-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, ImZ+Ok8JfOJfkbiS//2RAzHJj32jJjvhIBQL2hspH1AY8/UgUpt/O6h6LpjhUIQY mXZ1yKhThVXkOz9FBgpkUw== 0000950123-01-508346.txt : 20020410 0000950123-01-508346.hdr.sgml : 20020410 ACCESSION NUMBER: 0000950123-01-508346 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20010929 FILED AS OF DATE: 20011113 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: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-08056 FILM NUMBER: 1785059 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 10-Q 1 y54556e10-q.txt HANOVER DIRECT, INC. 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 September 29, 2001 ------------------ Commission file number 1-12082 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) 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 X NO --- --- Common stock, par value $.66 2/3 per share: 212,186,331 shares outstanding as of November 6, 2001. HANOVER DIRECT, INC. TABLE OF CONTENTS
Page ---- Part I - Financial Information Item 1. Financial Statements Condensed Consolidated Balance Sheets - September 29, 2001 and December 30, 2000 ....................................................... 3 Condensed Consolidated Statements of Income (Loss) - 13 and 39-weeks ended September 29, 2001 and September 23, 2000 ...................................................... 5 Condensed Consolidated Statements of Cash Flows - 39-weeks ended September 29, 2001 and September 23, 2000 ...................................................... 6 Notes to Condensed Consolidated Financial Statements............................................... 8 Item 2. Management's Discussion and Analysis of Consolidated Financial Condition and Results of Operations........................................................................... 15 Item 3. Quantitative and Qualitative Disclosures about Market Risk.................................... 22 Part II - Other Information Item 1. Legal Proceedings............................................................................. 22 Item 5. Other Information............................................................................. 22 Item 6. Exhibits and Reports on Form 8-K.............................................................. 23 Signature.............................................................................................. 24
2 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)
September 29, December 30, ------------- ------------ 2001 2000 ---- ---- ASSETS CURRENT ASSETS: Cash and cash equivalents $ 1,407 $ 1,691 Accounts receivable, net 17,380 27,703 Inventories 66,356 69,612 Prepaid catalog costs 21,376 23,084 Deferred tax asset, net 3,300 3,300 Other current assets 2,921 3,056 --------- --------- Total Current Assets 112,740 128,446 --------- --------- PROPERTY AND EQUIPMENT, AT COST: Land 4,509 4,724 Buildings and building improvements 18,197 23,442 Leasehold improvements 12,365 12,624 Furniture, fixtures and equipment 60,200 59,773 Construction in progress 106 647 --------- --------- 95,377 101,210 Accumulated depreciation and amortization (58,952) (55,570) --------- --------- Property and equipment, net 36,425 45,640 --------- --------- Goodwill, net 9,362 15,816 Deferred tax asset, net 11,700 11,700 Other assets 1,087 1,417 --------- --------- Total Assets $ 171,314 $ 203,019 ========= =========
See notes to Condensed Consolidated Financial Statements. 3 HANOVER DIRECT, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (CONTINUED) (In thousands of dollars, except share amounts) (Unaudited)
September 29, December 30, ------------- ------------ 2001 2000 ---- ---- LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT) CURRENT LIABILITIES: Current portion of long-term debt and capital lease obligations $ 3,095 $ 3,718 Accounts payable 48,931 67,858 Accrued liabilities 24,758 34,443 Customer prepayments and credits 6,374 5,592 --------- --------- Total Current Liabilities 83,158 111,611 --------- --------- NON-CURRENT LIABILITIES: Long-term debt 34,234 35,318 Other 6,844 8,914 --------- --------- Total Non-current Liabilities 41,078 44,232 --------- --------- Total Liabilities 124,236 155,843 --------- --------- SERIES A CUMULATIVE PARTICIPATING PREFERRED STOCK, mandatory redemption at $50 per share ($70,000), 2,345,000 shares authorized, 1,647,794 shares issued at September 29, 2001 and 1,475,498 shares issued at December 30, 2000 80,601 71,628 SHAREHOLDERS' EQUITY (DEFICIT): Common Stock, $.66 2/3 par value, 300,000,000 shares authorized; 214,425,498 shares issued at September 29, 2001 and December 30, 2000 142,951 142,951 Capital in excess of par value 300,240 307,595 Accumulated deficit (473,367) (471,651) --------- --------- (30,176) (21,105) --------- --------- Less: Treasury stock, at cost (2,239,167 shares at September 29, 2001 and 729,167 shares at December 30, 2000) (2,930) (2,223) Notes receivable from sale of Common Stock (417) (1,124) --------- --------- Total Shareholders' Equity (Deficit) (33,523) (24,452) --------- --------- Total Liabilities and Shareholders' Equity (Deficit) $ 171,314 $ 203,019 ========= =========
See notes to Condensed Consolidated Financial Statements. 4 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 39-Weeks Ended ---------------------- ---------------------- September 29, September 23, September 29, September 23, ------------- ------------- -------------- ------------- 2001 2000 2001 2000 --------- --------- --------- --------- NET REVENUES $ 117,431 $ 140,381 $ 395,232 $ 413,937 --------- --------- --------- --------- OPERATING COSTS AND EXPENSES Cost of sales and operating expenses 76,887 97,207 252,502 281,584 Special charges - - 6,081 - Selling expenses 30,435 34,465 107,491 103,485 General and administrative expenses 13,654 19,178 44,350 56,105 Depreciation and amortization 1,780 1,933 5,679 6,871 --------- --------- --------- --------- 122,756 152,783 416,103 448,045 --------- --------- --------- --------- (LOSS) FROM OPERATIONS (5,325) (12,402) (20,871) (34,108) Gain on sale of Improvements - - 22,818 - Gain on sale of Kindig Lane - - 1,529 - --------- --------- --------- --------- EARNINGS (LOSS) BEFORE INTEREST AND TAXES (5,325) (12,402) 3,476 (34,108) Interest expense, net 1,451 2,367 5,102 7,690 --------- --------- --------- --------- EARNINGS (LOSS) BEFORE INCOME TAXES (6,776) (14,769) (1,626) (41,798) Income tax provision 30 30 90 135 --------- --------- --------- --------- NET EARNINGS (LOSS) AND COMPREHENSIVE EARNINGS (LOSS) (6,806) (14,799) (1,716) (41,933) Preferred stock dividends and accretion 3,092 1,146 8,956 1,233 --------- --------- --------- --------- NET EARNINGS (LOSS) APPLICABLE TO COMMON SHAREHOLDERS $ (9,898) $ (15,945) $ (10,672) $ (43,166) ========= ========= ========= ========= NET EARNINGS (LOSS) PER COMMON SHARE: Net earnings (loss) per common share - basic and diluted $ (.05) $ (.07) $ (.05) $ (.20) ========= ========= ========= ========= Weighted average common shares outstanding - basic (thousands) 212,186 213,773 212,281 213,085 ========= ========= ========= ========= Weighted average common shares outstanding - diluted (thousands) 212,186 213,773 212,281 213,085 ========= ========= ========= =========
See notes to Condensed Consolidated Financial Statements. 5 HANOVER DIRECT, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands of dollars) (Unaudited)
For the 39-Weeks Ended ---------------------- September 29, September 23, ------------- ------------- 2001 2000 -------- -------- CASH FLOWS FROM OPERATING ACTIVITIES: Net earnings (loss) $ (1,716) $(41,933) Adjustments to reconcile net (loss) to net cash (used) by operating activities: Depreciation and amortization, including deferred fees 6,147 8,932 Provision for doubtful accounts 302 2,686 Special charges 2,389 - Gain on sale of Improvements (22,818) - Gain on sale of Kindig Lane (1,529) - Compensation expense related to stock options 1,601 3,962 Changes in assets and liabilities, net of sale of business: Accounts receivable 9,427 (332) Inventories (56) (19,315) Prepaid catalog costs (2,300) (7,320) Accounts payable (10,245) 1,726 Accrued liabilities (12,101) (3,972) Customer prepayments and credits 931 432 Other non-current liabilities (2,070) - Other, net 14 (28) -------- -------- Net cash (used) in operating activities (32,024) (55,162) -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Acquisitions of property and equipment (1,459) (9,308) Proceeds from sale of Blue Ridge Associates - 838 Proceeds from sale of Improvements 30,235 - Proceeds from sale of Kindig Lane 4,671 - -------- -------- Net cash provided by (used in) investing activities 33,447 (8,470) -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Net (payments) borrowings under Congress revolving loan facility 4,674 10,172 Net (payments) borrowings under Congress term loan facility (5,511) 10,553 Net proceeds from issuance of Series A Cumulative Participating Preferred Stock - 68,109 Redemption of Term financing facility - (16,000) Redemption of Industrial Revenue Bonds - (8,000) Redemption of 7.5% Convertible Debentures (751) - Payment of debt issuance costs - (2,360) Proceeds from issuance of Common Stock - 848 Series B Convertible Additional Preferred Stock dividends - (920) Other, net (119) (102) -------- -------- Net cash (used in) provided by financing activities (1,707) 62,300 -------- -------- Net increase (decrease) in cash and cash equivalents (284) (1,332) Cash and cash equivalents at the beginning of the year 1,691 2,849 -------- -------- Cash and cash equivalents at the end of the period $ 1,407 $ 1,517 ======== ========
See notes to Condensed Consolidated Financial Statements. 6 HANOVER DIRECT, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands of dollars) (Unaudited)
For the 39-Weeks Ended ---------------------- September 29, September 23, ------------- ------------- 2001 2000 -------- -------- Supplemental Disclosures of Cash Flow Information: Cash paid for: Interest $ 4,064 $ 5,754 ======== ======== Income taxes $ 122 $ 264 ======== ======== Non-cash investing and financing activities: Redemption of Series B Convertible Additional Preferred Stock $ - $ 6,349 ======== ======== Stock dividend and accretion of Series A Cumulative Participating Preferred Stock $ 8,956 $ 1,146 ======== ======== Capital lease obligations $ - $ 837 ======== ========
See notes to Condensed Consolidated Financial Statements. 7 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 30, 2000. 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. Certain prior year amounts have been reclassified to conform to the current year presentation. 2. RETAINED EARNINGS RESTRICTIONS The Company is restricted from paying dividends at any time on its Common Stock or from acquiring its capital stock by certain debt covenants contained in agreements to which the Company is a party. 3. NET EARNINGS (LOSS) PER SHARE Net earnings (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." The weighted average number of shares used in the calculation for both basic and diluted net (loss) per share for the 13-week period ended September 29, 2001 was 212,186,331. For the 13-week period ended September 23, 2000 the weighted average number of shares used in the calculation for both basic and diluted net (loss) per share was 213,773,193. The weighted average number of shares used in the calculation for both basic and diluted net (loss) per share for the 39-week periods ended September 29, 2001 and September 23, 2000 was 212,280,706 and 213,085,469 shares, respectively. Diluted earnings per share equals basic earnings per share as the dilutive calculation would have an anti-dilutive impact as a result of the net losses incurred during the 13-week periods ended September 29, 2001 and September 23, 2000 and the 39-week periods ended September 29, 2001 and September 23, 2000. The number of potentially dilutive securities excluded from the calculation of diluted (loss) per share was 447,374 and 319,862 common share equivalents for the 13-week period ended September 29, 2001 and September 23, 2000, respectively. The number of potentially dilutive securities excluded from the calculation of diluted (loss) per share were 996,036 and 4,665,915 common share equivalents for the 39-week periods ended September 29, 2001 and September 23, 2000, respectively. 4. SEGMENT REPORTING In prior years the Company reported two separate operating and reporting segments: direct commerce and business to business ("B-to-B") e-commerce transaction services. In conjunction with the Company's previously announced strategic business realignment program, the Company has (1) terminated an intercompany services agreement between erizon and Hanover Brands effective December 30, 2000, (2) ceased the Desius LLC business operations of erizon and (3) closed erizon's leased fulfillment and telemarketing facility in Maumelle, Arkansas. As a result of these actions, the Company's business to business revenues in fiscal 2001 and beyond are expected to be reduced and for the foreseeable future will be limited to third party clients serviced by Keystone Internet Services, Inc. Taken in conjunction with the Company's announced intention to direct resources primarily towards growth in core brands, these actions have caused the Company, pursuant to SFAS 131, to report results for the consolidated operations of Hanover Direct, Inc. as one segment commencing in fiscal year 2001. 8 5. COMMITMENTS AND CONTINGENCIES A class action lawsuit was commenced on March 3, 2000 entitled Edwin L. Martin v. Hanover Direct, Inc. and John Does 1 through 10, bearing case no. CJ2000-177 in the State Court of Oklahoma (District Court in and for Sequoyah County). Plaintiff commenced the action on behalf of himself and a class of persons who have at any time purchased a product from the Company and paid for an "insurance charge." The complaint sets forth claims for breach of contract, unjust enrichment, recovery of money paid absent consideration, fraud and a claim under the New Jersey Consumer Fraud Act. The complaint alleges that the Company charges its customers for delivery insurance even though, among other things, the Company's common carriers already provide insurance and the insurance charge provides no benefit to the Company's customers. Plaintiff also seeks a declaratory judgment as to the validity of the delivery insurance. The damages sought are (i) an order directing the Company to return to the plaintiff and class members the "unlawful revenue" derived from the insurance charges, (ii) declaring the rights of the parties, (iii) permanently enjoining the Company from imposing the insurance charge, (iv) awarding threefold damages of less than $75,000 per plaintiff and per class member, and (v) attorney's fees and costs. The Company's motion to dismiss is pending and discovery has commenced. The plaintiff has deposed a number of individuals. On April 12, 2001, the Court held a hearing on plaintiff's class certification motion. Subsequent to the April 12, 2001 hearing on plaintiff's class certification motion, plaintiff filed a motion to amend the definition of the class. On July 23, 2001, plaintiff's class certification motion was granted, defining the class as "All persons in the United States who are customers of any catalog or catalog company owned by Hanover Direct, Inc. and who have at any time purchased a product from such company and paid money which was designated to be an `insurance' charge." On August 21, 2001 the Company filed an appeal of the order with the Oklahoma Court of Appeals and subsequently moved to stay proceedings in the district court pending resolution of the appeal. No schedule for briefing or hearing of the appeal has yet been set and the district court has not yet ruled on the motion to stay. The Company believes it has defenses against the claims; however, it is too early to determine the outcome or range of potential settlement which could have a material impact on the Company's results of operations. On August 15, 2001, the Company was served with a summons and four-count complaint filed in Superior Court for the City and County of San Francisco, California, entitled Teichman v. Hanover Direct, Inc., Hanover Brands, Inc., Hanover Direct Virginia, Inc., and Does 1-100. The complaint was filed by a California resident, seeking damages and other relief for herself and a class of all others similarly situated, arising out of the $0.50 insurance fee charged by catalogs and internet sites operated by subsidiaries of the Company. Defendants, including the Company, have filed motions to dismiss based on a lack of personal jurisdiction over them. The motion to dismiss was set for hearing on November 9, 2001, but plaintiff has indicated that she will seek additional time in which to respond to the pending motion. The Company intends to vigorously defend this matter; however, it is too early to determine the outcome or range or potential settlement which could have a material impact on the Company's results of operations. In January 2000 and May 2001, the Company provided its full cooperation in an investigation by the Federal Trade Commission ("FTC") into the marketing of discount buying clubs to see whether any of the entities investigated engaged in (1) unfair or deceptive acts or practices in violation of Section 5 of the FTC Act and/or (2) deceptive or abusive telemarketing acts or practices in violation of the FTC's Telemarketing Sales Rule. It was subsequently revealed to the Company that the FTC was conducting an investigation into the activities of entities owned or controlled by Mr. Ira Smolev. On October 24, 2001, the FTC made final its "Stipulated Final Judgment And Order For Permanent Injunction And Monetary Settlement" against Ira Smolev and named defendant companies in the case of Federal Trade Commission v. Ira Smolev, et al. (USDC So.Dist. FL, Ft. Lauderdale Div.) (the "Order"). The named defendants included The Shoppers Edge, LLC (the Company's private label discount buying club which is owned by Mr. Smolev), FAR Services, LLC (the Smolev-owned contracting party to the Company's Marketing Agreement which was terminated in January 2001), and Consumer Data Depot, LLC (the Smolev-owned contracting party to the Company's Paymentech Processing Agreement). The Order will directly affect only those activities of the Company which are "in active concert or participation with [the named defendants]." The most important implication of the Order is that the Company, as bookkeeper to the club for sustaining members of The Shopper's Edge, may not process payments from members of The Shopper's Edge club for membership renewals where the purported authorization of the membership occurred prior to the effective date of the Order, without first obtaining, within 60 days prior to the date on which the consumer is billed, an "express verifiable authorization" of 9 such renewal that complies with the specifications of the Order. All choices specified for "express verifiable authorization" contained in the Order are effectively "positive opt-in," would require some direct mail or technology expenditures and would severely hurt response rates, which could have a material impact on the Company's profits from discount buying club membership revenues. The Company is considering the available alternatives to implement express verifiable authorization consistent with the Order. On June 28, 2001, Rakesh K. Kaul, the Company's former President and Chief Executive Officer, filed a five-count complaint (the "Complaint") in New York State Court against the Company, seeking damages and other relief arising out of his separation of employment from the Company, including severance payments of $2,531,352 plus the cost of employee benefits, attorneys' fees and costs incurred in connection with the enforcement of his rights under his employment agreement with the Company, payment of $149,325 for 13 weeks of accrued and unused vacation, damages in the amount of $3,583,800, or, in the alternative, a declaratory judgment from the court that he is entitled to all change of control benefits under the "Hanover Direct, Inc. Thirty-Six Month Salary Continuation Plan", and damages in the amount of $1,396,066 due to the Company's purported breach of the terms of the "Long-Term Incentive Plan for Rakesh K. Kaul" by failing to pay him a "tandem bonus" he alleges was due and payable to him on the 30th day following his termination of employment. The Company removed the case to the U.S. District Court for the Southern District of New York on July 25, 2001. Mr. Kaul filed an Amended Complaint ("Amended Complaint") in the U.S. District Court for the Southern District of New York on September 18, 2001. The Amended Complaint repeats many of the claims made in the original Complaint and adds ERISA claims. On October 11, 2001, the Company filed its Answer, Defenses and Counterclaim to the Amended Complaint, denying liability under each of Mr. Kaul's causes of action, raising several defenses and stating nine counterclaims against Mr. Kaul. The counterclaims include (1) breach of contract; (2) breach of the Non-Competition and Confidentiality Agreement with the Company; (3) breach of fiduciary duty; (4) unfair competition; and (5) unjust enrichment. The case is pending and the Company has commenced discovery against Mr. Kaul. In addition, the Company is involved in various routine lawsuits of a nature which are 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 or results of operations. 6. SPECIAL CHARGES In December 2000, the Company recorded special charges aggregating approximately $19.1 million. These charges consisted of severance ($5.0 million), facility exit costs ($5.9 million) and fixed asset write-offs ($8.2 million, of which $7.2 million is non-cash) related to the Company's previously announced strategic business realignment program which included (1) the elimination of approximately 285 full-time equivalent ("FTE") positions across all its business units; (2) the closure of the Company's Always in Style business; (3) the discontinuance by Hanover Brands of the under-performing Turiya, Kitchen & Home and Domestications Kitchen & Garden catalogs while incorporating some of the product offerings within continuing catalogs; (4) the termination by Hanover Brands of its marketing agreement with Compagnie de la Chine; (5) the closure by Hanover Brands of certain retail outlets and a satellite facility in New Jersey; (6) the closure by erizon of its leased fulfillment and telemarketing facility in Maumelle, Arkansas; and (7) the immediate cessation by erizon of the operations of Desius LLC. Such actions were taken in an effort to direct the Company's resources primarily towards continued profitable growth in Hanover Brands while reducing costs in all areas of the business and eliminating investment activities that had not yet generated sufficient revenue to produce profitable returns. erizon intended to consolidate the Maumelle operations within its remaining facilities and to provide the bulk of its fulfillment services for third party clients of its Keystone Internet Services, Inc. ("Keystone") subsidiary within its existing operations. The consolidation of Keystone's activities in other facilities was intended to provide a better opportunity to focus resources, particularly customer service support, on clients to service their needs. In the first quarter of 2001, an additional amount for special charges was recorded in the amount of $1.1 million which consisted primarily of severance costs related to the elimination of an additional 46 FTE positions across all divisions of the Company's business as part of the strategic business realignment program. In the second quarter of 2001, an additional amount for special charges was recorded in the amount of $5.0 million which consisted primarily of additional charges related to the exit of the Maumelle and Kindig Lane buildings including the write-down for impairment of remaining assets. Maumelle exit charges included a $1.0 million lease provision adjustment and a $1.9 million fixed asset write-down. Kindig Lane exit charges included $0.5 million for fixed asset write-downs. Also included are severance 10 costs of $1.4 million, $0.4 million related to the elimination of associates employed at the Kindig Lane facility, in addition to $1.0 million of severance costs related to the elimination of an additional 32 FTE positions across all divisions of the Company's business as part of the strategic business realignment program. The remaining special charges of $0.2 million represent the forgiveness of a loan as well as other fees. There were no additional charges incurred in the third quarter of 2001. As of the end of the third quarter of 2001, a liability is included on the Company's balance sheet related to future costs in connection with the Company's strategic business realignment program consisting of: Severance - The cost of employee severance includes termination benefits for line and supervisory personnel in fulfillment, telemarketing, MIS, merchandising, and various levels of corporate and catalog management. Approximately $1.9 million of these costs are recorded in accrued liabilities in the accompanying Condensed Consolidated Balance Sheet at September 29, 2001. Severance payments during the first, second, and third quarters of 2001 amounted to $1.9 million, $1.1 million, and $1.2 million, respectively. Facility Exit Costs and Fixed Asset Write-downs - These costs are primarily related to the Company's decision to close its fulfillment center in Maumelle, Arkansas, exit office space located in Edgewater, New Jersey and close several of its retail outlets. Furthermore, costs associated with closing the Always in Style business and terminating the Company's marketing agreement with Compagnie de la Chine are included in the amount written off. Approximately $3.3 million of these costs is included in accrued liabilities at September 29, 2001, and an additional $1.5 million is included in other non-current liabilities, as they will not be paid until 2002 or later. Facility exit and fixed asset write-off payments during the first, second, and third quarters of 2001 were $1.1 million, $1.6 million and $.7 million, respectively. In October 2001, the Company determined it was more cost effective to relocate certain of its operating and administrative functions from the first floor of its facility in Weehawken, New Jersey to previously closed space in Edgewater, New Jersey and sublet the space vacated in Weehawken, New Jersey. Currently, the Company does not anticipate the revised office facility utilization plan will impact restructuring charges already incurred and reported. 7. SALE OF IMPROVEMENTS BUSINESS On June 29, 2001, the Company sold certain assets and liabilities of its Improvements business to HSN, a division of USA Networks, Inc.'s Interactive Group for approximately $33.0 million. In conjunction with the sale, the Company's Keystone Internet Services, Inc. subsidiary agreed to provide telemarketing and fulfillment services for the Improvements business under a service agreement with the buyer for a period of three years. The asset purchase agreement between the Company and HSN provides for a reduction in the sale price if the performance of the Improvements business in the 2001 fiscal year fails to achieve a targeted EBITDA level as defined in the agreement. In addition, if Keystone Internet Services, Inc. fails to perform its obligations during the first two years of the services contract, the purchaser can receive a reduction in the original purchase price of up to $2.0 million. An escrow fund of $3.0 million, which was withheld from the original proceeds of the sale of approximately $33.0 million, has been established for a period of two years under the terms of an escrow agreement between LWI Holdings, Inc., HSN and The Chase Manhattan Bank as a result of these contingencies. As of September 29, 2001, the balance in the escrow fund is $2.6 million. The Company recognized a net gain on the sale of approximately $22.8 million, including a non-cash goodwill charge of $6.1 million, in the second quarter of 2001, which represents the excess of the net proceeds from the sale over the net assets assumed by HSN, the goodwill associated with the Improvements business and expenses related to the transaction. The recognition of an additional gain of up to approximately $2.5 million has been deferred until the contingencies described above expire, which will not occur prior to the middle of the 2003 fiscal year. 8. SALE OF KINDIG LANE PROPERTY On May 3, 2001, as part of the Company's strategic business realignment program, the Company sold its fulfillment warehouse in Hanover, Pennsylvania (the "Kindig Lane Property") and certain equipment located therein for $4.7 million to an unrelated third party. Substantially all of the net proceeds of the sale were paid to Congress Financial Corporation ("Congress"), pursuant to the terms of the Congress Credit facility, and applied to a partial repayment of the Tranche A Term Loan made to Hanover Direct Pennsylvania, Inc., an affiliate of the Company, and to a partial repayment of the indebtedness under the Congress Credit Facility. The Company realized a net gain on the sale of approximately $1.5 million, which included the sale price net of selling expenses as well as the net book value of assets sold. The Company has continued to use the Kindig Lane Property under a lease agreement with the third party, and will lease a portion of the Kindig Lane Property until August 2002. The Company intends to transition the activities of the Kindig Lane Property into the Company's fulfillment center in Roanoke, Virginia. 11 9. CHANGES IN EMPLOYMENT AGREEMENTS As of August 1, 2001, Thomas C. Shull, Meridian Ventures, LLC, a Nevada limited liability company controlled by Mr. Shull, and the Company entered into a Services Agreement (the "Services Agreement"), which replaces a previous Services Agreement dated as of December 5, 2000 which was to expire in December 2001. Under the Services Agreement, Meridian will provide for the benefit of the Company the services of Mr. Shull and the services of up to two additional consultants (the "Consultants"). The term of the Services Agreement, and the term for the services of Mr. Shull and the Consultants began on August 1, 2001 and will terminate on June 30, 2002 (the "Agreement Term"); provided, however, that on or prior to May 1, 2002, the Company may extend the Agreement Term on a day to day basis upon written notice to Mr. Shull, provided that thereafter, either Mr. Shull or the Company may terminate the Services Agreement and the Agreement Term with 60 days notice to the other. Under the Services Agreement, Meridian is to receive from the Company $75,000 per month for the services of Mr. Shull and up to an additional $60,000 per month for the services of the Consultants (collectively, the "Base Fees"). The Company also is required to pay Meridian up to $21,000 per month during the Agreement Term (the "Flat Fee"). The Company also reimburses Mr. Shull and the Consultants for reasonable out-of-pocket expenses incurred on behalf of the Company. Under the Services Agreement, the Company has guaranteed Mr. Shull a target bonus for the Company's 2001 fiscal year pursuant to the Company's 2001 Management Incentive Plan equal to $300,000, which shall be payable in a lump sum on or about April 1, 2002 (or on the date of closing of any transaction which constitutes a Change of Control (as defined in the Services Agreement), if earlier), provided that Mr. Shull is providing services to the Company under the Services Agreement on December 29, 2001 (or on the date of closing of such a transaction, if earlier). In addition, Mr. Shull shall be eligible to receive a maximum bonus for the Company's 2001 fiscal year pursuant to the Company's 2001 Management Incentive Plan equal to up to $600,000 (including the above-described target bonus) which shall be payable pursuant to the same terms as the payment of the target bonus, if he achieves the maximum goals set for him by the Company's Board of Directors. The Company also acknowledges in the Services Agreement that it has extended the benefits of its Key Executive Eighteen Month Compensation Continuation Plan, effective as of April 25, 2001, as amended (the "Change of Control Plan"), and its transaction bonus program, to Mr. Shull. Under the Services Agreement, upon the closing of any transaction which constitutes a Change of Control (as defined in the Services Agreement), provided that Mr. Shull is then employed by the Company, the Company shall make a lump sum cash payment to Meridian on the date of such closing of $900,000 pursuant to the Change of Control Plan, $300,000 pursuant to the Company's transaction bonus program and at least $300,000 in target bonus (plus any amount of maximum bonus) payable pursuant to the Company's 2001 Management Incentive Plan. Any such lump sum payment would be in lieu of (i) any cash payment under the Services Agreement as a result of a termination of the Services Agreement upon the first day after the acquisition of the Company (whether by merger or the acquisition of all of its outstanding capital stock) or the tenth day after the sale of 50% or more of the market value of the Company's assets (for this purpose under the Services Agreement, such 50% amount shall be deemed to be $107.6 million), and (ii) the aggregate amount of Base Fees and Flat Fees to which Meridian would have otherwise been entitled through the end of the Agreement Term. Pursuant to the Services Agreement, the stock options previously granted by the Company to Mr. Shull and the Consultants (the "Meridian Options") for an aggregate of 4,000,000 shares of the Company's Common Stock with an exercise price of $.25 per share shall (i) terminate upon any termination of the Services Agreement on account of (A) the material breach by Mr. Shull or Meridian of the terms of the Services Agreement or Willful Misconduct (as defined in the Services Agreement) committed by Mr. Shull or Meridian, or (B) Mr. Shull's death or permanent disability, and (ii) vest and become exercisable upon (A) any termination of the Services Agreement on account of the Company's material breach thereof, (B) the first day after the acquisition of the Company (whether by merger or the acquisition of all of its outstanding capital stock) or the tenth day after the sale of 50% or more of the market value of the Company's assets (for this purpose under the Services Agreement, such 50% amount shall be deemed to be $107.6 million) or (C) the Company's termination of its engagement of Meridian and Mr. Shull where there has been no Willful Misconduct (as defined in the Services Agreement) or material breach of the Services Agreement by either Meridian or Mr. Shull. In addition, provided that the Services Agreement shall then be in effect, one-half of Mr. Shull's portion of the Meridian Options 12 and all of the Consultants' portion of the Meridian Options shall vest and become exercisable on December 4, 2001, and Mr. Shull's remaining portion of the Meridian Options shall vest and become exercisable, provided that the Services Agreement shall then be in effect, on June 30, 2002. In addition, all of the Meridian Options shall vest and become exercisable upon the earliest to occur of (i) Mr. Shull's resignation For Good Reason (as defined in the Services Agreement), (ii) the Company's termination of Mr. Shull's services under the Services Agreement without such termination being For Cause (as defined in the Services Agreement), (iii) a Change of Control (as defined in the Services Agreement) or (iv) the expiration of the Agreement Term. The Services Agreement provides that any of the Meridian Options which so vest and become exercisable shall remain exercisable for a 3-year period. Under the Services Agreement, additional amounts are payable to Meridian by the Company under certain circumstances upon the termination of the Services Agreement. If the termination is on account of the expiration of the Agreement Term, Meridian shall be entitled to receive a lump sum payment equal to $600,000 in severance pay and at least $300,000 in target or maximum bonus pursuant to the Company's 2001 Management Incentive Plan. If the termination is on account of the Company's material breach of the Services Agreement or the Company's termination of the engagement of Meridian and Mr. Shull where there has been no Willful Misconduct (as defined in the Services Agreement) or material breach thereof by either Mr. Shull or Meridian, Meridian shall be entitled to receive (i) a lump sum payment equal to the aggregate amount of Base Fees and Flat Fees to which it would have otherwise been entitled through the end of the Agreement Term, plus (ii) $600,000 in severance pay and at least $300,000 in target or maximum bonus pursuant to the Company's 2001 Management Incentive Plan. If the termination is on account of the acquisition of the Company (whether by merger or the acquisition of all of its outstanding capital stock) or the sale of 50% or more of the market value of the Company's assets (for this purpose under the Services Agreement, such 50% amount shall be deemed to be $107.6 million) and the amount realized in the transaction is less than $0.50 per common share (or the equivalent of $0.50 per common share), if and only if the Company's Change of Control Plan shall not then be in effect, Meridian shall be entitled to receive a lump sum payment equal to the aggregate amount of Base Fees and Flat Fees to which it would have otherwise been entitled through the end of the Agreement Term. If the termination is on account of the acquisition of the Company (whether by merger or the acquisition of all of its outstanding capital stock) or the sale of 50% or more of the market value of the Company's assets (for this purpose under the Services Agreement, such 50% amount shall be deemed to be $107.6 million) and the amount realized in the transaction equals or exceeds $0.50 per common share (or the equivalent of $0.50 per common share), and if and only if the Company's Change of Control Plan shall not then be in effect, Meridian shall be entitled to receive a lump sum payment equal to the greater of the aggregate amount of Base Fees and Flat Fees to which it would have otherwise been entitled through the end of the Agreement Term, or $1,000,000. If the termination is on account of an acquisition or sale of the Company (whether by merger or the acquisition of all of its outstanding capital stock) or the sale of 50% or more of the market value of the Company's assets (for this purpose under the Services Agreement, such 50% amount shall be deemed to be $107.6 million) and the Company's Change of Control Plan shall then be in effect, Mr. Shull shall be entitled to receive his benefit under the Company's Change of Control Plan plus a lump sum cash payment on the date of closing of such sale or acquisition of $300,000 pursuant to the Company's transaction bonus program and at least $300,000 in target bonus (plus any amount of maximum bonus) payable pursuant to the Company's 2001 Management Incentive Plan. Under the Services Agreement, the Company is required to maintain directors' and officers' liability insurance during the Agreement Term. The Company is also required to indemnify Meridian, Mr. Shull or any member, officer or employee of, or consultant, contractor or subcontractor to, Meridian who serves as a Consultant to the Company. Under a transaction bonus agreement entered into between the Company and Mr. Shull, the Company shall pay him a lump sum transaction bonus equal to $300,000 on the date of closing of any transaction which constitutes a Change of Control (as defined in the Company's Change of Control Plan) provided that he is actively employed by the Company on the date the Change of Control occurs; provided that Mr. Shull's voluntary termination or involuntary termination for cause shall cause such transaction bonus to become null and void. 10. AMERICAN STOCK EXCHANGE NOTIFICATION The Company has received a letter from the American Stock Exchange (the "AMEX") notifying the Company that it is below certain of the AMEX's continued listing guidelines set forth in the AMEX Company Guide. The AMEX has instituted a review of the Company's eligibility for continuing listing of the Company's common stock on the AMEX. The Company has held discussions with the AMEX and awaits further response. 13 11. RECENTLY ISSUED ACCOUNTING STANDARDS In July 2001, the Financial Accounting Standards Board issued Statements of Financial Accounting Standards No. 141, "Business Combinations" ("FAS 141") and No. 142, "Goodwill and Other Intangible Assets" ("FAS 142"). FAS 141 requires all business combinations initiated after June 30, 2001 to be accounted for using the purchase method. Under FAS 142, goodwill and intangible assets with indefinite lives are no longer amortized but are reviewed annually (or more frequently if impairment indicators arise) for impairment. Separable intangible assets that are not deemed to have indefinite lives will continue to be amortized over their useful lives (but with no maximum life). The amortization provisions of FAS 142 apply to goodwill and intangible assets acquired after June 30, 2001. With respect to goodwill and intangible assets acquired prior to July 1, 2001, the Company is required to adopt FAS 142 effective January 1, 2002. The Company is currently evaluating the effect that adoption of the provisions of FAS 142, that are effective January 1, 2002, will have on its results of operations and financial position. Goodwill is comprised of the Men's and the Gump's brands and the net balance at September 29, 2001 is $9.4 million. 12. REDEMPTION OF 7 1/2 % CONVERTIBLE SUBORDINATED DEBENTURES The Company is successor to The Horn & Hardart Company, the issuer of 7 1/2 % Convertible Subordinated Debentures which had been due March 7, 2007 (the "Securities"). In accordance with the optional redemption provisions of the Indenture and the Debentures, on September 28, 2001, the Company redeemed all of the outstanding principal balance of the Securities at $751,000, a price of 100% of the face value of the Securities, plus accrued and unpaid interest of an immaterial amount. 13. AMENDMENT TO CONGRESS LOAN AND SECURITY AGREEMENT In November 2001, the Company amended its Congress Credit Facility to waive a default that resulted from the calculation of the EBITDA covenant requirement and agreed to revise the definition to include the net income derived from the sale of the Kindig Lane Property and the assets of the Improvements business. The Company is currently in compliance with this revised definition and expects to remain in compliance for the remainder of the year. In addition, the amendment requires a reserve of $500,000 against the availability under the facility borrowings terms and a fee of $500,000, and the Company does not believe this will have a material impact on its liquidity. 14 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 39-Weeks Ended -------------- -------------- September 29, September 23, September 29, September 23, ------------- ------------- ------------- ------------- 2001 2000 2001 2000 ---- ---- ---- ---- Net revenues 100.0% 100.0% 100.0% 100.0% Cost of sales and operating expenses 65.5 69.2 63.9 68.0 Special charges 0.0 0.0 1.5 0.0 Selling expenses 25.9 24.5 27.2 25.0 General and administrative expenses 11.6 13.7 11.2 13.5 Depreciation and amortization 1.5 1.4 1.5 1.7 (Loss) from operations (4.5) (8.8) (5.3) (8.2) Gain on sale of Improvements and Kindig Lane 0.0 0.0 6.2 0.0 Interest expense, net 1.3 1.7 1.3 1.9 Net earnings (loss) and comprehensive earnings (loss) (5.8)% (10.5)% (0.4)% (10.1)%
RESULTS OF OPERATIONS - 13-WEEKS ENDED SEPTEMBER 29, 2001 COMPARED WITH THE 13-WEEKS ENDED SEPTEMBER 23, 2000 Net Earnings (Loss) and Comprehensive Earnings (Loss). The Company reported a net loss of $(6.8) million or $(.05) per share based on net earnings less preferred stock dividends and accretion for the 13-weeks ended September 29, 2001 compared with a net loss of $(14.8) million or $(.07) per share for the comparable period last year. The per-share amounts were calculated based on weighted average shares outstanding of 212,186,331 basic and diluted for the 13-week period ended September 29, 2001, and 213,773,193 basic and diluted for the 13-week period ended September 23, 2000. This decrease in weighted average shares was due to the conversion of 1,510,000 issued common shares into treasury shares. Compared to the comparable period last year, the $8.0 million decrease in net loss was primarily due to: (i) decreased cost of sales and operating expenses; (ii) decreased selling expenses; and (iii) decreased general and administrative expenses; partially offset by a decrease in net revenues. Net Revenues. Net revenues decreased $23.0 million (16.4%) for the 13-week period ended September 29, 2001 to $117.4 million from $140.4 million for the comparable period in 2000. This decrease was primarily due to the sale of the Improvements business on June 29, 2001, the closure of the Domestications Kitchen & Garden, Kitchen & Home and Turiya catalogs, and demand shortfalls in both the Silhouettes and International Male catalogs. The number of customers who made a purchase from the Company's catalogs during the 12 months preceding September 29, 2001 15 was 2.8 million as compared with 3.6 million during the 12 months preceding September 23, 2000. The Company circulated approximately 46.4 million catalogs during the 2001 period versus approximately 45.1 million catalogs during the 2000 period. Cost of Sales and Operating Expenses. Cost of sales and operating expenses decreased to 65.5% of net revenues for the 13-week period ended September 29, 2001 as compared to 69.2% of net revenues for the comparable period in 2000. This change is primarily due to an increase in the amount of direct import merchandise, which has a favorable impact on merchandise cost as compared to net revenue. Also contributing to the decrease are the reduced operating costs in information technology and the distribution centers related to the Company's strategic business realignment program. Selling Expenses. Selling expenses decreased by $4.0 million for the 13-weeks ended September 29, 2001 versus the comparable period in 2000 although, as a percentage relationship to net revenues, increased to 25.9% for the 13-weeks ended September 29, 2001 from 24.5% for the comparable period in 2000. This increase in percentage was primarily due to the under-performance of catalog mailings during this period. General and Administrative Expenses. General and administrative expenses were 11.6% of net revenues for the 13-weeks ended September 29, 2001 versus 13.7% of net revenues for the comparable period in 2000. The 28.8% decrease in total general and administrative expenditures reflects the impact of the Company's strategic business realignment activities. Depreciation and Amortization. Depreciation and amortization decreased by $.2 million for the 13-weeks ended September 29, 2001 versus the comparable period in 2000 although, as a percentage relationship to net revenues, increased to 1.5% for the 13-weeks ended September 29, 2001 from 1.4% for the comparable period in 2000. This increase in percentage was a result of the decrease in net revenues during the period. Loss from Operations. The Company's loss from operations decreased by $7.1 million to $5.3 million for the 13-weeks ended September 29, 2001 from a loss of $12.4 million for the comparable period in 2000. Interest Expense, Net. Interest expense, net decreased $0.9 million to $1.5 million for the 13-weeks ended September 29, 2001 as compared to $2.4 million for the same period last year. The decrease in interest expense in the third quarter of 2001 is primarily due to lower average borrowings and interest rates. RESULTS OF OPERATIONS - 39-WEEKS ENDED SEPTEMBER 29, 2001 COMPARED WITH THE 39-WEEKS ENDED SEPTEMBER 23, 2000 Net Earnings (Loss) and Comprehensive Earnings (Loss). The Company reported a net loss of $(1.7) million or $(.05) per share based on net earnings (loss) less preferred stock dividends and accretion for the 39-weeks ended September 29, 2001 compared with a net loss of $(41.9) million or $(.20) per share for the comparable period last year. The per-share amounts were calculated based on weighted average shares outstanding of 212,280,706 and 213,085,469 for the current and prior year periods, respectively. This decrease in weighted average shares was due to the conversion of 1,510,000 common shares into treasury shares. Compared to the comparable period last year, the $40.2 million decrease in net loss was primarily due to: (i) gain on sale of the Improvements business; (ii) gain on sale of the Kindig Lane Property; (iii) decreased cost of sales and operating expenses; and (iv) decreased general and administrative expenses; partially offset by: (i) increased selling expenses; and (ii) special charges associated with the Company's strategic business realignment program. 16 Net Revenues. Net revenues decreased $18.7 million (4.5%) for the 39-week period ended September 29, 2001 to $395.2 million from $413.9 million for the comparable period in 2000. This decrease was primarily due to the sale of the Improvements business on June 29, 2001, the closure of the Domestications Kitchen & Garden, Kitchen & Home and Turiya catalogs, and demand shortfalls in both the International Male and Gump's brands. The number of customers who made a purchase from the Company's catalogs during the 12 months preceding September 29, 2001 was 2.8 million as compared with 3.6 million during the 12 months preceding September 23, 2000. The Company circulated approximately 173.0 million catalogs during the 2001 period versus approximately 155.3 million catalogs during the 2000 period. Cost of Sales and Operating Expenses. Cost of sales and operating expenses decreased to 63.9% of net revenues for the 39-week period ended September 29, 2001 as compared to 68.0% of net revenues for the comparable period in 2000. This change is primarily due to an increase in the amount of direct import merchandise, which has a favorable impact on merchandise cost as compared to net revenue. Also contributing to the decrease are the reduced operating costs in distribution centers related to the Company's strategic business realignment program. Selling Expenses. Selling expenses increased to 27.2% of revenues for the 39-weeks ended September 29, 2001 from 25.0% for the comparable period in 2000 primarily due to the under-performance of catalog mailings during the second quarter period. Special Charges. Special charges were 1.5% of net revenues for the 39-weeks ended September 29, 2001 versus 0.0% of net revenues for the comparable period in 2000. In the first quarter of 2001 an additional amount for special charges was recorded in the amount of $1.1 million which consisted primarily of severance costs related to the elimination of an additional 46 FTE positions across all divisions of the Company's business as part of the strategic business realignment program. In the second quarter of 2001 an additional amount for special charges was recorded in the amount of $5.0 million which consisted primarily of additional charges related to the exit of the Maumelle and Kindig Lane buildings including the write-down for impairment of remaining assets. Maumelle exit charges included a $1.0 million lease provision adjustment and a $1.9 million fixed asset write-down. Kindig Lane exit charges included $0.5 million for fixed asset write-downs. Also included are severance costs of $1.4 million, $0.4 million related to the elimination of associates employed at the Kindig Lane facility, and $1.0 million from the elimination of an additional 32 FTE positions across all divisions of the Company's business as part of the strategic business realignment program. The remaining special charges of $0.2 million represent the foregiveness of a loan as well as other fees. There were no additional charges incurred in the third quarter of 2001. General and Administrative Expenses. General and administrative expenses were 11.2% of net revenues for the 39-weeks ended September 29, 2001 versus 13.5% of net revenues for the comparable period in 2000. The 21.0% decrease in total general and administrative expenditures reflects the impact of the Company's strategic business realignment activities. Depreciation and Amortization. Depreciation and amortization decreased to 1.5% of net revenues for the 39-weeks ended September 29, 2001 from 1.7% for the comparable period in 2000. The decrease is a result of the complete amortization of a major computer system in the year 2000 as well as the write-down of fixed assets in connection with the Company's strategic business realignment program in the year 2001. Loss from Operations. The Company's loss from operations decreased by $13.2 million to $20.9 million for the 39-weeks ended September 29, 2001 from a loss of $34.1 million for the comparable period in 2000. Gain on sale of the Improvements business and the Kindig Lane Property. Gain on sale of the Improvements business and the Kindig Lane Property was 6.2% of net revenue for the 39-weeks ended September 29, 2001 versus 0.0% of net revenues for the comparable period in 2000. The Company recognized a net gain on the sale of approximately $22.8 million, including a non-cash goodwill charge of $6.1 million, in the second quarter of 2001, which represents the excess of the net proceeds from the sale over the net assets acquired by HSN, the goodwill associated with the Improvements business and expenses related to the transaction. The Company realized a net gain on the sale of the Kindig Lane Property of approximately $1.5 million, which included the sale price net of selling expenses as well as the net book value of assets sold. Interest Expense, Net. Interest expense, net decreased $2.6 million to $5.1 million for the 39-weeks ended September 29, 2001 as compared to $7.7 million for the same period last year. The first quarter of 2000 contained a 17 one-time commitment fee and the accelerated amortization of deferred financing costs due to refinancing the Company's credit facility with Congress. The absence of these costs for the first quarter of 2001 was partially offset by higher interest costs resulting from an increase in average borrowings. The decrease in interest expense in the second and third quarters of 2001 is primarily due to lower average borrowings and interest rates. LIQUIDITY AND CAPITAL RESOURCES Net cash used in operating activities. During the 39-week period ended September 29, 2001, net cash used in operating activities was $32.0 million. This was primarily due to net losses which, when adjusted for depreciation, amortization and other non-cash items, comprised $15.6 million of operating cash used in the period. Additionally, cash outflows resulted from the reduction in accrued liabilities and accounts payable partially offset by a decrease in net accounts receivable. Net cash provided by (used in) investing activities. During the 39-week period ended September 29, 2001, net cash provided by investing activities was $33.4 million, which was primarily due to approximately $30.0 million of gross proceeds from the sale of the Improvements business. Of the approximately $33.0 million, $3.0 million of the proceeds of the sale are being held in escrow for a period of up to two years under the terms of an Escrow Agreement between LWI Holdings, Inc., HSN LP and The Chase Manhattan Bank (Note 7). As of September 29, 2001, the balance in the escrow fund is $2.6 million. Net cash (used in) provided by financing activities. During the 39-week period ended September 29, 2001, net cash used in financing activities was $1.7 million, which was primarily due to payments under the Congress term loan facility and the redemption of the 7 1/2% Convertible Subordinated Debentures, partially offset by borrowings under the Congress revolving loan facility. Congress Credit Facility. On March 24, 2000, the Company amended its credit facility with Congress to provide the Company with a maximum credit line, subject to certain limitations, of up to $82.5 million (the "Congress Credit Facility"). The Congress Credit Facility, as amended, expires on January 31, 2004 and is comprised of a revolving loan facility, a $17.5 million Tranche A Term Loan and a $7.5 million Tranche B Term Loan. Total cumulative borrowings, however, are subject to limitations based upon specified percentages of eligible receivables and eligible inventory, and the Company is required to maintain $3.0 million of excess credit availability at all times. The Congress Credit Facility, as amended, is secured by all the assets of the Company and places restrictions on the incidence of additional indebtedness and on the payment of Common Stock dividends. As of September 29, 2001, the Company had $37.2 million of borrowings outstanding under the amended Congress Credit Facility comprised of $20.4 million under the revolving loan facility, and $10.9 million and $5.9 million of Tranche A Term Loans and Tranche B Term Loans, respectively. The Company may draw upon the amended Congress Credit Facility to fund working capital requirements as needed. In November 2001, the Company amended its Congress Credit Facility to waive a default that resulted from the calculation of the EBITDA covenant requirement and agreed to revise the definition to include the net income derived from the sale of the Kindig Lane Property and the assets of the Improvements business. The Company is currently in compliance with this revised definition and expects to remain in compliance for the remainder of the year. In addition, the amendment requires a reserve of $500,000 against the availability under the facility borrowings terms and a fee of $500,000, and the Company does not believe this will have a material impact on its liquidity. On May 3, 2001, as part of the Company's strategic business realignment program, the Company sold its fulfillment warehouse in Hanover, Pennsylvania (the "Kindig Lane Property") and certain equipment located therein for $4.7 million to an unrelated third party. Substantially all of the net proceeds of the sale were paid to Congress and applied to a partial repayment of the Tranche A Term Loan made to Hanover Direct Pennsylvania, Inc., an affiliate of the Company, and to a partial repayment of the indebtedness under the Congress Credit Facility. The Company realized a net gain on the sale of approximately $1.5 million, which included the sale price net of selling expenses as well as the net book value of assets sold. The Company has continued to use the Kindig Lane Property under a lease agreement with the third party, and will lease a portion of the Kindig Lane Property until August 2002. The Company intends to transition the activities of the Kindig Lane Property into the Company's fulfillment center in Roanoke, Virginia. On June 29, 2001, the Company sold certain assets and liabilities of its Improvements business to HSN, a division of USA Networks, Inc.'s Interactive Group for approximately $33.0 million. In conjunction with the sale, the Company's Keystone Internet Services, Inc. subsidiary agreed to provide telemarketing and fulfillment services for the Improvements business under a service agreement with the buyer for a period of three years. 18 The asset purchase agreement between the Company and HSN provides for a reduction in the sale price if the performance of the Improvements business in the 2001 fiscal year fails to achieve a targeted EBITDA level as defined in the agreement. In addition, if Keystone Internet Services, Inc. fails to perform its obligations during the first two years of the services contract, the purchaser can receive a reduction in the original purchase price of up to $2.0 million. An escrow fund of $3.0 million, which was withheld from the original proceeds of the sale of approximately $33.0 million, has been established for a period of two years under the terms of an escrow agreement between LWI Holdings, Inc., HSN and The Chase Manhattan Bank as a result of these contingencies. As of September 29, 2001, the balance in the escrow fund is $2.6 million. The Company recognized a net gain on the sale of approximately $22.8 million, including a non-cash goodwill charge of $6.1 million, in the second quarter of 2001, which represents the excess of the net proceeds from the sale over the net assets assumed by HSN, the goodwill associated with the Improvements business and expenses related to the transaction. The recognition of an additional gain of up to approximately $2.5 million has been deferred until the contingencies described above expire, which will not occur prior to the middle of the 2003 fiscal year. The Company has received a letter from the American Stock Exchange (the "AMEX") notifying the Company that the Company is below certain of the AMEX's continued listing guidelines set forth in the AMEX Company Guide. The AMEX has instituted a review of the Company's eligibility for continuing listing of the Company's common stock on the AMEX. The Company has held discussions with the AMEX and awaits further response. General. At September 29, 2001, the Company had $1.4 million in cash and cash equivalents compared with $1.5 million at September 23, 2000. Working capital and current ratios at September 29, 2001 were $29.6 million and 1.36 to 1 versus $43.0 million and 1.46 to 1 at September 23, 2000. Total cumulative borrowings, including financing under capital lease obligations, as of September 29, 2001, aggregated $37.3 million, $34.2 million of which is classified as long-term. Capital commitments at September 29, 2001 totaled approximately $0.2 million. Management believes that the Company has sufficient liquidity and availability under its credit agreements to fund its planned operations through at least September 28, 2002. Achievement of the cost saving and other objectives of the Company's strategic business realignment program is critical to the maintenance of adequate liquidity. SEASONALITY The revenues and business for both the Hanover Brands and erizon subsidiaries are seasonal. The Company processes and ships more catalog orders during the fourth quarter holiday season than in any other quarter of the year. Accordingly, the Company recognizes a disproportionate share of annual revenue during the last three months of the year. FORWARD-LOOKING STATEMENTS The following statement from above constitutes a forward-looking statement within the meaning of the Private Securities Litigation Reform Act of 1995: "Management believes that the Company has sufficient liquidity and availability under its credit agreements to fund its planned operations through at least September 28, 2002." CAUTIONARY STATEMENTS The following material identifies important factors that could cause actual results to differ materially from those expressed in the forward looking statement identified above and in any other forward looking statements contained elsewhere herein: The current general deterioration in economic conditions in the United States leading to reduced consumer confidence, reduced disposable income and increased competitive activity and the business failure of companies in the retail, catalog and direct marketing industries. Such economic conditions leading to a reduction in consumer spending 19 generally and in home fashions specifically, and leading to a reduction in consumer spending specifically with reference to other types of merchandise the Company offers in its catalogs or over the Internet, or which are offered by the Company's third party fulfillment clients. 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; and fluctuations in foreign currency exchange rates. The ability of the Company to achieve projected levels of sales and the ability of the Company to reduce costs commensurately with sales projections. Increases in postage, printing and paper prices and/or the inability of the Company to reduce expenses generally as required for profitability and/or increase prices of the Company's merchandise to offset expense increases. The failure of the Internet generally to achieve the projections for it with respect to growth of e-commerce or otherwise, and the failure of the Company to increase Internet sales. The imposition of regulatory, tax or other requirements with respect to Internet sales. Actual or perceived technological difficulties or security issues with respect to conducting e-commerce over the Internet generally or through the Company's web sites or those of its third-party fulfillment clients specifically. The ability of the Company to attract and retain management and employees generally and specifically with the requisite experience in e-commerce, Internet and direct marketing businesses. The ability of employees of the Company who have been promoted as a result of the Company's strategic business realignment program to perform the responsibilities of their new positions. The current general deterioration in economic conditions in the United States leading to key vendors and suppliers reducing or withdrawing trade credit to companies in the retail and catalog and direct marketing industries. The risk that key vendors or suppliers may reduce or withdraw trade credit to the Company, 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, increasing the Company's cost of capital and impacting the Company's ability to obtain merchandise in a timely manner. Vendors beginning to withhold shipments of merchandise to the Company. The ability of the Company to find alternative vendors and suppliers on competitive terms if vendors or suppliers who exist cease doing business with the Company. The inability of the Company to timely obtain and distribute merchandise, leading to an increase in backorders and cancellations. Defaults under the Congress Credit Facility, or inadequacy of available borrowings thereunder, reducing or impairing the Company's ability to obtain letters of credit or other credit to support its purchase of inventory and support normal operations, impacting the Company's ability to obtain, market and sell merchandise in a timely manner. Continued compliance by the Company with and the enforcement by Congress of financial and other covenants and limitations contained in the Congress Credit Facility, including net worth, net working capital, capital expenditure and EBITDA covenants, and limitations based upon specified percentages of eligible receivables and eligible inventory, and the requirement that the Company maintain $6.0 million of excess credit availability at all times, affecting the ability of the Company to continue to make borrowings under the Congress Credit Facility. Continuation of the Company's history of operating losses, and the incidence of costs associated with the Company's strategic business realignment program, resulting in the Company failing to comply with certain financial and other covenants contained in the Congress Credit Facility, including net worth, net working capital, capital expenditure and EBITDA covenants and the ability of the Company to obtain waivers from Congress in the event that future internal and/or external events result in performance which results in noncompliance by the Company with the terms of the Congress Credit Facility requiring remediation. The ability of the Company to complete the Company's strategic business realignment program within the time periods anticipated by the Company. The ability of the Company to realize the aggregate cost savings and other objectives anticipated in connection with the strategic business realignment program, or within the time periods anticipated therefor. The aggregate costs of effecting the strategic business realignment program may be greater than the amounts anticipated by the Company. 20 The ability of the Company to transfer its own as well as its third party fulfillment operations conducted at the fulfillment center located in Kindig Lane, Hanover, Pennsylvania to other facilities in a timely manner while satisfying its contractual obligations to provide fulfillment services for third party clients and itself. The ability of the Company to dispose of assets related to its third party fulfillment business, to the extent not transferred to other facilities. The initiation by the Company of additional cost cutting and restructuring initiatives, the costs associated therewith, and the ability of the Company to timely realize any savings anticipated in connection therewith. The ability of the Company to maintain insurance coverage required in order to operate its businesses and as required by the Congress Credit Facility. The inability of the Company to access the capital markets due to market conditions generally, including a lowering of the market valuation of companies in the direct marketing and retail businesses, and the Company's business situation specifically. The inability of the Company to sell assets at industry multiples or at all due to market conditions generally, as a result of market conditions following the events of September 11, 2001 and otherwise. The Company's dependence up to August 24, 2000 on Richemont and its affiliates for financial support and the fact that they are not under any obligation ever to provide any additional support in the future. The ability of the Company to maintain the listing of its Common Stock on the American Stock Exchange. The continued willingness of customers to place and receive mail orders in light of worries about bio-terrorism. The Company undertakes no obligation to publicly update any forward-looking statement whether as a result of new information, future events or otherwise. Readers are advised, however, to consult any further disclosures the Company may make on related subjects in its Forms 10-Q, 8-K, 10-K or any other reports filed with the Securities and Exchange Commission. 21 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 Congress Credit Facility, which bear interest at variable rates. At September 29, 2001, outstanding principal balances under the Congress Credit Facility subject to variable rates of interest were approximately $20.4 million. If interest rates were to increase by one quarter of one percent from current levels, the resulting increase in interest expense of approximately $0.1 million would not have a material impact on the Company's results of operations taken as a whole. PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS On June 28, 2001, Rakesh K. Kaul, the Company's former President and Chief Executive Officer, filed a five-count complaint (the "Complaint") in New York State Court against the Company, seeking damages and other relief arising out of his separation of employment from the Company, including severance payments of $2,531,352 plus the cost of employee benefits, attorneys' fees and costs incurred in connection with the enforcement of his rights under his employment agreement with the Company, payment of $149,325 for 13 weeks of accrued and unused vacation, damages in the amount of $3,583,800, or, in the alternative, a declaratory judgment from the court that he is entitled to all change of control benefits under the "Hanover Direct, Inc. Thirty-Six Month Salary Continuation Plan", and damages in the amount of $1,396,066.80 due to the Company's purported breach of the terms of the "Long-Term Incentive Plan for Rakesh K. Kaul" by failing to pay him a "tandem bonus" he alleges was due and payable to him on the 30th day following his termination of employment. The Company removed the case to the U.S. District Court for the Southern District of New York on July 25, 2001. Mr. Kaul filed an Amended Complaint ("Amended Complaint") in the U.S. District Court for the Southern District of New York on September 18, 2001. The Amended Complaint repeats many of the claims made in the original Complaint and adds ERISA claims. On October 11, 2001, the Company filed its Answer, Defenses and Counterclaim to the Amended Complaint, denying liability under each of Mr. Kaul's causes of action, raising several defenses and stating nine counterclaims against Mr. Kaul. The counterclaims include (1) breach of contract; (2) breach of the Non-Competition and Confidentiality Agreement with the Company; (3) breach of fiduciary duty; (4) unfair competition; and (5) unjust enrichment. The case is pending and the Company has commenced discovery against Mr. Kaul. See also Note 5, Commitments and Contingencies, of the Notes to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this report for a discussion of legal proceedings pending against the Company and its subsidiaries. ITEM 5. OTHER INFORMATION The Company has received a letter from the American Stock Exchange (the "AMEX") notifying the Company that the Company is below certain of the AMEX's continued listing guidelines set forth in the AMEX Company Guide. The AMEX has instituted a review of the Company's eligibility for continuing listing of the Company's Common Stock on the AMEX. The Company has held discussions with the AMEX and awaits further response. 22 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 10.1 Services Agreement dated as of August 1, 2001 by and among (i) Meridian Ventures, LLC, a Nevada limited liability company controlled by Thomas C. Shull, and Thomas C. Shull, jointly and severally; and (ii) Hanover Direct, Inc. 10.2 Agreement dated May 14, 2001 between Hanover Direct, Inc. and Thomas C. Shull regarding transaction bonus 10.3 Eighteenth Amendment to Loan and Security Agreement, dated as of November 12, 2001, among Congress Financial Corporation and various subsidiaries of the Company. (b) Reports on Form 8-K Form 8-K, filed July 2, 2001 - reporting pursuant to Item 5 of such Form the issuance of a press release announcing that the Company had completed the sale of certain assets and liabilities of the Improvements business to HSN, a division of USA Networks, Inc.'s Interactive Group, for approximately $33.4 million and attaching a copy of such press release. Form 8-K, filed August 6, 2001 - reporting pursuant to Item 5 of such Form the issuance of a press release announcing that a conference call with management to review the Fiscal 2001 first half operating results and ongoing strategic restructuring activities was to be held on Tuesday, August 14, 2001 and attaching a copy of such press release. Form 8-K/A-1, filed August 9, 2001 - reporting pursuant to Items 2 and 7 of such Form further information with respect to the recent sale of certain assets and liabilities of the Improvements business to HSN. Form 8-K, filed August 14, 2001 - reporting pursuant to Item 9 of such Form and Regulation FD the issuance of a press release announcing operating results for the 13 and 26 weeks ended June 30, 2001 and attaching a copy of such press release. Form 8-K, filed August 15, 2001 - reporting pursuant to Item 9 of such Form and Regulation FD the contents of a conference call on Tuesday August 14, 2001 to review the Fiscal 2001 first half operating results and providing an unofficial transcript of such call. Form 8-K, filed August 28, 2001 - reporting pursuant to Item 5 of such Form the resignation on August 16, 2001 of Robert F. Wright as a member of the Board of Directors and the election effective as of August 21, 2001 of Basil P. Regan as a member of the Board of Directors and attaching a copy of a press release with respect to such events. Form 8-K/A-2, filed September 12, 2001 - reporting pursuant to Item 2 of such Form further information with respect to the recent sale of certain assets and liabilities of the Improvements business to HSN and providing certain pro forma financial information with respect to the Company and its subsidiaries. 23 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: /s/ Brian C. Harriss ------------------------------------------- Brian C. Harriss Executive Vice President and Chief Financial Officer (On behalf of the Registrant and as principal financial officer) Date: November 13, 2001 24 EX-10.1 3 y54556ex10-1.txt SERVICES AGREEMENT Exhibit 10.1 SERVICES AGREEMENT This Services Agreement (this "Agreement") is made as of the first day of August, 2001 by and among: (i) Meridian Ventures, LLC, a Nevada limited liability company controlled by Thomas C. Shull ("Meridian"), and Thomas C. Shull ("Shull"), jointly and severally; and (ii) Hanover Direct, Inc. (the "Company"), a Delaware corporation. 1. Provision of Services. Meridian shall provide for the benefit of the Company the services of Shull and the services of up to two additional consultants (the "Consultants") who shall provide services equivalent to those which would be provided by up to two full-time consultants. In connection therewith, Shull shall serve as the President and Chief Executive Officer (the "President/CEO") and as a member of the Company's Board of Directors (the "Board of Directors"), its Executive Committee (the "Executive Committee") and its Nominating Committee (the "Nominating Committee"). 2. Responsibilities. The President/CEO shall act and serve during the term of this Agreement as the President and Chief Executive Officer of the Company and shall report to the Board of Directors. The employment responsibilities of the President/CEO will include those normally held by the president and chief executive officer of a corporation of a similar size and nature to the Company. The President/CEO shall devote his full-time efforts (which shall mean an average of 50 hours per work week, excluding reasonable vacation, personal, sick time or de minimus non-conflicting time for Meridian) in connection with his role as President, Chief Executive Officer and member of the Executive and Nominating Committees. All employees and officers shall report directly or indirectly to the President/CEO. 3. Term. Subject to paragraph 6, the term of this Agreement (the "Agreement Term") and the term for services of Shull and the Consultants shall commence as of August 1, 2001 and shall terminate on June 30, 2002; provided, however, that, on or prior to May 1, 2002, the Company may extend the Agreement Term on a day to day basis upon written notice to Shull provided that thereafter either party may terminate the Agreement and the Agreement Term with 60 days notice to the other party. 4. Compensation. The following compensation shall be payable pursuant to this Agreement: (a) In consideration for providing the services of Shull as President/CEO and the services of the Consultants, during the Agreement Term, Meridian shall receive, in addition to the other consideration provided in this Agreement, compensation at the rate of $75,000 per month for the services of Shull and up to an additional $60,000 per month for the aggregate services of the Consultants payable in advance during the first week of each month (the "Base Fee"). (b) The compensation payable to Meridian under this Agreement is in consideration for the services of Shull and services of the Consultants. To the extent permitted by applicable law, and except as otherwise provided herein, the Company shall not be obligated to provide Shull or any Consultant (and Meridian, Shull and Meridian on behalf of each other Meridian employee serving hereunder as a Consultant specifically decline) any employee benefits (for example, health, 401K, pension, or other benefits provided by the Company to its employees, etc.) under this Agreement; provided, however, that the Company has extended the benefits of its Key Executive Eighteen Month Compensation Continuation Plan effective as of April 25, 2001, as amended (the "Change of Control Plan"), and its transaction bonus program (each as referred to in Exhibit 1) to Shull. Notwithstanding the foregoing, the Company will allow Shull during the Agreement Term to avail himself of any Company employee discount offered to other employees generally. In addition, the Company has guaranteed to Shull a target bonus for fiscal 2001 pursuant to the Company's 2001 Management Incentive Plan equal to $300,000 which shall be payable in one lump sum on or about April 1, 2002 (or on the date of closing of any transaction which constitutes a Change of Control (as hereinafter defined), if earlier) so long as Shull is providing services to the Company hereunder on December 29, 2001 (or on the date of closing of such a transaction, if earlier). Shull shall be eligible to receive a maximum bonus for fiscal 2001 pursuant to the Company's 2001 Management Incentive Plan equal to up to $600,000 (including the target bonus described in the previous sentence) which shall be payable as set forth in the previous sentence if he achieves the maximum goals set for him by the Board of Directors (as set forth on Exhibit 2 hereto). (c) In addition to the payments required by paragraph 4(a), during the Agreement Term the Company shall pay Meridian a flat fee of up to $21,000 per month, which shall represent 20% of the comparable compensation in paragraph 4(a) for Shull and 10% of the comparable compensation in paragraph (4)(a) for the Consultants and is deemed to cover Meridian over-head (including legal and accounting), health care costs, payroll costs, and other expenses (the "Flat Fee"). If, notwithstanding paragraph 4(b), applicable law requires the Company to provide Shull or any Consultants with any employee benefits (other than the Company employee discount given Shull), the value of such benefits shall be offset against the Flat Fee. (d) The Company shall reimburse Meridian for the reasonable out-of-pocket expenses of the President/CEO and any Consultants (such as travel, meals, communications and lodging) which are incurred during the Agreement Term on behalf of the Company on appropriate business. Meridian shall submit invoices and documentation for such reimbursable expenses on a monthly basis, and the Company shall process payment of the same upon receipt in accordance with its customary procedures. (e) The Company shall provide a personal secretary to be interviewed and selected by Shull to assist Shull in the performance of his duties as 2 President/CEO during the Agreement Term. The secretary shall be employed by the Company at its cost. (f) The Company shall promptly reimburse Meridian and Shull for their reasonable legal fees in the event that either of them shall consult with their counsel during the Agreement Term in connection with their fiduciary responsibilities to the Company under the Agreement, provided that such fees shall not without the prior written approval of the Executive Committee (which shall not be unreasonably withheld) exceed $20,000 (except that such $20,000 cap shall not limit the fees payable pursuant to paragraph 8 hereof). (g) The Consultants shall have the right to accept another engagement during the Agreement Term, provided such engagement does not lessen the ability of Meridian and Shull to perform their services hereunder or conflict with the obligations of Meridian and Shull hereunder or present a conflict of interest with respect to the Company. Neither paragraph 2 nor any of the preceding subparagraphs of this paragraph 4 will be affected by this right given to the Consultants. (h) Upon the closing of any transaction which constitutes a "Change of Control" (as defined in paragraph 5), provided that Shull is then employed by the Company, the Company shall make a lump sum cash payment to Meridian on the date of such closing of $900,000 pursuant to the Change of Control Plan, $300,000 pursuant to the transaction bonus program and at least $300,000 in target bonus (plus any amount of maximum bonus) payable pursuant to the Company's 2001 Management Incentive Plan as described in paragraph 4(b) . The lump sum cash payment referred to in this paragraph 4(h) shall be in lieu of any cash payment pursuant to paragraph 6(b)(iii) as a result of a termination of this Agreement pursuant to paragraph 6(a)(v) and in lieu of the aggregate amount of Base Fees and Flat Fees to which Meridian would have otherwise been entitled through the end of the Agreement Term. 5. Stock Options. Pursuant to paragraph 5 of the Services Agreement made as of December 5, 2000 by and among Meridian, Shull and the Company (the "Prior Services Agreement"), the Company granted Shull and the Consultants stock options (the "Options") for an aggregate four million (4,000,000) shares of the common stock of the Company (the "Shares"). All Shares underlying the Options shall be registered by the Company utilizing a Registration Statement on Form S-8 (or other similar form) prior to December 4, 2001. All Options shall terminate upon any termination of the Agreement pursuant to paragraph 6(a)(i) or 6(a)(iv). All outstanding Options shall vest and become exercisable upon any termination of the Agreement pursuant to paragraph 6(a)(ii), 6(a)(v) or 6(a)(vi). Further, and notwithstanding anything to the contrary contained herein, provided that this Agreement shall then be in effect, one-half (1/2) of Shull's Options and all of the Consultants' Options shall vest and become exercisable on December 4, 2001, and Shull's remaining Options shall vest and become exercisable, provided that this Agreement shall then be in effect, on June 30, 2002. In addition, and notwithstanding 3 anything to the contrary contained herein, all of the Options shall vest and become exercisable upon the earliest to occur of (i) Shull's resignation "For Good Reason" (as defined below), (ii) the Company's termination of Shull's services hereunder without being "For Cause" (as defined below), (iii) a "Change of Control" (as defined below), or (iv) the expiration of the Agreement Term. Options which vest and become exercisable pursuant to this paragraph 5 shall remain exercisable for a 3-year period (or the date of their earlier exercise). In the event of a vesting resulting from a termination of the Agreement pursuant to paragraph 6(a)(v), such vesting shall take place sufficiently in advance of such termination (but subject to its occurrence) to permit each optionee to take all steps reasonably necessary to exercise his Options and to deal with the Shares purchased under the Options so that those Shares may be treated in the same manner in connection with the transaction described in paragraph 6(a)(v) as the Shares of other shareholders. For purposes of this Agreement, the following terms shall have the following meanings: "For Good Reason" shall mean the voluntary termination by Shull of his employment with the Company on account of any of the following actions: (i) a substantial and material diminution of Shull's duties or responsibilities for the Company, (ii) a material and substantial diminution of Shull's base salary or any long-term incentive opportunity (each as in effect as of the first day of the Agreement Term), (iii) the Company's requiring Shull to regularly report to work at a facility that is more than 30 miles from the facility at which Shull regularly reported as of the first day of the Agreement Term, (iv) decisions or actions by the Board of Directors, committees or individual members of the Board that materially impede Shull's ability to take actions to increase value for all shareholders of the Company, (v) the failure of the Company to provide Shull with the number of paid vacation days to which he would otherwise be entitled in accordance with the vacation policy of the Company, or (vi) any action by the Company that adversely affects in a material way Shull's participation in or materially reduces Shull's benefits under any of such of the Company's employee benefit or compensation plans; provided, however, that in all cases, in order to terminate his employment with the Company For Good Reason, Shull must notify the Company in writing that Good Reason exists within 60 days of his knowledge of the event or events constituting Good Reason. The Company shall thereafter have 30 days within which to cure Shull's otherwise Good Reason (the "Cure Period"). Unless Shull's Good Reason is cured during the Cure Period, his termination For Good Reason shall become effective on the first business day following the conclusion of the Cure Period. "For Cause" shall mean the involuntary termination of Shull's employment with the Company on account of his (i) willful and continued failure to perform his regular duties for the Company, (ii) commission of an act of fraud relating to and adversely affecting the Company, or (iii) conviction of a felony in connection with his employment with the Company. "Change of Control" shall mean the first to occur of any of the events described in clauses (i) through (iii) below, following the first day of the Agreement Term: 4 (i) When any Person becomes, through an acquisition, the beneficial owner of shares of the Company having at least 50% of the total number of votes that may be cast for the election of directors of the Company (the "Voting Shares"); provided, however, that the following acquisitions shall not constitute a Change of Control: (A) if a Person owns less than 50% of the voting power of the Company and that Person's ownership increases above 50% solely by virtue of an acquisition of stock by the Company, then no Change of Control shall have occurred, unless and until that Person subsequently acquires one or more additional shares representing voting power of the Company; or (B) any acquisition by a Person who as of the first day of the Agreement Term owned at least 33% of the Voting Shares. (ii)(A) Notwithstanding the foregoing, a Change of Control will occur when the shareholders of the Company approve any of the following (each, a "Transaction"): (I) any reorganization, merger, consolidation or other business combination of the Company; (II) any sale of 50% or more of the market value of the Company's assets (for this purpose, said 50% amount shall be deemed to be $107.6 million); or (III) a complete liquidation or dissolution of the Company. (B) Notwithstanding clause (ii)(A) above, shareholder approval of either of the following types of Transactions will not give rise to a Change of Control: (I) a Transaction involving only the Company and one or more of its subsidiaries; or (II) a Transaction immediately following which the shareholders of the Company immediately prior to the Transaction continue to have a majority of the voting power in the resulting entity. (iii) When, within any 24 month period, persons who were directors of the Company (each, a "Director") immediately before the beginning of such period (the "Incumbent Directors") shall cease (for any reason other than death or disability) to constitute at least a majority of the Board of Directors or the board of directors of any successor to the Company. For purposes of this clause (iii), any Director who was not a Director as of the first day of the Agreement Term shall be deemed to be an Incumbent Director if such Director was elected to the Board of Directors by, or on the recommendation of, or with the approval of, at least a majority of the members of the Board of Directors or the Nominating Committee who, at the time of the vote, qualified as Incumbent Directors either actually or by prior operation of this clause (iii), and any persons (and their successors from time to time) who are designated by a holder of 33% 5 or more of the Voting Shares to stand for election and serve as Directors in lieu of other such designees serving as Directors on the first day of the Agreement Term shall be considered Incumbent Directors. Notwithstanding the foregoing, any director elected to the Board of Directors to avoid or settle a threatened or actual proxy contest shall not, under any circumstances, be deemed to be an Incumbent Director. 6. Termination. The following provisions shall relate to the termination of this Agreement: (a) The Agreement, the Agreement Term, the term for services of Shull and the engagement of Meridian and Shull hereunder will terminate upon the first to occur of the following: (i) the tenth day after written notice by the Company to Meridian and Shull with respect to any material breach by Meridian or Shull of the terms of this Agreement or Willful Misconduct (as defined below) committed by Meridian or Shull; (ii) the tenth day after written notice by Meridian and Shull to the Company that the Company is in material breach of this Agreement; (iii) the expiration of the Agreement Term; (iv) the death or permanent disability of Shull; (v) the first day after the acquisition of the Company (whether by merger or the acquisition of all of its outstanding capital stock) or the tenth day after the sale of 50% or more of the market value of the Company's assets (for this purpose, said 50% amount shall be deemed to be $107.6 million); or (vi) the day the Company terminates the engagement of Meridian and Shull when there has been no Willful Misconduct or material breach of the Agreement by either Meridian or Shull. (b) The parties agree that Meridian and Shull will have been unable to pursue alternative, profitable opportunities in order to take on this engagement, that Meridian and Shull would suffer substantial financial damage if either party were to exercise its rights of termination hereunder, and that the amount of damages to Meridian and Shull would be difficult, if not impossible, to calculate accurately. Accordingly, the parties agree that if pursuant to this paragraph 6, Meridian, Shull or the Company shall at any time cause this Agreement to terminate or the Agreement shall otherwise terminate, then the Company shall pay Meridian an amount as set forth below. In the event of the termination of this Agreement as provided in paragraph 6(a), Meridian shall receive hereunder the Base Fee and the Flat Fee through the end of the month in which the date of termination has occurred, plus a termination payment as follows: (i) If the termination is pursuant to paragraph 6(a)(i) or 6(a)(iv) above, no amount shall be due and owing to Meridian; (ii) If the termination is pursuant to paragraph 6(a)(iii) above, Meridian shall be entitled to receive a lump sum payment equal to $600,000 in severance pay and at least $300,000 in target or maximum bonus pursuant to the Company's 2001 6 Management Incentive Plan as described in paragraph 4(b); or (iii) If the termination is pursuant to paragraph 6(a)(ii) or 6(a)(vi), Meridian shall be entitled to receive a lump sum payment equal to (A) the aggregate amount of Base Fees and Flat Fees to which it would have otherwise been entitled through the end of the Agreement Term plus (B) $600,000 in severance pay and at least $300,000 in target or maximum bonus pursuant to the Company's 2001 Management Incentive Plan as described in paragraph 4(b). If the termination is pursuant to paragraph 6(a)(v) and the amount realized in the transaction described therein is less than $0.50 per Share (or the equivalent of $0.50 per Share), and if and only if the Change of Control Plan shall not then be in effect, Meridian shall be entitled to receive a lump sum payment equal to the aggregate amount of Base Fees and Flat Fees to which it would have otherwise been entitled through the end of the Agreement Term. If the termination is pursuant to paragraph 6(a)(v) and the amount realized in the transaction described therein equals or exceeds $0.50 per Share (or the equivalent of $0.50 per Share), and if and only if the Change of Control Plan shall not then be in effect, Meridian shall be entitled to receive a lump sum payment equal to the greater of the aggregate amount of Base Fees and Flat Fees to which it would have otherwise been entitled through the end of the Agreement Term or the sum of $1,000,000. If the termination is pursuant to paragraph 6(a)(v) and the Change of Control Plan is then in effect, no amount shall be payable hereunder pursuant to either of the immediately preceding two sentences, and Shull shall be entitled to receive his benefit under the Change of Control Plan plus the other amounts described in paragraph 4(h). (c) The parties agree that the amounts established hereunder are liquidated damages reasonable under the terms and circumstances of this Agreement (but excluding amounts due under paragraph 8 which shall continue to survive the termination of this Agreement), the payment of which shall fully satisfy and discharge any obligation of the Company to pay (i) any further compensation under paragraph 4 and (ii) any compensation for lost opportunity costs incurred by Meridian or Shull as a result of either party entering into this Agreement. (d) In addition, upon termination of this Agreement for any reason, the Company shall reimburse Meridian in accordance with paragraph 4(d) for all reasonable reimbursable expenses incurred by Meridian prior to the time of termination. 7 (e) Any amounts payable to Meridian pursuant to this paragraph 6 shall be paid in a lump sum within five business days after the termination date of this Agreement; provided, however, that, if the party receiving a notice pursuant to paragraph 6(a)(i) or 6(a)(ii) notifies the other party that a dispute exists concerning the termination, then, for purposes of paragraphs 5 and 6, the deemed date of termination of this Agreement shall be the date on which the dispute is finally resolved, either by mutual written agreement of the parties or by a final judgment, order or decree of an arbitrator or court of competent jurisdiction (which, in either case, is not appealable or with respect to which the time for appeal therefrom has expired and no appeal has been perfected); provided further that the date of termination of this Agreement shall be extended by a notice of dispute only if such notice is given in good faith and the party giving such notice pursues the resolution of such dispute with reasonable diligence. To the extent permitted by applicable law, any such dispute and any other controversy arising under or in connection with this Agreement, except (at the Company's election) a dispute or controversy under paragraph 9, shall be settled exclusively by binding arbitration in New York, New York, in accordance with the Employment Dispute Resolution Rules then in effect with the American Arbitration Association. Judgment may be entered on the arbitrator's award in any court having jurisdiction. 7. Insurance. The Company shall maintain in force during the term of this Agreement, directors' and officers' liability insurance ("D&O Insurance") with limits not less than five million dollars ($5,000,000) on terms and conditions currently provided for under the Company's existing insurance policy, and shall use reasonable efforts to name Shull as an insured thereunder. A copy of the policy shall be furnished to Shull for his information annually. 8. Indemnity. If Meridian, Shull or any member, officer or employee of, or consultant, contractor or subcontractor to, Meridian who serves as Consultant to the Company (including, without limitation, John F. Shull, Paul Jen, Peter Schweinfurth, Edward Lambert or Evan M. Dudik) ("Indemnitee") is threatened with or made a party to, or called as a witness or deposed or subpoenaed in, any action, suit or other legal, administrative or governmental proceeding or other legal process by reason that Indemnitee is or was deemed a consultant, officer, employee or other agent of the Company or any of its affiliates, the Company shall defend, indemnify and hold Indemnitee harmless to the maximum extent allowed by applicable law and the Company's Certificate of Incorporation and By-Laws against all liabilities, obligations, losses, damages, penalties, actions, judgments, suits, claims, disbursements and expenses, including counsel fees reasonably incurred by Indemnitee in connection therewith, to the extent the same are not paid under the D&O Insurance ("Indemnified Liability" or "Indemnified Liabilities"); provided however, that Indemnitee shall not be entitled to indemnification hereunder to the extent any such liability, obligation, loss, damage, penalty, action, judgment, suit, claim, disbursement or expense results from the gross negligence, willful misconduct or criminal conviction ("Willful Misconduct") of Indemnitee as determined by a court of competent jurisdiction. Indemnitee represents 8 and warrants that it or he has not received notice of any claim which might constitute an Indemnified Liability hereunder. The Company represents that it has not received any notice of any claim against Indemnitee that would constitute an Indemnified Liability hereunder. Payments under this indemnity in respect of indemnified settlements or judgments shall be paid at the time of final settlement or final judgment (from which no appeal may be taken), or, in respect of counsel fees or costs of defense, which shall be limited to one counsel for all Indemnitees, shall be paid at the time such fees or costs are incurred. With the prior written consent of the Company, which shall not be unreasonably withheld, Indemnitee shall have the right to pay or compromise and adjust all Indemnified Liabilities not manifestly without merit. The Company shall have the right to pay or compromise without Indemnitee's consent Indemnified Liabilities other than those which arise from or are related to any criminal action, suit or proceeding. Notwithstanding anything to the contrary contained in the preceding sentence, Indemnitee's consent shall be required for any settlement which contains a stipulation to, or admission or acknowledgement of, any liability or wrongdoing on the part of Indemnitee. This paragraph 8 shall survive the termination of this Agreement. 9. Confidentiality. Meridian and Shull shall at all times both during its and his engagement hereunder and after termination thereof regard and preserve as confidential all trade secrets and other confidential information pertaining to the business of the Company that have been or may be obtained by Meridian or Shull by reason of the performance of the terms of this Agreement. Meridian and Shull agree that all documents, reports, manuals, drawings, designs, tools, equipment, plans, proposals, marketing and sales plans, customer lists, or materials made by the Company or coming into Meridian's or Shull's possession by reason of its or his performance under this Agreement, are the property of the Company and shall not be used by Meridian or Shull in any way prohibited by this Agreement. Except as expressly provided herein, during the Agreement Term and after termination thereof, Meridian and/or Shull shall not deliver, reproduce, publish or in any way allow, after due care, information describing any trade secrets or other confidential documents or things to be delivered or used by any third party without specific direction or written consent of the Company or in response to lawful process. Immediately upon termination of this Agreement, Meridian and Shull shall promptly deliver to the Company all documents, tools, equipment, drawings, blueprints, manuals, material and significant or confidential letters and notes, reports, price lists, customer lists and copies thereof, and all other materials relating to the Company's business and which are in the possession of or under the control of Meridian or Shull. Confidential information as defined above shall exclude information or materials that become generally available to the public other than through disclosure by Meridian, Shull or any employee of Meridian in violation of this Agreement. This paragraph 9 shall survive the termination of the Agreement. 10. Miscellaneous. This Agreement shall be governed by and construed in accordance with the internal laws of the state of New Jersey. 9 11. Modification. This Agreement may only be modified by mutual agreement. 12. Assignment. This Agreement is a personal service contract and may not be assigned by either party. 13. Notices. All notices required or permitted by this Agreement shall be in writing and shall be personally delivered or faxed to the parties at their addresses set forth below or to such different addresses as such parties shall direct by notice sent in accordance with this paragraph. If to Thomas C. Shull or Meridian Ventures, LLC: 28 Leeward Lane Riverside, CT 06878 Tel.: 203-637-7659 Fax: 203-637-5576 with copies to: Morton M. Rosenfeld, Esq. Rosenfeld, Wolff, Aronson & Klein 2049 Century Park East, Suite 3090 Los Angeles, California 90067 Tel.: 310-556-1221 Fax: 310-556-0401 If to the Company: Corporate Counsel Hanover Direct, Inc. 1500 Harbor Boulevard Weehawken, New Jersey 07087 Tel.: 201-863-7300 Fax: 201-272-3468 with copies to: Sarah Hewitt, Esq. Brown Raysman Millstein Felder & Steiner LLP 900 Third Avenue New York, New York 10022 Tel.: 212-895-2000 Fax.: 212-895-2900 14. Counterparts. This Agreement may be signed in two or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. 10 15. Attorneys' Fees. Shull shall be entitled to reimbursement for reasonable attorneys' fees and disbursements incurred in connection with the review of, and advice with respect to the execution or extension of, or administration of, this Agreement; provided, however, that the aggregate amount of such reimbursement shall not exceed $8,000. If any legal action or proceeding or arbitration proceeding is brought either for the enforcement of this Agreement or because of an alleged dispute, breach, default, or material misrepresentation in connection with any of the provisions of the Agreement, the successful or prevailing party shall be entitled, in addition to any other relief to which it may be entitled, to recover reasonable attorneys' fees and other costs incurred in that action or proceeding including fees and costs incurred on appeal and in collecting any judgment, and the arbitrator or court shall so provide in its judgment. 16. Consent to Jurisdiction. Subject to their agreement to binding arbitration in paragraph 6(e), the Company, Meridian and Shull each hereby irrevocably consent to the jurisdiction of the courts of the State of New Jersey for all purposes in connection with any legal action or proceeding which arises out of or relates to this Agreement and agree that any legal action or proceeding instituted under this Agreement shall be brought only in such courts and that such courts shall have jurisdiction as provided above, except that the Company shall be entitled to enforce its rights under paragraph 9 in any court of competent jurisdiction. 17. Successors and/or Assigns. Whenever in this Agreement any of the parties hereto is referred to, such reference shall be deemed to include the successors and/or assigns and/or personal representatives of such party, and this Agreement shall inure to the benefit of and shall be binding on the parties hereto and the successors and/or assigns and/or personal representatives of each such party. 18. Entire Agreement. This Agreement (together with those agreements listed on Exhibit 1 hereto) sets forth the entire agreement of the parties hereto in respect of the subject matter contained herein and supersedes all prior agreements (including but not limited to the Prior Services Agreement), promises, covenants, arrangements, communications, representations or warranties, whether oral or written, by any officer, employee or representative of any party hereto, other than the indemnification obligations in paragraph 8 of the Prior Services Agreement and the obligations contained in the agreements listed on Exhibit 1 hereto. 11 IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first above written. HANOVER DIRECT, INC. By: /s/ Brian C. Harriss ---------------------------------- Name: Brian C. Harriss Title: Executive Vice President MERIDIAN VENTURES, LLC By: /s/ Thomas C. Shull ---------------------------------- Thomas C. Shull, President By: /s/ Thomas C. Shull ---------------------------------- Thomas C. Shull, as an individual 12 EXHIBIT 1 WRITTEN AGREEMENTS BETWEEN THE COMPANY AND SHULL RE: COMPENSATION AND BENEFITS Hanover Direct, Inc. Key Executive Eighteen Month Compensation Continuation Plan effective as of April 25, 2001, as amended Transaction Bonus in the event of a Change of Control as set forth in a letter agreement between the Company and Shull dated May 14, 2001 2001 Management Incentive Plan 13 EXHIBIT 2 2001 MANAGEMENT INCENTIVE PLAN MAXIMUM BONUS GOAL 15% per dollar of 2001 EBITDA in excess of $12.4 million (before deducting extraordinary legal and advisory fees related to one-time transactions during the period) limited to a maximum bonus of $300,000. 14 EX-10.2 4 y54556ex10-2.txt AGREEMENT RE: TRANSACTION BONUS Exhibit 10.2 To: Tom Shull From: Charlie Messina Date: May 14, 2001 Dear Tom, This is to confirm that you shall be granted a transaction bonus equal to 50% of your annualized base salary payable to you under the Services Agreement dated as of December 5, 2000, as amended, among Meridian Ventures, LLC, yourself and Hanover Direct, Inc. (the "Services Agreement") upon the occurrence of a Change of Control. "Change of Control" is defined in the Hanover Direct, Inc. Key Executive Eighteen Month Compensation Continuation Plan effective as of April 25, 2001, as amended (the "Plan"). For purposes of the benefits under the Plan and this letter agreement, the parties agree that your annualized base salary is $600,000. This bonus, payable in one lump sum on the date of closing of any transaction which constitutes a Change of Control, will be paid to you only if you are actively employed by the Company on the date the Change of Control occurs. Your voluntary termination or an involuntary termination for cause will cancel this obligation, the transaction bonus becoming null and void. This understanding does not effect any other provisions of the Services Agreement. Any dispute arising from this Agreement will be settled through binding arbitration, by an arbitrator mutually acceptable to the parties. HANOVER DIRECT, INC. Accepted by: By: /s/ Charles Messina /s/ Thomas C. Shull ------------------------------------ --------------------------- Charles Messina, Executive Thomas C. Shull Vice President EX-10.3 5 y54556ex10-3.txt OTHERS ??? [Execution Version] Exhibit 10.3 EIGHTEENTH AMENDMENT TO LOAN AND SECURITY AGREEMENT THIS EIGHTEENTH AMENDMENT TO LOAN AND SECURITY AGREEMENT, dated as of November 12, 2001, is entered into by and among CONGRESS FINANCIAL CORPORATION, a Delaware corporation ("Lender"), HANOVER DIRECT PENNSYLVANIA, INC., a Pennsylvania corporation ("HDPI"), 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"), LWI HOLDINGS, INC., a Delaware corporation ("LWI"), HANOVER DIRECT VIRGINIA INC., a Delaware corporation ("HDV"), 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"), TWEEDS, LLC, a Delaware limited liability company ("Tweeds LLC"), 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") and KEYSTONE INTERNET SERVICES, INC., a Delaware corporation ("Keystone Internet"; and together with HDPI, Brawn, GBM, Gump's, LWI, HDV, Hanover Realty, TCS Factory, TCS Office, Tweeds LLC, Silhouettes, HCS LLC and Domestications, each individually referred to herein as a "Borrower" and collectively, as "Borrowers"), and HANOVER DIRECT, INC., a Delaware corporation, ("Hanover"), AMERICAN DOWN & TEXTILE COMPANY, a Wisconsin corporation ("American Down"), D.M. ADVERTISING, INC., a New Jersey corporation ("DM Advertising"), SCANDIA DOWN CORPORATION, a Delaware corporation ("Scandia"), KEYSTONE LIQUIDATIONS, INC., a Delaware corporation, formerly known as Tweeds of Vermont, Inc., HANOVER HOME FASHIONS GROUP, LLC, a Delaware limited liability company ("HHFG LLC"), KITCHEN & HOME, LLC, a Delaware limited liability company ("Kitchen & Home, LLC"), DOMESTICATIONS KITCHEN & GARDEN, LLC, a Delaware limited liability company ("Domestications K&G, LLC"), ENCORE CATALOG, LLC, a Delaware limited liability company ("Encore LLC"), CLEARANCE WORLD OUTLETS, LLC, a Delaware limited liability company ("Clearance World"), SCANDIA DOWN, LLC, a Delaware limited liability company ("Scandia Down, LLC"), ERIZON, INC., a Delaware corporation ("erizon, inc."), HANOVER BRANDS, INC., a Delaware corporation ("Hanover Brands"), ERIZON.COM, INC., a Delaware corporation ("erizon.com"), LACROSSE FULFILLMENT, LLC, a Delaware limited liability company ("LaCrosse, LLC"), and SAN DIEGO TELEMARKETING, LLC, a Delaware limited liability company ("San Diego LLC"; each individually a "Guarantor" and collectively "Guarantors"). 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 First Amendment to Loan and Security Agreement, dated February 22, 1996, Second Amendment to Loan and Security Agreement, dated April 16, 1996, Third Amendment to Loan and Security Agreement, dated May 24, 1996, Fourth Amendment to Loan and Security Agreement, dated May 31, 1996, Fifth Amendment to Loan and Security Agreement, dated September 11, 1996, Sixth Amendment to Loan and Security Agreement, dated as of December 5, 1996, Seventh Amendment to Loan and Security Agreement, dated as of December 18, 1996, Eighth Amendment to Loan and Security Agreement, dated as of March 26, 1997, Ninth Amendment to Loan and Security Agreement, dated as of April 18, 1997, Tenth Amendment to Loan and Security Agreement, dated as of October 31, 1997, Eleventh Amendment to Loan and Security Agreement, dated as of March 25, 1998, Twelfth Amendment to Loan and Security Agreement, dated as of September 30, 1998, Thirteenth Amendment to Loan and Security Agreement, dated as of September 30, 1998, Fourteenth Amendment to Loan and Security Agreement, dated as of February 28, 2000, Fifteenth Amendment to Loan and Security Agreement, dated as of March 24, 2000, Sixteenth Amendment to Loan and Security Agreement, dated as of August 8, 2000, and Seventeenth Amendment to Loan and Security Agreement, dated as of January 5, 2001 (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 waive the Event of Default arising from the failure of Hanover and its Subsidiaries to maintain the cumulative minimum amount of EBITDA in accordance with Section 6.31(b) of the Loan Agreement for the cumulative fiscal quarter year to date period commencing on December 30, 2000 through and including June 30, 2001, and Lender has agreed to waive that Event of Default, subject to the terms and conditions contained herein; and WHEREAS, the parties to the Loan Agreement desire to enter into this Eighteenth Amendment to Loan and Security Agreement (this "Amendment") to evidence and effectuate such waiver and certain amendments to the Financing Agreements relating thereto, in each case 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) Amendment to Definition of Consolidated Net Income. Effective as of June 30, 2001, all references to the term "Consolidated Net Income" in the Loan Agreement and the other Financing Agreements shall be deemed and each such reference is hereby amended to mean, with respect to any Person and its Subsidiaries for any period, the aggregate of the net income (loss) of such Person and its Subsidiaries, on a consolidated basis, for such period (excluding to the extent included therein any extraordinary or unusual and non-recurring gains) after deducting all charges which should be deducted before arriving at the net income (loss) for such period and, without duplication, after deducting the Provision for Taxes for such period, all as determined in accordance with GAAP; provided, that, (A) the net income of any Person that is not a wholly-owned Subsidiary or that is accounted for by the equity method of accounting shall be included only to the extent of the amount of dividends or distributions paid or payable to such Person or a wholly-owned Subsidiary of such Person; (B) except to the extent included pursuant to the foregoing clause, the net income of any Person accrued prior to the date it becomes a wholly-owned Subsidiary of such Person or is merged into or consolidated with such Person or any of its wholly-owned Subsidiaries or that Person's assets are acquired by such Person or by its wholly-owned Subsidiaries shall be excluded; and (C) the net income (if positive) of any wholly-owned Subsidiary to the extent that the declaration or payment of dividends or similar distributions by such wholly-owned Subsidiary to such Person or to any other wholly-owned Subsidiary of such Person is not at the time permitted by operation of the terms of its charter or any agreement, instrument, judgment, decree, order, statute, rule or governmental regulation applicable to such wholly- 2 owned Subsidiary shall be excluded. For the purposes of this definition, net income excludes any gain (or loss) together with any related Provision for Taxes for such gain (or loss) realized upon the sale or other disposition of any assets that are not sold in the ordinary course of business (including, without limitation, Asset Sales and dispositions pursuant to sale and leaseback transactions) or of any Capital Stock of such Person or a Subsidiary of such Person and any net income realized or loss incurred as a result of changes in accounting principles or the application thereof to such Person, except, that, solely for purposes of calculating the minimum amount of EBITDA during the fiscal year of Hanover and its Subsidiaries ending December 29, 2001 pursuant to Section 6.31 of the Loan Agreement, Hanover and its Subsidiaries may include the net income derived from the sale of the HDPI Real Property permitted by the letter, dated as of April 30, 2001, by Congress to HDPI and Hanover Re: Sale of 101 Kindig Lane Facility of Hanover Direct Pennsylvania, Inc. and from the sale of the LWI Assets permitted by the letter, dated as of June 13, 2001, by Congress to LWI, Keystone Internet, Hanover Brands and Hanover Re: Sale of Certain Assets of the "Improvements" Mail Order Catalog Business of LWI Holdings, Inc., the term "Provision for Taxes" shall mean an amount equal to all taxes imposed on or measured by net income, whether Federal, State, Provincial, county or local, and whether foreign or domestic, that are paid or payable by any Person in respect of any period in accordance with GAAP, and the term "Capital Stock" shall mean, with respect to any Person, any and all shares, interests, participation or other equivalents (however designated) of such Person's capital stock at any time outstanding, and any and all rights, warrants or options exchangeable for or convertible into such capital stock (but excluding any debt security that is exchangeable for or convertible into such capital stock). (b) (c) Interpretation. All capitalized terms used herein and not defined herein shall have the meanings given to such terms in the Loan Agreement. (d) 2. Waiver of EBITDA Covenant Default. 3. (a) Lender hereby waives, subject to the terms and conditions contained in this Amendment, the Event of Default arising under Section 6.31(b) of the Loan Agreement as a result of the failure of Hanover and its Subsidiaries to maintain EBITDA in the amounts required thereunder for the cumulative fiscal year to date period measured from December 30, 2000 through and including June 30, 2001. (b) (c) Lender has not waived and is not by this Amendment waiving, and has no intention of waiving, any other Event of Default, which may have occurred before the date hereof, or may be continuing on the date hereof or any Event of Default that may occur after the date hereof, whether the same or similar to the Event of Default described in Section 2(a) hereof or otherwise, other than the Event of Default described in Section 2(a) hereof. Lender reserves the right, in its discretion, to exercise its rights and remedies arising under the Financing Agreements, applicable law or otherwise as a result of any other Events of Default that may have occurred before the date hereof, or are continuing on the date hereof, or any Event of Default that may occur after the date hereof, whether the same or similar to the Event of Default described in Section 2(a) hereof or otherwise. (d) 4. EBITDA Loan Availability Reserve. 5. (a) Effective on the date hereof, in addition to any then existing availability reserves that may be in effect at such time, Lender shall establish and maintain at all times thereafter an availability reserve against the amount of Revolving Loans and Letter of Credit Accommodations otherwise determined by Lender to be available to Revolving Loan Borrowers under the Loan Agreement and the other Financing Agreements in the amount equal to $500,000. (b) (c) The availability reserve established in accordance with this Section 3 is in addition to, and nots in limitation of, all other existing availability reserves and the rights of Lender from time to time to establish other and further reserves against the availability of Revolving Loans and Letter of Credit Accommodations under the Loan Agreement and the other Financing Agreements. (d) 6. Appraisals. Section 6.15 of the Loan Agreement is hereby deleted and replaced with the following: 7. 8. "6.15 Appraisals 9. (a) Borrowers shall, at Borrowers' expense, upon the request of Lender, obtain appraisals by the Appraiser of any or all of the Inventory of Borrowers, in form, scope and methodology acceptable to Lender, and including, but not limited to, a report as to the Net Orderly Liquidation Value of the Inventory of Borrowers, other than Inventory of Gump's at the Gump's Main Store, and of the Net GOB Value of the Inventory of Gump's at the Gump's Main Store. (b) Upon Lender's request, Borrowers shall, at their expense, once in any calendar year during the Term (excluding any such reports or appraisals delivered in connection with the closing hereunder) and at any time or times as Lender may request on or after an Event of Default, deliver or cause to be delivered to Lender written reports or appraisals as to their Real Property or Equipment, in form, scope and methodology acceptable to Lender and by an appraiser acceptable to Lender." 1. Fees. 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 the following additional fees: 2. (a) Borrowers shall pay to Lender, contemporaneously herewith, a closing fee in the amount of $375,000, which fee is fully earned as of the date hereof and may be charged into the loan account(s) of any Borrower. (b) Tranche B Term Loan Borrowers shall pay to Lender, contemporaneously herewith, a closing fee in the amount of $125,000, which fee is fully earned as of the date hereof and may be charged into the loan account(s) of any Tranche B Term Loan Borrower. (c) 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: 4. (a) This Amendment and each other agreement or instrument to be executed and delivered by each Borrower or Guarantor hereunder have been duly authorized, executed and delivered by all necessary action on the part of each of Borrower and each Guarantor 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 each Borrower and Guarantor, as the case may be, contained herein and therein constitute legal, valid and binding obligations of each Borrower and Guarantor, as the case may be, enforceable against them in accordance with their terms. (b) (c) No action of, or filing with, or consent of any governmental or public body or authority, and no consent of any other party, 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 to this Amendment. (d) (i) Neither the execution and delivery of this 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 has violated or shall violate any Federal or State securities laws or any other law or regulation or any order or decree of any court or governmental instrumentality in any respect, or 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 may be bound, or does or shall violate any provision of the Certificate of Incorporation or By-Laws of any Borrower or Guarantor. (ii) (e) All of the representations and warranties set forth in the Loan Agreement as amended hereby, and the other Financing Agreements, are true and correct in all material respects after giving effect to the provisions of this Amendment, except to the extent any such representation or warranty is made as of a specified date, in which case such representation or warranty shall have been true and correct as of such date. (f) (g) After giving effect to the provisions of this Amendment, no Event of Default or Incipient Default exists or has occurred and is continuing. (h) 5. 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: 6. (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) days after the date hereof), as the case may be, duly authorized, executed and delivered by Borrowers and Guarantors; (b) (c) Lender shall have received, in form and substance satisfactory to Lender, Secretary's or Assistant Secretary's Certificates of Directors' Resolutions with Shareholders' Consent evidencing the adoption and subsistence of corporate resolutions approving the execution, delivery and performance by Borrowers and Guarantors that are corporations of this Amendment and the agreements, documents and instruments to be delivered pursuant to this Amendment; and (d) (e) each of Borrowers and Guarantors 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, and such consent, approval or waiver shall be in a form reasonably acceptable to Lender. (f) 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 waivers 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. 9. 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. 10. 11. 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. 12. 13. 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. 14. 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. 15. 16. [REMAINDER OF 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/ Janet S. Last Title: First Vice President HANOVER DIRECT PENNSYLVANIA, INC. BRAWN OF CALIFORNIA, INC. GUMP'S BY MAIL, INC. GUMP'S CORP. LWI HOLDINGS, INC. HANOVER DIRECT VIRGINIA INC. HANOVER REALTY, INC. THE COMPANY STORE FACTORY, INC. THE COMPANY OFFICE, INC. KEYSTONE INTERNET SERVICES, INC. TWEEDS, LLC SILHOUETTES, LLC HANOVER COMPANY STORE, LLC DOMESTICATIONS, LLC By: /s/ Brian C. Harriss ------------------- Title: Vice President ---------------- 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/ Brian C. Harriss -------------------- Title: Executive Vice President and Chief Financial Officer ---------------------------------------------------- [SIGNATURES CONTINUE ON NEXT PAGE] [SIGNATURES CONTINUED FROM PREVIOUS PAGE] AMERICAN DOWN & TEXTILE COMPANY D.M. ADVERTISING, INC. SCANDIA DOWN CORPORATION KEYSTONE LIQUIDATIONS, INC. HANOVER HOME FASHIONS GROUP, LLC KITCHEN & HOME, LLC DOMESTICATIONS KITCHEN & GARDEN, LLC ENCORE CATALOG, LLC CLEARANCE WORLD OUTLETS, LLC SCANDIA DOWN, LLC ERIZON, INC. HANOVER BRANDS, INC. ERIZON.COM, INC. LA CROSSE FULFILLMENT, LLC SAN DIEGO TELEMARKETING, LLC By: /s/ Brian C. Harriss -------------------- Title: Vice President ------------------ -----END PRIVACY-ENHANCED MESSAGE-----