10-Q/A 1 y62894e10vqza.txt AMENDMENT NO. 1 TO FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q/A1 AMENDMENT NO.1 TO QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended JUNE 29, 2002 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.) 115 RIVER ROAD, BUILDING 10, EDGEWATER, NEW JERSEY 07020 (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: 138,315,800 shares outstanding as of August 9, 2002. HANOVER DIRECT, INC. TABLE OF CONTENTS
Page ---- Part I - Financial Information Item 1. Financial Statements Condensed Consolidated Balance Sheets - June 29, 2002 and December 29, 2001 ...................................................................... 2 Condensed Consolidated Statements of Income (Loss) - 13- and 26- weeks ended June 29, 2002 and June 30, 2001 .......................................................................... 4 Condensed Consolidated Statements of Cash Flows - 26- weeks ended June 29, 2002 and June 30, 2001........................................................................... 5 Notes to Condensed Consolidated Financial Statements........................................................ 6 Item 2. Management's Discussion and Analysis of Consolidated Financial Condition and Results of Operations..................................................................................... 17 Item 3. Quantitative and Qualitative Disclosures about Market Risk............................................ 25 Part II - Other Information Item 6. Exhibits and Reports on Form 8-K...................................................................... 26 Signatures..................................................................................................... 27
1 PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS HANOVER DIRECT, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AMOUNTS)
June 29, December 29, 2002 2001 ------------- ------------- (UNAUDITED) ASSETS CURRENT ASSETS: $ 885 $ 1,121 Cash and cash equivalents Accounts receivable, net 17,860 19,456 Inventories 51,266 59,223 Prepaid catalog costs 17,341 14,620 Deferred tax asset, net 3,300 3,300 Other current assets 3,566 3,000 --------- --------- Total Current Assets 94,218 100,720 --------- --------- PROPERTY AND EQUIPMENT, AT COST: Land 4,509 4,509 Buildings and building improvements 18,205 18,205 Leasehold improvements 12,369 12,466 Furniture, fixtures and equipment 59,562 59,287 --------- --------- 94,645 94,467 Accumulated depreciation and amortization (63,100) (60,235) --------- --------- Property and equipment, net 31,545 34,232 --------- --------- Goodwill, net 9,278 9,278 Deferred tax asset, net 11,700 11,700 Other assets 1,118 1,731 --------- --------- Total Assets $ 147,859 $ 157,661 ========= =========
See notes to Condensed Consolidated Financial Statements. 2 HANOVER DIRECT, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (CONTINUED) (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AMOUNTS)
June 29, December 29, 2002 2001 ------------- ----------------- (UNAUDITED) LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIENCY) CURRENT LIABILITIES: Current portion of long-term debt and capital lease obligations $ 3,068 $ 3,162 Accounts payable 40,510 46,348 Accrued liabilities 20,171 25,132 Customer prepayments and credits 7,396 5,143 --------- --------- Total Current Liabilities 71,145 79,785 --------- --------- NON-CURRENT LIABILITIES: Long-term debt 26,492 26,548 Other 8,469 10,233 --------- --------- Total Non-current Liabilities 34,961 36,781 --------- --------- Total Liabilities 106,106 116,566 --------- --------- SERIES B PARTICIPATING PREFERRED STOCK, authorized, issued and outstanding 1,622,111 shares at June 29, 2002 and December 29, 2001 83,230 76,823 SHAREHOLDERS' EQUITY (DEFICIENCY): Common Stock, $.66 2/3 par value, 300,000,000 shares authorized; 140,436,729 shares issued at June 29, 2002 and 140,336,729 shares issued at December 29, 2001 93,625 93,558 Capital in excess of par value 345,735 351,558 Accumulated deficit (477,491) (477,497) --------- --------- (38,131) (32,381) --------- --------- Less: Treasury stock, at cost (2,120,929 shares at June 29, 2002 and 2,100,929 shares at December 29, 2001) (2,996) (2,942) Notes receivable from sale of Common Stock (350) (405) --------- --------- Total Shareholders' Equity (Deficiency) (41,477) (35,728) --------- --------- Total Liabilities and Shareholders' Equity (Deficiency) $ 147,859 $ 157,661 ========= =========
See notes to Condensed Consolidated Financial Statements. 3 HANOVER DIRECT, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF INCOME (LOSS) (IN THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED)
FOR THE 13- WEEKS ENDED FOR THE 26- WEEKS ENDED ------------------------ ------------------------ JUNE 29, JUNE 30, JUNE 29, JUNE 30, 2002 2001 2002 2001 --------- --------- --------- --------- NET REVENUES $ 113,852 $ 133,507 $ 223,363 $ 277,801 --------- --------- --------- --------- OPERATING COSTS AND EXPENSES: Cost of sales and operating expenses 70,326 83,204 141,489 175,615 Special charges -- 5,025 233 6,081 Selling expenses 26,579 37,679 51,199 77,057 General and administrative expenses 12,552 15,399 24,972 30,695 Depreciation and amortization 1,481 1,940 2,983 3,899 --------- --------- --------- --------- 110,938 143,247 220,876 293,347 --------- --------- --------- --------- EARNINGS (LOSS) FROM OPERATIONS 2,914 (9,740) 2,487 (15,546) Gain on sale of Improvements 318 22,818 318 22,818 Gain on sale of Kindig Lane -- 1,529 -- 1,529 --------- --------- --------- --------- EARNINGS BEFORE INTEREST AND INCOME TAXES 3,232 14,607 2,805 8,801 Interest expense, net 1,386 1,845 2,739 3,651 --------- --------- --------- --------- Earnings before income taxes 1,846 12,762 66 5,150 Income tax provision 30 30 60 60 --------- --------- --------- --------- NET EARNINGS AND COMPREHENSIVE EARNINGS 1,816 12,732 6 5,090 Preferred stock dividends and accretion 3,503 2,984 6,407 5,864 --------- --------- --------- --------- NET EARNINGS (LOSS) APPLICABLE TO COMMON SHAREHOLDERS $ (1,687) $ 9,748) $ (6,401) $ (774) ========= ========= ========= ========= NET EARNINGS (LOSS) PER COMMON SHARE: Net earnings (loss) per common share - basic and diluted $ (.01) $ .05 $ (.05) $ (.00) ========= ========= ========= ========= Weighted average common shares outstanding - basic (thousands) 138,264 212,186 138,245 212,327 ========= ========= ========= ========= Weighted average common shares outstanding - diluted (thousands) 138,264 212,786 138,245 212,327 ========= ========= ========= =========
See notes to Condensed Consolidated Financial Statements. 4 HANOVER DIRECT, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS OF DOLLARS) (UNAUDITED)
FOR THE 26- WEEKS ENDED ----------------------- JUNE 29, JUNE 30, 2002 2001 -------- -------- CASH FLOWS FROM OPERATING ACTIVITIES: Net earnings $ 6 $ 5,090 Adjustments to reconcile net earnings to net cash provided (used) by operating activities: Depreciation and amortization, including deferred fees 3,696 4,212 Provision for doubtful accounts 83 283 Special charges -- 2,388 Gain on sale of Improvements -- (22,818) Gain on sale of Kindig Lane -- (1,529) Compensation expense related to stock options 627 1,379 Changes in assets and liabilities, net of sale of business: Accounts receivable 1,513 7,928 Inventories 7,957 5,382 Prepaid catalog costs (2,721) (3,824) Accounts payable (5,838) (2,377) Accrued liabilities (4,961) (9,241) Customer prepayments and credits 2,253 1,051 Other non-current liabilities (1,764) (1,577) Other, net (662) (248) -------- -------- Net cash provided (used) by operating activities 189 (13,901) -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Acquisitions of property and equipment (300) (734) Proceeds from sale of Improvements -- 30,235 Proceeds from sale of Kindig Lane -- 4,671 -------- -------- Net cash provided (used) by investing activities (300) 34,172 -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Net borrowings (payments) under Congress revolving loan facility 1,477 (15,029) Payments under Congress term loan facility (1,531) (4,746) Payments under capital lease obligations (96) -- Other, net 25 (88) -------- -------- Net cash (used) by financing activities (125) (19,863) -------- -------- Net increase (decrease) in cash and cash equivalents (236) 408 Cash and cash equivalents at the beginning of the year 1,121 1,691 -------- -------- Cash and cash equivalents at the end of the period $ 885 $ 2,099 ======== ======== SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid for: Interest $ 1,706 $ 2,946 ======== ======== Income taxes $ 137 $ 85 ======== ======== Non-cash investing and financing activities: Series B Participating Preferred Stock redemption price increase $ 6,407 $ -- ======== ======== Stock dividend and accretion of Series A Cumulative Participating Preferred Stock $ -- $ 5,864 ======== ========
See notes to Condensed Consolidated Financial Statements. 5 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 29, 2001. 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. Pursuant to SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," the consolidated operations of Hanover Direct, Inc. are reported as one segment. 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 Statement of Financial Accounting Standards ("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 June 29, 2002 was 138,264,152. For the 13-week period ended June 30, 2001, the weighted average number of shares used in the calculation for basic and diluted net earnings per share were 212,186,331 and 212,786,467 shares, respectively. The weighted average number of shares used in the calculation for both basic and diluted net (loss) per share for the 26-week periods ended June 29, 2002 and June 30, 2001 was 138,244,591 and 212,327,375 shares, respectively. Diluted net (loss) per share equals basic net (loss) per share as the inclusion of potentially dilutive securities would have an anti-dilutive impact on the diluted calculation as a result of the net losses incurred during the 13-week period ended June 29, 2002 and 26-week periods ended June 29, 2002 and June 30, 2001. The number of potentially dilutive securities excluded from the calculation of diluted net (loss) per share was 1,442,642 common share equivalents for the 13-week period ended June 29, 2002. The number of potentially dilutive securities excluded from the calculation of diluted net (loss) per share was 1,702,238 and 1,186,056 common share equivalents for the 26-week periods ended June 29, 2002 and June 30, 2001, respectively. 4. 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) attorneys' 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 6 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. The appeal has been fully briefed. At a subsequent status hearing, the parties agreed that issues pertaining to notice to the class would be stayed pending resolution of the appeal, that certain other issues would be subject to limited discovery, and that the issue of a stay for any remaining issues would be resolved if and when such issues arise. The Company believes it has defenses against the claims. 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 when settled in a future period. Defense counsel to the Company will seek to have the resolution of the five class action cases (Martin, Teichman, Wilson, and the two Argonaut cases which are discussed below) combined, or their effects lessened, in that there are common issues and a substantially similar class sought to be defined in the five cases. 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. In January 2002, plaintiff sought leave to name six additional entities: International Male, Domestications Kitchen & Garden, Silhouettes, Hanover Company Store, Kitchen & Home, and Domestications as co-defendants. On March 12, 2002, the Company was served with the First Amended Complaint in which plaintiff named as defendants the Company, Hanover Brands, Hanover Direct Virginia, LWI Holdings, Hanover Company Store, Kitchen and Home, and Silhouettes, and in which all causes of action related to state sales tax have been removed. With the removal of sales tax issues, the Teichman case concerns issues identical to the Martin case and may make it easier to stay the Teichman case pending the outcome of the Martin case. On April 15, 2002, the Company filed a Motion to Stay the Teichman action in favor of the previously filed Martin action and also filed a Motion to quash service of summons for lack of personal jurisdiction on behalf of defendants Hanover Direct, Inc., Hanover Brands, Inc. and Hanover Direct Virginia, Inc. On May 14, 2002, the Court (1) granted the Company's Motion to Quash service on behalf of Hanover Direct, Hanover Brands, and Hanover Direct Virginia, leaving only LWI Holdings, Hanover Company Store, Kitchen & Home, and Silhouettes, as defendants, and (2) granted the Company's Motion to Stay the action in favor of the previously filed Oklahoma action, so nothing will proceed on this case against the remaining entities until the Oklahoma case is decided. The Company believes it has defenses against the claims. 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 when settled in a future period. Defense counsel to the Company will seek to have the resolution of the five class action cases (Martin, Teichman, Wilson, and the two Argonaut cases which are discussed below) combined, or their effects lessened, in that there are common issues and a substantially similar class sought to be defined in the five cases. 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 Counterclaims to the Amended Complaint, denying liability under each of Mr. Kaul's causes of action, raising several defenses and 7 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 Company seeks damages, including, without limitation, the $341,803 in severance pay and car allowance Mr. Kaul received following his resignation, $412,336 for amounts paid to Mr. Kaul for car allowance and related benefits, the cost of a long-term disability policy, and certain payments made to personal attorneys and consultants retained by Mr. Kaul during his employment, $43,847 for certain services the Company provided and certain expenses the Company incurred, relating to the renovation and leasing of office space occupied by Mr. Kaul's spouse at 115 River Road, Edgewater, New Jersey, the Company's current headquarters, $211,729 on a tax loan to Mr. Kaul outstanding since 1997 and interest, compensatory and punitive damages and attorneys' fees. The case is pending. The discovery period has closed, the Company has moved to amend its counterclaims, and the parties have each moved for summary judgment. The Company requests summary judgment dismissing Mr. Kaul's claims including, without limitation, Mr Kaul's claim for 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 summary judgment awarding damages on the Company's claim for reimbursement of a tax loan. Mr. Kaul requests summary judgment dismissing certain of the Company's counterclaims and defenses. The briefing on the motions is completed. No trial date has been set. It is too early to determine the potential outcome, which could have a material impact on the Company's results of operations when resolved in a future period. 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 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 Shopper's 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 [i.e., The Shopper's Edge, LLC, FAR Services, LLC and Consumer Data Depot, LLC]." The most important implication of the Order was 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 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 have required some direct mail or technology expenditures and would have severely hurt response rates, which could have had a material impact on the Company's profits from discount buying club membership revenues. The last renewals of Shopper's Edge memberships were processed in October, 2001 by agreement between the Company and Ira Smolev. During April 2002, the Company received an inquiry from the FTC asking for an explanation of how the Company is complying with the Order and, if the Company is asserting that it is not subject to the Order, to provide an explanation of the basis for such assertion. The Company has replied in writing to the FTC that it is not subject to the Order, and has provided an explanation of its relationship with Mr. Smolev. The Company was named as one of 88 defendants in a patent infringement complaint filed on November 23, 2001 by the Lemelson Medical, Education & Research Foundation, Limited Partnership (the "Lemelson Foundation"). The complaint, filed in the U.S. District Court in Arizona, was not served on the Company until March 2002. In the complaint, the Lemelson Foundation accuses the named defendants of infringing seven U.S. patents which allegedly cover "automatic identification" technology through the defendants' use of methods for scanning production markings such as bar codes. The Company received a letter dated November 27, 2001 from attorneys for the Lemelson Foundation notifying the Company of the complaint and offering a license. The Court entered a stay of the case on March 20, 2002, requested by the Lemelson Foundation, pending the outcome of a related case in Nevada being fought by bar code manufacturers. The Nevada case is scheduled to go to trial in November 2002. The Order for the stay provides that the Company need not answer the complaint, although it has the option to do so. The Company has been invited to join a common interest/joint-defense group consisting of defendants named in the complaint as well as in other actions brought by the Lemelson Foundation. The Company is currently in the process of analyzing the merits of 8 the issues raised by the complaint, notifying vendors of its receipt of the complaint and letter, evaluating the merits of joining the joint-defense group, and having discussions with attorneys for the Lemelson Foundation regarding the license offer. A preliminary estimate of the royalties and attorneys' fees which the Company may pay if it decides to accept the license offer from the Lemelson Foundation range from about $125,000 to $400,000. The Company has decided to gather further information, but will not agree to a settlement at this time. A class action lawsuit was commenced on February 13, 2002 entitled Jacq Wilson, suing on behalf of himself, all others similarly situated, and the general public v. Brawn of California, Inc. dba International Male and Undergear, and Does 1-100 ("Brawn") in the Superior Court of the State of California, City and County of San Francisco. Does 1-100 are internet and catalog direct marketers offering a selection of men's clothing, sundries, and shoes who advertise within California and nationwide. The complaint alleges that for at least four years, members of the class have been charged an unlawful, unfair, and fraudulent insurance fee and tax on orders sent to them by Brawn; that Brawn was engaged in untrue, deceptive and misleading advertising in that it was not lawfully required or permitted to collect insurance, tax and sales tax from customers in California; and that Brawn has engaged in acts of unfair competition under the state's Business and Professions Code. Plaintiff and the class seek (i) restitution and disgorgement of all monies wrongfully collected and earned by Brawn, including interest and other gains made on account of these practices, including reimbursement in the amount of the insurance, tax and sales tax collected unlawfully, together with interest, (ii) an order enjoining Brawn from charging customers insurance and tax on its order forms and/or from charging tax on the delivery, shipping and insurance charges, (iii) an order directing Brawn to notify the California State Board of Equalization of the failure to pay the correct amount of tax to the state and to take appropriate steps to provide the state with the information needed for audit, and (iv) compensatory damages, attorneys' fees, pre-judgment interest, and costs of the suit. The claims of the individually named plaintiff and for each member of the class amount to less than $75,000. On April 15, 2002, the Company filed a Motion to Stay the Wilson action in favor of the previously filed Martin action. On May 14, 2002, the Court heard the argument in the Company's Motion to Stay the action in favor of the Oklahoma action, denying the motion. The Court decided that the California sales tax issue should be resolved in California. Discovery is proceeding and the Company plans to conduct a vigorous defense of this action. The Company believes it has defenses against the claims and intends to file a motion for summary judgment in the case. 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 when settled in a future period. Defense counsel to the Company will seek to have the resolution of the five class action cases (Martin, Teichman, Wilson, and the two Argonaut cases which are discussed below) combined, or their effects lessened, in that there are common issues and a substantially similar class sought to be defined in the five cases. A class action lawsuit was commenced on February 20, 2002 entitled Argonaut Consumer Rights Advocates Inc., suing on behalf of the General Public v. Gump's By Mail, Inc. ("Gump's"), and Does 1-100 in the Superior Court of the State of California, City and County of San Francisco. The plaintiff is a non-profit public benefit corporation suing under the California Business and Profession Code. Does 1-100 would include persons whose activities include the direct sale of tangible personal property to California consumers including the type of merchandise that Gump's -- the store and the catalog -- sell, by telephone, mail order, and sales through the web sites www.gumpsbymail.com and www.gumps.com. The complaint alleges that for at least four years members of the class have been charged an unlawful, unfair, and fraudulent tax and "sales tax" on their orders in violation of California law and court decisions, including the state Revenue and Taxation Code, Civil Code, and the California Board of Equalization; that Gump's engages in unfair business practices; that Gump's engaged in untrue and misleading advertising in that it was not lawfully required to collect tax and sales tax from customers in California; is not lawfully required or permitted to add tax and sales tax on separately stated shipping or delivery charges to California consumers; and that it does not add the appropriate or applicable or specific correct tax or sales tax to its orders. Plaintiff and the class seek (i) restitution of all tax and sales tax charged by Gump's on each transaction and/or restitution of tax and sales tax charged on the shipping charges; (ii) an order enjoining Gump's from charging customers for tax on orders or from charging tax on the shipping charges; and (iii) attorneys' fees, pre-judgment interest on the sums refunded, and costs of the suit. On April 15, 2002, the Company filed an Answer and Separate Affirmative Defenses to the complaint, generally denying the allegations of the complaint and each and every cause of action alleged, and denying that plaintiff has been damaged or is entitled to any relief whatsoever. During June, 2002, the Company filed its Answers and Objections to Plaintiff's First Set of Interrogatories, Responses and Objections to Plaintiff's First Request for Production of Documents, and a Stipulation and Protective Order. At a status conference held on July 26, 2002, plaintiff moved to have the court strike a January 2003 trial date, and re-set trial for a later date. Company counsel filed no objection to the motion. No new trial date has 9 been set. Discovery is now proceeding. The Company plans to conduct a vigorous defense of this action. The Company believes it has defenses against the claims and intends to file a motion for summary judgment in the case. 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 when settled in a future period. Defense counsel to the Company will seek to have the resolution of the five class action cases combined, or their effects lessened, in that there are common issues and a substantially similar class sought to be defined in the five cases. A class action lawsuit was commenced on March 5, 2002 entitled Argonaut Consumer Rights Advocates Inc., suing on behalf of the General Public v. Domestications LLC, and Does 1-100 ("Domestications") in the Superior Court of the State of California, City and County of San Francisco. The plaintiff is a non-profit public benefit corporation suing under the California Business and Profession Code. Does 1-100 would include persons responsible for the conduct alleged in the complaint, including the direct sale of tangible personal property to California consumers including the type of merchandise that Domestications sells, by telephone, mail order, and sales through the web site www.domestications.com. The plaintiff claims that for at least four years members of the class have been charged an unlawful, unfair, and fraudulent tax and sales tax for different rates and amounts on the catalog and internet orders on the total amount of goods, tax and sales tax on shipping charges, which are not subject to tax or sales tax under California law, in violation of California law and court decisions, including the state Revenue and Taxation Code, Civil Code, and the California Board of Equalization; that Domestications engages in unfair business practices; and that Domestications engaged in untrue and misleading advertising in that it was not lawfully required to collect tax and sales tax from customers in California. Plaintiff and the class seek (i) restitution of all sums, interest and other gains made on account of these practices; (ii) prejudgment interest on all sums wrongfully collected; (iii) an order enjoining Domestications from charging customers for tax on their orders and/or from charging tax on the shipping charges; and (iv) attorneys' fees and costs of the suit. The Company filed an Answer and Separate Affirmative Defenses to the Complaint, generally denying the allegations of the Complaint and each and every cause of action alleged, and denying that plaintiff has been damaged or is entitled to any relief whatsoever. On June 20, 2002, the Company filed its Answers and Objections to plaintiff's first set of form interrogatories and request for production of documents. The Company also submitted to plaintiff a draft of a proposed Stipulation and Protective Order for comment. Once the Protective Order has been agreed upon by the parties and entered by the Court, the Company will produce the documents responsive to plaintiff's requests. Discovery is proceeding and the Company plans to conduct a vigorous defense. The Company believes it has defenses against the claims. 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 when settled in a future period. Defense counsel to the Company will seek to have the resolution of the five class action cases combined, or their effects lessened, in that there are common issues and a substantially similar class sought to be defined in the five cases. 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. 5. SPECIAL CHARGES In December 2000, the Company began a strategic business realignment program that resulted in the recording of special charges for severance, facility exit costs and fixed asset write-offs. Special charges recorded in fiscal years 2000 and 2001 relating to the strategic business realignment program were $19.1 million and $11.3 million, respectively. The actions related to the strategic business realignment program were taken in an effort to direct the Company's resources primarily towards a loss reduction and return to profitability. In the first quarter of 2002, special charges relating to the strategic business realignment program were recorded in the amount of $0.2 million. These charges consisted primarily of severance costs related to the elimination of an additional 10 FTE positions and costs associated with the Company's decision to close a product manufacturing facility located in San Diego, California. In the second quarter of 2002, no additional special charges relating to the strategic business realignment program were recorded. As of the end of the second quarter of 2002, 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 the following (in thousands): 10 Severance & Personal Lease & Costs Exit Costs IT Leases Total -------- ---------- --------- ----- Balance at December 30, 2000 $ 4,324 $ 7,656 $ 1,043 $ 13,023 2001 Expenses 3,828 4,135 - 7,963 Paid in 2001 (5,606) (3,654) (670) (9,930) ------- ------- ------- -------- Balance at December 29, 2001 2,546 8,137 373 11,056 2002 Expenses 122 111 - 233 Paid in 2002 (2,008) (3,540) (114) (5,662) ------- ------- ------- -------- Balance at June 29, 2002 $ 660 $ 4,708 $ 259 $ 5,627 ======= ======= ======= ======== The Company entered into an agreement with the landlord and the sublandlord to terminate its sublease of the Company's closed 497,200 square foot warehouse and telemarketing facility located in Maumelle, Arkansas. The agreement provided for the payment by the Company to the sublandlord of $1,600,000, plus taxes through April 30, 2002 in the amount of $198,000. The Company made all of the payments in four weekly installments between May 2, 2002 and May 24, 2002. Upon the satisfaction by the Company of all of its obligations under the agreement, the sublease terminated and the Company was released from all further obligations under the sublease. The Company's previously established reserves for Maumelle, Arkansas were adequate based upon the terms of the final settlement agreement. 6. 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 services agreement with the buyer for a period of three years. The asset purchase agreement between the Company and HSN provides that 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, 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 June 29, 2002, the balance in the escrow fund is $2.6 million. The Company recognized a net gain on the sale of approximately $23.2 million, including a non-cash goodwill charge of $6.1 million, in fiscal year 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. In June 2002, the Company recognized $0.3 million of the deferred gain consistent with the terms of the escrow agreement. Proceeds of $0.3 million relating to the deferred gain were received July 2, 2002. The recognition of an additional gain of up to approximately $2.3 million has been deferred until the contingencies described above expire, which will occur no later than the middle of the 2003 fiscal year. 7. 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 by Congress 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. The Company has continued to use the Kindig Lane Property under a lease agreement 11 with the third party, and will continue to lease a portion of the Kindig Lane Property on a month-to-month basis. The Company intends to transition the activities of the Kindig Lane Property into the Company's fulfillment center in Roanoke, Virginia at a future date. 8. CHANGES IN EMPLOYMENT AGREEMENTS Shull Employment Agreement. Effective December 5, 2000, Thomas C. Shull, Meridian Ventures, LLC, a limited liability company controlled by Mr. Shull ("Meridian"), and the Company entered into a Services Agreement (the "December 2000 Services Agreement"). The December 2000 Services Agreement was replaced by a subsequent services agreement, dated as of August 1, 2001 (the "August 2001 Services Agreement"), among Mr. Shull, Meridian and the Company, and a Services Agreement, dated as of December 14, 2001 (the "December 2001 Services Agreement"), among Mr. Shull, Meridian, and the Company. The December 2001 Services Agreement is being replaced effective September 1, 2002 by an Employment Agreement between Mr. Shull and the Company, dated as of September 1, 2002 (the "Shull Employment Agreement"), pursuant to which Mr. Shull is to be employed by the Company as its President and Chief Executive Officer, as described below. The term of the Shull Employment Agreement will begin on September 1, 2002 and will terminate on September 30, 2004 (the "Shull Employment Agreement Term"). Under the Shull Employment Agreement, Mr. Shull is to receive from the Company base compensation equal to $900,000 per annum, payable at the rate of $75,000 per month ("Base Compensation"). Mr. Shull is to be provided with participation in the Company's employee benefit plans, including but not limited to the Company's Key Executive Eighteen Month Compensation Continuation Plan (the "Change of Control Plan") and its transaction bonus program. The Company is also to reimburse Mr. Shull for his reasonable out-of-pocket expenses incurred in connection with his employment by the Company. Under the Shull Employment Agreement, the Company shall pay the remaining unpaid $300,000 of Mr. Shull's fiscal 2001 bonus under the Company's 2001 Management Incentive Plan by no later than December 28, 2002 (or on the date of closing of any transaction which constitutes a "change of control" thereunder, if earlier). Mr. Shull shall receive the same bonus amount for fiscal 2002 under the Company's 2002 Management Incentive Plan as all other Class 8 participants (as defined in such Plan) receive under such Plan for such period, subject to all of the terms and conditions applicable generally to Class 8 participants thereunder. Mr. Shull shall earn annual bonuses for fiscal 2003 and 2004 under such plans as the Company's Compensation Committee may approve in a manner consistent with bonuses awarded to other senior executives under such plans. Under the Shull Employment Agreement, the Company shall, on December 28, 2002 (or the date of closing of any transaction which constitutes a "change of control" thereunder, if earlier), make the lump sum cash payment of $450,000 to Mr. Shull previously due to be paid to Meridian on June 30, 2002. In addition, the Company has agreed to make two equal lump sum cash payments of $225,000 each to Mr. Shull on March 31, 2003 and September 30, 2004, notwithstanding any "change of control." Under the Shull Employment Agreement, upon the closing of any transaction which constitutes a "change of control" thereunder, provided that Mr. Shull is then employed by the Company, the Company shall make a lump sum cash payment to Mr. Shull on the date of such closing of $1,350,000 pursuant to the Change of Control Plan, $450,000 pursuant to the Company's transaction bonus program and such bonuses as may be payable pursuant to the Company's Management Incentive Plans for the applicable fiscal year. Any such lump sum payment would be in lieu of (i) any cash payment under the Shull Employment Agreement as a result of a termination thereof 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 or any series of sales since April 27, 2001 involving an aggregate of 50% or more of the market value of the Company's assets (for this purpose under the Shull Employment Agreement, such 50% amount shall be deemed to be $107.6 million), and (ii) the aggregate amount of Base Compensation to which Mr. Shull would have otherwise been entitled through the end of the Shull Employment Agreement Term. Under the Shull Employment Agreement, additional amounts are payable to Mr. Shull by the Company under certain circumstances upon the termination of the Shull Employment Agreement. If the termination is on account of the expiration of the Shull Employment Agreement Term, Mr. Shull shall be entitled to receive such amount of bonus as may be payable pursuant to the Company's applicable bonus plan as well as employee benefits such as accrued vacation 12 and insurance in accordance with the Company's customary practice. If the termination is on account of the Company's material breach of the Shull Employment Agreement or the Company's termination of the Shull Employment Agreement where there has been no Willful Misconduct (as defined in the Shull Employment Agreement) or material breach thereof by Mr. Shull, Mr. Shull shall be entitled to receive (i) a lump sum payment equal to the aggregate amount of Base Compensation to which he would have otherwise been entitled through the end of the Shull Employment Agreement Term, plus (ii) $900,000 in severance pay and such amount of bonus as may be payable pursuant to the Company's applicable bonus plan as well as employee benefits such as accrued vacation and insurance in accordance with the Company's customary practice. 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 or any series of sales since April 27, 2001 involving an aggregate of 50% or more of the market value of the Company's assets (for this purpose under the Shull Employment 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), and if and only if the Change of Control Plan shall not then be in effect, Mr. Shull shall be entitled to receive a lump sum payment equal to the aggregate amount of Base Compensation to which he would have otherwise been entitled through the end of the Shull Employment 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 or any series of sales since April 27, 2001 involving an aggregate of 50% or more of the market value of the Company's assets (for this purpose under the Shull Employment 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 Change of Control Plan shall not then be in effect, Mr. Shull shall be entitled to receive a lump sum payment equal to the greater of the Base Compensation to which he would have otherwise been entitled through the end of the Shull Employment 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 or any series of sales since April 27, 2001 involving an aggregate of 50% or more of the market value of the Company's assets (for this purpose under the Shull Employment Agreement, such 50% amount shall be deemed to be $107.6 million) and the Change of Control Plan shall then be in effect, Mr. Shull shall only be entitled to receive his benefit under the Change of Control Plan. Under the Shull Employment Agreement, the Company is required to maintain directors' and officers' liability insurance for Mr. Shull during the Shull Employment Agreement Term. The Company is also required to indemnify Mr. Shull in certain circumstances. Amended Thomas C. Shull Stock Option Award Agreements. During December 2000, the Company entered into a stock option agreement with Thomas C. Shull to evidence the grant to Mr. Shull of an option to purchase 2.7 million shares of the Company's common stock (the "Shull 2000 Stock Option Agreement"). Effective as of September 1, 2002, the Company has amended the Shull 2000 Stock Option Agreement to (i) extend the final expiration date for the stock option under the Shull 2000 Stock Option Agreement to June 30, 2005, and (ii) replace all references therein to the December 2000 Services Agreement with references to the Shull Employment Agreement. During December 2001, the Company entered into a stock option agreement with Mr. Shull to evidence the grant to Mr. Shull of an option to purchase 500,000 shares of the Company's common stock under the Company's 2000 Management Stock Option Plan (the "Shull 2001 Stock Option Agreement"). Effective as of September 1, 2002, the Company has amended the Shull 2001 Stock Option Agreement to (i) provide that any shares purchased by Mr. Shull under the Shull 2001 Stock Option Agreement would not be saleable until September 30, 2004, and (ii) replace all references therein to the December 2001 Services Agreement with references to the Shull Employment Agreement. Amended Thomas C. Shull Transaction Bonus Letter. During May 2001, Thomas C. Shull entered into a letter agreement with the Company (the "Shull Transaction Bonus Letter") under which he would be paid a bonus on the occurrence of certain transactions involving the sale of certain of the Company's businesses. Effective as of September 1, 2002, the Company has amended the Shull Transaction Bonus Letter to (i) increase the amount of Shull's agreed to base salary for purposes of the transaction bonus payable thereunder from $600,000 to $900,000, and (ii) replace all references therein to the December 2000 Services Agreement with references to the Shull Employment Agreement. 13 9. RECENTLY ISSUED ACCOUNTING STANDARDS In July 2001, the Financial Accounting Standards Board (the "FASB") issued SFAS 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). Goodwill relates to the International Male and the Gump's brands and the net balance at June 29, 2002 is $9.3 million. The Company adopted FAS 142 effective January 1, 2002 and, as a result, the first and second quarters ended March 30, 2002 and June 29, 2002 did not include an amortization charge for goodwill. The Company obtained the services of an independent appraisal firm during the second quarter ended June 29, 2002 to evaluate whether there was any goodwill impairment upon adoption of FAS 142. The results of the appraisal indicated no goodwill transition impairment based upon the requirements set forth in FAS 142. If the provisions of FAS 142 had been implemented for the 13-week period ended June 30, 2001 and the Company had not included an amortization charge for goodwill, the Company's net earnings would have increased by $0.1 million to $12.9 million. If the provisions under FAS 142 had been implemented for the 26-week period ended June 30, 2001 and the Company had not included an amortization charge for goodwill, the Company's net (loss) would have decreased by $0.3 million to $(5.4) million. Net earnings (loss) per share for the 13-week and 26-week periods 14 ended June 30, 2001 would have remained unchanged at $.05 and $(.00) for both basic and diluted earnings (loss) per share calculations. In July 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations" ("FAS 143"). FAS 143 requires entities to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred. When the liability is initially recorded, the entity is required to capitalize the cost by increasing the carrying value of the related long-lived asset. Over time, the liability is accreted to its present value each period, and the capitalized cost is depreciated over the useful life of the related asset. FAS 143 is effective for fiscal years beginning after June 15, 2002 and will be adopted by the Company effective fiscal 2003. The Company believes adoption of FAS 143 will not have a material effect on its financial statements. In October 2001, the FASB issued SFAS No. 144, "Accounting for Impairment or Disposal of Long-Lived Assets" ("FAS 144"). FAS 144 addresses financial accounting and reporting for the impairment or disposal of long-lived assets. FAS 144 also extends the reporting requirements to report separately, as discontinued operations, components of an entity that have either been disposed of or classified as held-for-sale. The Company adopted the provisions of FAS 144 in fiscal 2002, and such adoption has had no effect on the Company's results of operations or financial position. In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB SFAS No. 13, and Technical Corrections" ("FAS 145"). FAS 145 rescinds FASB SFAS No. 4, 44, and 64 and amends FASB SFAS No. 13, "Accounting for Leases," to eliminate an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. FAS 145 also amends other existing authoritative pronouncements to make various technical corrections, clarify meanings, or describe their applicability under changed conditions. The Company adopted the provisions of FAS 145 in fiscal 2002, and such adoption has had no effect on the Company's results of operations or financial position. In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" ("FAS 146"). FAS 146 nullifies Emerging Issues Task Force Issue No. 94-3 ("EITF 94-3"). FAS 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred, whereas under EITF 94-3, the liability was recognized at the commitment date to an exit plan. The Company is required to adopt the provisions of FAS 146 effective for exit or disposal activities initiated after December 31, 2002. The Company is currently evaluating the impact of adoption of this statement. 10. AMENDMENT TO CONGRESS LOAN AND SECURITY AGREEMENT In March 2002, the Company amended the Congress Credit Facility to amend the definition of Consolidated Net Worth such that, effective July 1, 2002, to the extent that the goodwill or intangible assets of the Company and its subsidiaries were impaired under the provisions of FAS 142, such write-off of assets would not be considered a reduction of total assets for the purposes of computing consolidated net worth. The Company obtained the services of an independent appraisal firm during the second quarter ended June 29, 2002 to evaluate whether there has been any goodwill transition impairment. The results of the appraisal indicated no goodwill transition impairment based upon the requirements set forth in FAS 142. The consolidated net working capital, consolidated net worth and earnings before interest, taxes, depreciation, amortization and certain non-cash charges covenants were also amended. In addition, the amendment required the payment of a fee of $100,000. On August 16, 2002, the Company amended the Congress Credit Facility to (i) extend the term of the Tranche B Term Loan from March 31, 2003 to January 31, 2004, (ii) increase by $3,500,000 the borrowing reflected by the Tranche B Term Note from $4,910,714 to $8,410,714, and (iii) make certain related technical amendments to the Congress Credit Facility. The amendment required the payment of fees in the amount of $410,000. Pursuant to this amendment, the Company has reflected the Tranche B borrowings outstanding of $4.0 million at June 29, 2002 in Long-term debt on the Condensed Consolidated Balance Sheet. Achievement of the cost savings and other objectives of the Company's strategic business realignment program is critical to the maintenance of adequate liquidity as is compliance with the terms and provisions of the Congress Credit Facility. 11. SERIES B PARTICIPATING PREFERRED STOCK On December 19, 2001, the Company consummated a transaction with Richemont (the "Richemont Transaction") in which the Company issued to Richemont Finance S.A. ("Richemont") 1,622,111 shares of Series B Participating Preferred Stock ("Series B Preferred Stock"). The Series B Preferred Stock has a par value of $0.01 per share. The holders of the Series B Preferred Stock are entitled to ten votes per share on any matter on which the Common Stock votes. In addition, in the event that the Company defaults in its obligations arising in connection with the Richemont Transaction, the Certificate of Designations of the Series B Preferred Stock or its agreements with Congress, or in the event that the Company fails to redeem at least 811,056 shares of Series B Preferred Stock by August 31, 2003, then the holders of the Series B Preferred Stock, voting as a class, shall be entitled to elect two members to the Board of Directors of the Company. In the event of the liquidation, dissolution or winding up of the Company, the holders of the Series B Preferred Stock are entitled to a liquidation preference (the "Liquidation Preference") which was initially $47.36 per share and which increases quarterly, commencing March 1, 2002. As of March 1, 2002 and June 1, 2002, the Liquidation Preference was $49.15 and $51.31 per share, respectively. As of September 1, 2002 and December 1, 2002, the Liquidation Preference will be $53.89 and $56.95 per share, respectively. As of March 1, 2003, June 1, 2003 and September 1, 2003, the Liquidation Preference will be $60.54, $64.74 and $69.64 per share, respectively. As a result, beginning November 30, 2003, the aggregate Liquidation Preference of the Series B Preferred Stock will be effectively equal to the aggregate liquidation preference of the Class A Preferred Stock previously held by Richemont. As of December 1, 2003, March 1, 2004, June 1, 2004, September 1, 2004 and December 1, 2004, the Liquidation Preference 15 will be $72.25, $74.96, $77.77, $80.69 and $83.72 per share, respectively. As of March 1, 2005 and June 1, 2005, the Liquidation Preference will be $86.85 and $90.11 per share, respectively. Dividends on the Series B Preferred Stock are required to be paid whenever a dividend is declared on the Common Stock. The amount of any dividend on the Series B Preferred Stock shall be determined by multiplying (i) the amount obtained by dividing the amount of the dividend on the Common Stock by the then current fair market value of a share of Common Stock and (ii) the Liquidation Preference of the Series B Preferred Stock. The Series B Preferred Stock must be redeemed by the Company on August 23, 2005. The Company may redeem all or less than all of the then outstanding shares of Series B Preferred Stock at any time prior to that date. At the option of the holders thereof, the Company must redeem the Series B Preferred Stock upon a Change of Control or upon the consummation of an Asset Disposition or Equity Sale (all as defined in the Certificate of Designations of the Series B Preferred Stock). The redemption price for the Series B Preferred Stock upon a Change of Control or upon the consummation of an Asset Disposition or Equity Sale is the then applicable Liquidation Preference of the Series B Preferred Stock plus the amount of any declared but unpaid dividends on the Series B Preferred Stock. The Company's obligation to redeem the Series B Preferred Stock upon an Asset Disposition or an Equity Sale is subject to the satisfaction of certain conditions set forth in the Certificate of Designations of the Series B Preferred Stock. Pursuant to the terms of the Certificate of Designations of the Series B Preferred Stock, the Company's obligation to pay dividends on or redeem the Series B Preferred Stock is subject to its compliance with its agreements with Congress. The Certificate of Designations of the Series B Preferred Stock provides that, for so long as Richemont is the holder of at least 25% of the then outstanding shares of Series B Preferred Stock, it shall be entitled to appoint a non-voting observer to attend all meetings of the Board of Directors and any committees thereof. To date, Richemont has not appointed such an observer. 16 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following table sets forth, for the fiscal periods indicated, the percentage relationship to net revenues of certain items in the Company's Condensed Consolidated Statements of Income (Loss):
13-WEEKS ENDED 26-WEEKS ENDED -------------- -------------- JUNE 29, JUNE 30, JUNE 29, JUNE 30, 2002 2001 2002 2001 ------ ------ ------ ------ Net revenues 100.0% 100.0% 100.0% 100.0% Cost of sales and operating expenses 61.8 62.3 63.4 63.2 Special charges 0.0 3.8 0.1 2.2 Selling expenses 23.3 28.2 22.9 27.7 General and administrative expenses 11.0 11.5 11.2 11.1 Depreciation and amortization 1.3 1.5 1.3 1.4 Earnings (loss) from operations 2.6 (7.3) 1.1 (5.6) Gain on sale of Improvements and Kindig Lane Property 0.3 18.2 0.1 8.8 Interest expense, net 1.2 1.4 1.2 1.3 Net earnings and comprehensive earnings 1.6% 9.5% 0.0% 1.8%
RESULTS OF OPERATIONS - 13-WEEKS ENDED JUNE 29, 2002 COMPARED WITH THE 13-WEEKS ENDED JUNE 30, 2001 Net Earnings and Comprehensive Earnings. The Company reported net earnings of $1.8 million for the 13-weeks ended June 29, 2002 compared with net earnings of $12.7 million for the comparable period last year. In addition to measures of operating performance determined in accordance with generally accepted accounting principles, management also uses earnings before interest, income taxes, depreciation and amortization expense ("EBITDA") to evaluate performance. EBITDA is measured because management believes that such information is useful in evaluating the results relative to other entities that operate within its industries. EBITDA is an alternative to, and not a replacement measure of, operating performance as determined in accordance with generally accepted accounting principles. EBITDA decreased by $18.2 million to $5.0 million for the 13-weeks ended June 29, 2002 as compared with $23.2 million for the comparable period in 2001. The results for the 13-week periods ended June 29, 2002 and June 30, 2001 include $0.3 million and $24.3 million, respectively, in after tax gains resulting from the sale of the Improvements business and the Kindig Lane Property. Net earnings (loss) and EBITDA for the 13-weeks ended June 29, 2002 increased $13.1 million and $12.0 million, respectively, over the comparable period in 2001 prior to the recognition of these gains. Net earnings (loss) per share was $(.01) applied to common shareholders for the 13-weeks ended June 29, 2002 and $.05 for the 13-weeks ended June 30, 2001. The per share amounts were calculated after deducting the Series B Preferred Stock redemption price increase of $3.5 million for the 13-weeks ended June 29, 2002 and the Series A Preferred Stock dividends and accretion of $3.0 million for the comparable period in 2001. The weighted average number of shares outstanding used in both the basic and diluted net (loss) per share calculation was 138,264,152 for the 13-week period ended June 29, 2002. For the 13-week period ended June 30, 2001, the weighted average number of shares used in the calculation for the basic and diluted net earnings per share was 212,186,331 and 212,786,467 shares, respectively. This decrease in weighted average shares was primarily due to the transaction consummated with Richemont in December 2001, where the Company repurchased and retired 74,098,769 shares of Common Stock then held by Richemont. Compared with the comparable period last year, the $10.9 million decrease in net earnings was primarily due to: (i) gain on sale of the Improvements business of $22.8 million in the year 2001; and (ii) gain on sale of the Kindig Lane Property of $1.5 million in the year 2001; partially offset by: (i) decreased cost of sales and operating expenses; (ii) decreased selling expenses; (iii) decreased general and administrative expenses; and (iv) decreased special charges associated with the Company's strategic business realignment program. 17 Net Revenues. Net revenues decreased $19.6 million (14.7%) for the 13-week period ended June 29, 2002 to $113.9 million from $133.5 million for the comparable period in 2001. This decrease was due in part to the sale of the Improvements business on June 29, 2001, which accounted for $15.2 million of the reduction in revenues for the 13-week period ended June 29, 2002. The discontinuance of the Domestications Kitchen & Garden, Kitchen & Home and Encore catalogs contributed $1.2 million to the reduction in net revenues for the 13-week period ended June 29, 2002. The remaining balance of the decrease in net revenues can be attributed to softness in demand primarily related to certain brands and planned reductions in unprofitable circulation. Cost of Sales and Operating Expenses. Cost of sales and operating expenses decreased to 61.8% of net revenues for the 13- week period ended June 29, 2002 as compared with 62.3% of net revenues for the comparable period in 2001. This change was due primarily to reductions in spending related to the information technology systems area that have resulted from actions taken in connection with the Company's strategic business realignment program. Special Charges. In December 2000, the Company developed a plan to strategically realign its business and direct the Company's resources primarily towards a loss reduction and return to profitability. As a result of the continued actions needed to execute the plan, the Company recorded special charges of $5.0 million for the 13- week period ended June 30, 2001 to primarily cover additional charges related to the exit of the Maumelle and Kindig Lane buildings including the write-down for impairment of remaining assets. Also included were severance costs relating to the elimination of associates employed at the Kindig Lane Property, in addition to 32 FTE positions across all divisions of the Company's business as part of the strategic business realignment program. For the 13-week period ended June 29, 2002, the Company did not incur any additional special charges relating to the strategic business realignment program. Selling Expenses. Selling expenses decreased by $11.1 million to $26.6 million for the 13- weeks ended June 29, 2002 as compared with $37.7 million for the comparable period in the year 2001. As a percentage relationship to net revenues, selling expenses decreased to 23.3% for the 13- weeks ended June 29, 2002 versus 28.2% for the comparable period in the year 2001. This decrease was due primarily to reductions in catalog paper pricing, postage costs, and circulation. In addition, decreases in catalog printing and preparation costs also contributed to the lower percentage relationship to net revenues. General and Administrative Expenses. General and administrative expenses decreased by $2.8 million to $12.6 million for the 13- weeks ended June 29, 2002 as compared with $15.4 million for the comparable period last year. As a percentage relationship to net revenues, general and administrative expenses were 11.0% of net revenues for the 13- weeks ended June 29, 2002 versus 11.5% of net revenues for the comparable period in the year 2001. The reductions in costs are primarily attributable to the elimination of a significant number of FTE positions across all departments which began late in 2000 as part of the Company's strategic business realignment program and has continued throughout the 13- weeks ended June 29, 2002. This decrease is partially offset by additional professional and legal fees associated with the Company's engagement in legal proceedings as mentioned in Note 4, Commitments and Contingencies, to the Condensed Consolidated Financial Statements. Depreciation and Amortization. Depreciation and amortization decreased by $0.5 million for the 13- weeks ended June 29, 2002 versus the comparable period in the year 2001. The decrease is primarily due to the elimination of goodwill amortization of $0.1 million resulting from the implementation of FAS 142 and the complete amortization of computer software in the year 2001. As a percentage relationship to net revenues, depreciation and amortization was 1.3% for the 13- weeks ended June 29, 2002 and 1.5% for the comparable period in the year 2001. Earnings (Loss) from Operations. The Company's earnings from operations increased by $12.6 million to $2.9 million for the 13- weeks ended June 29, 2002 from a loss of ($9.7) million for the comparable period in the year 2001. 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 18.2% of net revenues for the 13- weeks ended June 30, 2001. The Company realized a net gain on the sale of the Improvements business of approximately $22.8 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. In June 2002, the Company 18 recognized $0.3 million of the deferred gain consistent with the terms of the escrow agreement. The Company realized a net gain on the sale of the Kindig Lane Property of approximately $1.5 million. Interest Expense, Net. Interest expense, net decreased $0.4 million to $1.4 million for the 13- weeks ended June 29, 2002 as compared with $1.8 million for the comparable period in the year 2001. The decrease in interest expense in the second quarter of 2002 is primarily due to lower average borrowings, coupled with lower interest rates. This decrease is partially offset by an increase in amortization from additional deferred financing costs relating to the Company's credit facility with Congress. RESULTS OF OPERATIONS - 26- WEEKS ENDED JUNE 29, 2002 COMPARED WITH THE 26- WEEKS ENDED JUNE 30, 2001 Net Earnings and Comprehensive Earnings. The Company reported net earnings of $0.0 million for the 26- weeks ended June 29, 2002 compared with net earnings of $5.1 million for the comparable period last year. EBITDA decreased by $13.8 million to $6.4 million for the 26- weeks ended June 29, 2002 as compared with $20.2 million for the comparable period in 2001. The results for the 26-week periods ended June 29, 2002 and June 30, 2001 include $0.3 million and $24.3 million, respectively, in after tax gains resulting from the sale of the Improvements business and the Kindig Lane Property. Net earnings and EBITDA for the 26- weeks ended June 29, 2002 increased $18.9 million and $16.4 million, respectively, over the comparable period in 2001 prior to the recognition of these gains. Net (loss) per share was $(.05) applied to common shareholders for the 26- weeks ended June 29, 2002 and $(0.0) for the 26- weeks ended June 30, 2001. The per share amounts were calculated after deducting the Series B Preferred Stock redemption price increase of $6.4 million for the 26- weeks ended June 29, 2002 and the Series A Preferred Stock dividends and accretion of $5.9 million for the comparable period in 2001. The weighted average number of shares outstanding used in both the basic and diluted net (loss) per share calculation was 138,244,591 for the 26-week period ended June 29, 2002 and 212,327,375 for the 26-week period ended June 30, 2001. This decrease in weighted average shares was primarily due to the transaction consummated with Richemont in December 2001, where the Company repurchased and retired 74,098,769 shares of Common Stock then held by Richemont. Compared with the comparable period last year, the $5.1 million decrease in net earnings was primarily due to: (i) gain on sale of the Improvements business of $22.8 million in the year 2001; and (ii) gain on sale of the Kindig Lane Property of $1.5 million in the year 2001; partially offset by: (i) decreased cost of sales and operating expenses; (ii) decreased selling expenses; (iii) decreased general and administrative expenses; and (iv) decreased special charges associated with the Company's strategic business realignment program. Net Revenues. Net revenues decreased $54.4 million (19.6%) for the 26-week period ended June 29, 2002 to $223.4 million from $277.8 million for the comparable period in 2001. This decrease was due in part to the sale of the Improvements business on June 29, 2001, which accounted for $34.1 million of the reduction in revenues for the 26-week period ended June 29, 2002. The discontinuance of the Domestications Kitchen & Garden, Kitchen & Home, Encore and Turiya catalogs contributed $6.0 million to the reduction in net revenues for the 26-week period ended June 29, 2002. An additional portion of the drop in revenues amounting to $0.7 million can be attributed to the Company's decision to scale back on its third-party fulfillment business by focusing only on profitable operations. The remaining balance of the decrease in net revenues can be attributed to softness in demand primarily related to certain brands and planned reductions in unprofitable circulation. Cost of Sales and Operating Expenses. Cost of sales and operating expenses increased to 63.4% of net revenues for the 26-week period ended June 29, 2002 as compared with 63.2% of net revenues for the comparable period in 2001. This change is due to an increase in merchandise inventory costs, which accounted for 0.6% of the percentage increase, partially offset by decreases in operating costs that have resulted from actions taken in connection with the Company's strategic business realignment program. These decreases occurred primarily in the areas of fixed telemarketing and 19 distribution costs and information systems costs associated with the Company's fulfillment centers, which accounted for 0.4% of the offsetting percentage decrease. Special Charges. In December 2000, the Company developed a plan to strategically realign its business and direct the Company's resources primarily towards a loss reduction and return to profitability. As a result of the continued actions needed to execute the plan, the Company recorded special charges of $6.1 million for the 26-week period ended June 30, 2001. These special charges were recorded to primarily cover severance costs related to the elimination of 78 FTE positions across all departments of the Company's business and additional charges related to the exit of the Maumelle and Kindig Lane buildings including the write-down for impairment of remaining assets. For the 26-week period ended June 29, 2002, the Company recorded an additional $0.2 million of special charges relating to the strategic business realignment program. These charges consisted primarily of severance costs related to the elimination of an additional 10 FTE positions in various levels of catalog operations and costs associated with the Company's decision to close the San Diego product manufacturing facility. Selling Expenses. Selling expenses decreased by $25.9 million to $51.2 million for the 26- weeks ended June 29, 2002 as compared with $77.1 million for the comparable period in the year 2001. As a percentage relationship to net revenues, selling expenses decreased to 22.9% for the 26- weeks ended June 29, 2002 versus 27.7% for the comparable period in the year 2001. This decrease was due primarily to reductions in catalog paper pricing, catalog preparation costs and circulation. In addition, decreases in catalog printing and postage costs also contributed to the lower percentage relationship to net revenues. General and Administrative Expenses. General and administrative expenses decreased by $5.7 million to $25.0 million for the 26- weeks ended June 29, 2002 as compared with $30.7 million for the comparable period last year. As a percentage relationship to net revenues, general and administrative expenses were 11.2% of net revenues for the 26- weeks ended June 29, 2002 versus 11.1% of net revenues for the comparable period in the year 2001. This increase is primarily due to additional professional and legal fees associated with the Company's engagement in legal proceedings as mentioned in Note 4, Commitments and Contingencies, to the Condensed Consolidated Financial Statements. This increase is partially offset by reductions in costs primarily attributable to the elimination of a significant number of FTE positions across all departments which began late in 2000 as part of the Company's strategic business realignment program and have continued throughout the 26- weeks ended June 29, 2002. Depreciation and Amortization. Depreciation and amortization decreased by $0.9 million for the 26- weeks ended June 29, 2002 versus the comparable period in the year 2001. The decrease is primarily due to the elimination of goodwill amortization of $0.3 million resulting from the implementation of FAS 142 and the complete amortization of computer software in the year 2001. As a percentage relationship to net revenues, depreciation and amortization was 1.3% for the 26- weeks ended June 29, 2002 and 1.4% for the comparable period in the year 2001. Earnings (Loss) from Operations. The Company's earnings from operations increased by $18.0 million to $2.5 million for the 26- weeks ended June 29, 2002 from a loss of ($15.5) million for the comparable period in the year 2001. 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 8.8% of net revenues for the 26- weeks ended June 30, 2001. The Company realized a net gain on the sale of the Improvements business of approximately $22.8 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. In June 2002, the Company recognized $0.3 million of the deferred gain consistent with the terms of the escrow agreement. The Company realized a net gain on the sale of the Kindig Lane Property of approximately $1.5 million. Interest Expense, Net. Interest expense, net decreased $1.0 million to $2.7 million for the 26- weeks ended June 29, 2002 as compared with $3.7 million for the comparable period in the year 2001. The decrease in interest expense is primarily due to lower average borrowings, coupled with lower interest rates. This decrease is partially offset by an increase in amortization from additional deferred financing costs relating to the Company's credit facility with Congress. 20 LIQUIDITY AND CAPITAL RESOURCES Net cash provided by operating activities. During the 26-week period ended June 29, 2002, net cash provided by operating activities was $0.2 million. Net cash provided by operating activities, when adjusted for depreciation, amortization and other non-cash items, resulted in positive cash flow of $4.4 million for the period. These funds were primarily used to reduce accounts payable and accrued liabilities. Net cash used by investing activities. During the 26-week period ended June 29, 2002, net cash used by investing activities was $0.3 million, which was due to capital expenditures primarily relating to upgrades in equipment located at the Roanoke, Virginia distribution center and various computer software applications. Net cash used by financing activities. During the 26-week period ended June 29, 2002, net cash used by financing activities was $0.1 million, which was primarily due to payments made under the Congress term loan facility, partially offset by net borrowings under the Congress revolving credit 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 comprises 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 June 29, 2002, the Company had $29.5 million of borrowings outstanding under the amended Congress Credit Facility consisting of $15.0 million under the revolving credit facility and $9.4 million and $5.1 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 March 2002, the Company amended the Congress Credit Facility to amend the definition of Consolidated Net Worth such that, effective July 1, 2002, to the extent that the goodwill or intangible assets of the Company and its subsidiaries are impaired under the provisions of FAS 142, such write-off of assets would not be considered a reduction of total assets for the purposes of computing consolidated net worth. The Company obtained the services of an independent appraisal firm during the second quarter ended June 29, 2002 to evaluate whether there has been any goodwill transition impairment. The results of the appraisal indicated no goodwill transition impairment based upon the requirements set forth in FAS 142. The consolidated net working capital, consolidated net worth and EBITDA covenants were also amended. In addition, the amendment required the payment of a fee of $100,000. On August 16, 2002, the Company amended the Congress Credit Facility to (i) extend the term of the Tranche B Term Loan from March 31, 2003 to January 31, 2004, (ii) increase by $3,500,000 the borrowing reflected by the Tranche B Term Note from $4,910,714 to $8,410,714, and (iii) make certain related technical amendments to the Congress Credit Facility. The amendment required the payment of fees in the amount of $410,000. Pursuant to this amendment, the Company has reflected the Tranche B borrowings outstanding of $4.0 million at June 29, 2002 in Long-term debt on the Condensed Consolidated Balance Sheet. Achievement of the cost savings and other objectives of the Company's strategic business realignment program is critical to the maintenance of adequate liquidity as is compliance with the terms and provisions of the Congress Credit Facility as mentioned in Note 10, Amendment to Congress Loan and Security Agreement, to the Condensed Consolidated Financial Statements. 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 services agreement with the buyer for a period of three years. The asset purchase agreement between the Company and HSN provides that 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, 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 June 29, 2002, the balance in the escrow fund is $2.6 million. The Company recognized a net gain on the sale of approximately $23.2 million, including a non-cash goodwill charge of $6.1 million, in fiscal year 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 21 transaction. In June 2002, the Company recognized $0.3 million of the deferred gain consistent with the terms of the escrow agreement. Proceeds of $0.3 million relating to the deferred gain were received July 2, 2002. The recognition of an additional gain of up to approximately $2.3 million has been deferred until the contingencies described above expire, which will occur no later than the middle of the 2003 fiscal year. General. At June 29, 2002, the Company had $0.9 million in cash and cash equivalents compared with $2.1 million at June 30, 2001. Working capital and current ratios at June 29, 2002 were $23.1 million and 1.32 to 1 versus $17.1 million and 1.18 to 1 at June 30, 2001. Total cumulative borrowings, including financing under capital lease obligations, as of June 29, 2002, aggregated $29.6 million, $26.5 million of which is classified as long-term. Remaining availability under the Congress Credit Facility as of June 29, 2002 was $7.3 million. There were nominal capital commitments (less than $0.1 million) at June 29, 2002. The Company entered into an agreement with the landlord and the sublandlord to terminate its sublease of the Company's closed 497,200 square foot warehouse and telemarketing facility located in Maumelle, Arkansas. The agreement provided for the payment by the Company to the sublandlord of $1,600,000, plus taxes through April 30, 2002 in the amount of $198,000. The Company made all of the payments in four weekly installments between May 2, 2002 and May 24, 2002. Upon the satisfaction by the Company of all of its obligations under the agreement, the sublease terminated and the Company was released from all further obligations under the sublease. On March 22, 2002, the Postal Rate Commission approved a settlement that allowed postal rates to increase an average of 7.7% on June 30, 2002. The Company had anticipated this action in its 2002 planning process and will accommodate the increased cost as part of normal business operations. The Company has implemented cost conservation measures, such as reduced paper weights and trim size changes, as a way of mitigating such cost increases. Management believes that the Company has sufficient liquidity and availability under its credit agreements to fund its planned operations through at least December 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 as is compliance with the terms and provisions of the Congress Credit Facility as mentioned in Note 10, Amendment to Congress Loan and Security Agreement, to the Condensed Consolidated Financial Statements. USES OF ESTIMATES AND OTHER CRITICAL ACCOUNTING POLICIES During the second quarter ended June 29, 2002, there were no changes in the Company's policies regarding the use of estimates and other critical accounting policies. See "Management's Discussion and Analysis of Consolidated Financial Condition and Results of Operations," found in the Company's Annual Report on Form 10-K for the fiscal year ended December 29, 2001, for additional information relating to the Company's uses of estimates and other critical accounting policies. NEW ACCOUNTING PRONOUNCEMENTS The Company adopted FAS 142 effective January 1, 2002 and, as a result, the first and second quarters ended March 30, 2002 and June 29, 2002 did not include an amortization charge for goodwill. The Company obtained the services of an independent appraisal firm during the second quarter ended June 29, 2002 to evaluate whether there has been any goodwill transition impairment. The results of the appraisal indicated no goodwill transition impairment based upon the requirements set forth in FAS 142. If the provisions of FAS 142 had been implemented for the 13-week period ended June 30, 2001 and the Company had not included an amortization charge for goodwill, the Company's net earnings would have increased by $0.1 million to $12.9 million. If the provisions under FAS 142 had been implemented for the 26-week period ended June 30, 2001 and the Company had not included an amortization charge for goodwill, the Company's net (loss) would have decreased by $0.3 million to $(5.4) million. Net earnings (loss) per share for the 13-week and 26-week periods ended June 30, 2001 would have remained unchanged at $.05 and $(.00) for both basic and diluted earnings (loss) per share calculations. 22 See "Management's Discussion and Analysis of Consolidated Financial Condition and Results of Operations," found in the Company's Annual Report on Form 10-K for the fiscal year ended December 29, 2001 and Note 9 herein for additional information relating to new accounting pronouncements which the Company has adopted. SEASONALITY The revenues and business for the Company 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 December 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 recent 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 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 recent 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 23 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, as a result of foreign sourcing or otherwise, 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 $3.0 million of excess credit availability at all times, affecting the ability of the Company to continue to make borrowings under the Congress Credit Facility as needed. 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. The ability of the Company to obtain advance rates under the Congress Credit Facility which are at least as favorable as those obtained in the past. The ability of the Company to extend the term of the Congress Credit Facility beyond January 31, 2004, its scheduled expiration date, or obtain other credit facilities on the expiration of the Congress Credit Facility on terms at least as favorable as those under the Congress Credit Facility. 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 24 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 ability of the Company to sublease or terminate or renegotiate the leases of its vacant facilities in Weehawken, New Jersey, San Francisco, California and certain other locations. 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. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK INTEREST RATES: The Company's exposure to market risk relates to interest rate fluctuations for borrowings under the Congress revolving credit facility and its term financing facility, which bear interest at variable rates. At June 29, 2002, outstanding principal balances under these facilities subject to variable rates of interest were approximately $24.4 million. If interest rates were to increase by one percent from current levels, the resulting increase in interest expense, based upon the amount outstanding at June 29, 2002, would be approximately $0.24 million on an annual basis. 25 PART II - OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 10.1 Employment Agreement dated as of September 1, 2002 between the Company and Thomas C. Shull. 10.2 Amendment Number 1 to Agreement dated May 14, 2001 between Thomas C. Shull and the Company. 10.3 Form of letter agreement between the Company and certain Level 8 executive officers. 10.4 Twenty-Second Amendment to Loan and Security Agreement, dated as of August 16, 2002, among Congress Financial Corporation and certain Subsidiaries of the Company. 99.1 Certification signed by Thomas C. Shull. 99.2 Certification signed by Edward M. Lambert.
26 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 in the City of Edgewater, State of New Jersey. HANOVER DIRECT, INC. Registrant By: /s/ Edward M. Lambert ------------------------------------- Edward M. Lambert Executive Vice President and Chief Financial Officer (On behalf of the Registrant and as principal financial officer) Date: August 19, 2002 27