% above prime rate) in 2004	8,159	--
Capital lease obligations	52	353
Long-term debt	$ 11,196	$ 9,042
Total debt	$ 27,886	$ 22,510

Wachovia Facility

Wachovia and the Company are parties to a Loan and Security Agreement dated November 14, 1995 (as amended by the First through Thirty-Fourth Amendments, the “Wachovia Loan Agreement”) pursuant to which Wachovia provided the Company with the Wachovia Facility which has included, since inception, one or more term loans and a revolving credit facility (“Revolver”). The Wachovia Facility expires on July 8, 2007.

Prior to the Chelsey Facility, there were two term loans outstanding, Tranche A and Tranche B, under the Wachovia Facility. The Tranche B term loan had a principal balance of approximately $4.9 million and bore interest at 13.0% when the Company used a portion of the proceeds of the Chelsey Facility to repay this loan on July 8, 2004. The Tranche A term loan had a principal balance of approximately $5.0 million as of December 25, 2004, of which approximately $2.0 million is classified as short term and approximately $3.0 million is classified as long term on the Consolidated Balance Sheet. The Tranche A term loan bears interest at 0.5% over the Wachovia prime

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rate and requires monthly principal payments of approximately $166,000.

The Revolver has a maximum loan limit of $34.5 million, subject to inventory and accounts receivable sublimits that limit the credit available to the Company’s subsidiaries, which are borrowers under the Revolver. The interest rate on the Revolver is currently 0.5% over the Wachovia prime rate. As of December 25, 2004, the interest rate on the Revolver was 5.5%.

Consolidated Working Capital and EBITDA, as those terms are defined in the Wachovia Loan Agreement.

Due to, among other things, the Restatement which resulted in the Company violating several financial covenants and the Company’s inability to timely file its periodic reports with the SEC, the Company was in technical default under the Wachovia and Chelsey Facilities. The Company has obtained waivers from both Wachovia and Chelsey Finance for such defaults.

2004 Amendments to Wachovia Loan Agreement

On March 25, 2004, the Company and Wachovia amended the Wachovia Loan Agreement, which adjusted the levels of Consolidated Net Worth and Consolidated Working Capital that the Company had to maintain during each month commencing January 2004, and amended the EBITDA covenant to specify minimum levels of EBITDA that the Company had to achieve on a quarterly basis during 2004, 2005 and 2006. In addition, the definition of “Event of Default” was amended by changing an Event of Default from the occurrence of a material adverse change in the business, assets, liabilities or condition of the Company and its subsidiaries to the occurrence of certain specific events such as a decrease in consolidated net revenues beyond certain specified levels or aging of inventory or accounts payable beyond certain specified levels.

Concurrent with the closing of the Chelsey Facility on July 8, 2004, the Company and Wachovia amended the Wachovia Loan Agreement in several respects including: (1) releasing certain existing availability reserves and removing the excess loan availability covenant that increased the Company’s availability by approximately $10.0 million, (2) reducing the amount of the maximum credit, the revolving loan limit and the inventory and accounts sublimits of the borrowers, and (3) permitting Chelsey Finance to have a junior secured lien on the Company’s assets. In addition, Wachovia consented to (a) the Company’s issuance to Chelsey Finance of the Common Stock Warrant and the Common Stock as described below, (b) the proposed reverse stock split of the Common Stock and the Company making cash payments to repurchase fractional shares, (c) certain amendments to the Company’s Certificate of Incorporation, and (d) the issuance by the Company of Common Stock to Chelsey as payment of a waiver fee. The Company paid Wachovia a $400,000 fee in connection with this amendment. This fee was recorded as a deferred charge on the Company’s Consolidated Balance Sheets and is being amortized over the three-year term of the amended Wachovia Facility.

2005 Amendments to Wachovia Loan Agreement

On March 11, 2005, Wachovia consented to the sale of Gump’s and Gump’s By Mail (collectively “Gump’s”). On March 11, 2005 the Wachovia Loan Agreement was amended to temporarily increase the amount of letters of credits that the Company could issue from $10.0 million to $13.0 million through June 30, 2005. The Company paid Wachovia a $25,000 fee in connection with this amendment.

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obligated to do so, prohibits the Company from terminating the WFNNB Credit Card Agreement without Wachovia’s consent and restricts the Company from borrowing on receivables generated under the WFNNB Credit Card Agreement. The amendment also waives enumerated defaults, resets the financial covenants, reallocates the availability that was previously allocated to Gump’s among other Company subsidiaries and, retroactive to June 30, 2005, increases the amount of letter of credits that the Company can issue to $15.0 million. The Company paid Wachovia a $60,000 fee in connection with this amendment.

On July 29, 2005 the Company and Chelsey Finance entered into a similar amendment of the Chelsey Facility.

Remaining availability under the Wachovia Facility as of December 25, 2004 was $14.0 million.

Chelsey Facility

On July 8, 2004, the Company closed on the Chelsey Facility, a $20.0 million junior secured credit facility with Chelsey Finance that was recorded net of a debt discount, at $7.1 million at issuance. The Chelsey Facility has a three-year term, subject to earlier maturity upon the occurrence of a change in control or sale of the Company (as defined), and carries a stated interest rate of 5.0% above the prime rate publicly announced by Wachovia. The financial and non-financial covenants contained in the Chelsey Facility mirror those in the Wachovia Facility except that the quantitative measures for the consolidated working capital and EBITDA covenants are 10.0% less restrictive and the consolidated net worth covenant is 5.0% less restrictive than the comparable financial covenants in the Wachovia Facility. The Chelsey Facility is secured by a second priority lien on substantially all of the assets of the Company. As part of this transaction, Chelsey Finance entered into an intercreditor and subordination agreement with Wachovia. At December 25, 2004, the amount recorded as debt on the Consolidated Balance Sheet is $8.2 million, net of the un-accreted debt discount of $11.8 million.

Under the original terms of the Chelsey Facility, the Company was obligated to make payments of principal of up to the full outstanding amount of the Chelsey Facility in each quarter, provided, among other things: (1) the aggregate amount of availability under the Wachovia Facility is at least $7.0 million, (2) the cumulative EBITDA for the four fiscal quarters immediately preceding the quarter in which the payment is made is at least $14.0 million, and (3) the aggregate amount of principal prepayments is no more than $2.0 million in any quarter. Subsequent to the closing of the Chelsey Facility, the Company and Chelsey Finance amended the Chelsey Facility to provide that the Company was not obligated to make principal payments prior to the July 8, 2007, except in the event of a change in control or sale of the Company. This resulted in the recorded amount of the Chelsey Facility plus the accreted cost of the debt discount (as described below) being classified as long term on the Company’s Consolidated Balance Sheets as of December 25, 2004.

In consideration for providing the Chelsey Facility to the Company, Chelsey Finance received a closing fee of $200,000 and a warrant (the “Common Stock Warrant”) with a fair value of $12.9 million, exercisable immediately and for a period of ten years to purchase 30.0% of the fully diluted shares of Common Stock of the Company (equal to 10,259,366 shares of Common Stock) at an exercise price of $0.01 per share. The closing fee of $200,000 was recorded as a deferred charge in other assets on the Company’s Consolidated Balance Sheets and is being amortized over the three-year term of the Chelsey Facility utilizing the interest-method. Because the issuance of the Common Stock Warrant was subject to shareholder approval, the Company initially issued a warrant to Chelsey Finance to purchase newly-issued Series D Participating Preferred Stock (“Series D Preferred”) that was automatically exchanged for the Common Stock Warrant on September 23, 2004 following receipt of shareholder approval.

In connection with the closing of the Chelsey Facility, Chelsey waived its blockage rights over the issuance of senior securities and received in consideration a waiver fee equal to 1.0% of the liquidation preference of the Series C Preferred, payable in 434,476 shares of Common Stock (calculated based upon the fair market value thereof two business days prior to the closing date). The $0.6 million waiver fee was recorded as a deferred charge within other assets on the Company’s Consolidated Balance Sheets and is being amortized over the remaining redemption period

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of the Series C Preferred utilizing the interest-method. After consideration of the waiver fee paid in Common Stock and the change in the par value of Common Stock (see Note 9), the Company’s Common Stock increased by less than $0.1 million and Capital in excess of par value increased by $0.6 million. Both the shares underlying the Common Stock Warrant and the shares issued in payment of the waiver fee are subject to an existing Registration Rights Agreement between the Company and Chelsey.

As part of the Chelsey Facility, the Company and its subsidiaries agreed to indemnify Chelsey Finance and its affiliates, which includes Chelsey, from any losses suffered arising out of the Chelsey Facility other than liabilities resulting from Chelsey Finance and its affiliates’ gross negligence or willful misconduct. The indemnification agreement is not limited as to term and does not include any limitations on maximum future payments thereunder.

The terms of the Chelsey Facility were approved by the Company’s Audit Committee, all of whose members are independent, and the Company’s Board of Directors.

On July 8, 2004, approximately $4.9 million of the proceeds from the Chelsey Facility were used to repay the Tranche B Term Loan with the balance used to provide ongoing working capital for the Company, which has been used to reduce outstanding payables and increase inventory. The Chelsey Facility, together with the concurrent amendment of the Wachovia Facility, increased the Company’s liquidity by approximately $25.0 million.

In accordance with Accounting Principles Board Opinion No. 14, “Accounting for Convertible Debt and Debt Issued with Stock Purchase Warrants” (“APB 14”), proceeds received from the sale of debt with detachable stock purchase warrants should be allocated to both the debt and warrants, with the portion allocable to the warrants to be accounted for as Capital in excess of par value of $7.1 million with the remaining portion classified as debt. The fair value of the Common Stock Warrant of $12.9 million was determined using the Black-Scholes option pricing model and is being treated as debt discount, which will be accreted as interest expense utilizing the interest method over the 36-month term of the Chelsey Facility. The assumptions used for the Black-Scholes option pricing model were as follows: risk-free interest rate of 4.5%, expected volatility of 80.59%, an expected life of ten years and no expected dividends. A summary of the debt relating to the Chelsey Facility is as follows (in thousands):

Amount Borrowed Under the Chelsey Facility	$ 20,000
Fair Value of Common Stock Warrant (Recorded as Capital in excess of par value)	(12,939)
Accretion of Debt Discount (Recorded as Interest Expense)	1,098

Balance at December 25, 2004	$ 8,159

The annual effective interest rate of the Chelsey Facility is approximately 62.7%. For the 52- weeks ended December 25, 2004, the Company has incurred approximately $0.9 million of interest expense and have made interest payments of approximately $0.8 million related to the Chelsey Facility.

General

At December 25, 2004, the aggregate future annual principal payments required on debt instruments (including capital lease obligations) are as follows (in thousands): 2005 — $16,690; 2006 — $2,039; 2007 — $20,998.

8. PREFERRED STOCK

Currently, the Company has one series of preferred stock outstanding, Series C Preferred. Chelsey holds all 564,819 outstanding shares of Series C Preferred which it acquired after a series of transactions that began with its May 19, 2003 acquisition of all of the Series B Participating Preferred Stock (“Series B Preferred”) from Richemont. The transactions leading up to Chelsey’s acquisition of the Series C Preferred and the terms of the Series C Preferred are summarized below.

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Series A Cumulative Participating Preferred Stock and Series B Participating Preferred Stock

On August 24, 2000, the Company issued 1.4 million shares of newly created Series A Cumulative Participating Preferred Stock (“Series A Preferred”) to Richemont, the then holder of approximately 47.9% of the Company’s Common Stock, for $70.0 million. On December 19, 2001, the Company and Richemont agreed to exchange all of the outstanding shares of the Series A Preferred and 7,409,876 shares of the Common Stock held by Richemont for 1,622,111 shares of newly-created Series B Preferred. The effect of the exchange was to reflect the elimination of the Series A Preferred for the then $82.4 million carrying amount and the issuance of Series B Preferred in the amount of $76.8 million, which was equal to the aggregate liquidation preference of the Series B Preferred on December 19, 2001. In addition, the Common Stock’s $0.7 million par value repurchased by the Company and subsequently retired was reflected as a reduction of Common Stock, with an offsetting increase to capital in excess of par value. The Company recorded a net decrease in shareholders’ deficiency of $5.6 million as a result of the Richemont transaction. The shares of the Series A Preferred repurchased from Richemont represented all of the outstanding Series A Preferred. The Company filed a certificate in Delaware eliminating the Series A Preferred.

The Series B Preferred had a par value of $0.01 per share and a liquidation preference initially of $47.36 per share, increasing thereafter to a maximum of $86.85 per share in 2005.

The Company learned from filings made with the SEC that on May 19, 2003 Richemont sold to Chelsey all of its securities in the Company consisting of 2,944,688 shares of Common Stock and 1,622,111 shares of Series B Preferred for $40.0 million. The Company was not a party to the transaction and did not provide Chelsey with any material non-public information nor did the Company’s Board of Directors endorse the transaction. As a result of the transaction, Chelsey succeeded to Richemont’s rights in the Common Stock and the Series B Preferred, including the rights of the Series B Preferred holder to a liquidation preference that was equal to approximately $98.2 million on May 19, 2003, the date of the sale by Richemont, and that could have increased to a maximum of approximately $146.2 million on August 23, 2005, the final Series B Preferred redemption date.

Recapitalization Agreement

On November 30, 2003, the Company and Chelsey consummated the transactions contemplated by a Recapitalization Agreement, dated as of November 18, 2003 under which the Company recapitalized, the Company completed the reconstitution of its Board of Directors and outstanding litigation between the Company and Chelsey was settled. As part of the Recapitalization, the Company exchanged all of Chelsey’s Series B Preferred for 564,819 shares of newly created $0.01 par value Series C Preferred and 8,185,783 shares of Common Stock. The Company filed a certificate in Delaware eliminating the Series B Preferred.

Effective upon the closing of the transactions contemplated by the Recapitalization Agreement, the size of the Board of Directors was increased to nine members. For a period of two years from the closing of the Recapitalization, five of the nine directors of the Company were to be designated by Chelsey and one was to be designated by Regan Partners, L.P. Effective July 30, 2004, Basil Regan, the general partner of Regan Partners, L.P. and its designee to the Board of Directors, resigned from the Board of Directors. Regan Partners, L.P. held the right to appoint a designee to the Company’s Board of Directors until the January 10, 2005 sale of Common Stock held by Regan Partners, L.P., Regan International Fund Limited and Basil Regan to Chelsey.

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Because the Series B Preferred was mandatorily redeemable and thus accounted for as a liability pursuant to SFAS 150, the Company accounted for the exchange of the 1,622,111 shares of Series B Preferred for the 564,819 shares of Series C Preferred and the 8,185,783 shares of Common Stock in accordance with SFAS No. 15, “Accounting by Debtors and Creditors for Troubled Debt Restructurings.” As such, the $107.5 million carrying value of the Series B Preferred as of the consummation date of the exchange was compared with the fair value of the Common Stock of approximately $19.6 million issued to Chelsey as of the consummation date and the total maximum potential cash payments of approximately $72.7 million that could be made pursuant to the terms of the Series C Preferred. Since the carrying value, net of issuance costs of approximately $1.3 million, exceeded these amounts by approximately $13.9 million, pursuant to SFAS No. 15, such excess was determined to be a “gain” and the Series C Preferred was recorded at the amount of total potential cash payments (including dividends and other contingent amounts) that could be required pursuant to its terms. Because Chelsey was a significant stockholder at the time of the exchange and, as a result, a related party, the “gain” was recorded to “Capital in Excess of Par Value” within “Shareholders’ Deficiency” on the accompanying Consolidated Balance Sheets.

Series C Preferred

The Series C Preferred holders are entitled to one hundred votes per share on any matter on which the Common Stock votes and are entitled to one hundred votes per share plus that number of votes equal to the dollar value of any accrued, unpaid and compounded dividends with respect to such share. The holders of the Series C Preferred are also entitled to vote as a class on any matter that would adversely affect such Series C Preferred. In addition, if the Company defaults on its obligations under the Certificate of Designations, the Recapitalization Agreement or the Wachovia Facility, then the holders of the Series C Preferred, voting as a class, shall be entitled to elect twice the number of directors as comprised the Board of Directors on the default date, and such additional directors shall be elected by the holders of record of Series C Preferred as set forth in the Certificate of Designations.

If the Company liquidates, dissolves or is wound up, the holders of the Series C Preferred are entitled to a liquidation preference of $100 per share, or an aggregate of approximately $56.5 million based on the shares of Series C Preferred currently owned by Chelsey, plus all accrued and unpaid dividends on the Series C Preferred. As described further below, commencing January 1, 2006, dividends will be payable quarterly on the Series C Preferred at the rate of 6% per annum, but such dividends may be accrued at the Company’s option. Effective October 1, 2008 and assuming the Company has elected to accrue all dividends from January 1, 2006 through such date, the maximum aggregate amount of the liquidation preference plus accrued and unpaid dividends on the Series C Preferred will be approximately $72.7 million.

The Series C Preferred may be redeemed in whole and not in part, except as set forth below, at the option of the Company at any time for the liquidation preference and any accrued and unpaid dividends (the “Redemption Price”). The Series C Preferred, if not redeemed earlier, must be redeemed by the Company on January 1, 2009 (the “Mandatory Redemption Date”) for the Redemption Price. If the Series C Preferred is not redeemed on or before the Mandatory Redemption Date, or if other mandatory redemptions are not made, the Series C Preferred will be entitled to elect one-half of the Company’s Board of Directors. Notwithstanding the foregoing, the Company will redeem the maximum number of shares of Series C Preferred as possible with the net proceeds of certain asset and equity sales not required to be used to repay Wachovia pursuant to the terms of the Wachovia Loan Agreement, and Chelsey will be required to accept such redemptions. At the Company’s request, Chelsey agreed to permit the Company to apply the sales proceeds from the sale of Gump’s to reduce the Wachovia Facility. Chelsey retained the right to require redemption of approximately $6.9 million (the Gump’s sales proceeds available for redemption) of the Series C Preferred subject to Wachovia’s approval.

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9. CAPITAL STOCK

General — At December 25, 2004 there were 22,426,296 shares of Common Stock issued and outstanding. Additionally, an aggregate of 1,318,883 and 10,259,366 shares of Common Stock were reserved for issuance pursuant to the exercise of outstanding options and common stock warrants, respectively, at December 25, 2004. After its January 10, 2005 purchase of an aggregate of 3,799,735 shares of Common Stock formerly held by Regan Partners, L.P., Regan International Fund Limited and Basil Regan, which was reported in an SEC filing, Chelsey and related affiliates beneficially owned approximately 69% of the issued and outstanding Common Stock and approximately 75% of the Common Stock after giving effect to the exercise of all outstanding options and warrants to purchase Common Stock beneficially owned by Chelsey. In addition, Chelsey is holder of all of the Company’s Series C Preferred. Including the Series C Preferred and outstanding options and warrants (after giving effect to the exercise of all outstanding options and warrants) beneficially owned by Chelsey, Chelsey maintains approximately 91% of the voting rights of the Company. Effective July 30, 2004, Basil Regan resigned from the Board of Directors and continued to hold the right to appoint a designee to the Company’s Board of Directors until the January 10, 2005 sale of Common Stock held by Regan Partners, L.P., Regan International Fund Limited and Basil Regan to Chelsey..

Recapitalization — On November 30, 2003 as part of the Recapitalization, the Company issued 8,185,783 shares of Common Stock to Chelsey.

Reverse Stock Split — At the 2004 Annual Meeting of Shareholders of the Company held on August 12, 2004, the Company’s shareholders approved a one-for-ten reverse stock split of the Common Stock that became effective at the close of business on September 22, 2004. The number of shares of Common Stock in these consolidated financial statements and footnotes have been adjusted to take into account the effect of the reverse stock split.

Amendment to the Company’s Certificate of Incorporation — On September 22, 2004, the Company filed a Certificate of Amendment to the Company’s Amended and Restated Certificate of Incorporation (1) reducing the par value of the Common Stock from $0.66-2/3 to $0.01 per share and reclassifying the outstanding shares of Common Stock into such lower par value shares; (2) increasing the number of authorized shares of additional Preferred Stock from 5,000,000 shares to 15,000,000 shares and making a corresponding change to the aggregate number of authorized shares of all classes of preferred stock; and (3) after giving effect to the reverse split, increasing the authorized number of shares of Common Stock from 30,000,000 shares to 50,000,000 shares and making a corresponding change to the aggregate number of authorized shares of all classes of common stock.

Retirement of Treasury Stock — The Company approved the retirement of the Company’s 212,093 treasury shares on November 16, 2004. Pursuant to the Delaware General Corporation Law, such shares will assume the status of authorized and unissued shares of Common Stock of the Company.

Dividend Restrictions — The Company is restricted from paying dividends on its Common Stock or from acquiring its Common Stock under the Wachovia and Chelsey Facilities.

10. MANAGEMENT AND COMPENSATION

Chief Executive Officer

Garten Employment Agreement. On May 6, 2004, Wayne P. Garten became the Company’s Chief Executive Officer and President. Mr. Garten is employed pursuant to the terms of a May 6, 2004 Employment Agreement. Under Mr. Garten’s Employment Agreement he will be paid an annual salary of $600,000 over a term expiring on May 6, 2006. The Company also granted Mr. Garten options to acquire 200,000 shares of the Company’s common stock, half pursuant to its 2000 Management Stock Option Plan and half outside the plan. All of the options have an exercise price of $1.95 per share, the Common Stock’s average closing price for the ten trading days preceding the grant date and the ten trading days after the grant date. One third of each of the options vested upon execution of the Employment Agreement and the balance will vest in two equal installments over a two-year period, vesting on the anniversary of the original grant date, subject to earlier vesting in the event of a change in control of the Company (as that term is defined in the Employment Agreement). Mr. Garten is entitled to participate in the Company’s bonus plan for executives, as established by the Board of Directors.

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The Employment Agreement provides for a lump sum change in control payment equal to 200% of Mr. Garten’s annual salary if a change in control occurs during the term. The Employment Agreement also provides for eighteen months of severance payments if Mr. Garten is not otherwise entitled to change in control benefits and (i) is terminated without cause or terminates his employment for good reason (as both terms are defined in the Employment Agreement) during the term or (ii) his Employment Agreement is not renewed.

Shull Employment and Severance Agreement. Thomas Shull, the Company’s prior Chief Executive Officer, resigned from the Company on May 5, 2004. Mr. Shull and the Company executed a General Release and Separation Agreement dated effective as of May 5, 2004 which provided for the Company to pay Mr. Shull $900,000 of severance in lieu of any other benefits provided for in the Employment Agreement dated September 1, 2002, as amended (the “Shull Employment Agreement”). The severance was paid with a $300,000 lump sum on execution and the balance in biweekly installments that were completed in 2004. The Company also agreed to pay for eighteen months of COBRA coverage for Mr. Shull.

Prior to his resignation, Mr. Shull was employed pursuant to the Shull Employment Agreement which provided for an $855,000 base salary and had term expiring on March 31, 2006. Mr. Shull was a participant in the Company’s Key Executive Eighteen Month Compensation Continuation Plan (the “Change of Control Plan”) and its transaction bonus program. The Recapitalization was a change in control under the Change in Control Plan and therefore the Company paid Mr. Shull $1,350,000 in 2003. The Company also paid Mr. Shull $450,000 under the transaction bonus program in 2003. Mr. Shull received $450,000 in 2002 related to the terms of his agreement.

Chief Operating Officer

Michael Contino, the Company’s Executive Vice President and Chief Operating Officer, is employed pursuant to a October 29, 2002 letter agreement. Under the letter agreement, Mr. Contino is to receive an annual salary of $387,000 and is entitled to participate in the Company’s bonus plan for executives, as established by the Board of Directors. Mr. Contino was awarded options to purchase 100,000 shares under the 2000 Management Stock Option Plan. Under the agreement, if Mr. Contino is terminated other than “for cause” or terminates his employment for “good reason” (as those terms are defined in the agreement), he is entitled to eighteen months of severance pay and health benefits. Mr. Contino was a participant in the Company’s 18 month change in control plan and was entitled to a Transaction Bonus equal to half of his base salary on a change in control. Mr. Contino was paid the Transaction Bonus following the Recapitalization in 2003. In addition, in January 1998, the Company made a $75,000 non interest-bearing loan to Mr. Contino for the purchase by Mr. Contino of a new principal residence. The terms of the loan agreement, as amended, included a provision for the Company to forgive the original amount of the loan on the fifth anniversary of the loan. The Company forgave the loan in accordance with its terms in January 2003 and paid the applicable withholding taxes of $64,063.

Chief Financial Officer

On April 4, 2005 John W. Swatek joined the Company as its Senior Vice President, Chief Financial Officer and Treasurer. Mr. Swatek will report directly to the Company’s Chief Executive Officer. Under the March 15, 2005 Employment Agreement between the Company and Mr. Swatek, Mr. Swatek will be paid an annual salary of $270,000 and has been granted options to acquire 50,000 shares of the Company’s common stock pursuant to its 2000 Management Stock Option Plan. All of the options have an exercise price of $0.81 per share, the Common Stock’s average closing price for the ten trading days preceding the grant date and the ten trading days after the grant date. One third of the options vested upon execution of the Employment Agreement and the balance will vest in two equal annual installments over the next two years on the anniversary of the original grant date, subject to earlier vesting in the event of a change in control of the Company (as that term is defined in the Employment Agreement). Mr. Swatek will be entitled to participate in the Company’s bonus plan for executives. The Employment Agreement expires on May 6, 2006 and provides for a sign-on bonus of up to $25,000 to the extent his bonus from his prior employer was reduced as a result of his decision to join the Company. The Company paid Mr. Swatek $17,208 under this provision.

The Employment Agreement provides for a lump sum change in control payment equal to Mr. Swatek’s annual salary if his employment is terminated due to a change in control during the term of the agreement. The Employment Agreement also provides for one year of severance payments if Mr. Swatek is not otherwise entitled to

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change in control benefits and (i) is terminated without cause or terminates his employment for good reason (as both terms are defined in the Employment Agreement) or (ii) if his agreement is not renewed at the end of the term.

Charles E. Blue had been appointed Chief Financial Officer of the Company effective November 11, 2003, replacing Edward M. Lambert. Mr. Blue joined the Company in 1999 and prior to his appointment had most recently served as Senior Vice President, Finance. Mr. Lambert continued to serve as Executive Vice President of the Company until his January 2, 2004 resignation. Mr. Lambert and the Company entered into a severance agreement dated November 4, 2003 providing for payments of $640,000, as well as other benefits that were accrued and paid in the fourth quarter of 2003. Mr. Lambert received a payment of $72,512 under the Company’s 2003 Management Incentive Plan.

Mr. Blue’s employment with the Company was terminated effective March 8, 2005 and the Company reported in a Current Report on Form 8-K that he had resigned voluntarily. The Company and Mr. Blue were unable to agree on the terms of his voluntary resignation and the Company notified Mr. Blue that his employment had been terminated for cause.

General Counsel

On January 31, 2005, the Company appointed Daniel J. Barsky as its Senior Vice President and General Counsel. Under a letter agreement with the Company, Mr. Barsky will be paid an annual salary of $265,000 and was granted options to purchase 50,000 shares of Common Stock. One third of the options vested on February 17, 2005 and the balance will vest in two equal annual installments over the next two years on the anniversary of the original grant date, subject to earlier vesting in the event of a change in control of the Company. All of the options have an exercise price of $1.03 per share, the Common Stock’s average closing price for the ten trading days preceding the grant date and the ten trading days after the grant date. Mr. Barsky will be entitled to participate in the Company’s bonus plan for executives. The agreement also provides for six months of severance payments if Mr. Barsky is terminated without cause or terminates his employment for good reason. Mr. Barsky was appointed as the Company’s Secretary on March 7, 2005.

Other Severance and Compensation Related Agreements

Charles F. Messina. During September 2002, Charles F. Messina resigned as Executive Vice President, Chief Administrative Officer and Secretary of the Company. In connection with his resignation, the Company and Mr. Messina entered into a September 30, 2002 severance agreement providing for payments of $884,500 and other benefits which were accrued in the fourth quarter of 2002.

Brian C. Harriss. Effective February 15, 2004, the Company eliminated Mr. Harriss’ position as Executive Vice President, Finance and Administration, as part of its ongoing strategic business realignment program. Mr. Harriss and the Company entered into a severance agreement providing for payments of $545,000, as well as other benefits that were accrued and paid in the first quarter of 2004. Mr. Harriss also received a payment of $61,091 under the Company’s 2003 Management Incentive Plan.

William C. Kingsford. William C. Kingsford, the Company’s Senior Vice President Treasury and Control (Corporate Controller) resigned from the Company effective September 22, 2004. In connection with his resignation, the Company and Mr. Kingsford entered into a Separation Agreement and General Release under which the Company agreed to pay him severance at his then current salary of $200,000, payable over the shorter of one year following resignation or the date Mr. Kingsford secured a new job. The Company paid Mr. Kingsford one year of severance payments.

Compensation Continuation Agreements. The Company has entered into and established a number of compensation continuation agreements and programs (some of which were included in employment agreements and transaction bonus letters) for its executives and its non-employee directors. In general, the plans provided that a plan participant whose employment is terminated other than for cause or for a resignation without good reason within two years of a change in control is entitled to change in control benefits. These benefits for the plans applicable to employees included payments equal to eighteen months, twelve months or six months (depending on the level of the plan participant) of salary and COBRA benefits and outplacement services. As of December 25, 2004, the potential maximum salary payout was $6.5 million (as of October 20, 2005 the maximum salary payout was $4.8 million).

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The change in control benefits for Directors was equal to the greater of (i) $40,000 or (ii) 150.0% of the sum of the annual retainer fee, meeting fees and per diem fees paid to a Director for his/her service on the Board of Directors of the Company during the twelve month period immediately preceding the effective date of the change of control. Certain of the compensation continuation plans, including the plan applicable to non-employee directors and those applicable to certain senior executives, were “single trigger” plans – the plan participant was entitled to change in benefits on a change of control regardless of whether his employment was terminated or remained a director.

The Board concluded that the Recapitalization, which closed on November 30, 2003, was a change in control for purposes of the compensation continuation plans. On November 16, 2004, the Board of Directors resolved to continue the change in control plans solely for plan participants who were employed when the November 30, 2003 change in control occurred.

In December 2003, Messrs. Shull, Harriss and Contino received payments of $450,000, $168,500 and $193,500, respectively, under their “single trigger” change in control plans. On December 18, 2003, each of the eight non-employee directors (Messrs. Brown, James, Krushel, Sonnenfeld, Masson, Regan, Garten and Edelman) received an $87,000 payment under the terms of the Directors Change of Control Plan. No other plan participants received change in control payments in 2003 and five triggered change in control benefits in 2004 totaling $1,194,257 (excluding the Shull Severance Agreement). Of these five, three received payments in 2004 totaling $772,257 and two in 2005 totaling $422,000.

Salary Reduction. The Company effected salary reductions of 5.0% of base pay for participants in its 2003 Management Incentive Plan, including Executive Officers, effective with the pay period starting August 3, 2003. These salary reductions were restored at or below the Vice-President levels on March 28, 2004 and levels above Vice-President on August 1, 2004.

Summary of Severance Costs. For the year ended December 25, 2004, the Company agreed to pay termination benefits to eight director level and above positions (including the Shull Severance Agreement and five change in control benefits, excluding positions eliminated due to the International Male and Undergear relocation). These costs totaled $2.6 million, of which $0.8 million was recorded during the 1st quarter of 2004, $0.9 million recorded during the 2nd quarter of 2004, $0.3 million during the third quarter of 2004 and $0.6 million in the fourth quarter of 2004. The Company recorded costs relating to termination benefits for director level and above positions of $1.5 million and $1.6 million for the years ended December 27, 2003 and December 28, 2002, respectively.

11. EMPLOYEE BENEFIT PLANS

The Company maintains two defined contribution 401(k) plans that are available to all employees of the Company. The Company matches a percentage of employee contributions to the plans up to $13,000. Matching contributions for both plans was $0.5 million for each of the fiscal years 2004, 2003 and 2002.

12. INCOME TAXES

On May 19, 2003 the Company had a change in control, as defined by Internal Revenue Code Section 382, which places an annual limit of $3.0 million on the utilization of the Company’s Federal income tax net operating loss (“NOLs”) carryovers and alternative minimum tax net operating loss (“AMT NOLs”) carryovers that existed prior to the change in control date. The unused portion of the $3.0 million annual limitation for any year may be carried forward to succeeding years to increase the annual limitation for those succeeding years. In addition to the Section 382 annual limit, the utilization of AMT NOLs in any year is further limited to 90% of that year’s Federal alternative minimum taxable income. The annual Section 382 limit, discussed above, may be increased, under certain circumstances, up to the amount of net unrealized built-in gains that existed on the change in control date, which are recognized within five years of that date. The Company is in the process of determining whether it has net unrealized built-in gains and whether it will be able to realize them within the requisite period.

At December 25, 2004, the Company’s NOLs and AMT NOLs significantly exceeded the maximum utilizable pursuant to the above limits. The Company estimates that maximum utilizable carryforwards consist of $54.3 million of NOLs and AMT NOLs, expiring between 2019 and 2023, subject to a $3.0 million annual limitation under Section 382 and $1.1 million of NOLs and $1.2 million of AMT NOLs, both expiring in 2023, not subject to such limitation.

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SFAS 109 requires management to assess the realizability of the Company’s deferred tax assets. Realization of the future tax benefits is dependent, in part, on the Company’s ability to generate taxable income within the carry forward period and the periods in which net temporary differences reverse. Future levels of operating income and taxable income are dependent upon general economic conditions, competitive pressures on sales and margins, postal and other delivery rates, and other factors beyond the Company’s control. Accordingly, no assurance can be given that sufficient taxable income will be generated for utilization of NOLs and reversals of temporary differences. Management believes that the $5.5 million deferred tax asset (excluding the $5.5 million deferred tax liability), as of December 25, 2004, represents a “more-likely-than-not” estimate of the future utilization of the NOLs and the reversal of temporary differences. The valuation allowance decreased by $0.2 million in 2004 and increased by $108.6 million in 2003. Management will continue to routinely evaluate the likelihood of future profits and the necessity of future adjustments to the valuation allowance.

The Company’s Federal income tax provision consists of $0.1 million of current income taxes for 2004, $11.3 million of deferred income tax for 2003 and $3.7 million of deferred income tax for 2002. The Company’s current state income tax provision was $28,000 in 2004, $28,000 in 2003 and $91,000 in 2002.

The Company has adjusted the calculation of its deferred tax assets and liabilities as of December 27, 2003 to also consider the effect of deferred state income taxes as of that date, in addition to calculating deferred taxes on only those NOL carryforwards that may be utilizable in the future. These adjustments resulted in a decrease of the deferred tax assets and liabilities by $0.8 million and $0.8 million, respectively, as of December 27, 2003. As the Company’s net deferred tax asset had a full valuation allowance at that date, there was no impact on the Company’s financial position, cash flows or operating results for this change.

The components of the net deferred tax asset at December 25, 2004 and December 27, 2003 are as follows (in millions):

	2004			2003 As Restated
	Current	Non- Current	Total	Current	Non- Current	Total
Deferred Tax Assets Federal and state tax NOL, alternative minimum tax and business tax credit carry forwards	$ 1.4	$ 20.1	$ 21.5	$ 2.4	$ 21.0	$ 23.4
Allowance for doubtful accounts	0.5	—	0.5	0.4	—	0.4
Property and equipment	—	4.0	4.0	—	4.0	4.0
Mailing lists and trademarks	—	0.3	0.3	—	0.4	0.4
Accrued liabilities	6.2	—	6.2	3.2	—	3.2
Customer prepayments and credits	4.6	—	4.6	3.8	—	3.8
Deferred rent credits	0.7	1.3	2.0	1.0	1.8	2.8
Total	13.4	25.7	39.1	10.8	27.2	38.0
Valuation allowance	11.5	22.1	33.6	9.5	23.9	33.4
Deferred tax asset, net of valuation allowance	1.9	3.6	5.5	1.3	3.3	4.6
Deferred Tax Liabilities Inventories	(0.3)	—	(0.3)	(0.2)	—	(0.2)
Prepaid catalog costs	(3.5)	—	(3.5)	(2.7)	—	(2.7)
Other current assets	(0.1)	—	(0.1)	(0.1)	—	(0.1)
Excess of net assets of acquired business	—	(1.5)	(1.5)	—	(1.5)	(1.5)
Other	—	(0.1)	(0.1)	(0.1)	—	(0.1)
Deferred tax liability	(3.9)	(1.6)	(5.5)	(3.1)	(1.5)	(4.6)
Net deferred tax (liability) asset	$ (2.0)	$ 2.0	$ 0.0	$ (1.8)	$ 1.8	$ 0.0

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The Company’s effective tax rate for the three fiscal years presented differs from the Federal statutory income tax rate due to the following:

	2004 Percent of Pre-tax Income	2003 Percent of Pre-tax Loss As Restated	2002 Percent of Pre-tax Loss As Restated
Tax expense (benefit) at Federal statutory rate	35.0%	(35.0)%	(35.0)%
State and local taxes, net of Federal benefit	1.5	0.2	0.8
Permanent differences:
$1 million salary limit and stock option compensation	5.5	16.0	15.0
Non-deductible interest expense on Series B Preferred Stock	—	29.0	—
Other permanent differences	3.2	(1.0)	2.0
Change in valuation allowance	(30.4)	120.5	70.5
Tax expense at effective tax rate	14.8 %	129.7%	53.3%

13. LEASES

The Company is the lessee under certain leases that require it to pay real estate taxes and common area maintenance by the Company. Most leases are accounted for as operating leases and include various renewal options with specified minimum rentals. Rental expense for operating leases, net of sublease income, was as follows (in thousands):

	Year Ended
	2004	2003	2002
Rent expense by lease type:
Land and building	$ 4,626	$ 4,798	$ 4,682
Computer equipment	362	1,359	3,516
Plant, office and other	336	548	446
Rent expense	$ 5,324	$ 6,705	$ 8,644
Sublease income	—	—	(53)
Net rent expense	$ 5,324	$ 6,705	$ 8,591

The amounts above include the net minimum rentals for the Gump’s operations of (in thousands) $1,428, $1,526 and $1,567 for 2004, 2003 and 2002, respectively.

Future minimum lease payments as of December 25, 2004 under non-cancelable operating leases, by lease type are as follows (in thousands):

Year Ending	Land and Buildings	Computer Equipment	Plant, Office and Other	Total
2005	$ 3,056	$ 130	$ 208	$ 3,394
2006	1,963	9	74	2,046
2007	1,720	—	38	1,758
2008	1,676	—	24	1,700
2009	1,668	—	—	1,668
Thereafter (extending to 2015)	278	—	—	278
Total future minimum lease payments	$ 10,361	$ 139	$ 344	$ 10,844

The amounts above include the future commitments of non-cancelable operating leases for the Gump’s operations of (in thousands) $8,585 for Land and Buildings and $95 for Plant, Office and Other.

On February 12, 2005, the Company entered into a ten-year lease extension and modification for 50,000 square feet of the 85,000 square feet previously leased for our corporate headquarters and administrative offices located in Weehawken, New Jersey. Effective June 2005, the annual rent is approximately $1,075,000 for the first five years of the extension, and increases to an annual rent of approximately $1,175,000 during the final five years. These amounts are not reflected in the table above.

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Effective October 1, 2005, the Company entered into a one-year lease for auxiliary warehouse storage space in Salem, Virginia. The lease provides for an annual rental of $477,000 for 212,000 square feet of space. An additional 90,880 square feet of space in the same facility is being leased on a month-to-month basis at a monthly rental of $15,147. These amounts are not reflected in the table above.

The Company leases certain machinery and equipment under agreements that are classified as capital leases. The cost of equipment under capital leases is included in the Balance Sheet in Furniture, fixtures and equipment and was $1,506,512 at both December 25, 2004 and December 27, 2003. Accumulated amortization of the leased equipment at December 25, 2004 and December 27, 2003 was $1,139,155 and $434,509, respectively. The future minimum lease payments as of December 25, 2004 are as follows (in thousands):

Year Ending	Total
2005	$ 305
2006	49
2007	4
Total minimum lease payments	$ 358
Less:
Amount representing interest computed at annual
rates ranging from 7.5% to 9.0%	(16)
Present value of net minimum lease payments	342
Less:
Current maturities of capital lease obligations	(290)
Long-term capital lease obligations	$ 52

The Company has established reserves for certain future minimum lease payments under noncancelable operating leases due to the restructuring of business operations which previously utilized such leased space. The future commitments under such leases, net of related sublease income under noncancelable subleases, as of December 25, 2004 are as follows (in thousands):

Year Ending	Minimum Lease Commitments	Sublease Income	Net Lease Commitments
2005	$ 1,624	$ (785)	$ 839
2006	1,002	(581)	421
2007	1,002	(469)	533
2008	1,003	(292)	711
2009	1,003	(296)	707
Thereafter (extending to 2010)	167	(49)	118
Total minimum lease payments	$ 5,801	$ (2,472)	$ 3,329

The amounts above include the future commitments under noncancelable operating leases, net of related sublease income under noncancelable subleases, for the Gump’s operations of (in thousands) $5,179 of minimum lease commitments less $2,275 of sublease income for a net lease commitment of $2,904.

The future minimum lease payments under non-cancelable leases that remain from the Company’s discontinued restaurant operations as of December 25, 2004 are as follows (in thousands):

Year Ending	Minimum Lease Payments	Sublease Income
2005	357	(329)
2006	72	(100)
Total minimum lease payments	$ 429	$ (429)

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14. STOCK-BASED COMPENSATION PLANS

The Company has established several stock-based compensation plans for the benefit of its officers and employees. As discussed in the Summary of Significant Accounting Policies, the Company applies the fair-value-based methodology of SFAS No. 123 and, accordingly, has recorded stock compensation expense of $0.2 million, $1.1 million and $1.3 million for 2004, 2003 and 2002, respectively. The information below details each of the Company’s stock compensation plans, including any changes during the years presented.

1999 Stock Option Plan for Directors — In August 1999, the Board of Directors adopted the 1999 Stock Option Plan for Directors providing options to purchase shares of Common Stock to certain non-employee directors (the “Directors’ Option Plan”). The Company’s shareholders ratified the Directors’ Option Plan at the 2000 Annual Meeting of Shareholders. Under the Directors’ Option Plan, the Company may grant stock options to purchase up to 70,000 shares of Common Stock to eligible directors at an exercise price equal to the fair market value as of the grant date. An eligible director received an initial stock option grant to purchase 5,000 shares of Common Stock as of the effective date of his/her initial appointment or election to the Board of Directors. Furthermore, on each Award Date, defined as August 4, 2000 or August 3, 2001, eligible directors were granted options to purchase an additional 1,000 shares of Common Stock. Stock options granted have terms not to exceed ten years and shall be exercisable in accordance with the terms and conditions specified in each option agreement. In addition, options became exercisable over three years from the grant date. Option holders may pay for shares purchased on exercise in cash or Common Stock.

The following table summarizes information concerning the options outstanding, granted and the weighted average exercise prices of options granted under the Directors’ Option Plan:

1999 Stock Option Plan for Directors

	2004		2003		2002
	Shares	Weighted Average Exercise Price	Shares	Weighted Average Exercise Price	Shares	Weighted Average Exercise Price
Options outstanding, beginning of period	42,000	$ 16.15	42,000	$ 16.15	37,000	$ 17.82
Granted	—	—	—	—	5,000	3.80
Exercised	—	—	—	—	—	—
Forfeited	(35,000)	$ 15.68	—	—	—	—
Options outstanding, end of period	7,000	$ 18.50	42,000	$ 16.15	42,000	$ 16.15
Options exercisable, end of period	7,000	$ 18.50	36,667	$ 17.98	31,667	$ 20.15
Weighted average fair value of options granted	$ —		$ —		$ 2.90

The fair value of each option granted is estimated on the grant date using the Black-Scholes option-pricing model. The weighted average assumptions for grants in 2002 under the Directors’ Option Plan were as follows: risk-free interest rate of 4.70%, expected volatility of 89.28%, expected life of six years, and no expected dividends.

The following table summarizes information about stock options outstanding at December 25, 2004 under the 1999 Stock Option Plan for Directors:

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1999 Stock Option Plan for Directors

	Options Outstanding			Options Exercisable
Exercise Prices	Number Outstanding	Weighted Average Remaining Contractual Life	Weighted Average Exercise Price	Number Exercisable	Weighted Average Exercise Price
$ 2.00	1,000	0.25	$ 2.00	1,000	$ 2.00
$ 10.00	1,000	0.25	$ 10.00	1,000	$ 10.00
$ 23.50	5,000	0.25	$ 23.50	5,000	$ 23.50
	7,000	0.25	$ 18.50	7,000	$ 18.50

2002 Stock Option Plan for Directors — In 2002, the Board of Directors adopted the 2002 Stock Option Plan for Directors providing options to purchase shares of Common Stock of the Company to certain non-employee directors (the “2002 Directors’ Option Plan”). Under the 2002 Directors’ Option Plan, the Company may issue options to eligible directors to purchase up to 90,000 shares of Common Stock at an exercise price equal to the fair market value as of the grant date. An eligible director received an initial option grant to purchase 5,000 shares of Common Stock as of the effective date of his/her initial appointment or election to the Board of Directors. On each Award Date, defined as August 2, 2002, August 1, 2003, or August 3, 2004, eligible directors were granted options to purchase additional shares of Common Stock. On August 2, 2002, each eligible director was granted options to purchase an additional 2,500 shares of Common Stock. For the August 1, 2003 and August 3, 2004 Award Dates, each eligible director was granted options to purchase an additional 3,500 shares of Common Stock. Stock options granted have terms of ten years and shall vest and become exercisable over three years from the grant date; however, due to the Recapitalization on November 30, 2003, certain options vested and became exercisable immediately. Option holders may pay for shares purchased on exercise in cash or Common Stock.

The following table summarizes information concerning the options outstanding, granted, forfeited and the weighted average exercise prices of options granted under the 2002 Directors’ Option Plan:

2002 Stock Option Plan for Directors

	2004		2003		2002
	Shares	Weighted Average Exercise Price	Shares	Weighted Average Exercise Price	Shares	Weighted Average Exercise Price
Options outstanding, beginning of period	71,000	$2.40	10,000	$ 2.30	—	$ —
Granted	26,000	1.60	61,000	2.41	10,000	2.30
Exercised	—	—	—	—	—	—
Forfeited	(31,500)	2.49	—	—	—	—
Options outstanding, end of period	65,500	$2.04	71,000	$ 2.40	10,000	$2.30
Options exercisable, end of period	36,167	$2.35	47,167	$ 2.39	—	$ —
Weighted average fair value of options granted	$ 1.11		$ 1.83		$ 1.56

The fair value of each option granted is estimated on the grant date using the Black-Scholes option-pricing model. The weighted average assumptions for grants in 2004, 2003 and 2002 under the 2002 Directors’ Option Plan were as follows: risk-free interest rate of 3.30%, 3.64% and 3.76%, respectively, expected volatility of 99.68%, 90.74% and 89.36%, respectively, expected life of four, six, and six years, respectively, and no expected dividends.

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The following table summarizes information about stock options outstanding at December 25, 2004 under the 2002 Directors’ Option Plan:

2002 Stock Option Plan for Directors

	Options Outstanding			Options Exercisable
Exercise Price	Number Outstanding	Weighted Average Remaining Contractual Life	Weighted Average Exercise Price	Number Exercisable	Weighted Average Exercise Price
$1.43	21,000	9.6	$1.43	--	$1.43
$1.95	5,000	8.0	$1.95	5,000	$1.95
$2.20	15,000	8.9	$2.20	11,667	$2.20
$2.30	7,500	6.3	$2.30	2,500	$2.30
$2.51	7,000	8.6	$2.51	7,000	$2.51
$2.54	5,000	8.6	$2.54	5,000	$2.54
$2.69	5,000	8.8	$2.69	5,000	$2.69
	65,500	8.7	$2.04	36,167	$2.35

2004 Stock Option Plan for Directors – During 2004, the Board of Directors adopted the 2004 Stock Option Plan for Directors providing stock options to purchase shares of Common Stock of the Company to certain non-employee directors (the “2004 Directors’ Option Plan”). The Company’s shareholders ratified the 2004 Directors’ Option Plan at the 2004 Annual Meeting of Shareholders. The Company may grant options to purchase up to 100,000 shares of Common Stock to eligible directors at an exercise price equal to the fair market value as of the grant date. An eligible director will receive an initial option grant to purchase 5,000 shares of Common Stock as of the effective date of his/her appointment or election to the Board of Directors. On each Award Date, defined as August 3, 2004, August 3, 2005 and August 3, 2006, eligible directors are to be granted options to purchase additional shares of Common Stock (to the extent the 2002 Stock Option Plan for Directors did not have enough remaining shares). Stock options granted have terms of 10 years and vest over three years from the grant date; however, if there is a Change in Control (as defined in the Hanover Direct, Inc. Directors Change of Control Plan), the participant has the cumulative right to purchase up to 100% of the option shares. Option holders may pay for shares purchased on exercise in cash or Common Stock. As of December 25, 2004 no options have been granted under the 2004 Directors’ Option Plan. In addition, options that were to be granted on the August 3, 2005 Award Date have been deferred until the Company issues its December 25, 2004 audited financial statements.

1993 Executive Equity Incentive Plan — In December 1992, the Board of Directors adopted the 1993 Executive Equity Incentive Plan (the “Incentive Plan”) under which executives were given options to purchase shares of Common Stock with up to 80% of the purchase price financed with a six-year full recourse loan from the Company. As of December 25, 2004 and December 27, 2003, no stock options remained outstanding or exercisable related to the Incentive Plan.

Changes to the notes receivable balances related to the Incentive Plan are as follows:

1993 Executive Equity Incentive Plan

	2004	2003	2002
Notes Receivable, beginning of period	$ 269,400	$ 269,400	$ 313,400
Payments	—	—	—
Forfeitures	(269,400)	—	(44,000)
Notes Receivable, end of period	$ --	$ 269,400	$ 269,400

The Common Stock issued under the Incentive Plan was held in escrow as collateral security for the loans extended to each remaining plan participant. During 2004, the Company transferred and retired the Common Stock held in escrow to satisfy the outstanding notes receivable and the participants forfeited their initial 20% cash down payment.

Management Stock Option Plans — The Company approved for issuance to employees 2,000,000 shares of the Company’s Common Stock pursuant to the Company’s 2000 Management Stock Option Plan and 700,000 shares of the Company’s Common Stock pursuant the Company’s 1996 Stock Option Plan. Under both plans, the option

DRAFT

exercise price is equal to the fair market value as of the grant date. However, for stock options granted to an employee owning more than 10.0% of the total combined voting power of all classes of Company stock, the exercise price is equal to 110.0% of the fair market value of the Company’s Common Stock as of the grant date. Stock options granted to an individual employee under the 2000 Management Stock Option Plan may not exceed 100,000 shares of the Company’s Common Stock. Stock options granted to an individual employee under the 1996 Stock Option Plan may not exceed 50,000 shares of the Company’s Common Stock and may be performance-based. All options granted must be specifically identified as incentive stock options or non-qualified stock options, as defined in the Internal Revenue Code. Furthermore, the aggregate fair market value of Common Stock for which an employee is granted incentive stock options that first became exercisable during any given calendar year shall be limited to $100,000. To the extent this limitation is exceeded, the option shall be treated as a non-qualified stock option. Stock options may be granted for terms not to exceed ten years and shall be exercisable in accordance with the terms and conditions specified in each option agreement. In the case of an employee who owns common stock possessing more than 10.0% of the total combined voting power of all classes of common stock, the options must become exercisable within five years. Due to the change in control that occurred on November 30, 2003, certain options became fully vested. Option holders may pay for shares purchased on exercise in cash or Common Stock.

The following table summarizes information concerning the options outstanding, granted and the weighted average exercise prices of options granted under the 1996 and 2000 Management Stock Option Plans:

1996 and 2000 Management Stock Option Plans

	2004		2003		2002
	Shares	Weighted Average Exercise Price	Shares	Weighted Average Exercise Price	Shares	Weighted Average Exercise Price
Options outstanding, beginning of period	822,145	$ 8.08	923,027	$ 8.13	396,278	$ 24.59
Granted	127,000	1.84	6,500	2.32	676,100	2.43
Exercised	—	—	—	—	—	—
Forfeited	(172,762)	6.39	(107,382)	8.13	(149,351)	25.98
Options outstanding, end of period	776,383	$ 7.44	822,145	$ 8.08	923,027	$ 8.13
Options exercisable, end of period	671,216	$ 8.32	802,920	$ 8.21	191,327	$ 21.81
Weighted average fair value of options granted	$ 1.34		$ 1.62		$ 1.84

The fair value of each option granted is estimated on the grant date using the Black-Scholes option-pricing model. The weighted average assumptions for grants in 2004, 2003 and 2002 are as follows: risk-free interest rate of 3.44%, 3.58% and 3.81%, respectively, expected volatility of 103.78%, 90.96% and 89.58%, respectively, expected lives of four, six and six years, respectively, for 2004, 2003 and 2002, and no expected dividends.

The following table summarizes information about stock options outstanding at December 25, 2004 under both the 1996 and 2000 Management Stock Option Plans:

1996 and 2000 Management Stock Option Plans

	Options Outstanding			Options Exercisable
		Weighted
		Average	Weighted		Weighted
		Remaining	Average		Average
	Number	Contractual	Exercise	Number	Exercise
Range of Exercise Prices	Outstanding	Life	Price	Exercisable	Price
$ 1.44 to $2.10	127,000	9.4	$1.84	33,333	$1.95
$ 2.40 to $2.70	500,000	7.6	$2.44	488,500	$2.44
$ 10.10 to $14.38	12,000	2.5	$13.67	12,000	$13.67
$ 17.30 to $23.80	17,500	2.1	$22.87	17,500	$22.87
$ 26.61 to $31.88	119,883	3.9	$31.38	119,883	$31.38
	776,383	7.1	$7.44	671,216	$8.32

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Wayne P. Garten Stock Option Agreement – During 2004, the Company granted Mr. Garten an option (the “Garten Option”) to purchase up to 100,000 shares of the Company’s Common Stock for an exercise price of $1.95 per share. The Garten Option was not issued pursuant to any of the Company’s plans and Mr. Garten has registration rights for these options. The options vest over a two year period: one-third upon execution of the Garten Employment Agreement, one-third on May 5, 2005 and the final one-third on May 5, 2006; provided that all of the options vest and become fully exercisable upon the earliest to occur of (i) Mr. Garten’s resignation “For Good Reason” (ii) a “Change of Control” or (iii) the Company’s termination of Mr. Garten’s employment other than “For Cause” (as defined in the Garten Employment Agreement). The options expire on May 4, 2014.

The fair value of the options was estimated to be $1.45 per share at the grant date based on the following assumptions: risk-free interest rate of 3.45%, expected life of four years, expected volatility of 103.71%, and no expected dividends.

Meridian Options — In December 2000, the Company granted options (the “2000 Meridian Options”) for the purchase of an aggregate of 400,000 shares of Common Stock with an exercise price of $2.50 per share to Meridian, an affiliate of Mr. Shull. These options were allocated as follows: Thomas C. Shull, 270,000 shares; Paul Jen, 50,000 shares; John F. Shull, 50,000 shares; Evan M. Dudik, 20,000 shares; and Peter Schweinfurth, 10,000 shares. All of the remaining 2000 Meridian Options are vested but expired unexercised on June 30, 2005.

The fair value of the 2000 Meridian Options was estimated to be $0.70 per share at the grant date based on the following assumptions: risk-free interest rate of 6.0%, expected life of 1.5 years, expected volatility of 54.0%, and no expected dividends.

During December 2001, the Company granted to Meridian, and the Company’s Board of Directors approved, options to Meridian (the “2001 Meridian Options”) for the purchase of an additional 100,000 shares of Common Stock with an exercise price of $3.00. These options were allocated as follows: Thomas C. Shull, 50,000 shares; Edward M. Lambert, 30,000 shares; Paul Jen, 10,000 shares; and John F. Shull, 10,000 shares. The 2001 Meridian Options vested and became exercisable on March 31, 2003, and are due to expire on March 31, 2006.

The fair value of the 2001 Meridian Options was estimated to be $1.60 per share at the grant date based on the following assumptions: risk-free interest rate of 2.82%, expected life of 1.25 years, expected volatility of 129.73%, and no expected dividends.

The following table summarizes information concerning the options outstanding, granted and the weighted average exercise prices of options granted for the 2000 Meridian Options and the 2001 Meridian Options:

Meridian Option Plans

	2004		2003		2002
		Weighted		Weighted		Weighted
		Average		Average		Average
		Exercise		Exercise		Exercise
	Shares	Price	Shares	Price	Shares	Price
Options outstanding, beginning of period	490,000	$2.60	490,000	$2.60	500,000	$2.60
Granted	—	—	—	—	—	—
Exercised	—	—	—	—	(10,000)	2.50
Forfeited	(120,000)	2.50	—	—	—	—
Options outstanding, end of period	370,000	$2.64	490,000	$2.60	490,000	$2.60
Options exercisable, end of period	370,000	$2.64	490,000	$2.60	390,000	$2.50

The following table summarizes information about stock options outstanding and exercisable at December 25, 2004 for the 2000 Meridian Options and the 2001 Meridian Options:

Meridian Option Plans

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	Options Outstanding			Options Exercisable
Exercise Prices	Number Outstanding	Weighted Average Remaining Contractual Life	Weighted Average Exercise Price	Number Exercisable	Weighted Average Exercise Price
$2.50	270,000	1.3	$ 2.50	270,000	$ 2.50
$3.00	100,000	1.3	$ 3.00	100,000	$ 3.00
	370,000	1.3	$ 2.64	370,000	$ 2.64

15. CONTINGENICES

SEC Informal Inquiry:

Class Action Lawsuits:

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Claims for Post-Employment Benefits

16. DELISTING OF COMMON STOCK

The Company’s Common Stock was delisted from the American Stock Exchange (the “AMEX”) on February 16, 2005 as a result of the Company’s inability to comply with the AMEX’s continued listing standards and because

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the Company did not file on a timely basis its Form 10-Q for the fiscal quarter ended September 25, 2004 as a result of the Restatement.

Initially the Company received a May 21, 2004 letter from the AMEX advising that a review of the Company’s Form 10-K for the fiscal period ended December 27, 2003 indicated that the Company did not meet the following continued listing standards as set forth in Part 10 of the AMEX’s Company Guide: (i) Section 1003(a)(i) with shareholders’ equity of less than $2.0 million and losses from continuing operations and/or net losses in two out of its three most recent fiscal years; and (ii) Section 1003(a)(ii) with shareholders’ equity of less than $4 million and losses from continuing operations and/or net losses in three out of its four most recent fiscal years; and (iii) Section 1003(a)(iii) with shareholders’ equity of less than $6.0 million and losses from continuing operations and/or net losses in its five most recent fiscal years. To maintain its AMEX listing, the Company was required to submit a plan to the AMEX by June 22, 2004, advising the AMEX of action that would bring it into compliance with the continued listing standards of the AMEX by November 21, 2005 (18 months of receipt of the original letter from the AMEX). The Company submitted a plan to the AMEX on June 22, 2004 and on August 3, 2004 the AMEX notified the Company that it accepted the Company’s plan and granted the Company an extension until November 21, 2005 to regain compliance with the continued listing standards.

The Company received a December 9, 2004 letter from the AMEX notifying the Company that it had failed to satisfy an additional continued listing standard because the Company had yet to file its Quarterly Report on Form 10-Q for the fiscal quarter ended September 25, 2004, a condition for the Company’s continued listing on the AMEX under Sections 234 and 1101 of the Company Guide. The AMEX advised that if the Company did not file the Form 10-Q by December 31, 2004, the AMEX staff would initiate delisting proceedings as appropriate.

The Company received a January 24, 2005 letter from the AMEX notifying it that the AMEX had determined to proceed with the filing of an application with the SEC to strike the Common Stock of the Company from listing and registration on the AMEX based on the Company’s failure to regain compliance with the AMEX’s filing requirements as set forth in Section 134 and 1101 of the Company Guide by December 31, 2004 and the fact that the Company was not in compliance with Sections 1003(a)(i), 1003(a)(ii) and 1003(a)(iii) of the Company Guide. The Company had a limited right to appeal the AMEX’s determination which it did not because, in addition to its continued inability to file its Quarterly Report on Form 10-Q for the fiscal quarter ended September 25, 2004 and its inability to satisfy the requirements for minimum stockholders’ equity, the Company did not meet the alternative financial standards set forth in Section 1003 of the Company Guide.

The Company’s common stock was formally suspended from trading on the AMEX on February 2, 2005 and removed from listing and registration effective February 16, 2005. Current trading information about the Company’s common stock can be obtained from the Pink Sheets (www.pinksheets.com) under the trading symbol HNVD.PK.

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17. SELECTED QUARTERLY FINANCIAL INFORMATION (UNAUDITED)

	First Quarter		Second Quarter		Third Quarter				Fourth Quarter
	As Reported	As Restated	As Reported	As Restated
	(in thousands, except per share amounts)
2004
Net revenues	$ 95,312	$ 90,184	$ 96,545	$ 96,886		$ 94,443					$ 121,647
Income before interest and income taxes	1,445	10	1,276	933		2,476					7,323
Net income (loss) and comprehensive income (loss)	418	(796)	586	33		1,360					4,404
Net income (loss) applicable to common shareholders	$ 417	$ (796)	$ 585	$ 33		$ 1,345					$ 4,295
Net income (loss) per share – basic	$ 0.02	$ (0.04)	$ 0.03	$ 0.00		$ 0.06					$ 0.19
Net income (loss) per share – diluted	$ 0.02	$ (0.04)	$ 0.03	$ 0.00		$ 0.04					$ 0.13

	First Quarter		Second Quarter		Third Quarter					Fourth Quarter
	As Reported	As Restated	As Reported	As Restated	As Reported			As Restated		As Reported		As Restated
	(in thousands, except per share amounts)
2003
Net revenues	$ 102,474	$ 97,311	$ 105,765	$ 105,317	$ 96,633		$ 96,925			$ 110,002		$ 114,730
Income (loss) before interest and income taxes	1,655	245	1,805	1,235	(64)		(219)			4,621		2,095
Net income (loss) and comprehensive income (loss)	192	(1,209)	690	115	(16,645)		(16,810)			364		(2,156)
Preferred stock dividends and accretion	3,632	3,632	4,290	4,290	--		--			--		--
Net income (loss) applicable to common shareholders	$ (3,440)	$ (4,841)	$ (3,600)	$ (4,175)	$ (16,645)		$ (16,810)			$ 364		$ (2,156)
Net income (loss) per share – basic and diluted	$ (0.25)	$ (0.35)	$ (0.26)	$ (0.30)	$ (1.20)		$ (1.22)			$ 0.00		$ (0.13)

The quarterly amounts above include the impact of the Restatement identified in Note 2.

18. SUBSEQUENT EVENTS

Gump’s Business

On March 14, 2005, the Company sold all of the stock of Gump’s to Gump’s Holdings, LLC, an unrelated third party (“Purchaser”) for $8.9 million, including a purchase price adjustment of $0.4 million, pursuant to the terms of a February 11, 2005 Stock Purchase Agreement. The Company will recognize a gain on the sale of approximately $3.6 million in the quarter ended March 26, 2005. Chelsey, as the holder of all of the Series C Preferred, consented to the application of the sales proceeds to reduce the outstanding balance of the Wachovia Facility in lieu of the current redemption of a portion of the Series C Preferred. Chelsey expressly retained its right to require redemption of approximately $6.9 million (the Gump’s sales proceeds available for redemption) of the Series C Preferred subject to Wachovia’s approval.

After the sale, the Company continues as the guarantor of one of the two leases for the San Francisco building where the store is located (the Company was released from liability on the other lease). The Purchaser is required to use its commercially reasonable efforts to secure the Company’s release from the guarantee within a year of the closing. If the Purchaser cannot secure the Company’s release within a year of the closing, an affiliate of the Purchaser will either (i) transfer a percentage interest in its business so that the Company will own, indirectly, 5% interest of the Purchaser’s common stock, or (ii) provide the Company with a $2.5 million stand-by letter of credit or other form of compensation acceptable to the Company to reimburse the Company for any liabilities the Company may incur under the guarantee until the Company is released from the guarantee or the lease is terminated. As of September 15, 2005 there are $7.6 million (net of $0.5 million of expected sublease income) in lease commitments for which the Company is the guarantor. Based on its evaluation, the Company has concluded it is unlikely any payments will be required under the guarantee.

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The Company entered into a Direct Marketing Services Agreement with the Purchaser to provide telemarketing and fulfillment services for the Gump’s catalog and direct marketing businesses for eighteen months. We have the option to extend the term for an additional eighteen months.

Listed below are the carrying values of the major classes of assets and liabilities of Gump’s included in the Consolidated Balance Sheets:

In thousands (000’s)	December 25, 2004	December 27, 2003
Total current assets	$ 10,842	$ 10,995
Total non-current assets	$ 3,221	$ 3,801
Total assets	$ 14,063	$ 14,796
Total current liabilities	$ 6,727	$ 7,980
Total non-current liabilities	$ 3,283	$ 3,995
Total liabilities	$ 10,010	$ 11,975

Listed below are the revenues and income before income taxes included in the Consolidated Statements of Income (Loss) (these results exclude certain corporate overhead charges allocated to Gump’s for services provide by the Company to run the business):

In thousands (000’s)

For the Year

Ended

December 25,

2004

For the Year

Ended

December 27,

2003

Net revenues

$ 42,633

$ 44,188

Income before income taxes

$ 2,967

$ 1,215

Private Label and Co-Brand Credit Card Agreement

On February 22, 2005, the Company entered into a seven year co-brand and private label credit card agreement (as amended by Amendment Number One on March 30, 2005, the “Credit Card Agreement”) with WFNNB under which WFNNB will provide private label (branded) and co-brand credit cards to the Company’s customers. The Company began offering the private label credit card to its customers in April 2005. The program extends credit to our customers at no credit risk to the Company and is expected to lead to increased sales and lower expenses. WFNNB will provide a fixed dollar amount as marketing funds in the first year of which 25% of any unused amount can be utilized in the first six months of the second year and a percentage of the lesser of private label net sales or average accounts receivable balance in later years to support the Company’s promotion of the program. In general, WFNNB will pay the Company proceeds from sales of Company merchandise using the cards issued under the program with no discount. In addition, WFNNB paid the Company an up-front fee when the private label plan commenced and will pay a per card fee for each card issued under the co-brand program and a percentage of the net finance charges on co-brand accounts.

If the Credit Card Agreement is terminated or expires other than as a result of a default by WFNNB, the Company will be obligated to purchase any outstanding private label accounts at their fair market value. The Company will have the option of purchasing any outstanding co-brand accounts at their fair market value when the Credit Card Agreement terminates unless the termination is attributable to the Company’s default. Under the 34^th Amendment to the Loan & Security Agreement executed by the Company and Wachovia on July 29, 2005, the Company is prohibited from using the Wachovia Facility to fund the purchase of the private label and co-brand accounts. As a consequence, should the Company become obligated to purchase the accounts and should it not have secured a replacement credit card program with a new credit card issuer, the Company will be forced to seek financing from a different source which financing will be subject to Wachovia’s and Chelsey’s approval.

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Audit Committee Investigation; SEC Inquiry

The Audit Committee of the Board of Directors began an investigation of matters relating to restatements of the Company’s financial statements and other accounting-related matters with the assistance of independent outside counsel Wilmer Cutler Pickering Hale and Dorr LLP (“Wilmer Cutler”).

The Audit Committee concluded its investigation and, with the assistance of Wilmer Cutler, reported its findings to the Board of Directors. The Audit Committee, again with the assistance of Wilmer Cutler, formulated a series of recommendations to the Company and the Board of Directors concerning potential improvements in the Company’s internal controls and procedures for financial reporting. The Board of Directors and management have begun implementing these recommendations.

The Company was notified by the SEC that it was conducting an informal inquiry relating to the Company’s financial results and financial reporting since 1998. The SEC indicated in its letter to the Company that the inquiry should not be construed as an indication by the SEC that there has been any violation of the federal securities laws. The Company is cooperating fully with the SEC in connection with the inquiry and has directed Wilmer Cutler to brief the SEC and the Company’s former independent registered public accounting firm, KPMG LLP (“KPMG”) on the results of its investigation. Wilmer Cutler has briefed both the SEC and KPMG on the results of the investigation. The Company intends to continue to cooperate with the SEC in connection with its informal inquiry concerning the Company’s financial reporting.

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SCHEDULE II

HANOVER DIRECT, INC.

VALUATION AND QUALIFYING ACCOUNTS

Years Ended December 25, 2004, December 27, 2003

and December 28, 2002

(In thousands of dollars)

Column A	Column B	Column C		Column D	Column E
		Additions
Description	Restated Balance at Beginning of Period	Charged to Costs and Expenses	Charged to Other Accounts (Describe)	Deductions (Describe)	Balance at End of Period
2004:
Allowance for Doubtful Accounts Receivable	$ 1,105	$ 609	-	$ 347(4)	$ 1,367
Reserve for Closed Restaurant Operations	69	42	-	90(5)	21
Special Charges Reserve	5,794	1,536	-	2,452(5)	4,878
Reserves for Sales Returns	1,981	3,549	-	3,545(6)	1,985
Deferred Tax Asset Valuation Allowance	33,414	-	2,139(1)	1,922(7)	33,631
2003 (As Restated):
Allowance for Doubtful Accounts Receivable	1,560	378	-	833(4)	1,105
Reserve for Closed Restaurant Operations	322	40	-	293(5)	69
Special Charges Reserve	8,032	1,304	-	3,542(6)	5,794
Reserves for Sales Returns	1,710	2,551	-	2,280(6)	1,981
Deferred Tax Asset Valuation Allowance	142,054	-	11,300(2)	119,940(8)	33,414
2002 (As Restated):
Allowance for Doubtful Accounts Receivable	2,117	304	-	861(4)	1,560
Reserve for Closed Restaurant Operations	737	40	-	455(5)	322
Special Charges Reserve	11,056	4,769	-	7,793(6)	8,032
Reserves for Sales Returns	2,547	345	-	1,182(6)	1,710
Deferred Tax Asset Valuation Allowance	137,252	-	4,802(3)	-	142,054

(1)	$2,138 increase in the valuation allowance used to offset net increases in temporary differences.
(2)	$11,300 increase in the valuation allowance charged to deferred income tax provision.
(3)	$3,700 charged to deferred income tax provision, $1,102 increase in the valuation allowance used to offset net increase in temporary differences.
(4)	Written-off.
(5)	Utilization and reversal of reserves.
(6)	Utilization of reserves.
(7)	Represents the utilization and expiration of NOLs.
(8)	$117,671 represents the expiration of NOL and tax credit carryovers and $2,269 is attributable to the net reversal of temporary differences.

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

There were no disagreements with accountants on accounting and financial disclosure.

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Item 9A. Controls and Procedures

Disclosure Controls and Procedures

Company management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, has completed an evaluation of the effectiveness of the Company’s disclosure controls and procedures pursuant to Rule 13a-15 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). This evaluation has allowed management to make conclusions, as set forth below, regarding the state of the Company’s disclosure controls and procedures as of December 25, 2004. While management has made significant improvements in its disclosure controls and procedures and has completed various action plans to remedy identified weaknesses in these controls (as more fully discussed below), based on management’s evaluation, management has concluded that the Company’s disclosure controls and procedures were not effective in alerting management on a timely basis to material information relating to the Company required to be included in the Company’s periodic filings under the Exchange Act. In coming to this conclusion, management considered, among other things, the control deficiency related to periodic review of the application of generally accepted accounting principles, which resulted in the Restatement as disclosed in Note 2 to the accompanying consolidated financial statements included in this Form 10-K.

As background, the following occurred during 2004 and during the first nine months of 2005:

•	During the second quarter of 2004, the Company identified a revenue recognition cut-off issue that resulted in revenue being recorded in advance of the actual shipment of merchandise to the customer. The practice was stopped immediately. Subsequently, the Company determined that revenue should be recognized when merchandise is received by the customer rather than when shipped because the Company routinely replaces customer merchandise damaged or lost in transit as a customer service matter (even though risk of loss, as a legal matter, passes on shipment). As a consequence, the Company has restated all affected periods presented to recognize revenue when merchandise is received by the customer.
•	In the first quarter of 2004, former management identified a potential issue with the accounting treatment of discount obligations due to members of certain of the Company’s buyers’ club programs, and at that time, an inappropriate conclusion regarding the accounting treatment was reached. During the third quarter of 2004, the issue was re-evaluated and it was determined that an error in the accounting treatment had occurred. The cumulative impact of the error for which the Company restated resulted in the overstatement of revenues and the omission of the related liability to the guarantee of these discount obligations that aggregated $2.4 million as of June 26, 2004 (the end of the second quarter of 2004). The Company immediately implemented accounting policies to appropriately account for all obligations due to members of the buyers’ club programs.
•	On November 9, 2004, the Company’s Audit Committee discussed the two matters noted above with the Company’s former independent registered public accounting firm, KPMG LLP (“KPMG”) and then on November 17, 2004, the Audit Committee launched an investigation relating to the restatement of the Company’s consolidated financial statements and other accounting-related matters and engaged Wilmer Cutler as its independent outside counsel to assist with the investigation.
•	The Company was notified on January 11, 2005 by the SEC that the SEC was conducting an informal inquiry relating to the Company’s financial results and financial statements since 1998. The Audit Committee, the Board of Directors and the Company’s management have been cooperating fully with the SEC in connection with the inquiry.
•	On February 3, 2005, the Company reported that its Common Stock was being delisted by the AMEX as a consequence, among other reasons, of the Company’s inability to meet the AMEX’s continued listing requirements and its inability to timely file its Form 10-Q for the fiscal quarter ended September 25, 2004.
•	On March 14, 2005, the Audit Committee reported that it had concluded its investigation and, with the assistance of Wilmer Cutler, reported its findings to the Board of Directors. The Audit Committee, with Wilmer Cutler’s assistance, formulated recommendations to the Company and the Board of Directors concerning ways of improving the Company’s internal controls and procedures for financial reporting which the Board of Directors and the Company began to implement.

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•	The Audit Committee instructed Wilmer Cutler to cooperate fully with the SEC in connection with its inquiry and share the results of its investigation with both the SEC and KPMG. Wilmer Cutler has presented the results of its investigation to both the SEC and KPMG.
•	During the course of preparing its 2004 consolidated financial statements, the Company evaluated a previously reversed litigation reserve relating to post employment benefits allegedly owed to its former CEO. In the course of evaluating the accounting treatment of the restoration of the reserve, the Company identified that the original reserve had been improperly established as a litigation reserve rather than an accrual for post employment benefits and that legal expenses had been improperly charged against the reserve rather than treated as period expenses. Management corrected these errors and restated all affected periods presented in accordance with the corrected treatment of the reserve.
•	During the course of preparing its 2004 consolidated financial statements, the Company determined that an accrual related to certain customer prepayments and credits had been inappropriately released and that other liabilities relating primarily to certain miscellaneous catalog costs and other miscellaneous costs had not been appropriately accrued in the appropriate periods. The Company re-established the improperly released accrual and accrued certain miscellaneous catalog costs in the appropriate periods and restated all affected periods presented in accordance with the corrected treatment of these items.

Internal Control Over Financing Reporting

In connection with its audit of the Company’s financial statements for the year ended December 25, 2004, KPMG, the Company’s former auditors, identified material weaknesses in internal control over financial reporting and other matters relating to the Company’s internal controls based upon its audit of the 2004 consolidated financial statements which it did not complete. Our management considered the material weaknesses identified by KPMG in evaluating the adequacy of the Company’s internal controls.

A control deficiency exists when the design or operation of a control does not allow management or employees, in the normal course of performing their assigned functions, to detect or prevent misstatements on a timely basis. A deficiency in design exists when (a) a control necessary to meet the control objective is missing, or (b) an existing control is not properly designed so that even if the control operates as designed, the control objective is not always met. A deficiency in operation exists when a properly designed control does not operate as designed, or when the person performing the control does not posses the necessary authority or qualification to perform the control effectively. A material weakness is a significant deficiency, or combination of significant deficiencies, that result in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. In connection with KPMG’s audit of the Company’s consolidated financial statements which it did not complete, KPMG identified the following material weaknesses:

•	The Company lacks a sufficient number of financial and tax personnel with the appropriate level of expertise to independently monitor, interpret and implement the application of financial accounting standards in accordance with generally accepted accounting principles,
•	The environment of the Company was such that members of management were not encouraged to discuss transactions and events that could impact the appropriate financial reporting of the Company, and
•	The Company does not have adequate policies and procedures relating to the origination and maintenance of contemporaneous documentation to support key accounting judgments or to effectively document the terms of all significant contracts and agreements and the related accounting treatment for these contracts and agreements.

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corporate culture that focuses on ethics, unfettered communication within the organization and compliance, and sets a new standard for corporate behavior within the Company. Toward this end during 2004, the Company has:

•	Appointed a new Chief Executive Officer;
•	Replaced its Corporate Controller and Director of Internal Audit;
•	Instituted a policy of open channels of communication including regularly scheduled meetings of and with senior management;
•	Instituted weekly meetings between the CEO and Director of Internal Audit to review the status of internal audits and assess internal controls; and
•	Instituted periodic trips by senior management to the Company’s remote facilities to foster communication and ensure compliance with the Company’s reporting, internal control and ethics policies.

The Company continued to implement changes to its internal controls during 2005 and has:

•	Replaced its Chief Financial Officer, and filled other open finance positions which resulted from earlier terminations and other departures;
•	Hired a General Counsel and replaced its outside counsel;
•	Instituted weekly reviews of financial results with the Chief Financial Officer and senior management to enhance transparency and accountability;
•	Instituted a policy that requires review and approval of all material agreements and marketing plans by the legal and financial departments;
•	Instituted a policy that requires all systems changes that could impact financial reporting be subject to approval by the financial department;
•	Revised the Company’s reporting structure to have the catalog finance directors report to the CFO;
•	Documented the Company’s significant accounting policies and implemented a procedure to periodically review and update these policies; and
•	Implemented a policy that requires the preparation of contemporaneous memoranda and related documentation to support key accounting judgments and to maintain and document the significant terms of material contracts and the accounting treatment thereof.

Since the employment of new management personnel beginning in 2004, the Company has committed considerable resources to implementing the remedial steps outlined above and realigning the Company’s corporate culture. However, the effectiveness of any system of controls and procedures, including our own, is subject to certain limitations, including the exercise of judgment in designing, implementing and evaluating the controls and procedures and the inability to eliminate misconduct completely.

Item 9B. Other Information.

None.

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PART III

Item 10. Directors and Executive Officers of the Registrant

(a)

Identification of Directors

As provided in the Company’s Certificate of Incorporation and Bylaws, Directors hold office until the next annual meeting or until their successors have been elected or until their earlier death, resignation, retirement, disqualification or removal.

Pursuant to the Corporate Governance Agreement, dated as of November 30, 2003, by and among the Company, Chelsey, Stuart Feldman and the Regan Entities, for two years from the closing of the Recapitalization, five of the nine directors of the Company were to have been designated by Chelsey and one by the Regan Entities. The Corporate Governance Agreement was terminated when Basil Regan resigned from the Board of Directors on July 31, 2004.

The following sets forth certain information regarding the current directors of the Company as of the date hereof:

Name	Age	Title and Other Information	Director Since
Robert H. Masson	70	Robert H. Masson served as Senior Vice President, Finance and Administration and Vice President and Chief Financial Officer of Parsons & Whittemore, Inc., a global pulp and paper manufacturer, from May 1990 until his retirement June 30, 2002. Prior thereto, Mr. Masson held various executive, financial and treasury roles with The Ford Motor Company, Knutson Construction Company, Ellerbe, PepsiCo, Inc. and Combustion Engineering (now part of the ABB Group). Mr. Masson currently serves as a Trustee and as the Chairman of the Finance Committee of The Naval Aviation Museum Foundation, Inc. in Pensacola, Florida. Mr. Masson was elected a director of the Company effective January 1, 2003. Mr. Masson is the Chairman of the Audit Committee and a member of the Corporate Governance and Nominating Committees.	2003
A. David Brown	63	Mr. Brown is the co-founder of Bridge Partners LLC, a consumer financial services and diversity headhunting firm. Prior to co-founding Bridge Partners, Mr. Brown served as a Managing Director of Whitehead Mann after having served as Vice President of the Worldwide Retail/Fashion Specialty Practice at Korn/Ferry International. Previously, Mr. Brown served for 12 years as Senior Vice President for Human Resources at R.H. Macy & Co. He was responsible for human resources and labor relations for 50,000 employees in five U.S. divisions and 17 foreign buying offices around the world. He serves on the Boards of Zale Corporation and Selective Insurance Group, Inc. He is a member of the Board of Trustees of Morristown Memorial Hospital, Drew University and the Jackie Robinson Foundation. Mr. Brown was elected a director of the Company effective July 29, 2003 and is the Chairman of the Corporate Governance and Transaction Committees and a member of the Audit Committee.	2003
Wayne P. Garten	53	Mr. Garten was elected a director of the Company by Chelsey effective September 29, 2003 and appointed President and Chief Executive Officer of the Company on May 5, 2004. Mr. Garten is a member of the Executive and Nominating Committees. Prior to his appointment, Mr. Garten served as the President of Caswell-Massey Ltd., Inc., a retailer and direct marketer of fragrance and other personal care products, from January 2004. Prior thereto, Mr. Garten was a financial consultant specializing in the direct marketing industry. He was Chief Executive Officer and President of Popular Club, Inc., a direct selling, catalog marketer of apparel and general merchandise products, from 2001 to 2003. From 1997 to 2000, he was Executive Vice President and Chief Financial Officer of Micro Warehouse, Inc., an international catalog reseller of computer products. From 1983 to 1996, Mr. Garten held various financial positions at Hanover Direct and its predecessor, The Horn & Hardart Company, including Executive Vice President and Chief Financial Officer from 1989 to 1996. Mr. Garten is a Certified Public Accountant.	2003

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William B. Wachtel	51	Mr. Wachtel has been a managing partner of Wachtel & Masyr, LLP, or its predecessor law firm (Gold & Wachtel, LLP), since its founding in August 1984. He is the co-founder of the Drum Major Institute, a not-for-profit organization carrying forth the legacy of Dr. Martin Luther King, Jr. Mr. Wachtel is the Manager of Chelsey. Mr. Wachtel was elected a director of the Company effective November 18, 2003, the date of the Recapitalization Agreement. Mr. Wachtel was appointed the Chairman of the Board of Directors on May 5, 2004 and is Chairman of the Nominating Committee and is a member of the Executive and Corporate Governance Committees. Mr. Wachtel is the Manager of Chelsey and Chelsey Finance and the trustee of Chelsey Capital Profit Sharing Plan which is the sole member of Chelsey and Chelsey Finance.	2003
Stuart Feldman	45	Mr. Feldman has been a principal of Chelsey Capital, LLC, a private hedge fund, for more than the past five years. Mr. Feldman is the principal beneficiary of Chelsey Capital Profit Sharing Plan, which is the sole member of Chelsey. Mr. Feldman was elected a director of the Company effective November 18, 2003, the date of the Recapitalization Agreement and is Chairman of the Executive Committee and a member of the Compensation Committee. Mr. Feldman is the principal beneficiary of the Chelsey Capital Profit Sharing Plan, which is the sole member of Chelsey and Chelsey Finance and the sole officer and director of DSJ International Resources Ltd., the sole sponsor of the Chelsey Capital Profit Sharing Plan. Mr. Feldman was elected a director of the Company effective November 18, 2003, the date of the Recapitalization and is Chairman of the Executive Committee and a member of the Compensation Committee.	2003
Donald Hecht	72	Mr. Hecht has, since 1966, together with his brother Michael Hecht, managed Hecht & Company, an accounting firm. Mr. Hecht was elected a director of the Company effective November 18, 2003, the date of the closing of the Recapitalization and is a member of the Audit and Compensation Committees.	2003
Paul S. Goodman	51	Mr. Goodman is the Chief Executive Officer of Billybey Ferry Company, LLC, a ferry company that provides commuter ferry service between Manhattan and New Jersey and also provides ferry cruise services. Since 2003, Mr. Goodman has been CEO of Chelsey Broadcasting Company, LLC, which owns middle market network-affiliated television stations. Until October 2002, Mr. Goodman had served as a director of Benedek Broadcasting Corporation from November 1994 and as a director of Benedek Communications Corporation from its inception. From 1983 until October 2002, Mr. Goodman was also corporate counsel to Benedek Broadcasting and Benedek Communications since its formation in 1996 until October 2002. From April 1993 to December 2002, Mr. Goodman was a member of the law firm of Shack Siegel Katz Flaherty & Goodman, P.C. From January 1990 to April 1993, Mr. Goodman was a member of the law firm of Whitman & Ransom. Mr. Goodman became a director of the Company effective April 12, 2004. Mr. Goodman is a member of the Corporate Governance Committee.	2004

(b)

Identification of Executive Officers

Pursuant to the Company’s Bylaws, the Company’s officers are chosen annually by the Board of Directors and hold office until their respective successors are chosen and qualified.

On May 5, 2004, Thomas C. Shull was replaced as the Company’s Chief Executive Officer by Wayne P. Garten. On November 3, 2003, Charles E. Blue was appointed Chief Financial Officer of the Company effective November 11, 2003, replacing Edward M. Lambert. Mr. Blue resigned as Chief Financial Officer and Secretary on March 8, 2005 and John W. Swatek was appointed as Chief Financial Officer and Treasurer effective on April 4, 2005. During the interim period, Mr. Garten served as the Chief Financial Officer. Daniel J. Barsky was appointed as Senior Vice President and General Counsel on January 31, 2005 and Secretary on March 8, 2005.

DRAFT

Set forth below is certain information regarding the current executive officers of the Company

Name	Age	Title and Other Information	Office Held Since
Wayne P. Garten	53	Chief Executive Officer, President and Director. Information concerning Mr. Garten appears above under Directors.	2004
Michael D. Contino	44	Executive Vice President and Chief Operating Officer since April 25, 2001. Senior Vice President and Chief Information Officer from December 1996 to April 25, 2001 and President of Keystone since November 2000. Mr. Contino joined the Company in 1995 as Director of Computer Operations and Telecommunications. Prior to 1995, Mr. Contino was the Senior Manager of IS Operations at New Hampton, Inc., a subsidiary of Spiegel, Inc.	2001
John W. Swatek	40	Senior Vice President, Chief Financial Officer and Treasurer. Prior to joining the Company Mr. Swatek was Vice President and Controller of Linens ‘n Things, Inc. Before joining Linens ‘n Things, Inc. in 2001, Mr. Swatek held various positions with Micro Warehouse, Inc. including serving as its Senior Vice President, Finance from 2000 to 2001.	2005
Daniel J. Barsky	50	Senior Vice President, General Counsel and Secretary. Prior to joining the Company, Mr. Barsky was an independent legal consultant. Mr. Barsky served as acting General Counsel to Directrix, Inc. from 2001 to 2003, Executive Vice President, General Counsel and Secretary to American Interactive Media, Inc. from 1999 to 2001 and Executive Vice President, General Counsel and Secretary to Spice Entertainment Companies, Inc. from 1994 to 1999.	2005
Steven Lipner	57	Vice President, Taxation since October 2000. Mr. Lipner served as Director of Taxes from February 1984 to October 2000. Prior thereto, he served as Director of Taxes at Avnet, Inc. and held various positions in public accounting. He holds a license as a Certified Public Accountant in New York.	2000
John DiFrancesco	56	President, The Company Store Group since October, 2002. Mr. DiFrancesco joined the Company in July 1999 as President of Gump’s By Mail and President of The Company Store in September 2001. Prior to joining the Company, Mr. DiFrancesco served as Vice President of Marketing and Advertising for several companies including Bloomingdale’s By Mail and Bedford Fair Industries.	2001

(c)

Audit Committee Financial Expert

The Company’s Board of Directors has determined that the Company has at least one “audit committee financial expert” serving on the Audit Committee of the Board of Directors who is “independent” of management within the definition of such term under Rule Section 121A of the AMEX listing standards. Robert H. Masson, a member of the Board of Directors and the Chairman of its Audit Committee, is the “audit committee financial expert” serving on the Company’s Audit Committee. Mr. Masson meets the AMEX requirements that at least one member of the Audit Committee be an “audit committee financial expert.”

The current Audit Committee members are Messrs. Masson (Chairman), Brown and Hecht. Mr. Garten was an Audit Committee member until he became CEO and resigned from the Audit Committee.

DRAFT

(d)

Code of Ethics

The Company has adopted a code of ethics that applies to the Company’s principal executive officer, principal financial officer and principal accounting officer and other persons performing similar functions. A copy of the code of ethics has been filed as an Exhibit to the Company’s 2002 Annual Report on Form 10-K. The Company has also adopted a code of conduct that applies to the Company’s directors, officers and employees. A copy of the code of conduct was filed as an Exhibit to the 2003 Annual Report on Form 10-K.

(e)

Section 16(a) Beneficial Ownership Reporting Compliance

Section 16(a) of the Securities Exchange Act of 1934 requires officers, directors and beneficial owners of more than 10% of the Company’s shares to file reports with the Securities and Exchange Commission and the American Stock Exchange. Based solely on a review of the reports and representations furnished to the Company during the last fiscal year by such persons, the Company believes that each of these persons is in compliance with all applicable filing requirements.

Item 11. Executive Compensation

The following table shows salaries, bonuses, and long-term compensation paid during the last three years for the Chief Executive Officer (including Mr. Shull who resigned during 2004) and the Company’s four next most highly compensated executive officers who were serving as executive officers at the end of the Company’s 2004 fiscal year.

					Long Term Compensation
					Awards
					Securities
					Underlying
Name and		Annual Compensation		Other Annual	Options/	All Other
Principal Position	Year	Salary	Bonus	Compensation	SARs	Compensation

Wayne P. Garten(1)	2004	$ 380,769 (2)	$ 300,000 (6)	$ 14,500 (11)	200,000 (16)	$ 4,846 (18)
President and Chief	2003	—	—	$ 101,500 (11)	5,000 (16)	—
Executive Officer

Michael D. Contino(1)	2004	$ 375,837	—	—	—	$ 13,083 (19)
Executive Vice President	2003	$ 393,698	$ 263,656 (7)	—	—	$ 151,282 (20)
And Chief Operating Officer	2002	$ 382,270	$ 565,988 (7)	$ 4,000 (12)	100,000 (17)	$ 9,833 (21)

John DiFrancesco(1)	2004	$ 309,300	$ 253,500 (8)	—	—	$ 11,442 (22)
President, The Company	2003	$ 317,400	$ 55,180 (8)	—	—	$ 10,531 (23)
Store Group, LLC	2002	$ 307,846	$ 412,000 (8)	$ 4,000 (13)	40,000 (17)	$ 8,198 (24)

Steven Lipner(1)	2004	$ 175,520	$ 10,000 (9)	—	—	$ 3,927 (25)
Vice President	2003	$ 172,924	$ 7,768 (9)	—	—	$ 4,220 (26)
Taxation	2002	$ 163,900	$ 78,877 (9)	—	5,000 (17)	$ 3,849 (27)

Thomas C. Shull(1)	2004	$ 295,962 (3)	—	—	—	$ 906,776 (28)
Former President and Chief	2003	$ 915,588 (4)	$2,250,000 (4)		—	$ 12,369 (29)
Executive Officer	2002	$ 905,923 (5)	$1,327,500 (5)	$ 165,000 (14)	—	$ 2,116 (30)

Charles E. Blue(1)	2004	$ 271,029	—	—	—	$ 13,608 (31)
Former Senior Vice	2003	$ 231,096	$ 47,133 (10)		—	$ 12,218 (32)
President and Chief	2002	$ 197,000	$ 206,938 (10)	$ 4,000 (15)	25,000 (17)	$ 10,174 (33)
Financial Officer

__________

DRAFT

(1)	Thomas C. Shull was named President and Chief Executive Officer and was elected to the Company’s Board of Directors on December 5, 2000. He resigned on May 5, 2004. Wayne P. Garten was appointed to the Board of Directors on September 30, 2003 and was named President and Chief Executive Officer on May 5, 2004. Charles E. Blue was appointed Senior Vice President and Chief Financial Officer on November 11, 2003. Mr. Blue resigned on March 7, 2005. Mr. Garten served as interim Chief Financial Officer until April 4, 2005 when Mr. Swatek became Chief Financial Officer. Mr. Contino was appointed Executive Vice President and Chief Operating Officer on April 25, 2001. Mr. DiFrancesco was appointed as President of The Company Store Group in September 2001. Mr. Lipner was appointed Vice President of Taxation in 2000.
(2)	$380,769 of salary under the May 5, 2004 Employment Agreement between Mr. Garten and the Company (“Garten Employment Agreement”).
(3)	Salary until resignation on May 5, 2004.
(4)	$915,588 of salary, a $450,000 stay bonus and a $1,350,000 change of control payment was paid to Mr. Shull under an Employment Agreement between Mr. Shull and the Company, dated as of September 1, 2002 (as amended, the “Shull Employment Agreement”). An additional $450,000 transaction bonus was paid to Mr. Shull under the Shull Transaction Bonus Letter (as defined below).
(5)	$276,923 of salary and a $450,000 stay bonus was paid to Mr. Shull under the Shull Employment Agreement. Includes an $877,500 performance bonus for 2002 paid in 2003 under the Shull Employment Agreement. The remaining $629,000 of salary and bonus was paid to Meridian Ventures, LLC, a limited liability company controlled by Mr. Shull (“Meridian”) pursuant to an agreement (“Meridian Services Agreement”) that predated the Shull Employment Agreement. See “Employment Contracts, Termination of Employment and Change-in-Control Arrangements.”
(6)	Includes for 2004, a $300,000 2004 performance bonus scheduled to be paid during 2005.
(7)	Includes the following payments made to Mr. Contino: for 2003 a $193,500 transaction bonus and a $70,156 2003 performance bonus paid in 2004; for 2002, a $565,988 2002 performance bonus paid in 2003.
(8)	Includes the following payments made to Mr. DiFrancesco: for 2004 a $253,500 2004 performance bonus scheduled to be paid during 2005; for 2003 a $55,180 2003 performance bonus paid in 2004; for 2002, a $412,000 2002 performance bonus paid in 2003.
(9)	Includes the following payments made to Mr. Lipner: for 2004 a $10,000 performance bonus scheduled to be paid during 2005; for 2003 a $7,768 performance bonus paid in 2004; for 2002, a $78,877 2002 paid in 2003.
(10)	Includes the following payments made by the Company to Mr. Blue: for 2003, a $47,133 performance bonus for 2003 paid in 2004; for 2002, a $206,938 performance bonus for 2002 paid in 2003.
(11)	Mr. Garten received the following payments as a member of the Board of Directors: for 2004 $14,500 prior to his employment as President and Chief Executive Officer of the Company; for 2003 $101,500. He was granted options to purchase 5,000 shares of Common Stock in 2003.
(12)	Includes the following payments made by the Company on behalf of Mr. Contino: $4,000 in car allowance and related benefits in 2002.
(13)	Includes the following payments made by the Company on behalf of Mr. DiFrancesco: $4,000 in car allowance and related benefits in 2002.
(14)	Paid to Meridian pursuant to the Meridian Services Agreements for Meridian’s over-head (including legal and accounting), health care costs, payroll costs, and other expenses relating to Mr. Shull. See “Employment Contracts, Termination of Employment and Change in Control Arrangements.”
(15)	Includes the following payments made by the Company on behalf of Mr. Blue: $4,000 in car allowance and related benefits in 2002.
(16)	200,000 options granted per the Garten Employment Agreement, half under the 2000 Management Stock Option Plan and half outside the 2000 Management Stock Option Plan. 5,000 options granted under the 2002 Stock Option Plan for directors.
(17)	Granted by the Company pursuant to the Company’s 2000 Management Stock Option Plan. See “Report of the Stock Option and Executive Compensation Committee on Executive Compensation—2000 Management Stock Option Plan.”

DRAFT

(18)	Includes the following payments made by the Company on behalf of Mr. Garten in 2004: $170 in group term life insurance premiums; $24 in accidental death and disability insurance premiums; $119 in core life insurance premiums; $103 in dental insurance premiums; $85 in long-term disability premiums; $4,345 in health care insurance premiums.
(19)	Includes payments made by the Company on behalf of Mr. Contino in 2004: $120 in group term life insurance premiums; $40 in accidental death and disability insurance premiums; $182 in core life insurance premiums; $219 in dental insurance premiums; $146 in long-term disability premiums; $8,959 in health care insurance premiums; and $3,417 in matching contributions under the Company’s 401(k) Savings Plan.
(20)	Includes payments made on behalf of Mr. Contino in 2003; $125 in group term life insurance premiums; $40 in accidental death and disability insurance premiums; $162 in core life insurance premiums; $205 in dental insurance premiums; $159 in long-term disability premiums; $8,195 in health care insurance premiums; $3,333 in matching contributions under the Company’s 401 (k) Savings Plan. Also includes forgiveness of a $75,000 non-interest-bearing loan made by the Company to Mr. Contino in January 1998. The loan was forgiven in full in accordance with its terms during January 2003. In addition to the loan forgiveness, the Company paid all applicable withholding taxes totaling $64,063.
(21)	Includes payments made on behalf of Mr. Contino in 2002; $120 in group term life insurance premiums; $40 in accidental death and disability insurance premiums; $162 in core life insurance premiums; $143 in dental insurance premiums; $484 in long-term disability premiums; $5,589 in health care insurance premiums; $2 in vision assistance; $3,333 in matching contributions under the Company’s 401(k) Savings Plan.
(22)	Includes the following payments made by the Company on behalf of Mr. DiFrancesco in 2004: $516 in group term life insurance premiums; $40 in accidental death and disability insurance premiums; $182 in core life insurance premiums; $170 in dental insurance premiums; $146 in long-term disability premiums; $6,990 in health care insurance premiums; and $3,398 in matching contributions under the Company’s 401(k) Savings Plan.
(23)	Includes the following payments made by the Company on behalf of Mr. DiFrancesco in 2003: $287 in group term life insurance premiums; $40 in accidental death and disability insurance premiums; $162 in core life insurance premiums; $160 in dental insurance premiums; $158 in long-term disability premiums; $6,391 in health care insurance premiums; and $3,333 in matching contributions under the Company’s 401(k) Savings Plan.
(24)	Includes the following payments made by the Company on behalf of Mr. DiFrancesco in 2002: $276 in group term life insurance premiums; $40 in accidental death and disability insurance premiums; $162 in core life insurance premiums; $116 in dental insurance premiums; $407 in long-term disability premiums; $4,601 in health care insurance premiums; $2 in vision assistance, $2,633 in matching contributions under the Company’s 401(k) Savings Plan.
(25)	Includes the following payments made by the Company on behalf of Mr. Lipner in 2004: $516 in group term life insurance premiums; $40 in accidental death and disability insurance premiums; $182 in core life insurance premiums; $146 in long-term disability premiums; and $3,043 in matching contributions under the Company’s 401(k) Savings Plan.
(26)	Includes the following payments made by the Company on behalf of Mr. Lipner in 2003: $527 in group term life insurance premiums; $40 in accidental death and disability insurance premiums; $162 in core life insurance premiums; $158 in long-term disability premiums; and $3,333 in matching contributions under the Company’s 401(k) Savings Plan.
(27)	Includes the following payments made by the Company on behalf of Mr. Lipner in 2002: $276 in group term life insurance premiums; $40 in accidental death and disability insurance premiums; $162 in core life insurance premiums; $38 in dental insurance premiums; $260 in long-term disability premiums; and $3,073 in matching contributions under the Company’s 401(k) Savings Plan.
(28)	Includes the following payments made by the Company on behalf of Mr. Shull in 2004: $900,000 in severance payments; $96 in group term life insurance premiums; $14 in accidental death and disability insurance premiums; $56 in core life insurance premiums; $78 in dental insurance premiums; $55 in long-term disability premiums; $3,060 in health care insurance premiums; $3,417 in matching contributions under the Company’s 401(k) Savings Plan;

DRAFT

(29)	Includes the following payments made by the Company on behalf of Mr. Shull in 2003: $276 in group term life insurance premiums; $40 in accidental death and disability insurance premiums; $162 in core life insurance premiums; $205 in dental insurance premiums; $158 in long-term disability premiums; $8,195 in health care insurance premiums; and $3,333 in matching contributions under the Company’s 401(k) Savings Plan.
(30)	Includes the following payments made by the Company on behalf of Mr. Shull in 2002: $85 in group term life insurance premiums; $12 in accidental death and disability insurance premiums; $50 in core life insurance premiums; $44 in dental insurance premiums; $49 in long-term disability premiums; $1,876 in health care insurance premiums.
(31)	Includes the following payments made by the Company on behalf of Mr. Blue in 2004: $120 in group term life insurance premiums; $40 in accidental death and disability insurance premiums; $182 in core life insurance premiums; $219 in dental insurance premiums; $146 in long-term disability premiums; $8,959 in health care insurance premiums; and $3,402 in matching contributions under the Company’s 401(k) Savings Plan.
(32)	Includes the following payments made by the Company on behalf of Mr. Blue in 2003: $125 in group term life insurance premiums; $40 in accidental death and disability insurance premiums; $162 in core life insurance premiums; $205 in dental insurance premiums; $158 in long-term disability premiums; $8,195 in health care insurance premiums; and $3,333 in matching contributions under the Company’s 401(k) Savings Plan.
(33)	Includes the following payments made by the Company on behalf of Mr. Blue in 2002: $120 in group term life insurance premiums; $40 in accidental death and disability insurance premiums; $162 in core life insurance premiums; $143 in dental insurance premiums; $285 in long-term disability premiums; $6,195 in health care insurance premiums; and $3,265 in matching contributions under the Company’s 401(k) Savings Plan; and $2 in vision plan premiums.

Stock Options and Stock Appreciation Rights

The following table contains information concerning options granted to the Chief Executive Officer and the Company’s four next most highly compensated executive officers who were serving as executive officers at the end of the Company’s 2004 fiscal year. There were no stock appreciation rights (“SARs”) granted during fiscal 2004.

Option/SAR Grants in Fiscal 2004

	Individual Grants
	Number of
	Securities	Percentage of
	Underlying	Total Options/
	Options/	SARs Granted	Exercise	Market Price
	SARs	to Employees in	or Base	on Date of		Grant Date
Name	Granted	Fiscal Year 2004	Price	Grant	Expiration Date	Value($)

Wayne P. Garten	200,000	88.1%	$1.95	$2.00	5/5/2014	291,400

The following table contains information concerning the fiscal 2004 year-end values of all options and SARs granted to the Chief Executive Officer and the Company’s four (4) next most highly compensated executive officers who were serving as executive officers at the end of the Company’s 2004 fiscal year.

Aggregated Option/SAR Exercises in 2004 Fiscal Year

and December 25, 2004 Option/SAR Values

			Number of Securities Underlying Unexercised Options/SARs at December 25, 2004	Value of Unexercised In-the-Money Options/SARs at December 25, 2004
Name	Shares Acquired on Exercise(#)	Value Realized($)	Exercisable/ Unexercisable	Exercisable/ Unexercisable

Wayne P. Garten	--	--	71,666 exercisable	$0/$0
			133,334 unexercisable

DRAFT

Director Compensation

Standard Arrangements. The Company pays its non-employee directors a $58,000 annual fee; no supplemental fees are paid for serving as Chairman of a Board committee or for attending Board meetings. Non-employee directors also participated in the 1999 Stock Option Plan for Directors (“1999 Directors’ Plan”) and the 2002 Stock Option Plan for Directors (“2002 Directors’ Plan”) and may in the future participate in the 2004 Stock Option Plan for Directors (the “2004 Directors’ Option Plan”). See “Employment Contracts, Termination of Employment and Change-in-Control Arrangements.” The Company does not compensate its employees, or employees of its subsidiaries, who serve as directors. During fiscal 2004, the Company also provided $50,000 of term life insurance for each director.

Effective January 1, 2003, the 2002 Directors’ Plan was amended to increase the annual award for non-employee directors from options to purchase 2,500 shares to 3,500 shares of Common Stock. In November 2003, the 2002 Directors’ Plan was amended to increase the pool of options to purchase shares of Common Stock from 50,000 to 90,000 shares of Common Stock.

During 2004, options to purchase 5,000 shares of Common Stock were granted to a new non-employee director under the 2002 Directors’ Plan and options to purchase 21,000 shares of Common Stock were granted to the six non-employee directors under the automatic annual grant on August 3, 2004 under the 2002 Directors’ Plan. No options were exercised by Directors during 2004. As of December 25, 2004, 7,000 options to purchase Common Stock under the 1999 Directors’ Plan were outstanding and exercisable. As of December 25, 2004, 65,500 options to purchase Common Stock under the 2002 Stock Option Plan for Directors were outstanding, 36,167 of which were exercisable.

2004 Stock Option Plan for Directors – During 2004, the Board of Directors adopted the 2004 Directors’ Option Plan, pursuant to which stock options to purchase shares of Common Stock may be granted to certain non-employee directors. The Company’s shareholders ratified the 2004 Directors’ Option Plan at the 2004 Annual Meeting of Shareholders. The Company may grant options to purchase up to 100,000 shares of Common Stock to eligible directors at an exercise price equal to the fair market value as of the grant date. An eligible director will receive an initial option grant to purchase 5,000 shares of Common Stock as of the effective date of his/her appointment or election to the Board of Directors. On each Award Date, defined as August 3, 2004, August 3, 2005 and August 3, 2006, eligible directors are to be granted options to purchase additional shares of Common Stock (to the extent the 2002 Stock Option Plan for Directors did not have enough remaining shares). Stock options granted have terms of ten years and vest over three years from the grant date; however, if there is a Change in Control (as defined in the Hanover Direct, Inc. Directors Change of Control Plan), the participant has the cumulative right to purchase up to 100% of the option shares. Option holders may pay for shares purchased on exercise in cash or Common Stock. As of December 25, 2004 no options have been granted under the 2004 Directors’ Option Plan.

The non-employee directors waived their right to the automatic grant of options to be granted on August 3, 2005.

Director Compensation Continuation Agreement. Effective May 3, 2001, the Company’s Board of Directors established the Hanover Direct, Inc. Directors Change of Control Plan (the “Director Compensation Continuation Agreement”) for all non-employee Directors of the Company.

A participant in the Director Compensation Continuation Agreements is entitled to receive a Change of Control Payment if a Change of Control occurs while a director on the effective date of the Change of Control. The Change of Control Payment under the Director Compensation Continuation Agreement is the greater of (i) $40,000 or (ii) 150% of the sum of the annual retainer fee, meeting fees and per diem fees paid to a Director for his/her service on the Board of Directors of the Company during the twelve month period immediately preceding the Change of Control. The Recapitalization was a “Change of Control” for purposes of the Director Compensation Continuation Agreement and on December 18, 2003, each of the then eight non-employee directors (Messrs. Brown, James, Krushel, Sonnenfeld, Masson, Regan, Garten and Edelman) received an $87,000 payment.

DRAFT

Employment Contracts, Termination of Employment and Change-in-Control Arrangements

Garten Employment Agreement. On May 6, 2004, Wayne P. Garten became the Company’s Chief Executive Officer and President. Mr. Garten is employed pursuant to the terms of a May 6, 2004 Employment Agreement. Under Mr. Garten’s Employment Agreement he will be paid an annual salary of $600,000 over a term expiring on May 6, 2006. The Company also granted Mr. Garten options to acquire 200,000 shares of the Company’s common stock, half pursuant to its 2000 Management Stock Option Plan (“2000 Management Option Plan”) and half outside the plan. All of the options have an exercise price of $1.95 per share, the Common Stock’s average closing price for the ten trading days preceding the grant date and the ten trading days after the grant date. One third of each of the options vested upon execution of the Employment Agreement and the balance will vest in two equal annual installments on the anniversary of the original grant date, subject to earlier vesting in the event of a change in control of the Company (as that term is defined in the Employment Agreement). Mr. Garten is entitled to participate in the Company’s bonus plan for executives, as established by the Board of Directors.

Contino Letter Agreement. Michael Contino, the Company’s Chief Operating Officer, is employed pursuant to a October 29, 2002 letter agreement. Under the letter agreement, Mr. Contino was to receive an annual salary of $387,000 and is entitled to participate in the Company’s bonus plan for executives, as established by the Board of Directors. Mr. Contino was awarded options to purchase 100,000 shares under the 2000 Management Stock Option Plan. Under the agreement, if Mr. Contino is terminated other than “for cause” or terminates his employment for “good reason” (as those terms are defined in the agreement), he is entitled to eighteen months of severance pay and health benefits. Mr. Contino was a participant in the Company’s eighteen month change in control plan and was entitled to a Transaction Bonus equal to half of his base salary on a change in control. Mr. Contino was paid the Transaction Bonus following the Recapitalization in 2003.

Shull Employment and Severance Agreement. Thomas Shull, the Company’s prior Chief Executive Officer resigned from the Company on May 5, 2004. Mr. Shull and the Company executed a General Release and Separation Agreement dated effective as of May 5, 2004 which provided for the Company to pay Mr. Shull $900,000 of severance in lieu of any other benefits provided for in the Employment Agreement dated September 1, 2002, as amended (the “Shull Employment Agreement”). The severance was paid with a $300,000 lump sum on execution and the balance in biweekly installments that were completed in 2004. The Company also agreed to pay for eighteen months of COBRA coverage for Mr. Shull.

Prior to his resignation, Mr. Shull was employed pursuant to the Shull Employment Agreement which provided for an $855,000 base salary and had a term expiring on March 31, 2006. Mr. Shull was a participant in the Company’s Key Executive Eighteen Month Compensation Continuation Plan (the “Change of Control Plan”) and its transaction bonus program. The Recapitalization was a change in control under the Change in Control Plan and the Company paid Mr. Shull $1,350,000 in 2003. The Company also paid Mr. Shull $450,000 under the transaction bonus program in 2003.

Charles E. Blue had been appointed Chief Financial Officer of the Company effective November 11, 2003, replacing Edward M. Lambert. Mr. Blue joined the Company in 1999 and prior to his appointment had most recently served as Senior Vice President, Finance. Mr. Lambert continued to serve as Executive Vice President of the Company until his January 2, 2004 resignation. Mr. Lambert and the Company entered into a severance agreement dated November 4, 2003 providing for $640,000 of cash payments, as well as other benefits that were accrued and paid in the fourth quarter of 2003.

DRAFT

Barsky Letter Agreement. On January 31, 2005, the Company appointed Daniel J. Barsky as its Senior Vice President and General Counsel. Under a letter agreement with the Company, Mr. Barsky will be paid an annual salary of $265,000 and was granted options to purchase 50,000 shares of Common Stock. One third of the options vested on February 17, 2005 and the balance will vest in two equal annual installments over the next two years on the anniversary of the original grant date, subject to earlier vesting in the event of a change in control of the Company. All of the options have an exercise price of $1.03 per share, the Common Stock’s average closing price for the ten trading days preceding the grant date and the ten trading days after the grant date. Mr. Barsky will be entitled to participate in the Company’s bonus plan for executives. The agreement also provides for six months of severance payments if Mr. Barsky is terminated without cause or terminates his employment for good reason. Mr. Barsky was appointed as the Company’s Secretary on March 7, 2005.

Swatek Employment Agreement. On April 4, 2005, John W. Swatek became Senior Vice President, Chief Financial Officer and Treasurer of the Company under a March 15, 2005 Employment Agreement. Under the agreement, Mr. Swatek will be paid an annual salary of $270,000 and was granted options to acquire 50,000 shares of the Company’s common stock pursuant to its 2000 Management Stock Option Plan. The options have an exercise price of $0.81 per share, the Common Stock’s average closing price for the ten trading days preceding the grant date and the ten trading days after the grant date. One third of the options vested on execution of the agreement and the balance will vest in two equal annual installments over the next two years on the anniversary of the original grant date, subject to earlier vesting in the event of a change in control of the Company (as that term is defined in the Employment Agreement). The Employment Agreement has a term expiring on May 6, 2006 and provides for a sign-on bonus of up to $25,000 to the extent his bonus from his prior employer was reduced as a result of his agreeing to join the Company. The Company paid Mr. Swatek $17,208 under this provision.

The Employment Agreement provides for a lump sum change in control payment equal to Mr. Swatek’s annual compensation if his employment is terminated during the term and a change in control occurs during that time. The Employment Agreement also provides for one year’s severance if Mr. Swatek is terminated without cause or terminates his employment for good reason (as both terms are defined in the Employment Agreement) during the term and he is not otherwise entitled to change in control benefits. Mr. Swatek will also be entitled to one year of severance payments equal to his annual base salary if his agreement is not renewed at the end of the term.

Compensation Committee Interlocks and Insider Participation

Mr. Garten, the current CEO, was a member of the Compensation Committee until his April 29, 2004 resignation before becoming CEO. Stuart Feldman, a Compensation Committee member during 2004, is a principal of Chelsey and Chelsey Finance.

Report of the Compensation Committee

The report of the Stock Option and Executive Compensation Committee (the “Compensation Committee”) for the fiscal year ended December 25, 2004, is as follows:

The Compensation Committee, whose members are A. David Brown (Chairman), Donald B. Hecht and Stuart Feldman as of the date of this report and for the fiscal year ended December 25, 2004, has the responsibility, under delegated authority from the Company’s Board of Directors, for developing, administering and monitoring the executive compensation policies of the Company and making recommendations to the Company’s Board of Directors with respect to these policies. The Board of Directors has accepted the Compensation Committee’s recommendations for 2004 compensation.

Executive Compensation Philosophy

The Compensation Committee’s executive compensation philosophy supports the Company’s overall business strategy and has at its core a strong link between pay, performance and retention. The philosophy emphasizes recognition of achievement at both the Company and individual level. A significant portion of compensation delivered to executives to reflect such achievement is intended to be in the form of annual bonuses tied to Company performance. In addition, executives are encouraged to hold an ownership stake in the Company so that their interests are closely aligned with those of the stockholders in terms of both risk and reward.

DRAFT

The specific executive compensation plans are designed to support the executive compensation philosophy. Compensation of the Company’s executives consists of three components, which are discussed below: salary, annual incentive awards and to a limited extent, equity compensation. Base salary levels have been established in order to attract and retain key executives, commensurate with their level of responsibility within the organization. Annual incentives closely link executive pay with performance in areas that are critical to the Company’s short-term operating success. Long-term incentives in the form of equity compensation are intended to motivate executives to make decisions that are in the best interests of the Company’s owners and reward them for the creation of stockholder value. It is the intent of both the Company and the Compensation Committee that the components of the executive compensation program will support the Company’s compensation philosophy, reinforce the Company’s overall business strategy, and ultimately drive stockholder value creation.

Base Salaries

Individual salaries for executives of the Company are generally influenced by several equally weighted factors: the qualifications and experience of the executive, the executive’s level of responsibility within the organization, pay levels at firms that compete with the Company for executive talent, individual performance, and performance-related factors used by the Company to determine annual incentive awards. The base salaries of the Company’s executives are subject to periodic review and adjustment. Annual salary adjustments are made based on the factors described above.

Mr. Garten, the Company’s Chief Executive Officer, is employed pursuant to the terms of a May 6, 2004 Employment Agreement. Under Mr. Garten’s Employment Agreement he is paid an annual salary of $600,000 over a term expiring on May 6, 2006. Mr. Garten’s salary was based in part on a review of the compensation of similarly situated executives in the direct marketing industry and in public companies of similar size, compensation trends in the direct marketing industry, his experience both as an executive officer and as chief executive officer of other companies and the Company’s financial position.

Annual Incentive Awards

In addition to base salaries, each of the Company’s executives and selected key managers participate in the Company’s Management Incentive Plan. Approximately 160 executives and key managers received bonuses under the annual 2004 Management Incentive Plan. Under this plan, a portion of the excess, if any, of the Company’s Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) over the Company’s budgeted level of EBITDA was made available for discretionary bonuses. An individual’s entitlement to a bonus was based on the person’s responsibility level in the organization.

Payouts of awards have been determined based on the Company’s performance during fiscal 2004. Mr. Garten’s bonus was set at $300,000 by the Compensation Committee. Mr. Lipner was awarded a $10,000 bonus and Mr. DiFrancesco was awarded a $253,500 bonus for 2004.

Long-Term Incentive Awards

2000 Management Stock Option Plan

Because of issues concerning the continued listing of the Common Stock, the Compensation Committee granted options to only select new hires during 2004.

During 2004, Mr. Garten was granted options to purchase 100,000 shares of Common Stock under the 2000 Management Option Plan and options to purchase 100,000 shares outside of the Company’s option plans. The new President of Domestications was granted 25,000 options and one other mid level management hire was granted options during 2004. During the first fiscal quarter of 2005, Messrs. Barsky and Swatek were each granted options to purchase 50,000 shares of Common Stock. All of these options had an exercise price equal to the average closing price of the Common Stock on the ten trading days before and after the grant date, were exercisable for ten years and were one third vested on the grant date with the balance vesting in two equal annual installments on the anniversaries of the grant date.

DRAFT

2002 Stock Option Plan for Directors

The purpose of the 2002 Directors’ Plan for Directors is to advance the interests of the Company by providing non-employee directors of the Company, through the grant of options to purchase shares of Common Stock, with a larger personal and financial interest in the success of the Company. Under the terms of the plan, non-employee directors are granted an option to purchase 5,000 shares of Common Stock as of the effective date of his or her initial appointment or election to the Board of Directors and automatic annual grants of options to purchase 3,500 shares of Common Stock in August of each year during which the non-employee Director served. The exercise price of the options is equal to the fair market value of the grant date. The options have terms of ten years and vest one-third on each of the first, second and third anniversaries of the grant date. In addition, options may not be exercised more than three months after a participant ceases to be a Company director, except in the case of death or disability, in which cases options may be exercised within twelve months after the date of such death or disability.

During 2004, a total of 26,000 options to purchase shares of Common Stock were granted to eligible directors under the 2002 Directors’ Plan. During 2004, no options to purchase shares of Common Stock under the 2002 Directors’ Plan were exercised. As of December 25, 2004, 65,500 options to purchase Common Stock under the 2002 Directors’ Plan were outstanding, 36,167 of which were exercisable.

2004 Stock Option Plan for Directors

During 2004, the Board of Directors adopted the 2004 Directors’ Option Plan, pursuant to which stock options to purchase shares of Common Stock may be granted to certain non-employee directors. The Company’s shareholders ratified the 2004 Directors’ Option Plan at the 2004 Annual Meeting of Shareholders. The Company may grant options to purchase up to 100,000 shares of Common Stock to eligible directors at an exercise price equal to the fair market value as of the grant date. An eligible director will receive an initial option grant to purchase 5,000 shares of Common Stock as of the effective date of his/her appointment or election to the Board of Directors. On each Award Date, defined as August 3, 2004, August 3, 2005 and August 3, 2006, eligible directors are to be granted options to purchase additional shares of Common Stock (to the extent the 2002 Stock Option Plan for Directors did not have enough remaining shares). Stock options granted have terms of ten years and vest over three years from the grant date; however, if there is a Change in Control (as defined in the Hanover Direct, Inc. Directors Change of Control Plan), the participant has the cumulative right to purchase up to 100.0% of the option shares. Option holders may pay for shares purchased on exercise in cash or Common Stock. As of December 25, 2004 no options have been granted under the 2004 Directors’ Option Plan. In addition, options that were to be granted on the August 3, 2005 Award Date have been deferred until the Company issues its December 25, 2004 audited financial statements.

Compensation Continuation Agreement Payments

The Recapitalization was a “change in control” of the Company for purposes of all of the Company’s Compensation Continuation Agreements. During 2004, the Company paid a total amount of $772,257 to three individuals who were provided Compensation Continuation Agreements by the Company. Two additional individuals triggered “change in control” during 2004 and the Company paid a total of $442,000 in 2005. None of such persons were named executive officers.

DRAFT

Nondeductible Compensation

Section 162(m) of the Internal Revenue Code, as amended (the “Code”), generally disallows a tax deduction to public companies for compensation over $1,000,000 (the “$1 Million Limit”) paid to a company’s chief executive officer and four (4) other most highly compensated executive officers, as reported in its proxy statement. Qualifying performance-based compensation is not subject to the deduction limit, if certain requirements are met. The Company has not structured certain aspects of the performance-based portion of the compensation for its executive officers (which currently includes awards under performance based annual management incentive plans) in a manner that complies with the statute. There was no compensation paid in 2004 over the $1 Million Limit.

Respectfully Submitted,

The Stock Option and Executive Compensation

Committee (July 2005)

A. David Brown (Chairman)

Stuart Feldman

Donald Hecht

DRAFT

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

Certain Beneficial Owners

The following table lists the beneficial owners known by management of at least 5.0% of the Company’s Common Stock or 5.0% of the Company’s Series C Preferred as of June 25, 2005. The information is determined in accordance with Rule 13d-3 promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), based upon information furnished by the persons listed or contained in filings made by them with the Commission. Except as noted below, to the Company’s knowledge, each person named in the table will have sole voting and investment power with respect to all shares of Common Stock and Series C Preferred shown as beneficially owned by them.

Title of Class	Name and Address of Beneficial Owner	Amount and Nature of Beneficial Ownership(1)	Percentage of Class(1)

Series C	Chelsey Direct, LLC,	564,819 (1)	100.0%
Participating	William B. Wachtel and
Preferred Stock	Stuart Feldman
	c/o Wachtel & Masyr, LLP
	152 West 57th Street
	New York, New York 10019

Common Stock	Chelsey Direct, LLC,	25,652,113 (2)	76.0%
	William B. Wachtel and
	Stuart Feldman
	c/o Wachtel & Masyr, LLP
	152 West 57th Street
	New York, New York 10019

__________

(1)

In the case of Common Stock, includes shares of Common Stock issued upon exercise of options or warrants exercisable within 60 days for the subject individual only. Percentages of Common Stock are computed on the basis of 22,426,296 shares of outstanding Common Stock, 10,259,366 exercisable warrants and 1,051,751 exercisable options as of June 25, 2005. Percentages of the Series C Preferred are computed on the basis of 564,819 shares of Series C Preferred outstanding as of June 25, 2005.

(2)

Information concerning the number of shares beneficially owned has been taken from Amendment No. 12 to the Statement on Schedule 13D filed by Chelsey on January 10, 2005 with the SEC. Chelsey is the record holder of shares of Common Stock and 564,819 shares of Series C Preferred. Chelsey Capital Profit Sharing Plan (the “Chelsey Plan”) is the sole member of Chelsey and Mr. Wachtel is the Manager of Chelsey. The sponsor of the Chelsey Plan is DSJ International Resources Ltd. (“DSJI”). Mr. Feldman is the sole officer and director of DSJI and a principal beneficiary of the Chelsey Plan. Mr. Feldman is also the owner of 16,090 shares of Common Stock. Mr. Wachtel, in his capacity as the Manager of Chelsey and Chelsey Finance, will have sole voting and dispositive power with respect to 25,629,856 shares of Common Stock, options and warrants and 564,819 shares of Series C Preferred owned by Chelsey. Each of Messrs. Wachtel and Feldman have vested options to purchase 6,167 shares of Common Stock exercisable within 60 days. The shares of Common Stock and Series C Preferred which are owned by Chelsey and Messrs. Wachtel and Feldman collectively represent approximately 91.0% of the combined voting power of the Company’s securities (after giving effect to the exercise of all outstanding options and warrants to purchase Common Stock beneficially owned by Chelsey).

DRAFT

Management Ownership

The following table lists share ownership of the Company’s Common Stock and Series C Preferred as of June 25, 2005. The information includes beneficial ownership by (i) each of the Company’s directors and executive officers and (ii) all directors and executive officers as a group. The information is determined in accordance with Rule 13d-3 promulgated under the Exchange Act based upon information furnished by the persons listed or contained in filings made by them with the Commission. Except as noted below, to the Company’s knowledge, each person named in the table will have sole voting and investment power with respect to all shares of Common Stock and Series C Preferred shown as beneficially owned by them.

Name of Beneficial Owner	Amount and Nature of Beneficial Ownership(1)	Percentage of Class(1)

William B. Wachtel	25,629,856 (2)	76.0%
	564,819 (2)	100.0%
A. David Brown	9,667 (1)	*
Stuart Feldman	25,645,946 (2)	76.0%
	564,819 (2)	100.0%
Paul S. Goodman	2,833 (1)	*
Donald Hecht	2,833 (1)	*
Robert H. Masson	9,667 (1)	*
Wayne P. Garten	138,334 (1)	*
Michael D. Contino	125,240 (1)(5)	*
John W. Swatek	16,667 (1)	*
Daniel J. Barsky	16,667 (1)	*
Steven Lipner	7,000 (1)	*
John DiFrancesco	55,000 (1)	*
Thomas C. Shull	320,000 (1)	*

Directors and Executive Officers as a Group (13 persons)	26,356,021 (3)	78.1%
	564,819 (4)	100.0%

* Less than one percent

(1)	Represents options to purchase shares of Common Stock exercisable within 60 days.
(2)	Chelsey and its related affiliate, Chelsey Finance, is the record holder of 15,364,323 shares of Common Stock, 10,259,366 outstanding Common Stock warrants and 564,819 shares of Series C Preferred. Chelsey Capital Profit Sharing Plan (the “Chelsey Plan”) is the sole member of Chelsey and Mr. Wachtel is the Manager of Chelsey. The sponsor of the Chelsey Plan is DSJ International Resources Ltd. (“DSJI”). Mr. Feldman is the sole officer and director of DSJI and a principal beneficiary of the Chelsey Plan. Mr. Feldman is also the owner of 16,090 shares of Common Stock. Mr. Wachtel, in his capacity as the Manager of Chelsey, has sole voting and dispositive power with respect to 15,364,323 shares of Common Stock and 564,819 shares of Series C Preferred owned by Chelsey, and Mr. Feldman has sole voting and dispositive power with respect to 16,090 shares of Common Stock owned by him. Each of Messrs. Wachtel and Feldman have vested options to purchase 6,167 shares of Common Stock exercisable within 60 days. The shares of Common Stock and Series C Preferred Stock owned by Chelsey and Messrs. Wachtel and Feldman collectively represent approximately 91% of the combined voting power of the Company’s securities (after giving effect to the exercise of all outstanding options and warrants to purchase Common Stock beneficially owned by Chelsey).
(3)	Shares of Common Stock; includes options to purchase 716,002 shares exercisable within 60 days and 10,259,366 warrants.
(4)	Shares of Series C Preferred Stock.
(5)	Includes 240 shares owned by Mr. Contino.

DRAFT

Item 13. Certain Relationships and Related Transactions

On July 8, 2004, the Company closed on the Chelsey Facility, a $20.0 million junior secured credit facility with Chelsey Finance. The Chelsey Facility has a three-year term, subject to earlier maturity upon the occurrence of a change in control or sale of the Company (as defined), and carries a stated interest rate of 5.0% above the prime rate publicly announced by Wachovia. In consideration for providing the Chelsey Facility to the Company, Chelsey Finance received a closing fee of $200,000 and a warrant exercisable immediately and for a period of ten years to purchase 30.0% of the then fully diluted shares of Common Stock of the Company (equal to 10,259,366 shares of Common Stock) at an exercise price of $0.01 per share.

As part of the Chelsey Facility, the Company and its subsidiaries agreed to indemnify Chelsey Finance from any losses suffered arising out of the Chelsey Facility other than liabilities resulting from such parties’ gross negligence or willful misconduct. The indemnification agreement is not limited as to term and does not include any limitations on maximum future payments thereunder.

In connection with the closing of the Chelsey Facility, Chelsey waived its blockage rights over the issuance of senior securities and received in consideration a waiver fee equal to 1.0% of the liquidation preference of the Company’s outstanding Series C Preferred payable in 434,476 shares of Common Stock (calculated based upon the fair market value thereof two business days prior to the closing date).

The Company retained the law firm of Wachtel & Masyr LLP to handle the appeal of the Kaul litigation. Mr. Wachtel, the Company’s Chairman and the Manager of Chelsey, is a partner in Wachtel & Masyr. Wachtel & Masyr agreed to handle the appeal for a $150,000 fixed fee, of which half was incurred and paid in 2004 and the balance was paid and incurred in 2005.

The Company completed the reverse stock split effective on September 22, 2004. The voting rights of the Series C Preferred were not adjusted as a result of the reverse stock split and consequently, Chelsey’s voting control was increased vis-à-vis the other Common Stock holders.

Either the majority of the independent directors of the Company’s Board of Directors, a committee of the Company’s Board of Directors consisting of independent directors, or, in certain cases, the stockholders have approved these relationships and transactions and, to the extent that such arrangements are available from nonaffiliated parties, all relationships and transactions are on terms no less favorable to the Company than those available from nonaffiliated parties.

Item 14. Principal Accountants Fees and Services

Fees and Independence -

Prior to their dismissal on October 20, 2005, KPMG provided audit services to the Company consisting of the annual audit of the Company’s 2004 and 2003 consolidated financial statements contained in the Company’s Annual Report on Form 10-K for each year and reviews of the financial statements contained in the Company’s Quarterly Reports on Form 10-Q for the 2004 and 2003 fiscal periods. KPMG did not complete the 2004 audit. The following table shows the fees that were billed to the Company by KPMG for professional services rendered for the fiscal years ended December 25, 2004 and December 27, 2003.

Fee Category	Fiscal Year 2004	% of Total	Fiscal Year 2003	% of Total
Audit Fees(1)	$1,722,000	96.5%	$ 814,500	84.6%
Audit-Related Fees(2)	38,000	3.5%	133,500	13.9%
Tax Fees(3)	-0-	0%	14,500	1.5%
Total Fees	$1,760,000	100.0%	$ 962,500	100.0%

_________

(1)	Audit Fees are fees for professional services performed for the audit of the Company’s annual financial statements and review of financial statements included in the Company’s 10-Q filings, and services that are normally provided in connection with statutory and regulatory filings or engagements.

100

DRAFT

(2)

Audit-Related Fees are fees for assurance and related services that are reasonably related to the performance of the audit or review of the Company’s financial statements. This includes: employee benefit and compensation plan audits; due diligence related to mergers and acquisitions; auditor attestations that are not required by statute or regulation; and professional services related to the application of financial accounting / reporting standards. 100% and 100% of these fees for fiscal years 2004 and 2003, respectively, were approved by the Audit Committee pursuant to Paragraph (c)(7)(i)(C) of Rule 2-01 of Regulation S-X.

(3)	Tax Fees are fees for professional services performed with respect to tax compliance, tax advice and tax planning. 100% and 100% of these fees for fiscal years 2004 and 2003, respectively, were approved by the Audit Committee pursuant to Paragraph (c)(7)(i)(C) of Rule 2-01 of Regulation S-X.

KPMG did not provide any services that would be characterized as All Other Fees, which would include fees for other permissible work that does not meet the above category descriptions during the 2004 and 2003 fiscal years.

The Audit Committee of the Board of Directors has considered whether the provision of services by KPMG described above are compatible with maintaining KPMG’s independence as the Company’s principal accountant.

Pre-Approval Policy

The Audit Committee has adopted an audit and non-audit services pre-approval policy, whereby it may pre-approve the provision of services to us by the independent auditors. The policy of the Audit Committee is to pre-approve the audit, audit-related, tax and non-audit services to be performed during the year on an annual basis, in accordance with a schedule of such services approved by the Audit Committee. The annual audit services engagement terms and fees will be subject to the specific pre-approval of the Audit Committee. Audit-related services and tax services to be provided by the auditors will be subject to general pre-approval by the Audit Committee. The Audit Committee may grant specific case-by-case approval for permissible non-audit services. The Audit Committee will establish pre-approval fee levels or budgeted amounts for all services to be provided on an annual basis. Any proposed services exceeding those levels or amounts will require specific pre-approval by the Audit Committee. The Audit Committee has delegated pre-approval authority to the Chairman of the Audit Committee, who will report any such pre-approval decisions to the Audit Committee at its next scheduled meeting.

PART IV

Item 15. Exhibits and Financial Statement Schedules

(a)	The following documents are filed as part of this report:

		Page No.
1.	Index to Financial Statements
	Report of Independent Registered Public Accounting Firm — Hanover Direct, Inc. and Subsidiaries Financial Statements
	Consolidated Balance Sheets as of December 25, 2004 and December 27, 2003 (as restated)
	Consolidated Statements of Income (Loss) for the years ended December 25, 2004, December 27, 2003 (as restated) and December 28, 2002 (as restated)
	Consolidated Statements of Cash Flows for the years ended December 25, 2004, December 27, 2003 (as restated) and December 28, 2002 (as restated)
	Consolidated Statements of Shareholders’ Deficiency for the years ended December 25, 2004, December 27, 2003 (as restated) and December 28, 2002 (as restated)
	Selected Quarterly Financial Information (unaudited) for the 13- week fiscal periods ended March 27, 2004 (as restated), June 26, 2004 (as restated), September 25, 2004, December 25, 2004, March 29, 2003 (as restated), June 28, 2003 (as restated), September 27, 2003 (as restated) and December 27, 2003 (as restated).
2.	Index to Financial Statement Schedule
	Schedule II — Valuation and Qualifying Accounts for the years ended December 25, 2004, December 27, 2003 (as restated) and December 28, 2002 (as restated)

101

DRAFT

Schedules other than that listed above are omitted because they are not applicable or the required information is shown

in the financial statements or notes thereto.

Exhibits

The exhibits required by Item 601 of Regulation S-K filed as part of, or incorporated by reference in, this report are listed in the accompanying Exhibit Index found after the Signature Page.

102

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

Date:
	HANOVER DIRECT, INC.
	(Registrant)
	By:__________________________
	Wayne. P. Garten,
	President
	and Chief Executive Officer
	(On behalf of the registrant and as principal executive officer)

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated and on the date indicated below.

Principal Officers:

By:__________________	By: _______________
John W. Swatek,	Hallie Sturgill
Senior Vice President, Chief Financial Officer and Treasurer	Vice President and Corporate Controller
(principal financial officer)	(principal accounting officer)

Board of Directors:

_____________________	_____________________
William Wachtel, Chairman of the Board of Directors	Donald Hecht, Director

_____________________	_____________________
Robert H. Masson, Director	Stuart Feldman, Director

_____________________	_____________________
A. David Brown, Director	Wayne P. Garten
_____________________
Paul S. Goodman, Director

Date:

103

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EXHIBIT INDEX

Exhibit Number Item 601 of Regulation S-K	Description of Document and Incorporation by Reference Where Applicable
2.1	Stock Purchase Agreement dated as of February 11, 2005 by and among Hanover Direct, Inc., The Company Store Group, LLC and Gump’s Holdings, LLC Incorporated by reference to the Form 8-K filed February 17, 2005.

3.1	Restated Certificate of Incorporation. Incorporated by reference to the Form 10-K for the year ended December 28, 1996.

3.2	Certificate of Correction filed to correct a certain error in the Restated Certificate of Incorporation. Incorporated by reference to the Form 10-K for the year ended December 26, 1998.

3.3	Certificate of Amendment to Certificate of Incorporation dated May 28, 1999. Incorporated by reference to the Form 10-K for the year ended December 25, 1999.

3.4	Certificate of Correction Filed to Correct a Certain Error in the Restated Certificate of Incorporation dated August 26, 1999. Incorporated by reference to the Form 10-K for the year ended December 25, 1999.

3.5	Certificate of Designations, Powers, Preferences and Rights of Series A Cumulative Participating Preferred Stock. Incorporated by reference to the Form 8-K filed August 30, 2000.

3.6	Certificate of the Designations, Powers, Preferences and Rights of Series B Participating Preferred Stock. Incorporated by reference to the Form 8-K filed December 20, 2001.

3.7	Certificate of Elimination of the Series A Cumulative Participating Preferred Stock. Incorporated by reference to the Form 8-K filed December 20, 2001.

3.8	Certificate of the Designations, Powers, Preferences and Rights of Series C Participating Preferred Stock. Incorporated by reference to the Form 8-K filed November 30, 2003.

3.9	Certificate of Elimination of the Series B Participating Preferred Stock. Incorporated by reference to the Form 8-K filed November 30, 2003.

3.10	Certificate of Correction filed on November 26, 2003 with the Delaware Secretary of State to Correct a Certain Error in the Amended and Restated Certificate of Incorporation of Hanover Direct, Inc. filed with the Delaware Secretary of State on October 31, 1996. Incorporated by reference to the Form 8-K filed November 30, 2003.

3.11	By-laws. Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended September 27, 1997.

3.12	Amendment to By-laws. Incorporated by reference to the Form 8-K filed November 30, 2003.

3.13	Amendment to By-laws. Incorporated by reference to the Form10-Q filed August 10, 2004.

3.14	Certificate of the Designations, Powers, Preferences and Rights of Series D Participating Preferred Stock of Hanover Direct, Inc., dated July 8, 2004. Incorporated by reference to the Form 8-K filed July 12, 2004.

3.15	Certificate of Amendment to Amended and Restated Certificate of Incorporation dated September 22, 2004.

3.16	Certificate of Elimination of the Series D Participating Preferred Stock dated September 30, 2004. Incorporated by reference to the Form 10-Q filed July 12, 2005.

104

DRAFT

10.12	Hanover Direct, Inc. Key Executive Eighteen Month Compensation Continuation Plan. Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2001.

10.13	Amendment No. 1 to the Hanover Direct, Inc. Key Executive Eighteen Month Compensation Continuation Plan, dated as of June 1, 2001. Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2001.

10.14	Amendment No. 2 to the Hanover Direct, Inc. Key Executive Eighteen Month Compensation Continuation Plan, effective as of August 1, 2001. Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended March 30, 2002.

10.15	Amendment No. 3 to Hanover Direct, Inc. Key Executive Eighteen Month Compensation Continuation Plan, effective October 29, 2003. Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended September 27, 2003.

10.16	Hanover Direct, Inc. Key Executive Twelve Month Compensation Continuation Plan. Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2001.

10.17	Amendment No. 1 to the Hanover Direct, Inc. Key Executive Twelve Month Compensation Continuation Plan, effective as of August 1, 2001. Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended March 30, 2002.

10.18	Amendment No. 2 to the Hanover Direct, Inc. Key Executive Twelve Month Compensation Continuation Plan, effective as of December 28, 2002. Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended September 27, 2003.

10.19	Hanover Direct, Inc. Key Executive Six Month Compensation Continuation Plan. Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2001.

10.20	Amendment No. 1 to the Hanover Direct, Inc. Key Executive Six Month Compensation Continuation Plan, effective as of August 1, 2001. Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended March 30, 2002.

10.21	Amendment No. 2 to the Hanover Direct, Inc. Key Executive Six Month Compensation Continuation Plan, effective as of December 28, 2002. Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended September 27, 2003.

10.22	Loan and Security Agreement dated as of November 14, 1995 by and among Congress Financial Corporation (“Congress”), HDPA, Brawn, Gump’s by Mail, Gump’s, The Company Store, Inc. (“The Company Store”), Tweeds, Inc. (“Tweeds”), LWI Holdings, Inc. (“LWI”), Aegis Catalog Corporation (“Aegis”), Hanover Direct Virginia, Inc. (“HDVA”) and Hanover Realty Inc. (“Hanover Realty”). Incorporated by reference to the Form 10-K for the year ended December 30, 1995.

10.23	First Amendment to Loan and Security Agreement dated as of February 22,1996 by and among Congress, HDPA, Brawn, Gump’s by Mail, Gump’s, The Company Store, Tweeds, LWI, Aegis, HDVA, Hanover Realty and TAC. Incorporated by reference to the Form 10-K for the year ended December 28, 1996.

10.24	Second Amendment to Loan and Security Agreement dated as of April 16, 1996 by and among Congress, HDPA, Brawn, Gump’s by Mail, Gump’s, The Company Store, Tweeds, LWI, Aegis, HDVA, Hanover Realty and TAC. Incorporated by reference to the Form 10-K for the year ended December 28, 1996.

10.25	Third Amendment to Loan and Security Agreement dated as of May 24, 1996by and among Congress, HDPA, Brawn, Gump’s by Mail, Gump’s, The Company Store, Tweeds, LWI, Aegis, HDVA, Hanover Realty and TAC. Incorporated by reference to the Form 10-K for the year ended December 28, 1996.

105

DRAFT

10.26	Fourth Amendment to Loan and Security Agreement dated as of May 31, 1996 by and among Congress, HDPA, Brawn, Gump’s by Mail, Gump’s, The Company Store, Tweeds, LWI, Aegis, HDVA, Hanover Realty and TAC. Incorporated by reference to the Form 10-K for the year ended December 28, 1996.

10.27	Fifth Amendment to Loan and Security Agreement dated as of September 11, 1996 by and among Congress, HDPA, Brawn, Gump’s by Mail, Gump’s, The Company Store, Tweeds, LWI, Aegis, HDVA, Hanover Realty and TAC. Incorporated by reference to the Form 10-K for the year ended December 28, 1996.

10.28	Sixth Amendment to Loan and Security Agreement dated as of December 5, 1996 by and among Congress, HDPA, Brawn, Gump’s by Mail, Gump’s, The Company Store, Tweeds, LWI, Aegis, HDVA, Hanover Realty and TAC. Incorporated by reference to the Form 10-K for the year ended December 28, 1996.

10.29	Seventh Amendment to Loan and Security Agreement dated as of December 18, 1996 by and among Congress, HDPA, Brawn, Gump’s by Mail, Gump’s, The Company Store, Tweeds, LWI, Aegis, HDVA, Hanover Realty and TAC. Incorporated by reference to the Form 10-K for the year ended December 28, 1996.

10.30	Eighth Amendment to Loan and Security Agreement dated as of March 26, 1997 by and among Congress, HDPA, Brawn, Gump’s by Mail, Gump’s, The Company Store, Tweeds, LWI, Aegis, HDVA, Hanover Realty and TAC. Incorporated by reference to the Form 10-K for the year ended December 26, 1998.

10.31	Ninth Amendment to Loan and Security Agreement dated as of April 18, 1997 by and among Congress, HDPA, Brawn, Gump’s by Mail, Gump’s, The Company Store, Tweeds, LWI, Aegis, HDVA, Hanover Realty and TAC. Incorporated by reference to the Form 10-K for the year ended December 26, 1998.

10.32	Tenth Amendment to Loan and Security Agreement dated as of October 31, 1997 by and among Congress, HDPA, Brawn, Gump’s by Mail, Gump’s, The Company Store, Tweeds, LWI, Aegis, HDVA, Hanover Realty and TAC. Incorporated by reference to the Form 10-K for the year ended December 26, 1998.

10.33	Eleventh Amendment to Loan and Security Agreement dated as of March 25,1998 by and among Congress, HDPA, Brawn, Gump’s by Mail, Gump’s, The Company Store, Tweeds, LWI, Aegis, HDVA, Hanover Realty and TAC. Incorporated by reference to the Form 10-K for the year ended December 26, 1998.

10.34	Twelfth Amendment to Loan and Security Agreement dated as of September 30, 1998 by and among Congress, HDPA, Brawn, Gump’s by Mail, Gump’s, The Company Store, Tweeds, LWI, Aegis, HDVA, Hanover Realty and TAC. Incorporated by reference to the Form 10-K for the year ended December 25, 1999.

10.35	Thirteenth Amendment to Loan and Security Agreement dated as of September 30, 1998 by and among Congress, HDPA, Brawn, Gump’s by Mail, Gump’s, The Company Store, Tweeds, LWI, Aegis, HDVA, Hanover Realty and TAC. Incorporated by reference to the Form 10-K for the year ended December 25, 1999.

10.36	Fourteenth Amendment to Loan and Security Agreement dated as of February 28, 2000 by and among Congress, HDPA, Brawn, Gump’s by Mail, Gump’s, The Company Store, Tweeds, LWI, Aegis, HDVA, Hanover Realty and TAC. Incorporated by reference to the Form 10-K for the year ended December 25, 1999.

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10.37	Fifteenth Amendment to Loan and Security Agreement dated as of March 24, 2000 by and among Congress, HDPA, Brawn, Gump’s by Mail, Gump’s, LWI, HDVA, Hanover Realty, The Company Store Factory, Inc., The Company Office, Inc., Keystone Internet Services, Inc., Tweeds, LLC, Silhouettes, LLC, Hanover Company Store, LLC and Domestications, LLC. Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended March 25, 2000.

10.38	Sixteenth Amendment to Loan and Security Agreement dated as of August 8, 2000 by and among Congress, HDPA, Brawn, Gump’s by Mail, Gump’s, LWI, HDVA, Hanover Realty, The Company Store Factory, Inc., The Company Office, Inc., Keystone Internet Services, Inc., Tweeds, LLC, Silhouettes, LLC, Hanover Company Store, LLC and Domestications, LLC. Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended June 24, 2000.

10.39	Seventeenth Amendment to Loan and Security Agreement dated as of January 5, 2001 by and among Congress, HDPA, Brawn, Gump’s by Mail, Gump’s, LWI, HDVA, Hanover Realty, The Company Store Factory, Inc., The Company Office, Inc., Keystone Internet Services, Inc., Tweeds, LLC, Silhouettes, LLC, Hanover Company Store, LLC and Domestications, LLC. Incorporated by reference to the Form 10-K for the year ended December 30, 2000.

10.40	Eighteenth Amendment to Loan and Security Agreement, dated as of November 12, 2001, among Congress, HDPA, Brawn, Gump’s by Mail, Gump’s, LWI, HDVA, Hanover Realty, The Company Store Factory, Inc., The Company Office, Inc., Keystone Internet Services, Inc., Tweeds, LLC, Silhouettes, LLC, Hanover Company Store, LLC and Domestications, LLC. Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended September 29, 2001.

10.41	Nineteenth Amendment to Loan and Security Agreement, dated as of December 18, 2001, by and among Congress, HDPA, Brawn, Gump’s by Mail, Gump’s, LWI, HDVA, Hanover Realty, The Company Store Factory, Inc., The Company Office, Inc., Keystone Internet Services, Inc., Tweeds, LLC, Silhouettes, LLC, Hanover Company Store, LLC and Domestications, LLC. Incorporated by reference to the Form 8-K filed December 20, 2001.

10.42	Twentieth Amendment to Loan and Security Agreement, dated as of March 5, 2002, by and among Congress, HDPA, Brawn, Gump’s by Mail, Gump’s, HDVA, Hanover Realty, The Company Store Factory, Inc., The Company Office, Inc., Keystone Internet Services, Inc., Silhouettes, LLC, Hanover Company Store, LLC and Domestications, LLC. Incorporated by reference to the Form 10-K for the year ended December 29, 2001.

10.43	Twenty-first Amendment to Loan and Security Agreement, dated as of March 21, 2002, among Congress, HDPA, Brawn, Gump’s by Mail, Gump’s, HDVA, Hanover Realty, The Company Store Factory, Inc., The Company Office, Inc., Keystone Internet Services, Inc., Silhouettes, LLC, Hanover Company Store, LLC and Domestications, LLC. Incorporated by reference to the Form 10-K for the year ended December 29, 2001.

10.44	Twenty-second Amendment to Loan and Security Agreement, dated as of August 16, 2002, among Congress, HDPA, Brawn, Gump’s by Mail, Gump’s, HDVA, Hanover Realty, The Company Store Factory, Inc., The Company Office, Inc., Silhouettes, LLC, Hanover Company Store, LLC, Domestications, LLC and Keystone Internet Services, Inc. Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended June 29, 2002.

10.45	Twenty-third Amendment to Loan and Security Agreement, dated as of December 27, 2002, among Congress, HDPA, Brawn, Gump’s by Mail, Gump’s, HDVA, Hanover Realty, The Company Store Factory, Inc., The Company Office, Inc., Silhouettes, LLC, Hanover Company Store, LLC, Domestications, LLC, Keystone Internet Services, Inc., Keystone Internet Services, LLC and The Company Store Group, LLC. Incorporated by reference to the Form 10-K for the year ended December 28, 2002.

10.46	Twenty-fourth Amendment to Loan and Security Agreement, dated as of February 28, 2003, among Congress, Brawn, Gump’s by Mail, Gump’s, Hanover Realty, The Company Store Factory, Inc., The Company Office, Inc., Silhouettes, LLC, Hanover Company Store, LLC, Domestications, LLC, Keystone internet Services, LLC and The Company Store Group, LLC. Incorporated by reference to the Form 10-K for the year ended December 28, 2002.

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10.47	Twenty-fifth Amendment to Loan and Security Agreement, dated as of April 21, 2003, among Congress, Brawn, Gump’s by Mail, Gump’s, Hanover Realty, The Company Store Factory, Inc., The Company Office, Inc., Silhouettes, LLC, Hanover Company Store, LLC, Domestications, LLC, Keystone internet Services, LLC and The Company Store Group, LLC. Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended March 29, 2003.

10.48	Twenty-sixth Amendment to Loan and Security Agreement, dated as of August 29, 2003, among Congress, Brawn, Gump’s by Mail, Gump’s, Hanover Realty, The Company Store Factory, Inc., The Company Office, Inc., Silhouettes, LLC, Hanover Company Store, LLC, Domestications, LLC, Keystone internet Services, LLC and The Company Store Group, LLC. Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended September 27, 2003.

10.49	Twenty-seventh Amendment to Loan and Security Agreement, dated as of October 31, 2003, among Congress, Brawn, Gump’s by Mail, Gump’s, Hanover Realty, The Company Store Factory, Inc., The Company Office, Inc., Silhouettes, LLC, Hanover Company Store, LLC, Domestications, LLC, Keystone internet Services, LLC and The Company Store Group, LLC. Incorporated by reference to the Form 8-K filed October 31, 2003.

10.50	Twenty-eighth Amendment to Loan and Security Agreement, dated as of November 4, 2003, among Congress, Brawn, Gump’s by Mail, Gump’s, Hanover Realty, The Company Store Factory, Inc., The Company Office, Inc., Silhouettes, LLC, Hanover Company Store, LLC, Domestications, LLC, Keystone internet Services, LLC and The Company Store Group, LLC. Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended September 27, 2003.

10.51	Twenty-ninth Amendment to Loan and Security Agreement, dated as of November 25, 2003, among Congress, Brawn, Gump’s by Mail, Gump’s, Hanover Realty, The Company Store Factory, Inc., The Company Office, Inc., Silhouettes, LLC, Hanover Company Store, LLC, Domestications, LLC, Keystone internet Services, LLC and The Company Store Group, LLC. Incorporated by reference to the Form 8-K filed November 30, 2003.

10.52	Employment Agreement dated as of September 1, 2002 between Thomas C. Shull and the Company. Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended June 29, 2002.

10.53	Amendment No. 1 to Employment Agreement dated as of September 1, 2002 between Thomas C. Shull and the Company. Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended September 28, 2002.

10.54	Amendment No. 2 to Employment Agreement dated as of June 23, 2003 between Thomas C. Shull and the Company. Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended June 28, 2003.

10.55	Amendment No. 3 to Employment Agreement effective as of August 3, 2003 between Thomas C. Shull and the Company. Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended June 28, 2003.

10.56	Final form of letter agreement between the Company and certain Level 8 executive officers. Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended September 28, 2002.

10.57	Form of Transaction Bonus Letter. Incorporated by reference to the Form 10-K for the year ended December 28, 2002.

10.58	Hanover Direct, Inc. Savings and Retirement Plan, as amended and restated as of July 1, 1999. Incorporated by reference to the Form 10-K for the year ended December 29, 2001.

10.59	First Amendment to the Hanover Direct, Inc. Savings and Retirement Plan, effective March 1, 2002. Incorporated by reference to the Form 10-K for the year ended December 29, 2001.

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10.60	Memorandum of Understanding dated November 10, 2003 by and among Hanover Direct, Inc., Chelsey Direct, LLC and Regan Partners, L.P. Incorporated by reference to the Form 8-K filed November 10, 2003.

10.61	Recapitalization Agreement dated as of November 18, 2003 by and between Hanover Direct, Inc. and Chelsey Direct, LLC. Incorporated by reference to the Form 8-K filed November 18, 2003.

10.62	Registration Rights Agreement dated as of November 30, 2003 by and among Hanover Direct, Inc., Chelsey Direct, LLC and Stuart Feldman. Incorporated by reference to the Form 8-K filed November 30, 2003.

10.63	Corporate Governance Agreement dated as of November 30, 2003 by and among Hanover Direct, Inc. Chelsey Direct, LLC, Stuart Feldman, Regan Partners, L.P., Regan International Fund Limited and Basil P. Regan. Incorporated by reference to the Form 8-K filed November 30, 2003.

10.64	Voting Agreement dated as of November 30, 2003 by and among Chelsey Direct, LLC, Stuart Feldman, Regan Partners, L.P., Regan International Fund Limited and Basil P. Regan. Incorporated by reference to the Form 8-K filed November 30, 2003.

10.65	General Release dated November 30, 2003 given by Hanover Direct, Inc. and its parents, affiliates, subsidiaries, predecessor firms, shareholders, officers, directors, members, managers, employees, agents and others to Chelsey Direct, LLC and its parents, affiliates, subsidiaries, predecessor firms, shareholders, officers, directors, members, managers, employees, attorneys, agents and others. Incorporated by reference to the Form 8-K filed November 30, 2003.

10.66	General Release dated November 30, 2003 given by Chelsey Direct, LLC and its parents, affiliates, subsidiaries, predecessor firms, shareholders, officers, directors, members, managers, employees, agents and others to Hanover Direct, Inc. and its parents, affiliates, subsidiaries, predecessor firms, shareholders, officers, directors, members, managers, employees, attorneys, agents and others. Incorporated by reference to the Form 8-K filed November 30, 2003.

10.67	Stipulation of Discontinuance of the action entitled Hanover Direct, Inc. v. Richemont Finance S.A. and Chelsey Direct, LLC in the Supreme Court of the State of New York, County of New York (Index No. 03/602269) dated November 30, 2003. Incorporated by reference to the Form 8-K filed November 30, 2003.

10.68	Code of Conduct of the Registrant. Incorporated by reference to the Form 10-K filed April 9, 2004.

10.69	Thirtieth Amendment to Loan and Security Agreement, dated as of March 25, 2004, among Congress, Brawn, Gump’s by Mail, Gump’s, Hanover Realty, The Company Store Factory, Inc., The Company Office, Inc., Silhouettes, LLC, Hanover Company Store, LLC, Domestications, LLC, Keystone internet Services, LLC and The Company Store Group, LLC. Incorporated by reference to the Form 10-K filed April 9, 2004.

10.70	Employment Agreement dated as of May 5, 2004 between Wayne P. Garten and the Company. Incorporated by reference to the Form10-Q filed August 10, 2004.

10.71	General Release and Covenant Not to Sue, dated as of May 5, 2004, between Thomas C. Shull and the Company. Incorporated by reference to the Form10-Q filed August 10, 2004.

10.72	Loan and Security Agreement, dated as of July 8, 2004, among Chelsey Finance, LLC, a Delaware limited liability company, and the Borrowers named therein. Incorporated by reference to the Form 8-K filed July 12, 2004.

10.73	Intercreditor and Subordination Agreement, dated as of July 8,2004, between Lender and Congress Financial Corporation, as acknowledged by Borrowers and Guarantors. Incorporated by reference to the Form 8-K filed July 12, 2004.

10.74	Thirty-first Amendment to Loan and Security Agreement, dated as of July 8, 2004, among Congress Financial Corporation and the Borrowers and Guarantors named therein. Incorporated by reference to the Form 8-K filed July 12, 2004.

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10.75	Series D Preferred Stock Purchase Warrant dated July 8, 2004 issued by Hanover Direct, Inc. to Chelsey Finance, LLC. Incorporated by reference to the Form 8-K filed July 12, 2004.

10.76	Thirty-Second Amendment to Loan and Security Agreement, dated as of December 30, 2004, among Congress Financial Corporation and the Borrowers and Guarantors named therein. Incorporated by reference to the Form 8-K filed October 27, 2005.

10.77	Common Stock Purchase Warrant dated September 23, 2004 issued by Hanover Direct, Inc. to Chelsey Finance, LLC.

10.78	Thirty-Third Amendment to Loan and Security Agreement, dated as of March 11, 2005, among Congress Financial Corporation and the Borrowers and Guarantors named therein. Incorporated by reference to the Form 8-K filed October 27, 2005.

10.79	Employment Agreement dated as of March 15, 2005 between John Swatek and the Company. Incorporated by reference to the Form 8-K filed March 18, 2005.

10.80	Thirty-Fourth Amendment to Loan and Security Agreement, dated as of July 29, 2005, by and among Wachovia Bank, National Association and the Borrowers and Guarantors named therein. Incorporated by reference to the Form 8-K filed October 27, 2005.

10.81	First Amendment to Loan And Security Agreement dated as of November 30, 2004, by and among Chelsey Finance, LLC and the Borrowers and Guarantors named therein. Incorporated by reference to the Form 8-K filed October 27, 2005.

10.82	Second Amendment to Loan And Security Agreement dated as of December 30, 2004, by and among Chelsey Finance, LLC and the Borrowers and Guarantors named therein. Incorporated by reference to the Form 8-K filed October 27, 2005.

10.83	Third Amendment to Loan And Security Agreement dated as of July 29, 2005, by and among Chelsey Finance, LLC and the Borrowers and Guarantors named therein. Incorporated by reference to the Form 8-K filed October 27, 2005.

10.84	Credit Card Program Agreement between Hanover Direct, Inc. and World Financial Network National Bank dated as February 22, 2005. Incorporated by reference to the Form 8-K filed October 27, 2005.

10.85	Amendment Number One to Credit Card Program Agreement between Hanover Direct, Inc. and World Financial Network National Bank dated as March 30, 2005. Incorporated by reference to the Form 8-K filed October 27, 2005.

14.1	Hanover Direct, Inc. and Subsidiaries Code of Ethics. Incorporated by reference to the Form 10-K for the year ended December 28, 2002.

21.1	Subsidiaries of the Registrant. **

31.1	Certification required by Rule 13a-14(a) or Rule 15d-14(a) signed by Wayne P. Garten. **

31.2	Certification required by Rule 13a-14(a) or Rule 15d-14(a) signed by John W. Swatek.**

32.1	Certification required by Rule 13a-14(b) or 15d-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C. 1350) signed by Wayne P. Garten.**

32.2	Certification required by Rule 13a-14(b) or 15d-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C. 1350) signed by John W. Swatek.**

*Hanover Direct, Inc., a Delaware corporation, is the successor by merger to The Horn & Hardart Company and The Hanover Companies.

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**Items indicated by an asterisk are to be filed when the Form 10-K is filed with the SEC.

111

EX-99.03 12 exhibit99_03.htm

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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 25, 2005

Commission file number 1-08056

HANOVER DIRECT, INC.

(Exact name of registrant as specified in its charter)

Delaware	13-0853260
(State of incorporation)	(IRS Employer Identification No.)

1500 Harbor Boulevard, Weehawken, New Jersey	07086
(Address of principal executive offices)	(Zip Code)

(201) 863-7300
(Telephone number)

Yes_ No X

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes_ No X

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)

Yes_ No X

Common stock, par value $0.01 per share: 22,426,296 shares outstanding as of October 17, 2005.

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EXPLANATORY NOTE

As explained herein, we have restated the condensed consolidated financial statements for, among other periods, the period ended June 26, 2004 which is included in this Form 10-Q (collectively, the “Restatement”). By way of summary, the Restatement corrects a revenue recognition issue that resulted in revenue being recorded in advance of the actual receipt of merchandise by the customer, corrects an error in the accounting treatment of discounts obligations for certain of the Company’s buyers’ club programs and corrects the premature reversal of a reserve for post employment benefits. The Restatement also records certain customer prepayments and credits inappropriately released and records other liabilities relating to certain miscellaneous catalog costs and other miscellaneous costs that were inappropriately not accrued in the appropriate periods. In addition, we have made adjustments to the federal and state tax provision and the deferred tax asset and liabilities to reflect the effect of the Restatement adjustments. For a more complete description of the Restatement, refer to Note 2 to the attached condensed consolidated financial statements. As previously disclosed in our Current Report on Form 8-K filed with the Securities and Exchange Commission (“SEC”) on November 10, 2004, the financial statements and related financial information contained in, among other reports, the Form 10-Q for the fiscal quarter ended June 26, 2004 should no longer be relied upon. Throughout this Form 10-Q all referenced amounts for the period ended June 26, 2004 and comparisons thereto reflect the balances and amounts after giving effect to the Restatement.

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HANOVER DIRECT, INC.

TABLE OF CONTENTS

Page

Part I - Financial Information

Item 1. Financial Statements

Condensed Consolidated Balance Sheets -

June 25, 2005, December 25, 2004 and Restated June 26, 2004

Condensed Consolidated Statements of Income (Loss) – 13 and 26- weeks ended

June 25, 2005 and Restated June 26, 2004

Condensed Consolidated Statements of Cash Flows – 13 and 26- weeks ended

June 25, 2005 and Restated June 26, 2004

Notes to Condensed Consolidated Financial Statements

Item 2. Management’s Discussion and Analysis of Consolidated Financial Condition and

Results of Operations

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Item 4. Controls and Procedures

Part II - Other Information

Item 1. Legal Proceedings

Item 3. Defaults Upon Senior Securities

Item 6. Exhibits

Signature Page

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PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

HANOVER DIRECT, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands of dollars, except share amounts)

(Unaudited)

	June 25, 2005	December 25, 2004	June 26, 2004
			(As Restated)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents	$ 542	$ 510	$ 392
Accounts receivable, net of allowance for doubtful accounts of $1,246, $1,367 and $1,035, respectively	14,981	17,819	13,332
Inventories	50,187	53,147	39,868
Prepaid catalog costs	18,717	15,644	17,673
Other current assets	3,332	4,482	3,821
Total Current Assets	87,759	91,602	75,086
PROPERTY AND EQUIPMENT, AT COST:
Land	4,361	4,361	4,361
Buildings and building improvements	18,237	18,221	18,212
Leasehold improvements	1,012	10,156	10,108
Furniture, fixtures and equipment	50,957	53,792	53,519
	74,567	86,530	86,200
Accumulated depreciation and amortization	(53,829)	(61,906)	(60,129)
Property and equipment, net	20,738	24,624	26,071
Goodwill	8,649	9,278	9,278
Deferred tax assets	3,253	2,034	1,769
Other assets	2,447	2,816	1,642
Total Assets	$ 122,846	$ 130,354	$ 113,846

Continued on next page.

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HANOVER DIRECT, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS (Continued)

(In thousands of dollars, except share amounts)

(Unaudited)

	June 25, 2005	December 25, 2004	June 26, 2004
			(As Restated)
LIABILITIES AND SHAREHOLDERS’ DEFICIENCY

CURRENT LIABILITIES:
Short-term debt and capital lease obligations	$ 4,635	$ 16,690	$ 12,232
Accounts payable	28,851	29,544	40,775
Accrued liabilities	18,596	20,535	16,048
Customer prepayments and credits	16,005	12,032	16,652
Deferred tax liability	3,253	2,034	1,769
Total Current Liabilities	71,340	80,835	87,476
NON-CURRENT LIABILITIES:
Long-term debt	11,709	11,196	6,970
Series C Participating Preferred Stock, authorized, issued and outstanding 564,819 shares; liquidation preference of $56,482	72,689	72,689	72,689
Other	3	3,286	3,692
Total Non-current Liabilities	84,401	87,171	83,351
Total Liabilities	155,741	168,006	170,827
SHAREHOLDERS’ DEFICIENCY:
Common Stock, $0.01 par value, authorized 50,000,000 shares at June 25, 2005 and December 25, 2004 and 30,000,000 shares at June 26, 2004; 22,426,296 shares issued and outstanding at June 25, 2005 and December 25, 2004; 22,229,456 shares issued and 22,017,363 shares outstanding at June 26, 2004	225	225	222
Capital in excess of par value	460,822	460,744	450,529
Accumulated deficit	(493,942)	(498,621)	(504,386)
	(32,895)	(37,652)	(53,635)
Less:
Treasury stock, at cost (0 shares at June 25, 2005 and December 25, 2004 and 212,093 shares at June 26, 2004)	--	--	(2,996)
Notes receivable from sale of Common Stock	--	--	(350)
Total Shareholders’ Deficiency	(32,895)	(37,652)	(56,981)
Total Liabilities and Shareholders’ Deficiency	$ 122,846	$ 130,354	$ 113,846

See Notes to Condensed Consolidated Financial Statements.

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HANOVER DIRECT, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME (LOSS)

(In thousands of dollars, except per share amounts)

(Unaudited)

	For the 13- Weeks Ended		For the 26- Weeks Ended
	June 25, 2005	June 26, 2004	June 25, 2005	June 26, 2004
	June 25, 2005	June 26, 2004	June 25, 2005	June 26, 2004
		As Restated		As Restated
NET REVENUES	$ 100,231	$ 87,744	$ 189,913	$ 169,025

OPERATING COSTS AND EXPENSES:
Cost of sales and operating expenses	61,030	52,617	115,002	103,704
Special charges (income)	(6)	42	18	42
Selling expenses	25,772	23,693	48,050	43,311
General and administrative expenses	9,250	9,931	19,833	19,553
Depreciation and amortization	774	838	1,527	1,681
	96,820	87,121	184,430	168,291

INCOME BEFORE INTEREST AND INCOME TAXES	3,411	623	5,483	734
Interest expense, net	1,928	700	3,755	1,525

INCOME (LOSS) BEFORE INCOME TAXES	1,483	(77)	1,728	(791)
Provision (benefit) for Federal income taxes	20	107	35	(1)
Provision (benefit) for state income taxes	11	3	10	(5)
Provision (benefit) for income taxes	31	110	45	(6)

INCOME (LOSS) FROM CONTINUING OPERATIONS	1,452	(187)	1,683	(785)

Gain from discontinued operations of Gump’s, net of $22 of income tax benefit, including a gain on disposal of $3,576 at June 25, 2005	--	220	2,996	22

NET INCOME (LOSS) AND COMPREHENSIVE INCOME (LOSS)	1,452	33	4,679	(763)
Earnings applicable to Preferred Stock	36	--	115	--

NET INCOME (LOSS) APPLICABLE TO COMMON SHAREHOLDERS	$ 1,416	$ 33	$ 4,564	$ (763)

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NET INCOME (LOSS) PER COMMON SHARE:
From continuing operations – basic	$ 0.06	$ (0.01)	$ 0.07	$ (0.03)
From continuing operations – diluted	$ 0.04	$ (0.01)	$ 0.05	$ (0.03)
From discontinued operations – basic	$ 0.00	$ 0.01	$ 0.13	$ 0.00
From discontinued operations – diluted	$ 0.00	$ 0.01	$ 0.09	$ 0.00
Net income (loss) per common share – basic	$ 0.06	$ 0.00	$ 0.20	$ (0.03)
Net income (loss) per common share – diluted	$ 0.04	$ 0.00	$ 0.14	$ (0.03)
Weighted average common shares outstanding – basic (thousands)	22,426	22,017	22,426	22,017
Weighted average common shares outstanding – diluted (thousands)	32,564	22,017	32,574	22,017

See Notes to Condensed Consolidated Financial Statements.

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HANOVER DIRECT, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands of dollars)

(Unaudited)

	For the 26- Weeks Ended
	June 25, 2005	June 26, 2004 As Restated
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)	$ 4,679	$ (763)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization, including deferred fees	2,003	2,158
Provision for doubtful accounts	471	268
Special charges	18	42
Gain on the sale of Gump’s	(3,576)	--
Gain on the sale of property and equipment	(71)	--
Compensation expense related to stock options	79	122
Accretion of debt discount	1,547	--
Changes in assets and liabilities:
Accounts receivable	292	735
Inventories	(3,028)	2,938
Prepaid catalog costs	(4,133)	(5,188)
Accounts payable	1,807	(1,967)
Accrued liabilities	(664)	(1,082)
Customer prepayments and credits	4,522	5,173
Other, net	1,049	(932)
Net cash provided by operating activities	4,995	1,504
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisitions of property and equipment	(875)	(308)
Proceeds from disposal of property and equipment	80	--
Proceeds from the sale of Gump’s	8,921	--
Net cash provided (used) by investing activities	8,126	(308)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net payments under Wachovia revolving loan facility	(11,928)	(1,050)
Payments under Wachovia Tranche A term loan facility	(996)	(996)
Payments under Wachovia Tranche B term loan facility	--	(900)
Payments of long-term debt and capital lease obligations	(165)	(362)
Payment of debt issuance costs	--	(125)
Refund of estimated Richemont tax obligation on Series B Participating Preferred Stock accretion	--	347
Net cash used by financing activities	(13,089)	(3,086)
Net increase (decrease) in cash and cash equivalents	32	(1,890)
Cash and cash equivalents at the beginning of the year	510	2,282
Cash and cash equivalents at the end of the period	$ 542	$ 392

Supplemental Disclosures of Cash Flow Information:
Cash paid for:
Interest	$ 2,016	$ 1,332
Income taxes	$ 133	$ 8

See Notes to Condensed Consolidated Financial Statements.

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HANOVER DIRECT, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1.	BASIS OF PRESENTATION

The accompanying unaudited interim condensed consolidated financial statements have been prepared in accordance with the instructions for Form 10-Q and, therefore, do not include all information and footnotes necessary for a fair presentation of financial condition, results of operations and cash flows in conformity with generally accepted accounting principles. Reference should be made to the annual financial statements, including the footnotes thereto, included in the Hanover Direct, Inc. (the “Company”) Annual Report on Form 10-K for the fiscal year ended December 25, 2004. In the opinion of management, the accompanying unaudited interim condensed consolidated financial statements contain all material adjustments, consisting of normal recurring accruals, necessary to present fairly the financial condition, results of operations and cash flows of the Company and its consolidated subsidiaries for the interim periods. Operating results for interim periods are not necessarily indicative of the results that may be expected for the entire year. All references in these unaudited condensed consolidated financial statements to the number of shares outstanding, per share amounts, stock warrants, and stock option data relating to the Company’s common stock have been restated, as appropriate, to reflect the effect of the one-for-ten reverse stock split occurring at the close of business on September 22, 2004.

The Company has adjusted the calculation of its deferred tax assets and liabilities as of June 26, 2004 to also consider the effect of deferred state income taxes as of that date, as well as the Company has calculated deferred taxes on only those Net Operating Loss Carryforwards that may be utilizable in the future. These adjustments resulted in a decrease of the deferred tax assets and liabilities by $0.8 million and $0.8 million, respectively, as of June 26, 2004. As the Company’s net deferred tax asset had a full valuation allowance at that date, there was no impact on the Company’s financial position, cash flows or operating results for this change.

On March 14, 2005, the Company sold all of the stock of Gump’s Corp. and Gump’s By Mail, Inc. (collectively, “Gump’s”) to an unrelated third party (See Note 6). The Condensed Consolidated Statements of Income (Loss) reflects the Gump’s operating results and gain on sale as discontinued operations.

Uses of Estimates and Other Critical Accounting Policies

The condensed consolidated financial statements include all subsidiaries of the Company and all intercompany transactions and balances have been eliminated. The preparation of financial statements, in conformity with generally accepted accounting principles, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

See “Management’s Discussion and Analysis of Consolidated Financial Condition and Results of Operations,” found in the Company’s Annual Report on Form 10-K for the fiscal year ended December 25, 2004 for additional information relating to the Company’s use of estimates and other critical accounting policies.

2.	RESTATEMENTS OF FINANCIAL STATEMENTS

We have restated the condensed consolidated financial statements for the 13 and 26- week periods ended June 26, 2004 included in this Form 10-Q (the “Restatement”).

Buyers’ Club Program. In the first quarter of 2004, former management identified a potential issue with the accounting treatment of discount obligations due to members of certain of the Company’s buyers’ club programs, and at that time, an inappropriate conclusion regarding the accounting treatment was reached. During the third quarter of 2004, the issue was re-evaluated and we determined that an error in the accounting treatment had occurred. The impact of the error resulted in the overstatement of revenues and the omission of a liability related to the guarantee for discount obligations. The proper accounting treatment has been applied to the condensed consolidated financial statements for the second quarter of 2004.

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Revenue Recognition Issues. During the second quarter of 2004, the Company identified a revenue recognition cut-off issue that resulted in revenue being recorded in advance of the actual shipment of merchandise to the customer. The practice was stopped immediately. Subsequently, the Company determined that revenue should be recognized when merchandise is received by the customer rather than when shipped because the Company routinely replaces customer merchandise damaged or lost in transit as a customer service matter (even though risk of loss, as a legal matter, passes on shipment). As a consequence, the Company has restated the second quarter of 2004 to recognize revenue when merchandise is received by the customer.

Kaul Accrual. During the year ended December 30, 2000, the Company estimated its liability related to Rakesh Kaul’s claims regarding benefits to which he was entitled as a result of his resignation as CEO on December 5, 2000. The accompanying condensed consolidated financial statements contain a restatement related to the Kaul reserve that corrects an error in the accounting treatment of the reserve. The first error identified was the premature reversal of the reserve in the fourth quarter of 2003 based upon a summary judgment decision in January 2004. Because this decision could be, and subsequently was appealed, management has determined that the reversal was premature. The second error identified was the accounting for legal fees associated with litigating this claim. Due to the fact that the Kaul reserve was recorded prior to the initiation of litigation, the Company has determined that the appropriate basis of accounting for the legal fees related to the litigation would have been to treat such fees as period costs and, therefore, expensed as incurred. However, the Company inappropriately recorded certain of these fees against the reserve as opposed to recording them as an expense in the income statement. As of June 25, 2005, the Company had accrued $4.5 million related to this matter. This accrual remained on the Company’s Condensed Consolidated Balance Sheet until the third fiscal quarter of 2005 when Kaul’s rights to pursue this claim expired.

Customer Prepayments and Credits. Starting in fiscal 2001, the Company inappropriately reduced the liability for certain customer prepayments and credits. The impact of the inappropriate reduction of this liability resulted in the understatement of general and administrative expenses and the omission of the related liability. During the fourth quarter of 2004, the Company re-evaluated the accounting treatment for these customer prepayments and credits. As a consequence, the Company has applied the proper accounting treatment to the condensed consolidated financial statements for the second quarter of 2004.

The summary of the effects of the Restatement, inclusive of any tax implications, on the Company’s condensed consolidated financial statements for the 13 and 26- week periods ended June 26, 2004 is stated below. The amounts presented below “As Previously Reported” reflect the Gump’s operating results and gain on sale as discontinued operations.

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	Quarter ended June 26, 2004
	As Previously Reported	Buyers’ Club Adjustment	Revenue Recognition Adjustments	Kaul Accrual Adjustment	Customer Prepayments And Credits Adjustment	Other Accrual Adjustments	As Restated
	(In thousands, except per share amounts)
Inventories	$ 36,974	--	2,894	--	--	--	$ 39,868
Prepaid catalog costs	$ 15,780	--	1,893	--	--	--	$ 17,673
Other current assets	$ 3,132	--	689	--	--	--	$ 3,821
Total current assets	$ 69,610	--	5,476	--	--	--	$ 75,086
Deferred tax asset	$ 1,453	--	316	--	--	--	$ 1,769
Accounts payable	$ 39,678	--	77	--	--	1,020	$ 40,775
Accrued liabilities	$ 12,004	--	(434)	4,488	--	(10)	$ 16,048
Customer prepayments and credits	$ 5,839	2,394	7,432	--	987	--	$ 16,652
Deferred tax liability	$ 1,453	--	316	--	--	--	$ 1,769
Total current liabilities	$ 71,206	2,394	7,391	4,488	987	1,010	$ 87,476
Accumulated Deficit	$ (493,908)	(2,394)	(1,599)	(4,488)	(987)	(1,010)	$ (504,386)
Total Shareholders’ Deficiency	$ (46,503)	(2,394)	(1,599)	(4,488)	(987)	(1,010)	$ (56,981)
Net revenues	$ 86,870	(233)	1,107	--	--	--	$ 87,744
Cost of sales and operating expenses	$ 52,091	--	526	--	--	--	$ 52,617
Selling expenses	$ 23,360	--	268	--	--	65	$ 23,693
General and administrative expenses	$ 9,696	--	28	134	62	11	$ 9,931
Income before interest and income taxes	$ 843	(233)	285	(134)	(62)	(76)	$ 623
Benefit (provision) for Federal income taxes	$ 62	--	--	--	--	(169)	$ (107)
Benefit (provision) for state income taxes	$ 38	--	--	--	--	(41)	$ (3)
Net income (loss) and comprehensive income (loss)	$ 463	(233)	285	(134)	(62)	(286)	$ 33
Net income (loss) applicable to common shareholders	$ 463	(233)	285	(134)	(62)	(286)	$ 33
Net income (loss) per share-basic and diluted	$ 0.02	(0.01)	0.01	(0.01)	--	(0.01)	$ 0.00

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	Six months ended June 26, 2004
	As Previously Reported	Buyers’ Club Adjustment	Revenue Recognition Adjustments	Kaul Accrual Adjustment	Customer Prepayments And Credits Adjustment	Other Accrual Adjustments	As Restated
	(In thousands, except per share amounts)
Net revenues	$ 173,279	(497)	(3,757)	--	--	--	$ 169,025
Cost of sales and operating expenses	$ 105,413	--	(1,709)	--	--	--	$ 103,704
Selling expenses	$ 44,393	--	(1,216)	--	--	134	$ 43,311
General and administrative expenses	$ 19,360	--	(84)	134	120	23	$ 19,553
Income before interest and income taxes	$ 2,390	(497)	(748)	(134)	(120)	(157)	$ 734
Benefit (provision) for Federal income taxes	$ (1)	--	--	--	--	2	$ 1
Benefit (provision) for state income taxes	$ (4)	--	--	--	--	9	$ 5
Net income (loss) and comprehensive income (loss)	$ 882	(497)	(748)	(134)	(120)	(146)	$ (763)
Net income (loss) applicable to common shareholders	$ 882	(497)	(748)	(134)	(120)	(146)	$ (763)
Net income (loss) per share-basic and diluted	$ 0.04	(0.02)	(0.03)	(0.01)	(0.00)	(0.01)	$ (0.03)

The Restatement did not result in a change to the Company’s cash flows during the restated periods.

Audit Committee Investigation; SEC Inquiry

On November 17, 2004, the Audit Committee of the Board of Directors began an investigation of matters relating to restatements of the Company’s financial statements and other accounting-related matters with the assistance of independent outside counsel, Wilmer Cutler Pickering Hale and Dorr LLP (“Wilmer Cutler”).

On March 14, 2005, the Audit Committee reported that it had concluded its investigation and, with the assistance of Wilmer Cutler, reported its findings to the Board of Directors. The Audit Committee, again with the assistance of Wilmer Cutler, formulated a series of recommendations to the Company and the Board of Directors concerning potential improvements in the Company’s internal controls and procedures for financial reporting. The Board of Directors and management have begun implementing these recommendations.

The Company was notified on January 11, 2005 by the Securities and Exchange Commission (“SEC”) that it was conducting an informal inquiry relating to the Company’s financial results and financial reporting since 1998. The SEC indicated in its letter to the Company that the inquiry should not be construed as an indication by the SEC that there has been any violation of the federal securities laws. The Company is cooperating fully with the SEC in connection with the inquiry and directed Wilmer Cutler to brief the SEC and the Company’s former independent registered public accounting firm, KPMG LLP (“KPMG”), on the results of its investigation. Wilmer Cutler has briefed both the SEC and KPMG on the results of the investigation. The Company intends to continue to cooperate with the SEC in connection with its informal inquiry concerning the Company’s financial reporting.

3.	NET INCOME (LOSS) PER COMMON SHARE

Net income (loss) per common share is computed using the weighted average number of common shares outstanding in accordance with the provisions of SFAS No. 128, “Earnings Per Share” (“SFAS 128”). Basic net income (loss) per common share is calculated by dividing net income (loss) available to common shareholders, reduced for participatory interests, by the weighted average number of common shares outstanding during the period. Diluted net income (loss) per common share is calculated using the weighted average number of common shares outstanding adjusted to include the potentially dilutive effect of stock options and stock warrants. The computations of basic and diluted net income (loss) per common share are as follows (in thousands except per share

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amounts):

	For the 13- Weeks Ended		For the 26- Weeks Ended
	June 25, 2005	June 26, 2004 As Restated	June 25, 2005	June 26, 2004 As Restated

Net income (loss)	$ 1,452	$ 33	$ 4,679	$ (763)
Less:
Earnings applicable to preferred stock	36	--	115	--
Net income (loss) applicable to common shareholders	$ 1,416	$ 33	$ 4,564	$ (763)
Basic net income (loss) per common share	$ 0.06	$ 0.00	$ 0.20	$ (0.03)

Weighted-average common shares outstanding	22,426	22,017	22,426	22,017

Diluted net income (loss)	$ 1,416	$ 33	$ 4,564	$ (763)
Diluted net income (loss) per common share	$ 0.04	$ 0.00	$ 0.14	$ (0.03)

Weighted-average common shares outstanding	22,426	22,017	22,426	22,017
Effect of Dilution:
Stock options	2	--	1	--
Stock warrants (issued July 8, 2004)	10,136	--	10,147	--
Weighted-average common shares outstanding assuming dilution	32,564	22,017	32,574	22,017

Diluted net loss per common share excluded incremental weighted-average shares of 24,607 for the 26-week period ended June 26, 2004. These incremental weighted-average shares were related to employee stock options and were excluded due to their anti-dilutive effect. No dilutive securities existed for the 13-week period ended June 26, 2004.

4.	CONTINGENCIES

As of June 25, 2005, the Company had accrued $4.5 million related to this matter. This accrual remained on the Company’s Condensed Consolidated Balance Sheet until the third fiscal quarter of 2005 when Kaul’s rights to pursue this claim expired.

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Class Action Lawsuits:

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Claims for Post-Employment Benefits

5.	SPECIAL CHARGES

2004 Plan

On June 30, 2004 the Company announced its plan to consolidate the operations of the LaCrosse, Wisconsin fulfillment center and storage facility into the Roanoke, Virginia fulfillment center by June 30, 2005. The LaCrosse fulfillment center and the storage facility were closed in June 2005 and August 2005, upon the expiration of their respective leases. The Company substantially completed the consolidation into the Roanoke, Virginia fulfillment center by the end of June 2005. The Company has incurred approximately $0.6 million in facility exit costs through June 25, 2005. The Company accrued $0.5 million in severance and related costs during 2004 associated with the LaCrosse operations and the elimination of 149 full and part-time positions, of which 96 employees will be provided severance benefits by the Company.

On November 9, 2004, the Company decided to relocate its International Male and Undergear catalog operations to its offices in New Jersey. The Company completed the relocation on February 28, 2005. The relocation was done primarily to consolidate operations, reduce costs, and leverage its catalog expertise in New Jersey. The Company accrued $0.9 million in severance and related costs during the fourth quarter 2004 associated with the elimination of 32 California based full-time equivalent positions.

During the first two quarters of 2005, the reserve activity represents the utilization of the severance reserves established in 2004 for the Lacrosse fulfillment center and storage facility and the International Male and Undergear catalog operations as well as additional severance charges of less than $0.1 million.

2000 Plan

Plan Summary

At June 25, 2005, a current liability of approximately $0.4 million was included within Accrued Liabilities relating to future payments in connection with the Company’s 2000 and 2004 plans and consists of the following (in thousands):

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	Severance & Personnel Costs	Real Estate Lease & Exit Costs
	2004 Plan	2000 Plan	Total

Balance at December 25, 2004	$ 1,518	$ 3,360	$ 4,878
2005 expenses	18	--	18
Paid in 2005	(1,153)	(538)	(1,691)
Reductions due to sale of Gump’s	--	(2,822)	(2,822)
Balance at June 25, 2005	$ 383	$ --	$ 383

6.	SALE OF GUMP’S BUSINESS

On March 14, 2005, the Company sold all of the stock of Gump’s to Gump’s Holdings, LLC, an unrelated third party (“Purchaser”) for $8.9 million, including a purchase price adjustment of $0.4 million, pursuant to the terms of a February 11, 2005 Stock Purchase Agreement. The Company recognized a gain of approximately $3.6 million in the quarter ended March 26, 2005. Chelsey, as the holder of all of the Series C Participating Preferred Stock (“Series C Preferred”), consented to the application of the sales proceeds to reduce the outstanding balance of the Wachovia Facility in lieu of the current redemption of a portion of the Series C Preferred. Chelsey expressly retained its right to require redemption of approximately $6.9 million of the Series C Preferred subject to Wachovia’s approval.

After the sale, the Company continues as the guarantor of one of the two leases for the San Francisco building where the store is located (the Company was released from liability on the other lease). The Purchaser is required to use its commercially reasonable efforts to secure the Company’s release from the guarantee within a year of the closing. If the Purchaser cannot secure the Company’s release within a year of the closing, an affiliate of the Purchaser will either (i) transfer a percentage interest in its business so that the Company will own, indirectly, 5% interest of the Purchaser’s common stock, or (ii) provide the Company with a $2.5 million stand-by letter of credit or other form of compensation acceptable to the Company to reimburse the Company for any liabilities the Company may incur under the guarantee until the Company is released from the guarantee or the lease is terminated. As of September 15, 2005 there are $7.6 million (net of $0.5 million in expected sublease income) in lease commitments for which the Company is the guarantor. Based on its evaluation, the Company has concluded it is unlikely any payments will be required under the guarantee, thus has not established a guarantee liability as of the March 14, 2005 sale date or as of June 25, 2005.

The Company entered into a Direct Marketing Services Agreement with the Purchaser to provide telemarketing and fulfillment services for the Gump’s catalog and direct marketing businesses for 18 months. We have the option to extend the term for an additional 18 months.

Listed below are the carrying values of the major classes of assets and liabilities of Gump’s included in the Consolidated Balance Sheets:

In thousands (000’s)	December 25, 2004	June 26, 2004
Total current assets	$ 10,842	$ 9,430
Total non-current assets	$ 3,221	$ 3,547
Total assets	$ 14,063	$ 12,977
Total current liabilities	$ 6,727	$ 6,487
Total non-current liabilities	$ 3,283	$ 3,676
Total liabilities	$ 10,010	$ 10,163

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In thousands (000’s)

13- Weeks Ended

June 26,

2004

26- Weeks Ended

June 26,

2004

Net revenues

$ 9,142

$ 18,045

Income before income taxes

$ 219

$ 23

7.	CHANGES IN MANAGEMENT

New Officers

On March 8, 2005, the Company terminated the employment of Charles E. Blue, the Company’s former Chief Financial Officer. Wayne P. Garten, the Company’s Chief Executive Officer, served as interim Chief Financial Officer until April 4, 2005 when John W. Swatek was appointed as the Company’s Senior Vice President, Chief Financial Officer and Treasurer.

DEBT

The Company has two credit facilities: a senior secured credit facility (the “Wachovia Facility”) provided by Wachovia National Bank (“Wachovia”) and a $20.0 million junior secured facility (the “Chelsey Facility”), provided by Chelsey Finance, LLC (“Chelsey Finance”), of which the entire $20.0 million was borrowed by the Company. Chelsey Finance is an affiliate of Chelsey, the Company’s principal shareholder.

As of June 25, 2005, December 25, 2004 and June 26, 2004, debt consisted of the following (in thousands):

	June 25, 2005	December 25, 2004	June 26, 2004
	June 25, 2005	December 25, 2004	June 26, 2004

Wachovia facility:
Tranche A term loans – Current portion, interest rate of 6.5% at June 25, 2005, 5.5% at December 25, 2004 and 4.75% at June 26, 2004	$ 1,992	$ 1,992	$ 1,992
Tranche B term loan – Current portion, interest rate of 13.0% in 2004	--	--	1,800
Revolver, interest rate of 6.5% at June 25, 2005, 5.5% at December 25, 2004 and 4.5% at June 26, 2004	2,480	14,408	7,947
Capital lease obligations – Current portion	163	290	493
Short-term debt	4,635	16,690	12,232

Wachovia facility:
Tranche A term loans, interest rate of 6.5% at June 25, 2005, 5.5% at December 25, 2004 and 4.75% at June 26, 2004	1,989	2,985	3,482
Tranche B term loan, interest rate of 13% at June 26, 2004	--	--	3,311
Chelsey facility – stated interest rate of 11.0% (5.0% above prime rate) at June 25, 2005 and 10.0% (5.0% above prime rate) at December 25, 2004	9,706	8,159	--
Capital lease obligations	14	52	177
Long-term debt	11,709	11,196	6,970
Total debt	$ 16,344	$ 27,886	$ 19,202

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Wachovia Facility

Currently, the Wachovia facility has a Tranche A term loan outstanding which has a principal balance of approximately $4.0 million as of June 25, 2005, of which approximately $2.0 million is classified as short term and approximately $2.0 million is classified as long term on the Condensed Consolidated Balance Sheet. The Tranche A term loan bears interest at 0.5% over the Wachovia prime rate and requires monthly principal payments of approximately $166,000. As of June 25, 2005, the interest rate on the Tranche A term loan was 6.5%.

The Revolver has a maximum loan limit of $34.5 million, subject to inventory and accounts receivable sublimits that limit the credit available to the Company’s subsidiaries, which are borrowers under the Revolver. The interest rate on the Revolver is currently 0.5% over the Wachovia prime rate. As of June 25, 2005, the interest rate on the Revolver was 6.5%.

Due to, among other things, the Restatement which resulted in the Company violating several financial covenants and the Company’s inability to timely file its periodic reports with the SEC, both as discussed in Note 2, the Company was in technical default under the Wachovia and Chelsey Facilities. The Company has obtained waivers from both Wachovia and Chelsey Finance for such defaults.

Remaining availability under the Wachovia Facility as of June 25, 2005 was $14.0 million.

2005 Amendments to Wachovia Loan Agreement

On July 29, 2005 the Company and Wachovia amended the Wachovia Loan Agreement to provide the terms under which the Company could enter into the World Financial Network National Bank (“WFNNB”) Credit Card Agreement which, among other things, prohibits the use of the proceeds of the Wachovia Facility to repurchase private label accounts created under the WFNNB Credit Card Agreement should the Company become obligated to do so, prohibits the Company from terminating WFNNB Credit Card Agreement without Wachovia’s consent and restricts the Company from borrowing on receivables generated under the WFNNB Credit Card Agreement. The amendment also waives enumerated defaults, resets the financial covenants, reallocates the availability that was previously allocated to Gump’s and Gump’s By Mail among other Company subsidiaries and, retroactive to June 30, 2005, increases the amount of letter of credits that the Company can issue to $15.0 million. The amendment also requires that the Company enter into an amended and restated loan agreement with Wachovia by October 31, 2005. The Company paid Wachovia a $60,000 fee in connection with this amendment.

On July 29, 2005 the Company and Chelsey Finance entered into a similar amendment of the Chelsey Facility.

Chelsey Facility

The Chelsey Facility is a $20.0 million junior secured credit facility with Chelsey Finance that was recorded at net of an un-accreted debt discount of $7.1 million. The Chelsey Facility has a three-year term, subject to earlier maturity upon the occurrence of a change in control or sale of the Company (as defined), and carries a stated interest rate of 5% above the prime rate publicly announced by Wachovia. The Company is not obligated to make principal payments until July 8, 2007, except if there is a change in control or sale of the Company. At June 25, 2005, the amount recorded as debt on the Condensed Consolidated Balance Sheet is $9.7 million, net of the un-accreted debt discount of $10.3 million.

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In accordance with Accounting Principles Board Opinion No. 14, “Accounting for Convertible Debt and Debt Issued with Stock Purchase Warrants” (“APB 14”), proceeds received from the sale of debt with detachable stock purchase warrants should be allocated to both the debt and warrants, with the portion allocable to the warrants to be accounted for as Capital in excess of par value with the remaining portion, or $7.1 million, classified as debt. The fair value of the Common Stock Warrant of $12.9 million was determined using the Black-Scholes option pricing model and is being treated as debt discount, which will be accreted as interest expense utilizing the interest method over the 36-month term of the Chelsey Facility. The assumptions used for the Black-Scholes option pricing model were as follows: risk-free interest rate of 4.5%, expected volatility of 80.59%, an expected life of ten years and no expected dividends. A summary of the debt relating to the Chelsey Facility is as follows (in thousands):

	June 25, 2005	December 25, 2004

Amount Borrowed Under the Chelsey Facility	$ 20,000	$ 20,000
Fair Value of Common Stock Warrant (Recorded as Capital in excess of par value)	(12,939)	(12,939)
Accretion of Debt Discount (Recorded as Interest Expense)	2,645	1,098

	$ 9,706	$ 8,159

9.	PRIVATE LABEL AND COBRAND CREDIT CARD AGREEMENT

On February 22, 2005, the Company entered into a seven year co-brand and private label credit card agreement (as amended by Amendment Number One on March 30, 2005 “Credit Card Agreement”) with World Financial Network National Bank (“WFNNB”) under which WFNNB will provide private label (branded) and co-brand credit cards to the Company’s customers. The Company began offering the private label credit card to its customers in April 2005. The program extends credit to our customers at no credit risk to the Company and is expected to lead to increased sales and lower expenses. WFNNB will provide a fixed dollar amount of marketing funds in the first year of which 25.0% of any unused amount can be utilized in the first six months of the second year and a percentage of the lesser of private label net sales or average accounts receivable balance in later years to support the Company’s promotion of the program. In general, WFNNB will pay the Company proceeds from sales of Company merchandise using the cards issued under the program with no discount. In addition, WFNNB paid the Company an upfront fee when the private label plan commenced and will pay a per card fee for each card issued under the co-brand program and a percentage of the net finance charges on co-brand accounts.

If the Credit Card Agreement is terminated or expires other than as a result of a default by WFNNB, the Company will be obligated to purchase any outstanding private label accounts at their fair market value. The Company will have the option of purchasing any outstanding co-brand accounts at their fair market value when the Credit Card Agreement terminates unless the termination is attributable to the Company’s default. Under the 34^th Amendment to the Loan & Security Agreement executed by the Company and Wachovia on July 29, 2005 the Company is prohibited from using the Wachovia Facility to fund the purchase of the private label and co-brand accounts. As a consequence, should the Company become obligated to purchase the private label accounts and should it not have secured a replacement credit card program with a new credit card issuer, the Company will be forced to seek financing from a different source which financing will be subject to Wachovia’s and Chelsey’s approval.

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

The following table sets forth, for the fiscal periods indicated, the percentage relationship to net revenues of certain items in the Company’s Condensed Consolidated Statements of Income (Loss):

	13- Weeks Ended				26- Weeks Ended
	June 25, 2005		June 26, 2004		June 25, 2005		June 26, 2004
			As Restated				As Restated

Net revenues	100.0	%	100.0	%	100.0	%	100.0	%
Cost of sales and operating expenses	60.9		60.0		60.6		61.4
Special charges	0.0		0.0		0.0		0.0
Selling expenses	25.7		27.0		25.3		25.6
General and administrative expenses	9.2		11.3		10.4		11.6
Depreciation and amortization	0.8		1.0		0.8		1.0
Income (loss) from operations	3.4		0.7		2.9		0.4
Interest expense, net	1.9		0.8		2.0		0.9
(Benefit) provision for Federal and state income taxes	0.1		0.1		0.0		0.0
Gain (loss) from discontinued operations of Gump’s	0.0		0.2		1.6		0.0
Net income (loss) and comprehensive income (loss)	1.4		0.0		2.5		(0.5)
Earnings applicable to Preferred Stock	0.0		0.0		0.1		0.0
Net income (loss) applicable to common shareholders	1.4	%	0.0	%	2.4	%	(0.5)	%

Restatement of Prior Year Financial Information and Related Matters

During the second quarter of 2004, the Company identified a revenue recognition cut-off issue that resulted in revenue being recorded in advance of the actual shipment of merchandise to the customer. The practice was stopped immediately. Subsequently, the Company determined that revenue should be recognized when merchandise is received by the customer rather than when shipped because the Company routinely replaces customer merchandise damaged or lost in transit as a customer service matter (even though risk of loss, as a legal matter, passes on shipment). As a consequence, the Company has restated the condensed consolidated financial statements for the second quarter of 2004 to recognize revenue when merchandise is received by the customer.

In the first quarter of 2004, former management identified a potential issue with the accounting treatment for Buyers’ Club memberships that contained a guarantee. At that time, an inappropriate conclusion regarding the accounting treatment was reached and during the third quarter of 2004, the issue was re-evaluated and we determined that an error in the accounting treatment had occurred. The impact of the error resulted in an overstatement of revenues and the omission of the related liability for guarantee obligations. The proper accounting treatment has been applied to the condensed consolidated financial statements for the second quarter of 2004.

Starting in fiscal 2001, the Company inappropriately reduced the liability for certain customer prepayments and credits. The impact of the inappropriate reduction of this liability resulted in the understatement of general and administrative expenses and the omission of the related liability. During the fourth quarter of 2004, the Company re-evaluated the accounting treatment for these customer prepayments and credits. As a consequence, the Company has applied the proper accounting treatment to the condensed consolidated financial statements for the second quarter of 2004.

The Company also corrected its accounting for an accrual related to a claim for post-employment benefits by a former CEO. See Note 4, Rakesh Kaul v. Hanover Direct, Inc.

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In addition, the Company has recorded other liabilities relating primarily to certain miscellaneous catalog costs and other miscellaneous costs that were inappropriately not accrued in the necessary periods and has made adjustments to the federal and state tax provision and deferred tax asset and liabilities to reflect the effect of the Restatement.

The Audit Committee of the Board of Directors conducted an investigation related to these issues (except for the revenue recognition issue based on receipt of merchandise by the customer that was addressed by the Company subsequent to the conclusion of the investigation) and other accounting-related matters with the assistance of independent outside counsel. The Company’s inability to timely file its financial statements as well as its non-compliance with several of the American Stock Exchange (“AMEX”) listing criteria caused the Company’s common stock to no longer be traded on the AMEX as of February 16, 2005. In addition, the SEC is currently conducting an informal inquiry of the Company. We intend to continue our cooperation with the SEC with its informal inquiry concerning our financial reporting.

See Note 2 to the condensed consolidated financial statements for additional information regarding the Restatement.

Executive Summary

During the first six months of 2005, net revenues increased $20.9 million or 12.4% to $189.9 million from $169.0 million in the first six months of 2004. The increase was primarily driven by an increase in catalog circulation levels supported by deeper inventory positions that enabled higher initial fulfillment rates for customer orders and lower overall cancellation rates. Higher demand was experienced in The Company Store, Domestications and Silhouettes catalogs, while lower demand was experienced in the International Male catalogs which are in the process of being repositioned to return it to its roots as a young men’s “lifestyle” fashion leader. This merchandising shift will be evident in catalogs commencing in the fourth quarter of 2005. The Domestications catalog experienced strong demand however lower initial fill and higher cancellation rates due to insufficient inventory positions negatively impacted its operating results. The Company is increasing inventory positions for Domestications to support the growth and improve the operating results in this catalog.

We also completed the implementation of strategies to reduce the infrastructure of the Company which were developed during fiscal 2004. These strategies included the consolidation of the operations of the LaCrosse, Wisconsin fulfillment center into the Roanoke, Virginia fulfillment center, which was substantially completed by the end of June 2005; the relocation of the International Male and Undergear catalog operations from San Diego, California to the corporate headquarters in Weehawken, New Jersey, which was completed February 28, 2005; and the consolidation of the Edgewater facility into the Weehawken, New Jersey premises, which was completed by May 31, 2005.

On March 14, 2005, the Company sold all of the stock of Gump’s Corp. and Gump’s By Mail, Inc. (collectively, “Gump’s”) to Gump’s Holdings, LLC, an unrelated third party for $8.9 million, including a purchase price adjustment of $0.4 million, pursuant to the terms of a February 11, 2005 Stock Purchase Agreement. The Company recognized a gain on the sale of approximately $3.6 million in the quarter ended March 26, 2005. Chelsey, as the holder of all of the Series C Participating Preferred Stock (“Series C Preferred”), consented to the application of the sales proceeds to reduce the outstanding balance of the Wachovia Facility in lieu of the current redemption of a portion of the Series C Preferred. Chelsey expressly retained its right to require redemption of approximately $6.9 million of the Series C Preferred subject to Wachovia’s approval.

Results of Operations – 13- weeks ended June 25, 2005 compared with the 13- weeks ended June 26, 2004 as restated

Net Income. The Company reported net income applicable to common shareholders of $1.4 million, or $0.06 basic income per share and $0.04 diluted income per share, for the 13- weeks ended June 25, 2005 compared with net income applicable to common shareholders of $0.0 million, or $0.00 basic and diluted income per share, for the comparable period in 2004.

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The Company primarily attributes the increase in net income to the following:

•	Improved operating results generated from a $12.5 million increase in net revenues;
•	A favorable impact of $0.9 million due to the reduction in general and administrative expenses related to severance recorded in the second quarter of 2004.

Partially offset by:

•	An unfavorable impact of $1.2 million on net interest expense primarily due to interest costs incurred with the $20.0 million junior secured credit facility with Chelsey Finance (“Chelsey Facility,”) which the Company closed on July 8, 2004. See Note 8 of Notes to the condensed consolidated financial statements for additional information regarding the Chelsey Facility;
•	An unfavorable impact of $0.2 million of discontinued operations representing income from Gump’s on-going operations for the 13- weeks ended June 26, 2004.

Net Revenues. Net revenues increased $12.5 million (14.2%) for the 13-week period ended June 25, 2005 to $100.2 million from $87.7 million for the comparable period in 2004. This increase was primarily driven by an increase in catalog circulation levels supported by deeper inventory positions that enabled higher initial fulfillment rates for customer orders and lower overall cancellation rates. Higher demand was experienced in The Company Store, Domestications and Silhouettes catalogs, while lower demand was experienced for the International Male catalogs. The Domestications catalog experienced strong demand for its merchandise however lower initial fill and higher cancellation rates due to insufficient inventory positions negatively impacted its operating results. The Company is increasing inventory positions for Domestications to support the growth in this catalog. Internet sales increased and comprised 37.0% of combined Internet and catalog revenues for the 13- weeks ended June 25, 2005 compared with 33.6% for the comparable fiscal period in 2004, and have increased by approximately $5.7 million, or 21.0%, to $32.8 million for the 13-week period ended June 25, 2005 from $27.1 million for the comparable period in 2004.

Cost of Sales and Operating Expenses. Cost of sales and operating expenses increased by $8.4 million to $61.0 million for the 13- weeks ended June 25, 2005 as compared with $52.6 million for the comparable period in 2004. Cost of sales and operating expenses increased to 60.9% of net revenues for the 13-week period ended June 25, 2005 as compared with 60.0% of net revenues for the comparable period in 2004. As a percentage of net revenues, this increase was primarily due to increases in product postage costs and higher inventory obsolescence charges on slower moving merchandise. These increases were partially offset by a decline in merchandise costs associated with the ability to source goods that have higher product margins.

Special Charges. In December 2000 and June 2004, the Company implemented strategic business realignment programs that resulted in the recording of special charges for severance, facility exit costs and fixed asset write-offs. The actions related to the strategic business realignment programs were taken in an effort to direct the Company’s resources primarily towards a loss reduction strategy and a return to profitability. There were nominal special charges (income) recorded for the 13- weeks ended June 25, 2005 and June 26, 2004.

Selling Expenses. Selling expenses increased by $2.1 million to $25.8 million for the 13- weeks ended June 25, 2005 as compared with $23.7 million for the comparable period in 2004. Selling expenses decreased to 25.7% of net revenues for the 13- weeks ended June 25, 2005 from 27.0% for the comparable period in 2004. As a percentage of net revenues, this change was due primarily due to increases in total revenue that exceeded the additional selling expenses due to better response rates on the higher catalog circulation.

General and Administrative Expenses. General and administrative expenses decreased by $0.7 million to $9.2 million for the 13- weeks ended June 25, 2005 as compared with $9.9 million for the comparable period in 2004. As a percentage of net revenues, general and administrative expenses declined to 9.2% of net revenues for the 13-week period ended June 25, 2005 as compared to 11.3% of net revenues for the comparable period in 2004. As a percentage of net revenues, this decrease was primarily due to severance and other costs incurred during the 13- weeks ended June 26, 2004 associated with the resignation of the Company’s former President. This decrease was

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partially offset by additional audit fees incurred during the 13-weeks ended June 25, 2005 associated with the Company’s restated financial statements.

Depreciation and Amortization. Depreciation and amortization decreased approximately $0.1 million during the 13- weeks ended June 25, 2005 from the comparable period in 2004. The decrease was primarily due to property and equipment that have become fully depreciated, partially offset by the depreciation of newly purchased property and equipment.

Income from Operations. The Company’s income from operations increased by approximately $2.8 million to $3.4 million for the 13- weeks ended June 25, 2005 from $0.6 million for the comparable period in 2004. See “Results of Operations – 13- weeks ended June 25, 2005 compared with the 13- weeks ended June 26, 2004 as restated - Net Income (Loss)” for further details as the relationships are the same excluding the discussion on income tax and interest expense.

Interest Expense, Net. Interest expense, net, increased $1.2 million to $1.9 million for the 13- weeks ended June 25, 2005 from $0.7 million for the comparable period in fiscal 2004. This increase in interest expense is primarily due to $0.8 million of accretion of the debt discount and $0.6 million of stated interest related to the Chelsey Facility during the 13- weeks ended June 25, 2005. These increases were partially offset by a decrease in interest expense due to lower average cumulative borrowings relating to the Wachovia Facility in the amount of $0.2 million.

Income Taxes. The provision for federal and state income taxes is approximately 2.1% of income before income taxes for the 13- week period ended June 25, 2005.

Gain (loss) from discontinued operations of Gump’s. On March 14, 2005, the Company sold all of the stock of to Gump’s Holdings, LLC, an unrelated third party. The Company recognized a gain of $0.2 million representing income from Gump’s on-going operations for the 13- weeks ended June 26, 2004.

Results of Operations – 26- weeks ended June 25, 2005 compared with the 26- weeks ended June 26, 2004 as restated

Net Income (Loss). The Company reported net income applicable to common shareholders of $4.6 million, or $0.20 basic income per share and $0.14 diluted income per share, for the 26- weeks ended June 25, 2005 compared with a net loss applicable to common shareholders of $0.8 million, or $0.03 basic and diluted loss per share, for the comparable period in 2004.

The Company primarily attributes the increase in net income to the following:

•	Improved operating results generated from a $20.9 million increase in net revenues;
•	A favorable impact of $3.0 million of discontinued operations due to the gain of $3.6 million recognized relating to the March 14, 2005 sale of stock of Gump’s;
•	A favorable impact of $1.5 million due to the reduction in general and administrative expenses related to severance recorded in the second quarter of 2004.

Partially offset by:

•	An unfavorable impact of $2.2 million on net interest expense primarily due to interest costs incurred with the $20.0 million junior secured credit facility with Chelsey Finance (“Chelsey Facility,”) which the Company closed on July 8, 2004. See Note 8 of Notes to the condensed consolidated financial statements for additional information regarding the Chelsey Facility;
•	An unfavorable impact of $0.9 million related to general and administrative expenses incurred for the investigation conducted by the Audit Committee of the Board of Directors in connection with the restatement of the Company’s consolidated financial statements and other accounting-related matters.

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Net Revenues. Net revenues increased $20.9 million (12.4%) for the 26-week period ended June 25, 2005 to $189.9 million from $169.0 million for the comparable period in 2004. This increase was primarily driven by an increase in catalog circulation levels supported by deeper inventory positions that enabled higher initial fulfillment rates for customer orders and lower overall cancellation rates. Higher demand was experienced in The Company Store, Domestications and Silhouettes catalogs, while lower demand was experienced for the International Male catalogs. The Domestications catalog experienced strong demand for its merchandise however lower initial fill and higher cancellation rates due to insufficient inventory positions negatively impacted its operating results. The Company is increasing inventory positions for Domestications to support the growth in this catalog. Internet sales increased and comprised 38.0% of combined Internet and catalog revenues for the 26- weeks ended June 25, 2005 compared with 34.0% for the comparable fiscal period in 2004, and have increased by approximately $11.0 million, or 20.9%, to $63.9 million for the 26-week period ended June 25, 2005 from $52.9 million for the comparable period in 2004.

Cost of Sales and Operating Expenses. Cost of sales and operating expenses increased by $11.3 million to $115.0 million for the 26- weeks ended June 25, 2005 as compared with $103.7 million for the comparable period in 2004. Cost of sales and operating expenses decreased to 60.6% of net revenues for the 26-week period ended June 25, 2005 as compared with 61.4% of net revenues for the comparable period in 2004. As a percentage of net revenues, this decrease was primarily due to declines in merchandise costs associated with the ability to source goods that have higher product margins and decreases in information technology costs due to declines in equipment rentals and maintenance. These decreases were partially offset by increases in product postage costs.

Special Charges. In December 2000 and June 2004, the Company implemented strategic business realignment programs that resulted in the recording of special charges for severance, facility exit costs and fixed asset write-offs. The actions related to the strategic business realignment programs were taken in an effort to direct the Company’s resources primarily towards a loss reduction strategy and a return to profitability. There were nominal special charges recorded for the 26- weeks ended June 25, 2005 and June 26, 2004.

Selling Expenses. Selling expenses increased by $4.7 million to $48.0 million for the 26- weeks ended June 25, 2005 as compared with $43.3 million for the comparable period in 2004. Selling expenses decreased to 25.3% of net revenues for the 26- weeks ended June 25, 2005 from 25.6% for the comparable period in 2004. As a percentage of net revenues, this change was due primarily due to increases in total revenue that exceeded the additional selling expenses due to better response rates on the higher catalog circulation.

General and Administrative Expenses. General and administrative expenses increased by $0.3 million to $19.8 million for the 26- weeks ended June 25, 2005 as compared with $19.5 million for the comparable period in 2004. As a percentage of net revenues, general and administrative expenses declined to 10.4% of net revenues for the 26-week period ended June 25, 2005 as compared to 11.6% of net revenues for the comparable period in 2004. As a percentage of net revenues, this decrease was primarily due to severance and other costs incurred during the 26- weeks ended June 26, 2004 associated with the resignation of three executives, including the Company’s former President. This decrease was partially offset by additional fees incurred for the investigation conducted by the Audit Committee of the Board of Directors in connection with the restatement of the Company’s consolidated financial statements and other accounting-related matters.

Depreciation and Amortization. Depreciation and amortization decreased $0.2 million to $1.5 million for the 26- weeks ended June 25, 2005 from $1.7 million for the comparable period in 2004. The decrease was primarily due to property and equipment that have become fully depreciated, partially offset by the depreciation of newly purchased property and equipment.

Income from Operations. The Company’s income from operations increased by approximately $4.8 million to $5.5 million for the 26- weeks ended June 25, 2005 from $0.7 million for the comparable period in 2004. See “Results of Operations – 26- weeks ended June 25, 2005 compared with the 26- weeks ended June 26, 2004 as restated - Net Income (Loss)” for further details as the relationships are the same excluding the discussion on income tax and interest expense.

Interest Expense, Net. Interest expense, net, increased $2.3 million to $3.8 million for the 26- weeks ended June 25, 2005 from $1.5 million for the comparable period in fiscal 2004. This increase in interest expense is

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primarily due to $1.5 million of accretion of the debt discount and $1.1 million of stated interest related to the Chelsey Facility during the 26- weeks ended June 25, 2005. These increases were partially offset by a decrease in interest expense due to lower average cumulative borrowings relating to the Wachovia Facility in the amount of $0.4 million.

Income Taxes. The provision for federal and state income taxes is approximately 2.6% of income before income taxes for the 26- week period ended June 25, 2005.

Gain (loss) from discontinued operations of Gump’s. On March 14, 2005, the Company sold all of the stock of to Gump’s Holdings, LLC, an unrelated third party. The Company recognized a gain of approximately $3.6 million in the 26- weeks ended June 25, 2005, offset by losses from Gump’s on-going operations through the sale date of approximately $0.6 million.

LIQUIDITY AND CAPITAL RESOURCES

Overview

In 2005, the liquidity position of the Company continues to strengthen as a result of improved operating results, proceeds from the sale of Gump’s and as a result of securing the $20.0 million Chelsey Facility on July 8, 2004 and concurrently amending the terms of the Wachovia Facility. The additional working capital has continued to provide us the ability to restore inventory to adequate levels in order to support higher demand driven by an overall increase in catalog circulation. The funding has eliminated substantially all vendor restrictions involving our credit arrangements. The $8.9 million in proceeds from the sale of Gump’s enabled the Company to pay down $8.1 million of the Wachovia revolving loan facility during the first quarter of 2005.

Net cash provided by operating activities. During the 26-week period ended June 25, 2005, net cash provided by operating activities was $5.0 million. This was due primarily to an increase in customer prepayments and credits, and $5.2 million of operating cash provided by net income, when adjusted for the gain on the disposition of Gump’s, depreciation, amortization and other non cash items, offset by payments made by the Company to increase inventory and prepaid catalog costs and reduce accrued liabilities.

Net cash provided (used) by investing activities. During the 26-week period ended June 25, 2005, net cash provided by investing activities was $8.1 million. This was due primarily to $8.9 million in proceeds received from the sale of Gump’s, partially offset by capital expenditures, consisting primarily of purchases and upgrades to various information technology hardware and software throughout the Company and purchases of furniture and equipment for the Company’s headquarters in New Jersey.

Net cash used by financing activities. During the 26-week period ended June 25, 2005, net cash used by financing activities was $13.1 million, which was primarily due to net payments of $12.9 million under the Wachovia Facility and payments of $0.2 million for obligations under capital leases.

Financing Activities

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As of June 25, 2005, December 25, 2004 and June 26, 2004, debt consisted of the following (in thousands):

	June 25, 2005	December 25, 2004	June 26, 2004
	June 25, 2005	December 25, 2004	June 26, 2004
Wachovia facility:
Tranche A term loans – Current portion, interest rate of 6.5% at June 25, 2005, 5.5% at December 25, 2004 and 4.75% at June 26, 2004	$ 1,992	$ 1,992	$ 1,992
Tranche B term loan – Current portion, interest rate of 13.0% in 2004	--	--	1,800
Revolver, interest rate of 6.5% at June 25, 2005, 5.5% at December 25, 2004 and 4.5% at June 26, 2004	2,480	14,408	7,947
Capital lease obligations – Current portion	163	290	493
Short-term debt	4,635	16,690	12,232

Wachovia facility:
Tranche A term loans, interest rate of 6.5% at June 25, 2005, 5.5% at December 25, 2004 and 4.75% at June 26, 2004	1,989	2,985	3,482
Tranche B term loan, interest rate of 13.0% at June 26, 2004	--	--	3,311
Chelsey facility – stated interest rate of 11.0% (5.0% above prime rate) at June 25, 2005 and 10.0% (5.0% above prime rate) at December 25, 2004	9,706	8,159	--
Capital lease obligations	14	52	177
Long-term debt	11,709	11,196	6,970
Total debt	$ 16,344	$ 27,886	$ 19,202

Wachovia Facility

Remaining availability under the Wachovia Facility as of June 25, 2005 was $14.0 million.

Chelsey Facility

In accordance with Accounting Principles Board Opinion No. 14, “Accounting for Convertible Debt and Debt Issued with Stock Purchase Warrants” (“APB 14”), proceeds received from the sale of debt with detachable stock purchase warrants should be allocated to both the debt and warrants, with the portion allocable to the warrants to be accounted for as Capital in excess of par value with the remaining portion, or $7.1 million, classified as debt. The fair value of the Common Stock Warrant of $12.9 million was determined using the Black-Scholes option pricing model and is being treated as debt discount, which will be accreted as interest expense utilizing the interest method over the 36-month term of the Chelsey Facility. The assumptions used for the Black-Scholes option pricing model were as follows: risk-free interest rate of 4.5%, expected volatility of 80.59%, an expected life of ten years and no expected dividends. A summary of the debt relating to the Chelsey Facility is as follows (in thousands):

	June 25, 2005	December 25, 2004

Amount Borrowed Under the Chelsey Facility	$ 20,000	$ 20,000
Fair Value of Common Stock Warrant (Recorded as Capital in excess of par value)	(12,939)	(12,939)
Accretion of Debt Discount (Recorded as Interest Expense)	2,645	1,098

	$ 9,706	$ 8,159

See Note 8 to the condensed consolidated financial statements for additional information relating to the Company’s debt.

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Other Activities

Consolidation of Men’s Apparel Business. The Company decided on November 9, 2004 to relocate and consolidate all functions of International Male and Undergear from San Diego, California to Weehawken, New Jersey by February 28, 2005. The decision was prompted by the business need to consolidate operations, reduce costs and leverage its catalog expertise in New Jersey. We accrued $0.9 million in severance and related costs during the fourth quarter of 2004 associated with the elimination of 33 California-based full-time equivalent positions. The payment of these costs began in February 2005 and continued through August 2005. During the 26- weeks ended June 25, 2005, the Company made payments of $0.7 million in severance and related costs associated with this consolidation.

The projected annual savings from the consolidation of the San Diego, California and the Edgewater, New Jersey facilities into the Weehawken, New Jersey facility is approximately $2.1 million.

Consolidation of Fulfillment Centers. On June 30, 2004 the Company announced plans to consolidate the operations of the LaCrosse, Wisconsin fulfillment center and storage facility into the Roanoke, Virginia fulfillment center by June 30, 2005. The LaCrosse fulfillment center and the LaCrosse storage facility were closed in June 2005 and August 2005, upon the expiration of their respective leases. The plan to consolidate operations was prompted by excess capacity at the Roanoke facility and the lack of sufficient warehouse space in the leased Wisconsin facilities to support the growth of The Company Store and reduce the overall cost structure of the Company. The Company substantially completed the consolidation into the Roanoke, Virginia fulfillment center by the end of June 2005. The Company accrued $0.7 million in severance and related costs and incurred $0.2 million of facility exit costs during 2004 associated with the consolidation of the LaCrosse operations and the elimination of 149 full and part-time positions. The payment of these costs began in January 2005 and is expected to continue into the fourth quarter of 2005. During the 26- weeks ended June 25, 2005, the Company has made payments of approximately $0.3 million in severance and related costs associated with this consolidation.

Delisting of Common Stock. The Common Stock was delisted from the American Stock Exchange (“AMEX”) on February 16, 2005 because of the Restatement which prevented us from timely filing our Form 10-Q for the fiscal quarter ended September 25, 2004, a condition of continued AMEX listing. Current trading information about the Company’s Common Stock can be obtained from the Pink Sheets (www.pinksheets.com) under the trading symbol HNVD.PK.

General. At June 25, 2005, the Company had $0.5 million in cash and cash equivalents, compared with $0.5 million at December 25, 2004 and $0.4 million at June 26, 2004. Working capital and current ratio at June 25, 2005 were $16.4 million and 1.23 to 1, respectively. Total borrowings, including financing under capital lease obligations, as of June 25, 2005, aggregated $16.3 million. Remaining availability under the Wachovia Facility as of June 25, 2005 was $14.0 million, compared with $5.1 million at June 26, 2004.

USES OF ESTIMATES AND OTHER CRITICAL ACCOUNTING POLICIES

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NEW ACCOUNTING PRONOUNCEMENTS

See “Management’s Discussion and Analysis of Consolidated Financial Condition and Results of Operations,” found in the Company’s Annual Report on Form 10-K for the fiscal year ended December 25, 2004, for additional information relating to new accounting pronouncements that the Company has adopted.

FORWARD-LOOKING STATEMENTS

This Form 10-Q, contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The use of words such as “anticipates,” “estimates,” “expects,” “projects,” “intends,” “plans,” and “believes,” among others, generally identify forward-looking statements. Forward-looking statements are predictions of future trends and events and as such, there are substantial risks and uncertainties associated with forward-looking statements, many of which are beyond management’s control. Some of the more material risks and uncertainties are identified in “Risk Factors” contained in Item 7 of the Company’s Annual Report on Form 10-K for the fiscal year ended December 25, 2004. We do not intend, and disclaim any obligation, to update any forward-looking statements.

ITEM 3. QUANTITIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Interest Rates: The Company’s exposure to market risk relates to interest rate fluctuations for borrowings under the Wachovia Facility, including the term loans, which bear interest at variable rates, and the Chelsey Facility, which bears interest at 5.0% above the prime rate publicly announced by Wachovia Bank, N.A. At June 25, 2005, outstanding principal balances under the Wachovia Facility and Chelsey Facility subject to variable rates of interest were approximately $6.5 million and $20.0 million, respectively. If interest rates were to increase by one percent from current levels, the resulting increase in interest expense, based upon the amount outstanding at June 25, 2005, would be approximately $0.3 million on an annual basis.

ITEM 4. CONTROLS AND PROCEDURES

Company management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, has completed an evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Rule 13a-15 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). This evaluation has allowed management to make conclusions, as set forth below, regarding the state of the Company’s disclosure controls and procedures as of March 26, 2005. While management has made significant improvements in its disclosure and accounting controls and procedures and has completed various action plans to remedy identified weaknesses in these controls (as more fully discussed below), based on management’s evaluation, management has concluded that the Company’s controls and procedures were not effective in alerting management on a timely basis to material information relating to the Company required to be included in the Company’s periodic filings under the Exchange Act. In coming to this conclusion, management considered, among other things, the control deficiency related to periodic review of the application of generally accepted accounting principles, which resulted in the Restatement as disclosed in Note 2 to the accompanying condensed consolidated financial statements included in this Form 10-Q.

As background, the following occurred during 2004 and during the first nine months of 2005:

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•	During the second quarter of 2004, the Company identified a revenue recognition cut-off issue that resulted in revenue being recorded in advance of the actual shipment of merchandise to the customer. The practice was stopped immediately. Subsequently, the Company determined that revenue should be recognized when merchandise is received by the customer rather than when shipped because the Company routinely replaces customer merchandise damaged or lost in transit as a customer service matter (even though risk of loss, as a legal matter, passes on shipment). As a consequence, the Company has restated the first quarter 2004 condensed consolidated financial statements to recognize revenue when merchandise is received by the customer.
•	In the first quarter of 2004, former management identified a potential issue with the accounting treatment of discount obligations due to members of certain of the Company’s buyers’ club programs, and at that time, an inappropriate conclusion regarding the accounting treatment was reached. During the third quarter of 2004, the issue was re-evaluated and it was determined that an error in the accounting treatment had occurred. The cumulative impact of the error for which the Company restated resulted in the overstatement of revenues and the omission of the related liability to the guarantee of these discount obligations that aggregated $2.4 million as of June 26, 2004 (the end of the second quarter of 2004). The Company immediately implemented accounting policies to appropriately account for all obligations due to members of the buyers’ club programs.
•	On November 9, 2004, the Company’s Audit Committee discussed the two matters noted above with the Company’s former independent registered public accounting firm, KPMG LLP (“KPMG”) and then on November 17, 2004, the Audit Committee launched an investigation relating to the restatement of the Company’s consolidated financial statements and other accounting-related matters and engaged the law firm of Wilmer Cutler Pickering Hale and Dorr LLP (“Wilmer Cutler”) as its independent outside counsel to assist with the investigation.
•	The Company was notified on January 11, 2005 by the SEC that the SEC was conducting an informal inquiry relating to the Company’s financial results and financial statements since 1998. The Audit Committee, the Board of Directors and the Company’s management have been cooperating fully with the SEC in connection with the inquiry.
•	On February 3, 2005, the Company reported that its Common Stock was being delisted by the AMEX as a consequence, among other reasons, of the Company’s inability to meet the AMEX’s continued listing requirements and its inability to timely file its Form 10-Q for the fiscal quarter ended September 25, 2004.
•	On March 14, 2005, the Audit Committee reported that it had concluded its investigation and, with the assistance of Wilmer Cutler, reported its findings to the Board of Directors. The Audit Committee, with Wilmer Cutler’s assistance, formulated recommendations to the Company and the Board of Directors concerning ways of improving the Company’s internal controls and procedures for financial reporting which the Board of Directors and the Company began to implement.
•	The Audit Committee instructed Wilmer Cutler to cooperate fully with the SEC in connection with its inquiry and share the results of its investigation with both the SEC and KPMG. Wilmer Cutler has presented the results of its investigation to both the SEC and KPMG.

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•

During the course of preparing its 2004 consolidated financial statements, the Company evaluated a previously reversed litigation reserve relating to post employment benefits allegedly owed to its former CEO. In the course of evaluating the accounting treatment of the restoration of the reserve, the Company identified that the original reserve had been improperly established as a litigation reserve rather than an accrual for post employment benefits and that legal expenses had been improperly charged against the reserve rather than treated as period expenses. Management corrected these errors and restated all affected periods presented in accordance with the corrected treatment of the reserve.

•

During the course of preparing its 2004 consolidated financial statements, the Company determined that an accrual related to certain customer prepayments and credits had been inappropriately released and that other liabilities relating primarily to certain miscellaneous catalog costs and other miscellaneous costs had not been appropriately accrued in the appropriate periods. The Company re-established the improperly released accrual and accrued certain miscellaneous catalog costs and other miscellaneous costs in the appropriate periods and restated all affected periods presented in accordance with the corrected treatment of these items.

Internal Control Over Financial Reporting

In connection with its audit of the Company’s financial statements for the year ended December 25, 2004, KPMG, the Company’s former auditors, identified material weaknesses in internal control over financial reporting and other matters relating to the Company’s internal controls based upon its audit of the 2004 consolidated financial statements. Our management considered the material weaknesses identified by KPMG in evaluating the adequacy of the Company’s internal controls.

A control deficiency exists when the design or operation of a control does not allow management or employees, in the normal course of performing their assigned functions, to detect or prevent misstatements on a timely basis. A deficiency in design exists when (a) a control necessary to meet the control objective is missing, or (b) an existing control is not properly designed so that even if the control operates as designed, the control objective is not always met. A deficiency in operation exists when a properly designed control does not operate as designed, or when the person performing the control does not possess the necessary authority or qualification to perform the control effectively. A material weakness is a significant deficiency, or combination of significant deficiencies, that result in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. In connection with KPMG’s audit of the Company’s consolidated financial statements which it did not complete, KPMG identified the following material weaknesses:

•	The Company lacks a sufficient number of financial and tax personnel with the appropriate level of expertise to independently monitor, interpret and implement the application of financial accounting standards in accordance with generally accepted accounting principles,
•	The environment of the Company was such that members of management were not encouraged to discuss transactions and events that could impact the appropriate financial reporting of the Company; and
•	The Company does not have adequate policies and procedures relating to the origination and maintenance of contemporaneous documentation to support key accounting judgments or to effectively document the terms of all significant contracts and agreements and the related accounting treatment for these contracts and agreements.

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The Company has strengthened and replaced its senior management commencing with the May 5, 2004 appointment of a new Chief Executive Officer. Under new management, the Company is committed to meeting and enhancing its internal control obligations as part of the Company’s overall commitment to establishing a new corporate culture that focuses on ethics, unfettered communication within the organization and compliance, and sets a new standard for corporate behavior within the Company. Toward this end, during 2004 and through the end of September 2005, the Company has:

•	Appointed a new Chief Executive Officer, Chief Financial Officer, General Counsel and Corporate Controller;
•	Replaced its Director of Internal Audit;
•	Replaced its outside counsel;
•	Instituted a policy of open channels of communication including regularly scheduled meetings of, and with senior management;
•	Instituted weekly meetings between the CEO and Director of Internal Audit to review the status of internal audits and assess internal controls;
•	Instituted periodic trips by senior management to the Company’s remote facilities to foster communication and ensure compliance with the Company’s reporting, internal control and ethics policies;
•	Filled open finance positions which resulted from earlier terminations and other departures;
•	Instituted weekly reviews of financial results with the Chief Financial Officer and senior management to enhance transparency and accountability;
•	Instituted a policy that requires review and approval of all material agreements and marketing plans by the legal and financial departments;
•	Instituted a policy that requires all systems changes that could impact financial reporting be subject to approval by the financial department;
•	Revised the Company’s reporting structure to have the catalog finance directors report to the CFO;
•	Documented the Company’s significant accounting policies and implemented a procedure to periodically review and update these policies; and
•	Implemented a policy that requires the preparation of contemporaneous memoranda and related documentation to support key accounting judgments and to maintain and document the significant terms of material contracts and the accounting treatment thereof.

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PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

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Class Action Lawsuits:

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Claims for Post-Employment Benefits

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

Due to, among other things, the Restatement, which resulted in the Company violating several financial covenants and the Company’s inability to timely file its periodic reports with the SEC, both as discussed in Notes 2 and 8 to the Consolidated Financial Statements, the Company was in technical default under the Wachovia and Chelsey Facilities. The Company has obtained waivers from both Wachovia and Chelsey Finance for such defaults pursuant to amendments to the Wachovia and Chelsey Facilities dated July 29, 2005.

ITEM 6. EXHIBITS

31.1 Certification signed by Wayne P. Garten.*

31.2 Certification signed by John W. Swatek.*

32.1 Certification signed by Wayne P. Garten and John W. Swatek.*

*Items indicated by an asterisk are to be filed when the Form 10-Q is filed with the SEC.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	HANOVER DIRECT, INC.
	(Registrant)

	By:
		John W. Swatek
		Senior Vice President, Chief Financial Officer and Treasurer (On behalf of the Registrant and as principal financial officer)

Date: