-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, ChcrC184DSmO6esspT0cvyZ3iJwGzKdvzDLRkXA3vDdhBRGXcTxydb3PWctopMuD zELHjJu2KnY9FakmIFcfSw== 0000950123-04-009533.txt : 20040810 0000950123-04-009533.hdr.sgml : 20040810 20040810172515 ACCESSION NUMBER: 0000950123-04-009533 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 20040626 FILED AS OF DATE: 20040810 FILER: COMPANY DATA: COMPANY CONFORMED NAME: HANOVER DIRECT INC CENTRAL INDEX KEY: 0000320333 STANDARD INDUSTRIAL CLASSIFICATION: RETAIL-CATALOG & MAIL-ORDER HOUSES [5961] IRS NUMBER: 138053260 STATE OF INCORPORATION: DE FISCAL YEAR END: 1227 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-08056 FILM NUMBER: 04965259 BUSINESS ADDRESS: STREET 1: 1500 HARBOR BLVD CITY: WEEHAWKEN STATE: NJ ZIP: 07087 BUSINESS PHONE: 2018653800 MAIL ADDRESS: STREET 1: 1500 HARBOR BLVD CITY: WEEHAWKEN STATE: NJ ZIP: 07087 FORMER COMPANY: FORMER CONFORMED NAME: HORN & HARDART CO /NV/ DATE OF NAME CHANGE: 19920703 10-Q 1 y99832e10vq.txt FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended JUNE 26, 2004 Commission file number 1-08056 HANOVER DIRECT, INC. -------------------- (Exact name of registrant as specified in its charter) DELAWARE 13-0853260 -------- ---------- (State of incorporation) (IRS Employer Identification No.) 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 [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). YES [ ] NO [X] Common stock, par value $.66 2/3 per share: 224,518,395 shares outstanding (net of treasury shares) as of August 4, 2004. HANOVER DIRECT, INC. TABLE OF CONTENTS
Page ---- Part I - Financial Information Item 1. Financial Statements Condensed Consolidated Balance Sheets - June 26, 2004 and Restated December 27, 2003 .............................................. 2 Condensed Consolidated Statements of Income (Loss) - 13 and 26- weeks ended June 26, 2004 and Restated June 28, 2003 .................................................. 4 Condensed Consolidated Statements of Cash Flows - 13 and 26- weeks ended June 26, 2004 and Restated June 28, 2003................................................... 5 Notes to Condensed Consolidated Financial Statements......................................... 6 Item 2. Management's Discussion and Analysis of Consolidated Financial Condition and Results of Operations...................................................................... 23 Item 3. Quantitative and Qualitative Disclosures about Market Risk............................. 35 Item 4. Controls and Procedures................................................................ 35 Part II - Other Information Item 1. Legal Proceedings...................................................................... 37 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds............................ 40 Item 5. Other Information...................................................................... 40 Item 6. Exhibits and Reports on Form 8-K....................................................... 42 Signatures...................................................................................... 44
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) (UNAUDITED)
JUNE 26, DECEMBER 27, 2004 2003 ---- ---- (AS RESTATED) ASSETS CURRENT ASSETS: Cash and cash equivalents $ 392 $ 2,282 Accounts receivable, net of allowance for doubtful accounts of $1,035 and $1,105, respectively 13,332 13,802 Inventories 36,974 41,794 Prepaid catalog costs 15,780 11,945 Other current assets 3,132 3,951 --------- --------- Total Current Assets 69,610 73,774 --------- --------- PROPERTY AND EQUIPMENT, AT COST: Land 4,361 4,361 Buildings and building improvements 18,212 18,210 Leasehold improvements 10,108 10,108 Furniture, fixtures and equipment 53,519 53,212 --------- --------- 86,200 85,891 Accumulated depreciation and amortization (60,129) (58,113) --------- --------- Property and equipment, net 26,071 27,778 --------- --------- Goodwill 9,278 9,278 Deferred tax assets 2,213 2,213 Other assets 1,642 1,575 --------- --------- Total Assets $ 108,814 $ 114,618 ========= =========
Continued on next page. 2 HANOVER DIRECT, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (CONTINUED) (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AMOUNTS) (UNAUDITED)
JUNE 26, DECEMBER 27, 2004 2003 ---- ---- (AS RESTATED) LIABILITIES AND SHAREHOLDERS' DEFICIENCY CURRENT LIABILITIES: Short-term debt and capital lease obligations $ 12,232 $ 13,468 Accounts payable 39,678 41,834 Accrued liabilities 12,004 12,907 Customer prepayments and credits 5,839 5,485 Deferred tax liability 2,213 2,213 ----------- ---------- Total Current Liabilities 71,966 75,907 ----------- ---------- NON-CURRENT LIABILITIES: Long-term debt 6,970 9,042 Series C Participating Preferred Stock, authorized, issued and outstanding 564,819 shares; liquidation preference of $56,482 72,689 72,689 Other 3,692 4,609 ----------- ---------- Total Non-current Liabilities 83,351 86,340 ----------- ---------- Total Liabilities 155,317 162,247 ----------- ---------- SHAREHOLDERS' DEFICIENCY: Common Stock, $0.66 2/3 par value, authorized 300,000,000 shares; 222,294,562 shares issued and 220,173,633 shares outstanding 148,197 148,197 Capital in excess of par value 302,554 302,432 Accumulated deficit (493,908) (494,912) ----------- ---------- (43,157) (44,283) ----------- ---------- Less: Treasury stock, at cost (2,120,929 shares) (2,996) (2,996) Notes receivable from sale of Common Stock (350) (350) ----------- ---------- Total Shareholders' Deficiency (46,503) (47,629) ----------- ---------- Total Liabilities and Shareholders' Deficiency $ 108,814 $ 114,618 =========== ==========
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 28, JUNE 28, JUNE 26, 2003 JUNE 26, 2003 2004 AS RESTATED 2004 AS RESTATED ---- ---- ---- ---- NET REVENUES $ 96,482 $ 105,883 $ 191,857 $ 207,412 --------- --------- --------- --------- OPERATING COSTS AND EXPENSES: Cost of sales and operating expenses 58,009 66,291 117,294 131,398 Special charges 43 211 11 488 Selling expenses 25,754 26,922 49,029 51,100 General and administrative expenses 10,419 9,491 20,786 20,746 Depreciation and amortization 1,004 1,138 2,016 2,321 --------- --------- --------- --------- 95,229 104,053 189,136 206,053 --------- --------- --------- --------- INCOME FROM OPERATIONS 1,253 1,830 2,721 1,359 Gain on sale of Improvements -- -- -- 1,911 --------- --------- --------- --------- INCOME BEFORE INTEREST AND INCOME TAXES 1,253 1,830 2,721 3,270 Interest expense, net 790 1,120 1,712 2,568 --------- --------- --------- --------- INCOME BEFORE INCOME TAXES 463 710 1,009 702 (Benefit) provision for Federal income taxes (62) -- 1 -- (Benefit) provision for state income taxes (38) (5) 4 10 --------- --------- --------- --------- NET INCOME AND COMPREHENSIVE INCOME 563 715 1,004 692 Preferred stock dividends -- 4,290 -- 7,922 Earnings applicable to Preferred Stock 1 -- 2 -- --------- --------- --------- --------- NET INCOME (LOSS) APPLICABLE TO COMMON SHAREHOLDERS $ 562 $ (3,575) $ 1,002 $ (7,230) --------- --------- --------- --------- NET INCOME (LOSS) PER COMMON SHARE: Net income (loss) per common share - basic and diluted $ 0.00 $ (0.02) $ 0.00 $ (0.05) --------- --------- --------- --------- Weighted average common shares outstanding - basic (thousands) 220,174 138,316 220,174 138,316 --------- --------- --------- --------- Weighted average common shares outstanding - diluted (thousands) 220,174 138,316 220,455 138,316 --------- --------- --------- ---------
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 26, JUNE 28, 2004 2003 AS RESTATED ---- ---- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 1,004 $ 692 Adjustments to reconcile net income to net cash provided (used) by operating activities: Depreciation and amortization, including deferred fees 2,158 2,966 Provision for doubtful accounts 268 298 Special charges 11 488 Gain on the sale of Improvements -- (1,911) Gain on the sale of property and equipment -- (2) Compensation expense related to stock options 122 341 Changes in assets and liabilities: Accounts receivable 202 2,114 Inventories 4,820 3,418 Prepaid catalog costs (3,835) (1,844) Accounts payable (2,156) (1,703) Accrued liabilities (914) (11,082) Customer prepayments and credits 354 2,396 Other, net (530) (1,087) -------- -------- Net cash provided (used) by operating activities 1,504 (4,916) -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Acquisitions of property and equipment (308) (1,202) Proceeds from the sale of Improvements -- 2,000 Costs related to the early release of escrow funds -- (89) Proceeds from disposal of property and equipment -- 2 -------- -------- Net cash (used) provided by investing activities (308) 711 -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Net (payments) borrowings under Congress revolving loan facility (1,050) 6,453 Payments under Congress Tranche A term loan facility (996) (994) Payments under Congress Tranche B term loan facility (900) (900) Payments of long-term debt and capital lease obligations (362) (6) Payment of debt issuance costs (125) (78) Refund (payment) of estimated Richemont tax obligation on Series B Participating Preferred Stock accretion 347 (347) -------- -------- Net cash (used) provided by financing activities (3,086) 4,128 -------- -------- Net decrease in cash and cash equivalents (1,890) (77) Cash and cash equivalents at the beginning of the year 2,282 785 -------- -------- Cash and cash equivalents at the end of the period $ 392 $ 708 ======== ======== SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid for: Interest $ 1,332 $ 1,642 Income taxes $ 8 $ 663 Non-cash investing and financing activities: Series B Participating Preferred Stock redemption price increase $ -- $ 7,575
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 27, 2003, as amended. 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. Pursuant to Statement of Financial Accounting Standards ("SFAS") No. 131, "Disclosures about Segments of an Enterprise and Related Information," the consolidated operations of the Company are reported as one segment. Uses of Estimates and Other Critical Accounting Policies The condensed consolidated financial statements include all subsidiaries of the Company and all intercompany transactions and balances have been eliminated. The preparation of financial statements, in conformity with generally accepted accounting principles, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. See "Management's Discussion and Analysis of Consolidated Financial Condition and Results of Operations," found in the Company's Annual Report on Form 10-K for the fiscal year ended December 27, 2003, as amended, for additional information relating to the Company's use of estimates and other critical accounting policies. 2. RESTATEMENTS OF PRIOR PERIOD FINANCIAL STATEMENTS During the second quarter of 2004, the Company identified a revenue recognition cut-off issue that resulted in revenue being recorded in advance of the actual shipment of merchandise to the customer. The practice was stopped immediately. The impact of the restatement on the years ended December 30, 2000, December 29, 2001 and December 28, 2002 as well as the quarterly and year-to-date financial statements for each of the periods ended March 29, 2003, June 28, 2003, September 27, 2003 and December 27, 2003 is not material. The affected prior quarters' and annual periods' results have been restated as set forth below. 6
YEAR ENDED DECEMBER 30, 2000 ---------------------------- AS PREVIOUSLY REPORTED AS RESTATED -------- ----------- (IN THOUSANDS) Accounts receivable, net $ 27,703 $ 27,357 Inventory $ 69,612 $ 69,731 Total Current Assets $ 128,446 $ 128,313 Accumulated Deficiency $(471,651) $(471,753) Total Shareholders' Deficiency $ (24,452) $ (24,554) Net revenues $ 603,014 $ 602,668 Loss before interest and income taxes $ (70,552) $ (70,652) Net loss and comprehensive income loss $ (80,800) $ (80,900) Net loss applicable to common shareholders $ (84,815) $ (84,915) Net loss per share-basic and diluted $ (0.40) $ (0.40)
YEAR ENDED DECEMBER 29, 2001 ---------------------------- AS PREVIOUSLY REPORTED AS RESTATED -------- ----------- (IN THOUSANDS) Net revenues $ 532,165 $ 532,519 Income before interest and income taxes $ 804 $ 906 Net loss and comprehensive income loss $ (5,845) $ (5,743) Net loss applicable to common shareholders $ (16,590) $ (16,488) Net loss per share-basic and diluted $ (0.08) $ (0.08)
YEAR ENDED DECEMBER 28, 2002 ---------------------------- AS PREVIOUSLY REPORTED AS RESTATED -------- ----------- (IN THOUSANDS) Accounts receivable, net $ 16,945 $ 16,938 Inventory $ 53,131 $ 53,134 Total Current Assets $ 88,287 $ 88,285 Accumulated Deficiency $(486,627) $(486,628) Total Shareholders' Deficiency $ (58,841) $ (58,842) Net revenues $ 457,644 $ 457,638 Net loss per share-basic and diluted $ (0.18) $ (0.18)
7
QUARTER ENDED MARCH 29, 2003 ---------------------------- AS PREVIOUSLY REPORTED AS RESTATED -------- ----------- (IN THOUSANDS) Accounts receivable, net $ 13,580 $ 12,652 Inventory $ 53,425 $ 53,787 Total Current Assets $ 90,837 $ 90,548 Accumulated Deficiency $(486,435) $(486,650) Total Shareholders' Deficiency $ (62,103) $ (62,318) Net revenues $ 102,474 $ 101,529 Income before interest and income taxes $ 1,655 $ 1,440 Net income (loss) and comprehensive income (loss) $ 192 $ (23) Net loss applicable to common shareholders $ (3,440) $ (3,655) Net loss per share-basic and diluted $ (0.02) $ (0.03)
QUARTER ENDED JUNE 28, 2003 --------------------------- AS PREVIOUSLY REPORTED AS RESTATED -------- ----------- (IN THOUSANDS) Accounts receivable, net $ 15,360 $ 14,526 Inventory $ 49,382 $ 49,716 Total Current Assets $ 84,667 $ 84,381 Accumulated Deficiency $(485,745) $(485,935) Total Shareholders' Deficiency $ (65,540) $ (65,730) Net revenues $ 105,765 $ 105,883 Income before interest and income taxes $ 1,805 $ 1,830 Net income and comprehensive income $ 690 $ 715 Net loss applicable to common shareholders $ (3,600) $ (3,575) Net loss per share-basic and diluted $ (0.02) $ (0.02)
SIX MONTHS ENDED JUNE 28, 2003 ------------------------------ AS PREVIOUSLY REPORTED AS RESTATED -------- ----------- (IN THOUSANDS) Net revenues $ 208,239 $ 207,412 Income before interest and income taxes $ 3,460 $ 3,270 Net income and comprehensive income $ 882 $ 692 Net loss applicable to common shareholders $ (7,040) $ (7,230) Net loss per share-basic and diluted $ (0.05) $ (0.05)
8
QUARTER ENDED SEPTEMBER 27, 2003 -------------------------------- AS PREVIOUSLY REPORTED AS RESTATED -------- ----------- (IN THOUSANDS) Net revenues $ 96,633 $ 97,466 Income (loss) before interest and income taxes $ (64) $ 126 Net loss and comprehensive loss $ (16,645) $ (16,455) Net loss applicable to common shareholders $ (16,645) $ (16,455) Net loss per share-basic and diluted $ (0.12) $ (0.12)
NINE MONTHS ENDED SEPTEMBER 27, 2003 ------------------------------------ AS PREVIOUSLY REPORTED AS RESTATED -------- ----------- (IN THOUSANDS) Net revenues $ 304,872 $ 304,878 Net loss per share-basic and diluted $ (0.17) $ (0.17)
QUARTER ENDED DECEMBER 27, 2003 ------------------------------- AS PREVIOUSLY REPORTED AS RESTATED -------- ----------- (IN THOUSANDS) Accounts receivable, net $ 14,335 $ 13,802 Inventory $ 41,576 $ 41,794 Total Current Assets $ 73,952 $ 73,774 Accumulated Deficiency $(494,791) $(494,912) Total Shareholders' Deficiency $ (47,508) $ (47,629) Net revenues $ 110,002 $ 109,469 Income before interest and income taxes $ 4,621 $ 4,500 Net income and comprehensive income $ 364 $ 243 Net income applicable to common shareholders $ 364 $ 243 Net income per share-basic and diluted $ 0.00 $ 0.00
9
YEAR ENDED DECEMBER 27, 2003 ---------------------------- AS PREVIOUSLY REPORTED AS RESTATED -------- ----------- (IN THOUSANDS) Net revenues $ 414,874 $ 414,347 Income before interest and income taxes $ 8,017 $ 7,896 Net loss and comprehensive loss $ (15,399) $ (15,520) Net loss applicable to common shareholders $ (23,321) $ (23,442) Net loss per share-basic and diluted $ (0.16) $ (0.16)
QUARTER ENDED MARCH 27,2004 ---------------------------- AS PREVIOUSLY REPORTED AS RESTATED -------- ----------- (IN THOUSANDS) Accounts receivable, net $ 12,614 $ 12,145 Inventory $ 37,646 $ 37,835 Total Current Assets $ 71,293 $ 71,152 Accumulated Deficiency $(494,373) $(494,470) Total Shareholders' Deficiency $ (47,086) $ (47,183) Net revenues $ 95,312 $ 95,375 Income before interest and income taxes $ 1,445 $ 1,468 Net income and comprehensive income $ 418 $ 441 Net income applicable to common shareholders $ 417 $ 440 Net income per share-basic and diluted $ 0.00 $ 0.00
The restatements did not result in a change to the Company's cash flows during the restated periods; however it did result in technical defaults by the Company with its covenants under the Congress Credit Facility and the Term Loan Facility. Congress and Chelsey Finance have waived such defaults. 3. DIVIDEND RESTRICTIONS The Company is restricted from paying dividends at any time on its Common Stock or from acquiring its Common Stock by certain debt covenants contained in agreements to which the Company is a party. 4. NET INCOME (LOSS) PER COMMON SHARE Net income (loss) per common share is computed using the weighted average number of common shares outstanding in accordance with the provisions of Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share" ("FAS 128"). Basic net income (loss) per common share is calculated by dividing net income (loss) available to common shareholders, reduced for participatory interests, by the weighted average number of common shares outstanding during the period. Diluted net income (loss) per common share is calculated using the weighted average number of common shares outstanding adjusted to include the potentially dilutive effect of convertible stock or stock options. The computations of basic and diluted net income (loss) per common share are as follows (in thousands except per share amounts): 10
FOR THE 13- WEEKS ENDED FOR THE 26- WEEKS ENDED ----------------------- ----------------------- JUNE 26, JUNE 28, JUNE 26, JUNE 28, 2004 2003 2004 2003 AS RESTATED AS RESTATED ---- ---- ---- ---- Net income $ 563 $ 715 $ 1,004 $ 692 Less: Preferred stock dividends -- 4,290 -- 7,922 Earnings applicable to preferred stock 1 -- 2 -- --------- --------- --------- --------- Net income (loss) applicable to common shareholders $ 562 $ (3,575) $ 1,002 $ (7,230) ========= ========= ========= ========= Basic net income (loss) per common share $ 0.00 $ (0.02) $ 0.00 $ (0.05) ========= ========= ========= ========= Weighted-average common shares outstanding 220,174 138,316 220,174 138,316 ========= ========= ========= ========= Diluted net income (loss) $ 562 $ (3,575) $ 1,002 $ (7,230) ========= ========= ========= ========= Diluted net income (loss) per common share $ 0.00 $ (0.02) $ 0.00 $ (0.05) ========= ========= ========= ========= Weighted-average common shares outstanding 220,174 138,316 220,174 138,316 Effect of Dilution: Stock options -- -- 281 -- --------- --------- --------- --------- Weighted-average common shares outstanding assuming dilution 220,174 138,316 220,455 138,316 ========= ========= ========= =========
Diluted net income (loss) per common share excluded incremental shares of 14.6 million and 14.4 million for the 13-week periods ended June 26, 2004 and June 28, 2003, respectively, and 12.3 million and 14.4 million incremental shares for the 26-week periods ended June 26, 2004 and June 28, 2003, respectively. These incremental shares were related to employee stock options and were excluded due to their antidilutive effect. 5. COMMITMENTS AND CONTINGENCIES A class action lawsuit was commenced on March 3, 2000 in the District Court in Sequoyah County, Oklahoma entitled Edwin L. Martin v. Hanover Direct, Inc. and John Does 1 through 10 ("Martin"), which 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 as a result of "insurance charges" paid to the Company by participants in the class action suit. 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. Plaintiff seeks an order (i) 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) enjoining the Company from imposing an insurance charge, (iv) awarding threefold damages of less than $75,000 per plaintiff and per class member, and (v) awarding attorneys' fees and costs. On July 23, 2001, the Court certified a class comprised of all persons in the United States who are customers of any catalog or catalog company owned by the Company and who at any time purchased a product from any such company and paid money which was designated to be an `insurance charge.' The Company filed an appeal of the class certification. On January 20, 2004, the plaintiff filed a motion for oral argument on the appeal of the class certification. The Company believes it has defenses against the claims and plans to conduct a vigorous defense of this action. The Company believes that a loss is not probable; therefore, no accrual for potential losses was deemed necessary. On August 15, 2001, the Company was served with a summons and four-count complaint entitled Teichman v. Hanover Direct, Inc., Hanover Brands, Inc., Hanover Direct Virginia, Inc., and Does 1-100 ("Teichman"), which was subsequently expanded to include other Hanover Direct, Inc. subsidiaries as defendants. The complaint was filed by a California resident in the Superior Court for the City and County of San Francisco seeking damages and other relief for herself and a class of all others similarly situated arising out of the insurance fee charged by catalogs and Internet sites operated by subsidiaries of the Company. On May 14, 2002, as a result of the Company having filed a Motion to Stay the Teichman action in favor of the previously-filed Martin action and a Motion to Dismiss the case against Hanover Direct, Inc., Hanover Brands, Inc., and Hanover Direct Virginia, Inc. for lack of personal jurisdiction, the Court (1) 11 granted the Company's Motion to Stay the action in favor of the previously-filed Martin action, and (2) granted the Company's Motion to Quash service, leaving only LWI Holdings, Hanover Company Store, Kitchen & Home, and Silhouettes as defendants. The Company believes it has defenses against the claims and plans to conduct a vigorous defense of this action. The Company believes that a loss is not probable; therefore, no accrual for potential losses was deemed necessary. A class action lawsuit was commenced on February 13, 2002 in the Superior Court of the State of California, City and County of San Francisco 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"). 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 alleged that, for at least four years, members of the class had 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 restitution and disgorgement of all monies wrongfully collected and earned by Brawn, including interest and other gains, reimbursement of the insurance charge with interest, an order enjoining Brawn from imposing insurance on its order forms; and compensatory damages, attorneys' fees, pre-judgment interest and costs of the suit. (Plaintiff lost at trial on the tax issue and has not appealed it so it is no longer among the issues being litigated in this case.) On November 25, 2003, the Court, after a trial, entered judgment for the plaintiff and the class, requiring Brawn, by June 30, 2004, to refund insurance charges collected from consumers for the period from February 13, 1998 through January 15, 2003 with interest from the date paid. On April 14, 2004, the Court awarded plaintiff's counsel approximately $445,000 of attorneys' fees. On April 23, 2004, the Company filed a Motion to Stay the enforcement of the insurance fees judgment pending resolution of the appeal, including a request to extinguish a lien filed on April 2, 2004, and including a request for a determination that an appellate bond will not be required by the Company. This motion was heard on May 11, 2004 and granted, the Court finding that enforcement of the judgment entered was stayed on January 23, 2004 when Brawn filed its Notice of Appeal. The Company has appealed the trial court's decision on the merits of the insurance fees issue as well as the decision on the attorneys' fees issue. On May 18, 2004, the Court of Appeals issued an Order consolidating the two appeals. The Company plans to conduct a vigorous defense of this action. The potential estimated exposure is in the range of $0 to $4.0 million. Based upon the Company's policy of evaluating accruals for legal liabilities, the Company has not established a reserve as a result of management determining that it is not probable that an unfavorable outcome will result. A class action lawsuit was commenced on October 28, 2002 in the Superior Court of New Jersey, Bergen County - Law Division entitled John Morris, individually and on behalf of all other persons & entities similarly situated v. Hanover Direct, Inc., and Hanover Brands, Inc. (referred to in this paragraph as "Hanover"). The plaintiff brought the action individually and on behalf of a class of all persons and entities in New Jersey who purchased merchandise from Hanover within six years prior to filing of the lawsuit and continuing to the date of judgment. On the basis of a purchase made by plaintiff in August 2002 of clothing from a Hanover men's division catalog, plaintiff alleged that Hanover had a policy and practice of improperly adding a charge for "insurance" to the orders it received, and concealed and failed to disclose the charge. Plaintiff claims that Hanover's conduct was in violation of the New Jersey Consumer Fraud Act as otherwise deceptive, misleading and unconscionable such as to constitute unjust enrichment of Hanover at the expense and to the detriment of plaintiff and the class and unconscionable per se under the Uniform Commercial Code for contracts related to the sale of goods. Plaintiff and the class seek damages equal to the amount of all insurance charges, interest thereon, treble and punitive damages, injunctive relief, costs and reasonable attorneys' fees, and such other relief as may be just, necessary and appropriate. On December 13, 2002, the Company filed a Motion to Stay the action pending resolution of the previously-filed Martin action in Oklahoma. The Court granted the Company's Motion to Stay and the case was stayed, and extended once, until March 31, 2004, at which time the stay was lifted. On April 30, 2004, the Company responded to Plaintiff's Amended Complaint. The case is in the discovery phase. The Company plans to conduct a vigorous defense of this action. The Company believes that a loss is not probable; therefore, no accrual for potential losses was deemed necessary. On June 28, 2001, Rakesh K. Kaul, the former President and Chief Executive Officer of the Company, filed a five-count complaint (the "Complaint") seeking damages and other relief arising out of his separation of employment 12 from the Company. On or about July 13, 2004, a final judgment was entered whereby the Court ordered and adjudged that certain claims in the case are dismissed with prejudice and that Mr. Kaul is to recover from the Company $45,946, representing four weeks of vacation pay, together with interest thereon from December 5, 2000. The parties have agreed to a final payment, including interest, in the amount of $60,856. The Court is expected to shortly issue a final judgment implementing its summary judgment Opinion. Each party will have the right to appeal any aspect of that judgment. The Company has reserved $65,435 for payments due Mr. Kaul and the associated employer payroll taxes. Payment was made to Mr. Kaul on July 15, 2004 for the interest portion of the agreement and on July 16, 2004 for the four weeks vacation. The Company was named as one of 88 defendants in a patent infringement complaint filed on November 23, 2001 in the U.S. District Court in Arizona by the Lemelson Medical, Education & Research Foundation, Limited Partnership (the "Lemelson Foundation"). The complaint 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 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. On January 23, 2004, the Nevada Court entered judgment declaring that the claims of each of the patents at issue in the Nevada case, including all seven patents asserted by the Lemelson Foundation against the Company in the Arizona case, are unenforceable under the doctrine of prosecution laches, are invalid for lack of written description and enablement, and are not infringed by the bar code equipment manufacturers. The Lemelson Foundation filed a notice of appeal before the deadline of May 28, 2004. The Arizona court confirmed that the stay of the Arizona case will extend until the entry of a final, non-appealable judgment in the Nevada litigation. The Company has analyzed the merits of the issues raised by the complaint, notified vendors of its receipt of the complaint and letter, evaluated the merits of joining a joint-defense group, and had discussions with attorneys for the Lemelson Foundation regarding their license offer. The Company will not agree to a settlement at this time and thus has not established a reserve. 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 believes it has defenses against the claims and plans to conduct a vigorous defense of this action. The Company believes that a loss is not probable; therefore, no accrual for potential losses was deemed necessary. In early March 2003, the Company learned that one of its business units had engaged in certain travel transactions that may have constituted violations under the provisions of U.S. government regulations promulgated pursuant to 50 U.S.C. App. 1-44, which proscribe certain transactions related to travel to certain countries. The Company immediately commenced an inquiry into the matter, incurred resulting charges, made an initial voluntary disclosure to the appropriate U.S. government agency under its program for such disclosures and will submit to that agency a detailed report on the results of the inquiry. In addition, the Company has taken steps to ensure that all of its business units are acting in compliance with the travel and transaction restrictions and other requirements of all applicable U.S. government programs. Although the Company is uncertain of the extent of the penalties, if any, that may be imposed on it by virtue of the transactions being voluntarily disclosed, it does not currently believe that any such penalties will have a material effect on its business or financial condition. The Company believes that a loss is not probable; therefore, no accrual for potential losses was deemed necessary. In addition, the Company is involved in various routine lawsuits of a nature that is deemed customary and incidental to its businesses. In the opinion of management, the ultimate disposition of these actions will not have a material adverse effect on the Company's financial position or results of operations. 6. SPECIAL CHARGES In December 2000, the Company began a strategic business realignment program that resulted in the recording of special charges for severance, facility exit costs and fixed asset write-offs. The actions related to the strategic business realignment program were taken in an effort to direct the Company's resources primarily towards a loss reduction strategy and return to profitability. As of June 26, 2004, a liability of approximately $2.0 million was included within Accrued Liabilities and a liability of approximately $2.6 million was included within Other Non-current Liabilities relating to future payments in 13 connection with the Company's strategic business realignment program. They are expected to be satisfied no later than February 2010 and consist of the following (in thousands):
SEVERANCE & REAL ESTATE PERSONNEL LEASE & COSTS EXIT COSTS TOTAL ----- ---------- ----- Balance at December 27, 2003 $ 205 $ 5,589 $ 5,794 2004 revisions of previous estimate (31) 42 11 Paid in 2004 (174) (1,013) (1,187) ------- ------- ------- Balance at June 26, 2004 $ -- $ 4,618 $ 4,618 ======= ======= =======
A summary of the liability related to real estate lease and exit costs, by location, as of June 26, 2004 and December 27, 2003, is as follows (in thousands):
JUNE 26, DECEMBER 27, 2004 2003 ---- ---- Gump's facility, San Francisco, CA $3,422 $3,788 Corporate facility, Weehawken, NJ 943 1,447 Corporate facility, Edgewater, NJ 166 261 Administrative and telemarketing facility, San Diego, CA 87 93 ------ ------ Total Real Estate Lease and Exit Costs $4,618 $5,589 ------ ------
7. SALE OF IMPROVEMENTS BUSINESS On June 29, 2001, the Company sold certain assets and liabilities of its Improvements business to HSN, a division of USA Networks, Inc.'s Interactive Group, for approximately $33.0 million. In conjunction with the sale, the Company's Keystone Internet Services, Inc. subsidiary (now Keystone Internet Services, LLC, or "Keystone") agreed to provide telemarketing and fulfillment services for the Improvements business under a services agreement with HSN for a period of three years. Effective June 28, 2004, the services agreement was extended an additional two years through June 27, 2006. The asset purchase agreement between the Company and HSN provided that if Keystone failed to perform its obligations during the first two years of the services contract, HSN could receive a reduction in the original purchase price of up to $2.0 million. An escrow fund of $3.0 million, which was withheld from the original proceeds of the sale, had been established for a period of two years under the terms of an escrow agreement between LWI Holdings, Inc. (a wholly-owned subsidiary of the Company), HSN and The Chase Manhattan Bank as a result of these contingencies. On March 27, 2003, the Company and HSN amended the asset purchase agreement to provide for the release of the remaining $2.0 million balance of the escrow fund and to terminate the related escrow agreement. By agreeing to the terms of the amendment, HSN forfeited its ability to receive a reduction in the original purchase price of up to $2.0 million if Keystone failed to perform its obligations during the first two years of the services contract. In consideration for the release, Keystone issued a credit to HSN for $100,000, which could be applied by HSN against any invoices of Keystone to HSN. This credit was utilized by HSN during the March 2003 billing period. On March 28, 2003, the remaining $2.0 million escrow balance was received by the Company, thus terminating the escrow agreement. The Company recognized a net gain on the sale of approximately $23.2 million, net of a non-cash goodwill charge of $6.1 million, in the second quarter of 2001. During fiscal 2002, the Company recognized approximately $0.6 million of the deferred gain consistent with the terms of the escrow agreement. The Company recognized the remaining net deferred gain of $1.9 million upon the receipt of the escrow balance on March 28, 2003. This gain was reported net of the costs incurred to provide the credit to HSN of approximately $0.1 million. 14 8. CHANGES IN MANAGEMENT AND BOARD OF DIRECTORS PRESIDENT AND CHIEF EXECUTIVE OFFICER Thomas C. Shull. Thomas C. Shull resigned as Chairman of the Board, President and Chief Executive Officer of the Company on May 5, 2004. In connection with Mr. Shull's resignation, effective May 5, 2004, Mr. Shull and the Company entered into a General Release and Covenant Not to Sue (the "Shull Severance Agreement") in conjunction with Mr. Shull's resignation from all positions with the Company pursuant to which the Company agreed to pay to Mr. Shull $900,000 ("Severance") in multiple installments of which the first installment of $300,000 was paid on May 18, 2004 and the remaining $600,000 is to be payable in 16 installments of $35,625 payable every two weeks commencing May 21, 2004 with a final payment in the amount of $30,000 to be payable on or about December 31, 2004. In addition, the Company agreed to pay the cost of continuing Mr. Shull's group health and dental benefits under COBRA and Exec-U-Care plan coverage ("Benefits Continuation" and together with Severance, "Termination Benefits") for a period of eighteen months. Under the Shull Severance Agreement, the Company and Mr. Shull agreed that, except for the Termination Benefits and the reimbursement of previously submitted out-of-pocket expenses, no other monies or benefits will be due, become due or be paid to Mr. Shull by the Company; provided that Mr. Shull's options remain vested and exercisable in accordance with their terms. The Shull Severance Agreement contained a general release by Mr. Shull in favor of the Company, and a limited release by the Company of certain claims against Mr. Shull, and covenants not to sue. The Company accrued the $900,000 severance, as well as $26,795 of other benefits, in the second quarter of 2004. Wayne P. Garten. Wayne P. Garten was elected as President and Chief Executive Officer of the Company effective May 5, 2004. In connection with Mr. Garten's election, effective May 5, 2004, Mr. Garten and the Company entered into an Employment Agreement (the "Garten Employment Agreement") pursuant to which Mr. Garten is employed by the Company as its President and Chief Executive Officer, as described below. The term of the Garten Employment Agreement began on May 5, 2004 and will terminate on May 5, 2006 (the "Garten Employment Agreement Term"). Under the Garten Employment Agreement, Mr. Garten is to receive from the Company base compensation equal to $600,000 per annum, payable in accordance with the Company's normal payroll procedures ("Base Compensation"). Mr. Garten is to be provided with the employee benefits the Company provides to its other senior executives, including but not limited to four weeks of paid vacation per year and participation in such bonus plans with such targets as the Compensation Committee of the Board of Directors may approve in its sole discretion, determined in a manner consistent with bonus opportunities afforded to other senior executives under such plans. The Company is to reimburse Mr. Garten for his reasonable out-of-pocket expenses incurred in connection with his employment by the Company. In addition, the Company is also to reimburse Mr. Garten for up to $12,500 of attorneys' fees incurred by him in connection with legal advice relating to, and the negotiation of, the Garten Employment Agreement. Under the Garten Employment Agreement, upon the closing of any transaction within the Garten Employment Agreement Term that constitutes a "change of control" thereunder (as defined in the Garten Employment Agreement), the Company will be required to make a lump sum cash payment to Mr. Garten in the amount of 200% of his Base Compensation (a "Change of Control Payment") within 30 days of the closing of the transaction resulting in the "change of control." Under the Garten Employment Agreement, additional amounts are payable to Mr. Garten by the Company under certain circumstances upon the termination of the Garten Employment Agreement. If the termination is on account of the expiration of the Garten Employment Agreement Term and no "change of control" has occurred thereunder, Mr. Garten shall be entitled to receive, subject to his continued compliance with his confidentiality and nonsolicitation obligations under the Garten Employment Agreement, monthly severance payments at the rate of Mr. Garten's Base Compensation for a period of 18 months, payable in accordance with the Company's normal payroll practices and policies and continued coverage under the Company's health, life insurance and long-term disability benefit plans for the 18-month period immediately following the end of the Garten Employment Agreement Term. If the termination is on account of the Company's termination of Mr. Garten's employment "For Cause," Mr. Garten's resignation other than "For Good Reason," or on account of Mr. Garten's death or "Disability" (all as defined in the Garten Employment Agreement), no additional amount (other than payment of Base Compensation through the end of the month in which the termination occurred) shall be payable to Mr. Garten. If the termination is on account of Mr. 15 Garten's resignation For Good Reason, or the Company's termination of Mr. Garten's employment other than For Cause, and in either such case Mr. Garten has not received or become entitled to receive a Change of Control Payment, Mr. Garten shall receive, subject to his continued compliance with his confidentiality and nonsolicitation obligations under the Garten Employment Agreement, continued payments of his monthly Base Compensation for a period equal to 18 months, payable in accordance with the Company's normal payroll practices and policies, the pro rated portion of bonuses earned for the fiscal year in which the effective date of termination occurs pursuant to the Company's bonus plans, accrued vacation and continued coverage under the Company's health, life insurance and long-term disability benefit plans for the 18-month period immediately following Mr. Garten's resignation or termination, as applicable. Under the Garten Employment Agreement, the Company is required to maintain directors' and officers' liability insurance for Mr. Garten during the Garten Employment Agreement Term. The Company is also required to indemnify Mr. Garten in certain circumstances. Under the Garten Employment Agreement, on May 5, 2004, the Company granted Mr. Garten an option to purchase 1,000,000 shares of Common Stock under the Company's 2000 Management Stock Option Plan at a price of $0.195 per share, and, subject to approval by the shareholders at the 2004 Annual Meeting of Shareholders, an additional option to purchase an additional 1,000,000 shares of Common Stock at a price of $0.195 per share, which option was granted under a Stock Option Agreement between the Company and Mr. Garten outside the Company's 2000 Management Stock Option Plan. All such options vest over a two-year period; one-third of such options vested on the execution of the Garten Employment Agreement, one-third will vest on May 5, 2005 and the final one-third will vest on May 5, 2006; provided that all such options will vest in their entirety and become fully exercisable upon the earliest to occur of Mr. Garten's resignation "For Good Reason," the Company's termination of Mr. Garten's services under the Garten Employment Agreement other than "For Cause," or a "change of control" under the Garten Employment Agreement. The Company expensed $113,337 during the second quarter of 2004 related to Mr. Garten's stock option grants. BOARD OF DIRECTORS Effective April 12, 2004, Paul S. Goodman joined the Company's Board of Directors as a designee of Chelsey Direct, LLC filling the vacancy created by the resignation effective February 15, 2004 of Martin L. Edelman from the Board of Directors. Thomas C. Shull resigned as Chairman of the Board, President and Chief Executive Officer of the Company on May 5, 2004. William B. Wachtel was elected as Chairman of the Board and Wayne P. Garten was elected as President and Chief Executive Officer of the Company effective the same date. On April 12, 2004, the Company issued options to purchase 50,000 shares of the Company's Common Stock to Mr. Goodman, the newly-appointed Board member, at a price of $0.23 per share and services rendered. On July 30, 2004, Basil P. Regan resigned as a member of the Company's Board of Directors. As a result, Mr. Regan has advised the Company that he will not be standing for reelection at the Company's August 12, 2004 Annual Meeting of Shareholders. Mr. Regan continues to have the right, which is required to be exercised as promptly as practicable, to appoint a designee to the Company's Board of Directors until November 30, 2005 pursuant to the Company's Corporate Governance Agreement dated as of November 30, 2003 among the Company, Chelsey Direct, LLC, Stuart Feldman, Regan Partners L.P., Regan International Fund Limited and Basil P. Regan so long as the Regan group collectively owns at least 29,128,762 shares of Common Stock of the Company (as adjusted for stock splits and the like). 9. RECENTLY ISSUED ACCOUNTING STANDARDS The Company accounts for goodwill in accordance with SFAS No. 142, "Goodwill and Other Intangible Assets," which requires that goodwill no longer be amortized but reviewed for impairment if impairment indicators arise and, at a minimum, annually. During the second quarters of 2004 and 2003, the Company completed its annual reviews of goodwill, which did not result in an impairment charge. In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity" ("SFAS 150"). SFAS 150 establishes standards for how an issuer 16 classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability, many of which had been previously classified as equity or between the liabilities and equity sections of the Condensed Consolidated Balance Sheet. The provisions of SFAS 150 are effective for financial instruments entered into or modified after May 31, 2003, and otherwise are effective at the beginning of the first interim period beginning after June 15, 2003. The standard is to be implemented by reporting the cumulative effect of a change in accounting principle for financial instruments created before the issuance of SFAS 150 and still existing at the beginning of the interim period of adoption. The Company adopted the provisions of SFAS 150, which resulted in the reclassification of its Series B Participating Preferred Stock to a liability rather than between the liabilities and equity sections of the Condensed Consolidated Balance Sheet. Based upon the requirements set forth by SFAS 150, this reclassification was subject to implementation beginning on June 29, 2003. Upon implementation of SFAS 150, the Company reflected subsequent increases in liquidation preference as an increase in Total Liabilities with a corresponding reduction in capital in excess of par value because the Company has an accumulated deficit. Accretion was recorded as interest expense. On March 31, 2004, the Financial Accounting Standards Board ("FASB") issued Emerging Issues Task Force Issue No. 03-6, "Participating Securities and the Two-Class Method under FASB Statement No. 128" ("EITF 03-6"). SFAS 128 defines earnings per share ("EPS") as "the amount of earnings attributable to each share of common stock" and indicates that the objective of EPS is to measure the performance of an entity over the reporting period. SFAS 128 addresses conditions under which a participating security requires the use of the two-class method of computing EPS. The two-class method is an earnings allocation formula that treats a participating security as having rights to earnings that otherwise would have been available to common shareholders, but does not require the presentation of basic and diluted EPS for securities other than common stock. The Company's Series C Participating Preferred Stock is a participating security and, therefore, the Company calculates EPS utilizing the two-class method, however, it has chosen not to present basic and diluted EPS for its preferred stock. 10. AMENDMENTS TO CONGRESS LOAN AND SECURITY AGREEMENT Concurrent with the closing of the Term Loan Facility on July 8, 2004 with Chelsey Finance (see Note 14), the Company amended its existing senior credit facility (the "Congress Credit Facility") with Congress Financial Corporation ("Congress") to (1) release certain existing availability reserves and remove the excess loan availability covenant, increasing availability to the Company by approximately $10 million, (2) reduce the amount of the maximum credit, the revolving loan limit and the inventory and accounts sublimits of the borrowers, (3) defer for three months the payment of principal with respect to the Tranche A Term Loan, (4) permit the secured indebtedness to Chelsey Finance arising under the Term Loan Facility, (5) modify certain provisions of the Congress Credit Facility with respect to asset sales and the application of proceeds thereof by borrowers, (6) extend the term of the Congress Credit Facility until July 8, 2007, and (7) amend certain other provisions of the Congress Credit Facility. In addition, Congress consented to (a) the issuance by the Company of the Common Stock Warrant, the Series D Preferred Stock Warrant, the Common Stock pursuant to the Common Stock Warrant and the Series D Preferred Stock pursuant to the Series D Preferred Stock Warrant (see note 14), (b) the filing of the Certificate of Designation of the Series D Preferred Stock, (c) the proposed reverse split and the Company making payments in cash to holders of Common Stock to repurchase fractional shares of such Common Stock from such shareholders as contemplated by the proposed reverse split (pending shareholder approval at the August 2004 shareholder meeting), (d) certain amendments to the Company's Certificate of Incorporation, and (e) the issuance by the Company of Common Stock to Chelsey Finance as payment of a waiver fee. The amendment required the payment of fees to Congress in the amount of $400,000. As of June 26, 2004, the Company had $18.5 million of cumulative borrowings outstanding under the Congress Credit Facility, comprising $7.9 million of short-term borrowings under the Revolving Loan Facility, bearing an interest rate of 4.50%, $5.5 million under the Tranche A Term Loan, bearing an interest rate of 4.75%, and $5.1 million under the Tranche B Term Loan, bearing an interest rate of 13.0%. The Tranche B Term Loan, originally scheduled to be repaid in January 2007, was repaid in full on July 9, 2004. Of the total borrowings on June 26, 2004, $11.7 million is classified as short-term, and $6.8 million classified as long-term, on the Company's Condensed Consolidated Balance Sheet. As of December 27, 2003, the Company had $21.5 million of borrowings outstanding under the Congress Credit Facility comprising $9.0 million of short-term borrowings under the revolving loan facility, bearing an interest rate of 4.50%, $6.5 million under the Tranche A Term Loan, bearing an interest rate of 4.75%, and $6.0 million under the Tranche B Term Loan, bearing an interest rate of 13.0%. Of the aggregate borrowings at December 27, 2003, $12.8 17 million is classified as short-term, and $8.7 million classified as long-term, on the Company's Condensed Consolidated Balance Sheet. Remaining availability under the Congress Credit Facility as of June 26, 2004 was $5.1 million. On or before August 15, 2004, the Company is required to enter into a restatement of the loan agreement with Congress requiring no changes to the terms of the current agreement. On April 14, 2004, the judge in the Wilson case (See Note 5) ruled on a motion filed by the plaintiff requesting attorneys' fees and costs, awarding plaintiff's counsel approximately $445,000. Prior thereto, on November 25, 2003, the Court entered judgment in the Wilson case in plaintiff's favor requiring the Company's Brawn of California subsidiary, which operates the International Male catalog business, to refund insurance fees collected from consumers for the period from February 13, 1998 through January 15, 2003 with interest from the date paid by June 30, 2004. The Company is appealing both of these decisions. On or about April 2, 2004, plaintiff's counsel filed a lien against Brawn of California's real property assets in the State of California with respect to the insurance fees judgment, which has subsequently been extinguished. Both the award of attorneys' fees and costs of $445,000 and the filing of a lien by plaintiff's counsel against Brawn of California's assets for the insurance fees judgment constituted defaults by the Company under the Congress Credit Facility. Congress agreed to conditionally waive such defaults so long as (1) the Company is diligently defending the Wilson action by all appropriate proceedings and sets aside adequate reserves in accordance with GAAP, (2) no action shall be taken by the plaintiff in the Wilson action against any collateral of Brawn of California or any other borrower or guarantor under the Congress Credit Facility, (3) Brawn shall not enter into any settlement agreement with the plaintiff in the Wilson action without prior written consent of Congress, (4) Congress' security interests remain senior to any interest of the plaintiff in the Wilson action, and (5) no other event of default exists or occurs. The Company believes that it may be a number of years before all appeals in the Wilson action are exhausted and continues to believe that an unfavorable outcome to the Company is not probable. 11. SERIES B PARTICIPATING PREFERRED STOCK On December 19, 2001, as part of the Company's transaction (the "Richemont Transaction") with Richemont Finance S.A. ("Richemont"), the Company issued to Richemont 1,622,111 shares of Series B Participating Preferred Stock. The Series B Participating Preferred Stock had a par value of $0.01 per share. In the event of the liquidation, dissolution or winding up of the Company, the holders of the Series B Participating Preferred Stock were entitled to a liquidation preference, which was initially $47.36 per share, increasing thereafter to a maximum of $86.85 per share in 2005. The Company was required to redeem the Series B Participating Preferred Stock on August 23, 2005 consistent with Delaware General Corporation Law. The Company could redeem all or less than all of the then outstanding shares of Series B Participating Preferred Stock at any time prior to that date. As a result of filings made by Richemont and certain related parties with the Securities and Exchange Commission on May 21, 2003, the Company learned that Richemont sold to Chelsey, on May 19, 2003, all of Richemont's securities in the Company consisting of 29,446,888 shares of Common Stock and 1,622,111 shares of 18 Series B Participating Preferred Stock for $40 million. The Company was not a party to such transaction and did not provide Chelsey with any material, non-public information in connection with such transaction, nor did the Company's Board of Directors endorse the transaction. As a result of the transaction, Chelsey succeeded to Richemont's rights in the Common Stock and the Series B Participating Preferred Stock, including the right of the holder of the Series B Participating Preferred Stock to a liquidation preference with respect to such shares which was equal to $98,202,600 on May 19, 2003, the date of the sale of the shares, and which could have increased to and capped at $146,168,422 on August 23, 2005, the final redemption date of the Series B Participating Preferred Stock. On November 30, 2003, the Company consummated the transactions contemplated by the Recapitalization Agreement, dated as of November 18, 2003, with Chelsey and recapitalized the Company, completed the reconstitution of the Board of Directors of the Company and settled outstanding litigation between the Company and Chelsey (the "Recapitalization"). In the transaction, the Company exchanged all of the 1,622,111 outstanding shares of the Series B Participating Preferred Stock held by Chelsey for the issuance to Chelsey of 564,819 shares of newly created Series C Participating Preferred Stock and 81,857,833 additional shares of Common Stock of the Company. Effective upon the closing of the transactions contemplated by the Recapitalization Agreement, the size of the Board of Directors was increased to nine (9) members. For a period of two (2) years from the closing of the Recapitalization, five (5) of the nine (9) directors of the Company will at all times be directors of the Company designated by Chelsey and one (1) of the nine (9) directors of the Company will at all times be a director of the Company designated by Regan Partners. Because its Series B Participating Preferred Stock was mandatorily redeemable and thus accounted for as a liability, the Company accounted for the exchange of the 1,622,111 outstanding shares of its Series B Participating Preferred Stock held by Chelsey for the issuance of the 564,819 shares of newly-created Series C Participating Preferred Stock and the 81,857,833 additional shares of Common Stock of the Company to Chelsey in accordance with SFAS No. 15, "Accounting by Debtors and Creditors for Troubled Debt Restructurings." As such, the $107.5 million carrying value of the Series B Participating Preferred Stock as of the consummation date of the exchange was compared with the fair value of the Common Stock of approximately $19.6 million issued to Chelsey as of the consummation date and the total maximum potential cash payments of approximately $72.7 million that could be made pursuant to the terms of the Series C Participating Preferred Stock. Since the carrying value, net of issuance costs of approximately $1.3 million, exceeded these amounts by approximately $13.9 million, pursuant to SFAS No. 15, such excess was determined to be a "gain" and the Series C Participating Preferred Stock was recorded at the amount of total potential cash payments (including dividends and other contingent amounts) that could be required pursuant to its terms. Since Chelsey was a significant stockholder at the time of the exchange and, as a result, a related party, the "gain" was recorded to "Capital in Excess of Par Value" within "Shareholders' Deficiency" on the accompanying Condensed Consolidated Balance Sheets. 12. SERIES C CUMULATIVE PARTICIPATING PREFERRED STOCK On November 30, 2003, as part of the Recapitalization, the Company issued to Chelsey 564,819 shares of Series C Participating Preferred Stock. The Series C Participating Preferred Stock has a par value of $.01 per share. The holders of the Series C Participating Preferred Stock are entitled to one hundred votes per share on any matter on which the Common Stock votes and are entitled to one hundred votes per share plus that number of votes as shall equal the dollar value of any accrued, unpaid and compounded dividends with respect to such share. The holders of the Series C Participating Preferred Stock are also entitled to vote as a class on any matter that would adversely affect the Series C Participating Preferred Stock. In addition, in the event that the Company defaults on its obligations under the Certificate of Designations, the Recapitalization Agreement or the Congress Credit Facility, then the holders of the Series C Participating Preferred Stock, voting as a class, shall be entitled to elect twice the number of directors as comprised the Board of Directors on the default date, and such additional directors shall be elected by the holders of record of Series C Participating Preferred Stock as set forth in the Certificate of Designations. In the event of the liquidation, dissolution or winding up of the Company, effective through December 31, 2005, the holders of the Series C Participating Preferred Stock are entitled to a liquidation preference of $100 per share, or an aggregate amount of $56,481,900. Effective October 1, 2008, the maximum aggregate amount of the liquidation preference is $72,689,337, which would occur if the Company elects to accrue unpaid dividends as mentioned below. 19 Commencing January 1, 2006, dividends will be payable quarterly on the Series C Participating Preferred Stock at the rate of 6% per annum, with the preferred dividend rate increasing by 1 1/2% per annum on each subsequent January 1 until redeemed. At the Company's option, in lieu of cash dividends, the Company may instead elect to cause accrued and unpaid dividends to compound at a rate equal to 1% higher than the applicable cash dividend rate. The Series C Participating Preferred Stock is entitled to participate ratably with the Common Stock on a share for share basis in any dividends or distributions paid to or with respect to the Common Stock. The right to participate has anti-dilution protection. The Congress Credit Facility and the Term Loan Facility currently prohibit the payment of dividends. The Series C Participating Preferred Stock may be redeemed in whole and not in part, except as set forth below, at the option of the Company at any time for the liquidation preference and any accrued and unpaid dividends (the "Redemption Price"). The Series C Participating Preferred Stock, if not redeemed earlier, must be redeemed by the Company on January 1, 2009 (the "Mandatory Redemption Date") for the Redemption Price. If the Series C Participating Preferred Stock is not redeemed on or before the Mandatory Redemption Date, or if other mandatory redemptions are not made, holders of the Series C Participating Preferred Stock will be entitled to elect one-half (1/2) of the Company's Board of Directors. Notwithstanding the foregoing, the Company will redeem the maximum number of shares of Series C Participating Preferred Stock as possible with the net proceeds of certain asset and equity sales not required to be used to repay Congress pursuant to the terms of the 19th Amendment to the Loan and Security Agreement with Congress (as modified by the 29th Amendment to the Loan and Security Agreement), and Chelsey will be required to accept such redemptions, as set forth in Section 5 of the Certificate of Designations of the Series C Participating Preferred Stock. Pursuant to the terms of the Certificate of Designations of the Series C Participating Preferred Stock, the Company's obligation to pay dividends on or redeem the Series C Participating Preferred Stock is subject to its compliance with its agreements with Congress and Chelsey Finance. 13. AMERICAN STOCK EXCHANGE NOTIFICATION The Company received a letter dated May 21, 2004 (the "Letter") from the American Stock Exchange (the "Exchange") advising that a review of the Company's Form 10-K for the period ended December 27, 2003 indicates that the Company does not meet certain of the Exchange's continued listing standards as set forth in Part 10 of the Exchange's Company Guide. Specifically, the Company is not in compliance with Section 1003(a)(i) of the Company Guide with shareholders' equity of less than $2,000,000 and losses from continuing operations and/or net losses in two out of its three most recent fiscal years; and Section 1003(a)(ii) of the Company Guide with shareholders' equity of less than $4,000,000 and losses from continuing operations and/or net losses in three out of its four most recent fiscal years; and Section 1003(a)(iii) of the Company Guide with shareholders' equity of less than $6,000,000 and losses from continuing operations and/or net losses in its five most recent fiscal years. The Exchange requested that the Company contact the Exchange by June 4, 2004 to confirm receipt of the Letter, discuss any possible financial data of which the Exchange's staff may be unaware, and indicate whether or not the Company intends to submit a plan of compliance. In order to maintain its listing on the Exchange, the Company had to submit a plan to the American Stock Exchange by June 22, 2004, advising the Exchange of action it has taken, or will take, that would bring it into compliance with the continued listing standards of the Exchange by November 21, 2005 (18 months of receipt of the Letter). The Company submitted a plan to the Exchange on June 22, 2004 and on August 3, 2004 the Exchange notified the Company that it accepted the Company's plan of compliance and granted the Company an extension of time until November 21, 2005 to regain compliance with the continued listing standards. The Company will be subject to periodic review by Exchange staff during the extension period. Failure to make progress consistent with the plan or to regain compliance with the continued listing standards by the end of the extension period on November 21, 2005 could result in the Company being delisted from the Exchange. There can be no assurance that the Company will be able to maintain the listing of its Common Stock on the Exchange. 14. SUBSEQUENT EVENTS TERM LOAN FACILITY WITH CHELSEY FINANCE On July 8, 2004, the Company completed a $20 million junior secured term loan facility (the "Term Loan 20 Facility") with Chelsey Finance, LLC ("Chelsey Finance"), an affiliate of its controlling shareholder, Chelsey Direct LLC ("Chelsey"). The Term Loan Facility is for a three-year term, subject to earlier maturity upon the occurrence of a change in control or sale of the Company (as defined), and carries an interest rate of 5% above the prime rate publicly announced by Wachovia Bank, N.A., which is calculated and payable monthly. The Term Loan Facility is secured by a second priority lien on the assets of the Company. In connection therewith, Chelsey Finance concurrently entered into an intercreditor and subordination agreement with the Company's senior secured lender, Congress. In consideration for providing the Term Loan Facility to the Company, Chelsey Finance received a closing fee of $200,000, which was paid in cash, and will receive a warrant (the "Common Stock Warrant") to purchase 30% of the fully diluted shares of Common Stock of the Company, which the Company believes would be equivalent to the issuance of an additional 10,247,210 shares of Common Stock (adjusted for the proposed one-for-ten reverse split of the Company's Common Stock) at an exercise price of $.01 per share. Pending shareholder approval of such issuance at the Company's Annual Meeting of Shareholders scheduled for August 12, 2004, Chelsey Finance received a warrant (the "Series D Preferred Warrant") to purchase a newly-issued series of nonvoting preferred stock of the Company, called Series D Participating Preferred Stock (the "Series D Preferred Stock"), that will be automatically exchanged for the Common Stock Warrant upon the receipt of shareholder approval of the issuance thereof at the Company's Annual Meeting of Shareholders. See the Series D Participating Preferred Stock discussion below for a description of the terms of the Series D Preferred Stock. In connection with the closing of the Term Loan Facility, Chelsey received a waiver fee equal to 1% of the liquidation preference of the Company's outstanding Series C Participating Preferred Stock, payable in Common Stock of the Company, or 4,344,762 additional shares of Common Stock (calculated based upon the fair market value thereof two business days prior to the closing date), in consideration for the waiver by Chelsey of its blockage rights over the issuance of senior securities. As part of the Term Loan Facility, the Company and its subsidiaries agreed to indemnify Chelsey Finance and its affiliates and each of its and their respective directors, officers, partners, attorneys and advisors from any losses suffered arising out of, in any way related to or resulting from the Term Loan Facility and the related agreements and the transactions contemplated thereby other than liabilities resulting from such parties' gross negligence or willful misconduct. The indemnification agreement is not limited as to term and does not include any limitations on maximum future payments thereunder. The terms of the Term Loan Facility with Chelsey Finance were approved by the Company's Audit Committee, all of whose members are independent, and the Company's Board of Directors. On July 8, 2004, proceeds from the Term Loan Facility with Chelsey Finance were used to repay, in full, the Tranche B Term Loan of approximately $4.9 million under the Congress Credit Facility (see Note 10) and the balance will be used to pay fees and expenses in connection with the transactions and will provide ongoing working capital for the Company which will be used to reduce outstanding payables. The Term Loan Facility, together with the concurrent amendment of the Congress Credit Facility discussed in Note 10, has increased the Company's liquidity by approximately $25 million. SERIES D PARTICIPATING PREFERRED STOCK On the closing of the Term Loan Facility, Chelsey Finance received the Series D Preferred Warrant, which entitles Chelsey Finance to purchase 100 shares of a newly issued series of non-voting preferred stock, the Series D Preferred Stock, as part of the consideration for providing the Term Loan Facility. The Series D Preferred Warrant will be automatically exchanged for the Common Stock Warrant (see discussion above) upon receipt of shareholder approval thereof at the 2004 Annual Meeting of Shareholders. The Common Stock Warrant will entitle Chelsey Finance to purchase 30% of the fully diluted shares of Common Stock of the Company at an exercise price of $.01 per share, which the Company believes would be equivalent to the issuance of an additional 10,247,210 shares of Common Stock (adjusted for the proposed one-for-ten reverse split of the Company's Common Stock). The Series D Preferred Warrant may not be exercised prior to September 30, 2004. The Series D Preferred Stock has a par value of $.01 per share. The holders of the Series D Preferred Stock have no voting rights except the right to vote as a class on certain matters that would adversely affect the rights of the Series D Preferred Stock. 21 In the event of the liquidation, dissolution or winding up of the Company, the holders of the Series D Preferred Stock are entitled to a liquidation preference equal to the fair market value of the Common Stock Warrant on July 8, 2004, or $81,868.40 per share ($8.2 million in the aggregate), plus declared but unpaid dividends thereon. The holders of the Series D Preferred Stock will be entitled to participate in dividends equal to the liquidation preference plus the amount of any declared but unpaid dividends thereon as of the record date, multiplied by the dividend yield of a share of Common Stock as of the close of the business day immediately preceding the record date for the dividend on the Common Stock. At the election of the holders of a majority of the shares of Series D Preferred Stock, in the event of the approval by the shareholders of the Company of a sale of the Company or substantially all of its assets or certain mergers, or upon the election of any holder following a Change of Control (as defined), such transaction will be treated as a liquidation and entitle such holders to have their shares of Series D Preferred Stock redeemed for an amount equal to the liquidation preference plus declared but unpaid dividends thereon. The Series D Preferred Stock is entitled to participate with the Common Stock in any dividends or distributions paid to or with respect to the Common Stock based upon the liquidation preference per share of Series D Preferred Stock times a fraction, the numerator of which is the dividend per share of Common Stock and the denominator is the fair market value of the Common Stock immediately prior to the record date for the dividend. The Company's credit agreements with Congress and Chelsey Finance currently prohibit the payment of dividends. The Series D Preferred Stock may be redeemed in whole and not in part, except as set forth below, at the option of the Company at any time for the liquidation preference plus any declared but unpaid dividends (the "Redemption Price"). The Series D Preferred Stock, if not redeemed earlier, must be redeemed by the Company out of the proceeds of certain equity sales, and any remaining outstanding shares shall be redeemed on January 1, 2009 (the "Mandatory Redemption Date") for the Redemption Price. Pursuant to the terms of the Certificate of Designations of the Series D Preferred Stock, the Company's obligation to pay dividends on or redeem the Series D Preferred Stock is subject to compliance with its credit agreements with Congress and Chelsey Finance. 22 ------------------------ 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 28, June 28, June 26, 2003 June 26, 2003 2004 As Restated 2004 As Restated ---- ----------- ---- ----------- Net revenues 100.0% 100.0% 100.0% 100.0% Cost of sales and operating expenses 60.1 62.6 61.1 63.4 Special charges 0.0 0.2 0.0 0.2 Selling expenses 26.7 25.4 25.6 24.6 General and administrative expenses 10.9 9.0 10.8 10.0 Depreciation and amortization 1.0 1.1 1.1 1.1 Income from operations 1.3 1.7 1.4 0.7 Gain on sale of Improvements 0.0 0.0 0.0 0.9 Interest expense, net 0.8 1.1 0.9 1.3 (Benefit) provision for Federal and state income taxes (0.1) 0.0 0.0 0.0 Net income and comprehensive income 0.6% 0.6% 0.5% 0.3%
EXECUTIVE SUMMARY The Company's second quarter results were negatively impacted by low inventory levels which resulted in substantially increased backorder levels, lower initial customer order fill rates and higher customer order cancellations. The low inventory levels were caused by the Company's reduced borrowing availability under the Congress Credit Facility and tighter vendor credit. In order to alleviate these situations, the Company entered into a new $20 million Term Loan Facility with Chelsey Finance on July 8, 2004 and concurrently amended the terms of the Congress Credit Facility. The additional working capital will provide the Company with the ability to restore inventory to adequate levels in order to fulfill demand, reduce existing backorder levels and increase initial customer order fill rates to more normal levels. In addition, the increased working capital will allow the Company to circulate more catalogs in order to grow the business. On May 5, 2004, Wayne P. Garten was appointed President and Chief Executive Officer ("CEO") of the Company succeeding Thomas C. Shull. The Company accrued $0.9 million in severance and other benefit costs during the second quarter associated with the resignation of Mr. Shull. During the second quarter of 2004, the Company identified a revenue recognition cut-off issue that resulted in revenue being recorded in advance of the actual shipment of merchandise to the customer. The practice was stopped immediately and the Company implemented procedures to ensure that this issue does not recur. See Note 2 of the Notes to the Condensed Consolidated Financial Statements for the required restatements. The Company announced on June 30, 2004, its intention to consolidate the operations of the LaCrosse, Wisconsin fulfillment centers into the Roanoke, Virginia fulfillment center over the next twelve months. The consolidation of operations was prompted by the lack of sufficient warehouse space in the leased Wisconsin facilities to support the growth of The Company Store and to reduce the overall cost structure of the Company. A review of the management structure leading the operations of both the Domestications and The Company Store brands determined the need for a separate management team to guide each brand. The size and diversity of the brands were the primary factors influencing the decision. The Company hired an individual to fill the brand president level position for Domestications in mid-July. While the new president assembles a management team and implements changes throughout the business, circulation will be decreased in the short-term to stabilize the brand; 23 therefore, it is expected that sales for Domestications will be lower than the prior year comparable periods for the remainder of the year. RESULTS OF OPERATIONS - 13- WEEKS ENDED JUNE 26, 2004 COMPARED WITH THE 13- WEEKS ENDED JUNE 28, 2003 AS RESTATED Net Income (Loss). The Company reported net income applicable to common shareholders of $0.5 million or $0.00 per share for the 13- weeks ended June 26, 2004 compared with a net loss of $3.6 million, or $0.02 per share, for the comparable fiscal period in 2003. The $4.1 million increase in net income applicable to common shareholders was primarily due to: - A favorable impact of $4.3 million due to the Recapitalization and exchange of the Series B Participating Preferred Stock for the Series C Participating Preferred Stock with Chelsey. During the 13- weeks ended June 28, 2003 Preferred Stock dividends and accretion were recorded relating to the Series B Participating Preferred Stock. The Series C Participating Preferred Stock has been recorded at the maximum amount of future cash payments; thus, the Company is currently not required to record interest expense relating to the Series C Participating Preferred Stock; - A favorable impact of $1.2 million due to continued reductions in cost of sales and operating expenses primarily associated with reductions in product postage costs and inventory write-downs; - A favorable impact of $1.1 million due to an increase in product sales margins primarily associated with the shift from domestic to foreign-sourced goods; - A favorable impact of $0.3 million due to reductions in interest resulting from lower average borrowings and deferred amendment fees which have been fully amortized relating to the Congress Credit Facility; - A favorable impact of $0.2 million due to the reduction of special charges recorded; - A favorable impact of $0.1 million due to a reduction in the estimated effective tax rate for fiscal 2004; and - A favorable impact of $0.1 million due to a decrease in depreciation and amortization. Partially offset by: - An unfavorable impact of $1.2 million due to increases in selling expenses primarily associated with increases in third-party Web site fees, catalog preparation costs and postage costs for mailing catalogs; - An unfavorable impact of $1.0 million due to increases in general and administrative expenses resulting from severance related to the resignation of the former President and Chief Executive Officer and compensation costs incurred on the appointment of his successor; - An unfavorable impact of $0.8 million due to a benefit recognized during the second quarter of 2003 from the revision of the Company's vacation and sick policy; and - An unfavorable impact of $0.2 million due to a reduction in variable contribution associated with the decline in net revenues. Net Revenues. Net revenues decreased $9.4 million (8.9%) for the 13-week period ended June 26, 2004 to $96.5 million from $105.9 million for the comparable fiscal period in 2003. Due to lower inventory levels across all brands resulting from the Company's reduced borrowing availability and tighter vendor credit, the Company experienced a decline in product fill rates caused by increases in backorders and cancellations. In addition, the decrease was due to a continued reduction in circulation for Domestications in order to limit the investment in catalog production costs and working capital necessary to maintain its inventory. For the balance of 2004, Domestications' circulation will be decreased while changes are implemented to stabilize the brand. Internet sales continued to grow, not withstanding the negative impact of low inventory levels, and comprised 31.1% of combined Internet and catalog revenues for the 13- weeks ended June 26, 2004 compared with 27.5% for the comparable fiscal period in 2003, and have increased by approximately $0.8 million, or 2.9%, to $28.3 million for the 13-week period ended June 26, 2004 from $27.5 million for the comparable fiscal period in 2003. 24 Cost of Sales and Operating Expenses. Cost of sales and operating expenses decreased by $8.3 million to $58.0 million for the 13- weeks ended June 26, 2004 as compared with $66.3 million for the comparable period in 2003. Cost of sales and operating expenses decreased to 60.1% of net revenues for the 13-week period ended June 26, 2004 as compared with 62.6% of net revenues for the comparable period in 2003. As a percentage of net revenues, this decrease was primarily due to a decline in merchandise costs associated with a shift from domestic to foreign-sourced goods that have higher product margins for The Company Store and Domestications (1.1%), a decrease in product postage costs resulting from utilizing more economical shipping sources and methods (1.0%), a decrease in inventory write-downs due to less slow moving inventory that would be required to be discounted and increasing sales of clearance merchandise through the Internet, which has less variable costs than utilizing catalogs as the clearance avenue (0.7%), and a decrease in information technology costs due to declines in equipment rentals and maintenance (0.1%). These reductions were partially offset by an increase in fixed distribution and telemarketing costs (0.4%). Special Charges. In December 2000, the Company began a strategic business realignment program that resulted in the recording of special charges for severance, facility exit costs and fixed asset write-offs. The actions related to the strategic business realignment program were taken in an effort to direct the Company's resources primarily towards a loss reduction strategy and a return to profitability. Special charges decreased by $0.2 million for the 13- weeks ended June 26, 2004 as compared with the comparable period in fiscal 2003. During the 13- weeks ended June 28, 2003, $0.2 million of costs were incurred to revise estimated losses related to sublease arrangements in connection with the office facilities in San Francisco, California. For the 13- weeks ended June 26, 2004, additional costs of less than $0.1 million were incurred relating to real estate lease and exit costs associated with the Weehawken, New Jersey and San Diego, California facilities. Selling Expenses. Selling expenses decreased by $1.1 million to $25.8 million for the 13- weeks ended June 26, 2004 as compared with $26.9 million for the comparable period in 2003. Selling expenses increased to 26.7% of net revenues for the 13- weeks ended June 26, 2004 from 25.4% for the comparable period in 2003. As a percentage of net revenues, this change was due primarily to an increase in fees paid to third-party Web sites for every click that leads to the Company's sites (0.5%), an increase in catalog preparation costs (0.4%), an increase in postage costs for mailing catalogs (0.3%) and an increase in costs associated with utilizing rented name lists from other mailers and compilers as a primary source of new customers (0.2%). These increases were partially offset by a reduction in paper and printing costs (0.1%). General and Administrative Expenses. General and administrative expenses increased by $0.9 million to $10.4 million for the 13- weeks ended June 26, 2004 as compared with $9.5 million for the comparable period in 2003. As a percentage of net revenues, general and administrative expenses increased to 10.9% of net revenues for the 13- weeks ended June 26, 2004 compared with 9.0% of net revenues for the comparable period in 2003. This increase was primarily due to severance and other benefit costs associated with the resignation of the former Company President and for compensation of his replacement. Depreciation and Amortization. Depreciation and amortization decreased approximately $0.1 million to $1.0 million for the 13- weeks ended June 26, 2004 from $1.1 million for the comparable period in 2003. The decrease was primarily due to fixed assets that have become fully amortized. Income from Operations. The Company's income from operations decreased by $0.6 million to $1.2 million for the 13- weeks ended June 26, 2004 from income from operations of $1.8 million for the comparable period in 2003. See "Results of Operations - 13- weeks ended June 26, 2004 compared with the 13- weeks ended June 28, 2003 as restated - Net Income (Loss)" for further details. Interest Expense, Net. Interest expense, net, decreased $0.3 million to $0.8 million for the 13- weeks ended June 26, 2004 from $1.1 million for the comparable period in fiscal 2003. The decrease in interest expense is due to lower average cumulative borrowings relating to the Congress Credit Facility and decreases in amortization from deferred financing costs relating to the Company's amendments to the Congress Credit Facility that have become fully amortized. 25 RESULTS OF OPERATIONS - 26- WEEKS ENDED JUNE 26, 2004 COMPARED WITH THE 26- WEEKS ENDED JUNE 28, 2003 AS RESTATED Net Income (Loss). The Company reported net income applicable to common shareholders of $1.0 million, or $0.00 per share, for the 26- weeks ended June 26, 2004 compared with a net loss of $7.2 million, or $0.05 per share, for the comparable period in fiscal 2003. The $8.2 million increase in net income applicable to common shareholders was primarily due to: - A favorable impact of $7.9 million due to the Recapitalization and exchange of the Series B Participating Preferred Stock for the Series C Participating Preferred Stock with Chelsey. During the 26- weeks ended June 28, 2003 Preferred Stock dividends and accretion were recorded relating to the Series B Participating Preferred Stock. The Series C Participating Preferred Stock has been recorded at the maximum amount of future cash payments; thus, the Company is currently not required to record interest expense relating to the Series C Participating Preferred Stock; - A favorable impact of $1.7 million comprising continued reductions in cost of sales and operating expenses primarily associated with reductions in product postage costs and inventory write-downs and a decrease in depreciation and amortization; - A favorable impact of $1.5 million due to an increase in product sales margins primarily associated with the shift from domestic to foreign-sourced goods; - A favorable impact of $0.9 million due to reductions in interest resulting from lower average borrowings and deferred amendment fees relating to the Congress Credit Facility, which have been fully amortized; and - A favorable impact of $0.5 million resulting from a reduction of special charges recorded. Partially offset by: - An unfavorable impact of $1.9 million due to the non-recurring deferred gain related to the June 29, 2001 sale of the Company's Improvements business recognized during the 26- weeks ended June 28, 2003; - An unfavorable impact of $1.0 million due to increases in general and administrative expenses resulting from severance related to the resignation of the former President and Chief Executive Officer and compensation costs incurred on the appointment of his successor; - An unfavorable impact of $0.8 million due to a benefit recognized during the second quarter of 2003 from the revision of the Company's vacation and sick policy; and - An unfavorable impact of $0.6 million due to a reduction in variable contribution associated with the decline in net revenues. Net Revenues. Net revenues decreased $15.5 million (7.5%) for the 26-week period ended June 26, 2004 to $191.9 million from $207.4 million for the comparable fiscal period in 2003. Due to lower inventory levels across all brands resulting from the Company's reduced borrowing availability and tighter vendor credit, the Company experienced a decline in product fill rates caused by increases in backorders and cancellations. In addition, the decrease was due to a reduction in circulation for Domestications in order to limit the investment in catalog production costs and working capital necessary to maintain its inventory. For the balance of 2004, Domestications' circulation will be decreased while changes are implemented to stabilize the brand. Internet sales continued to grow, not withstanding the negative impact of low inventory levels, and comprised 31.6% of combined Internet and catalog revenues for the 26- weeks ended June 26, 2004 compared with 27.1% for the comparable fiscal period in 2003, and have increased by approximately $3.9 million, or 7.3%, to $57.0 million for the 26-week period ended June 26, 2004 from $53.1 million for the comparable fiscal period in 2003. Cost of Sales and Operating Expenses. Cost of sales and operating expenses decreased by $14.1 million to $117.3 million for the 26- weeks ended June 26, 2004 as compared with $131.4 million for the comparable fiscal period in 2003. Cost of sales and operating expenses decreased to 61.1% of net revenues for the 26-week period ended June 26, 2004 as compared with 63.4% of net revenues for the comparable fiscal period in 2003. As a percentage of net revenues, this decrease was primarily due to a decline in merchandise costs associated with a shift from domestic 26 to foreign-sourced goods that have higher product margins for The Company Store and Domestications (0.8%), a decrease in product postage costs resulting from utilizing more economical shipping sources and methods (0.8%), a decrease in inventory write-downs due to less slow moving inventory that would be required to be discounted and increasing sales of clearance merchandise through the Internet, which has less variable costs than utilizing catalogs as the clearance avenue (0.7%), and a decrease in information technology costs due to declines in equipment rentals and maintenance (0.2%). These reductions were partially offset by an increase in fixed distribution and telemarketing costs (0.2%). Special Charges. In December 2000, the Company began a strategic business realignment program that resulted in the recording of special charges for severance, facility exit costs and fixed asset write-offs. The actions related to the strategic business realignment program were taken in an effort to direct the Company's resources primarily towards a loss reduction strategy and a return to profitability. Special charges decreased by $0.5 million for the 26- weeks ended June 26, 2004 as compared with the comparable period in fiscal 2003. During the 26- weeks ended June 28, 2003, the Company recorded $0.5 million of additional severance costs and charges incurred to revise estimated losses related to sublease arrangements for office facilities in San Francisco, California. Increased anticipated losses on sublease arrangements for the San Francisco office space resulted from the loss of a subtenant, coupled with declining market values in that area of the country. For the 26- weeks ended June 26, 2004, additional costs of less than $0.1 million were incurred relating to real estate lease and exit costs associated with the Weekhawken, New Jersey and San Diego, California facilities. Selling Expenses. Selling expenses decreased by $2.1 million to $49.0 million for the 26- weeks ended June 26, 2004 as compared with $51.1 million for the comparable period in 2003. Selling expenses increased to 25.6% of net revenues for the 26- weeks ended June 26, 2004 from 24.6% for the comparable period in 2003. As a percentage of net revenues, this change was due primarily to an increase in fees paid to third-party Web sites for every click that leads to the Company's sites (0.4%), an increase in costs associated with utilizing rented name lists from other mailers and compilers as a primary source of new customers (0.3%), an increase in postage costs for mailing catalogs (0.1%) and an increase in catalog preparation costs (0.2%). General and Administrative Expenses. General and administrative expenses remained constant at $20.8 million for the 26- weeks ended June 26, 2004 and June 28, 2003, respectively. As a percentage of net revenues, general and administrative expenses increased to 10.8% of net revenues for the 26- weeks ended June 26, 2004 compared with 10.0% of net revenues for the comparable period in 2003. This increase was primarily due to severance and other benefit costs associated with the resignation of three executives, including the former Company President and costs incurred in compensating his replacement. Depreciation and Amortization. Depreciation and amortization decreased approximately $0.3 million to $2.0 million for the 26- weeks ended June 26, 2004 from $2.3 million for the comparable period in 2003. The decrease was primarily due to fixed assets that have become fully amortized. Income from Operations. The Company's income from operations increased by $1.3 million to $2.7 million for the 26- weeks ended June 26, 2004 from income from operations of $1.4 million for the comparable period in 2003. See "Results of Operations - 26- weeks ended June 26, 2004 compared with the 26- weeks ended June 28, 2003 as restated - Net Income (Loss)" for further details. Gain on Sale of the Improvements Business. During the 26- weeks ended June 28, 2003, the Company recognized the remaining deferred gain of $1.9 million consistent with the terms of the March 27, 2003 amendment made to the asset purchase agreement relating to the sale of the Improvements business. Effective March 28, 2003, the remaining $2.0 million escrow balance was received by the Company, thus terminating the escrow agreement. See Note 7 of Notes to the Condensed Consolidated Financial Statements. Interest Expense, Net. Interest expense, net, decreased $0.9 million to $1.7 million for the 26- weeks ended June 26, 2004 from $2.6 million for the comparable period in fiscal 2003. The decrease in interest expense is due to lower average cumulative borrowings relating to the Congress Credit Facility and decreases in amortization from deferred financing costs relating to the Company's amendments to the Congress Credit Facility that have become fully amortized. 27 LIQUIDITY AND CAPITAL RESOURCES OVERVIEW As a result of lower than expected inventory levels in the fourth quarter of 2003 and the interruptions in the flow of merchandise, which prevented inventories from reaching adequate levels in the first quarter of 2004, the Company experienced a significant negative impact on second quarter revenues and cash flow. These lower inventory levels resulted in large part from tighter vendor credit and a more restrictive senior debt facility. This had a compounding effect on the business as a whole; lower levels of inventory reduced the amount of the financing available under the Congress Credit Facility as well as the ability to meet customer demand, which resulted in a significant increase in the Company's backorder position and cancellation of customer orders. During the second quarter of 2004, management determined that this inventory position was not sustainable for the long-term, as the Company was experiencing a significant negative impact on second quarter net revenues due to the decreased inventory levels. Management's primary objective became the formulation and execution of a plan to address the liquidity issue facing the Company and after reviewing alternatives available, the Company entered into the Chelsey Finance Loan and Security Agreement, dated July 8, 2004 and concurrently amended the terms of the Congress Credit Facility. The additional availability of working capital resulting from these transactions will provide for the purchase and receipt of inventory to fulfill current demand, reduce existing backorder levels and increase initial customer order fill rates to more normal levels. Finally, the funding also alleviates the difficulties with certain vendors who were suggesting the need for more restrictive credit arrangements. Net cash provided by operating activities. During the 26-week period ended June 26, 2004, net cash provided by operating activities was $1.5 million. Cash provided by operations, net of non-cash items, and receipts resulting from a decrease in accounts receivable were only partially offset by payments made to increase investment in working capital items such as prepaid catalog costs and a reduction in accrued liabilities and accounts payable. Net cash used by investing activities. During the 26-week period ended June 26, 2004, net cash used by investing activities was $0.3 million. This entire amount comprised capital expenditures, consisting primarily of purchases and upgrades to various information technology hardware and software throughout the Company and purchases of equipment for the Company's Lacrosse, Wisconsin and Roanoke, Virginia locations. Net cash used by financing activities. During the 26-week period ended June 26, 2004, net cash used by financing activities was $3.1 million, which was primarily due to net payments of $2.9 million under the Congress Credit Facility, payments of $0.4 million made to lessors relating to obligations under capital leases and a payment of $0.1 million to the Company's lender for fees relating to an amendment of the Congress Credit Facility. These payments were partially offset by a $0.3 million refund relating to withholding taxes remitted on behalf of Richemont Finance S.A. for estimated taxes due related to the Series B Participating Preferred Stock. Amendments to the Congress Credit Facility. In the fourth quarter of 2003, the Company re-examined the provisions of the Congress Credit Facility and, based on EITF Issue No. 95-22, "Balance Sheet Classification of Borrowings Outstanding under Revolving Credit Agreements that Include Both a Subjective Acceleration Clause and a Lock-Box Arrangement" ("EITF 95-22") and certain provisions in the credit agreement, the Company has classified its revolving loan facility as short-term debt at June 26, 2004 and December 27, 2003. Concurrent with the closing of the Term Loan Facility on July 8, 2004 with Chelsey Finance (see Note 14 of Notes to the Condensed Consolidated Financial Statements), the Company amended the Congress Credit Facility to (1) release certain existing availability reserves and remove the excess loan availability covenant, increasing availability to the Company by approximately $10 million, (2) reduce the amount of the maximum credit, the revolving loan limit and the inventory and accounts sublimits of the borrowers, (3) defer for three months the payment of principal with respect to the Tranche A Term Loan, (4) permit the secured indebtedness to Chelsey Finance arising under the Term Loan Facility, (5) modify certain provisions of the Congress Credit Facility with respect to asset sales and the application of proceeds thereof by borrowers, (6) extend the term of the Congress Credit Facility until July 8, 2007, and (7) amend certain other provisions of the Congress Credit Facility. In addition, Congress consented to (a) the issuance by the Company of the Common Stock Warrant, the Series D Preferred Stock Warrant, the Common Stock pursuant to the Common Stock Warrant and the Series D Preferred Stock pursuant to the Series D Preferred Stock Warrant, (b) the 28 filing of the Certificate of Designation of the Series D Preferred Stock, (c) the proposed reverse split and the Company making payments in cash to holders of Common Stock to repurchase fractional shares of such Common Stock from such shareholders as contemplated by the proposed reverse split (pending shareholder approval at the August 2004 shareholder meeting), (d) certain amendments to the Company's Certificate of Incorporation, and (e) the issuance by the Company of Common Stock to Chelsey Finance as payment of a waiver fee. The amendment required the payment of fees to Congress in the amount of $400,000. See Note 10 of Notes to the Condensed Consolidated Financial Statements. Under the Congress Credit Facility, the Company is required to maintain minimum net worth, working capital and EBITDA as defined throughout the term of the agreement, which it was in compliance with as of June 26, 2004. However, the Company's restatements resulted in technical defaults by the Company with its covenants under the Congress Credit Facility and the Term Loan Facility. Congress and Chelsey Finance have waived such defaults. As of June 26, 2004, the Company had $18.5 million of cumulative borrowings outstanding under the Congress Credit Facility, comprising $7.9 million of short-term borrowings under the Revolving Loan Facility, bearing an interest rate of 4.50%, $5.5 million under the Tranche A Term Loan, bearing an interest rate of 4.75%, and $5.1 million under the Tranche B Term Loan, bearing an interest rate of 13.0%. The Tranche B Term Loan, originally scheduled to be repaid in January 2007, was repaid in full on July 9, 2004. Of the total borrowings on June 26, 2004, $11.7 million is classified as short-term, and $6.8 million classified as long-term, on the Company's Condensed Consolidated Balance Sheet. As of December 27, 2003, the Company had $21.5 million of borrowings outstanding under the Congress Credit Facility comprising $9.0 million of short-term borrowings under the revolving loan facility, bearing an interest rate of 4.50%, $6.5 million under the Tranche A Term Loan, bearing an interest rate of 4.75%, and $6.0 million under the Tranche B Term Loan, bearing an interest rate of 13.0%. Of the aggregate borrowings on December 27, 2003, $12.8 million is classified as short-term, and $8.7 million classified as long-term, on the Company's Condensed Consolidated Balance Sheet. Remaining availability under the Congress Credit Facility as of June 26, 2004 was $5.1 million. On or before August 15, 2004, the Company is required to enter into a restatement of the loan agreement with Congress requiring no changes to the terms of the current agreement. 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 (now Keystone Internet Services, LLC, or "Keystone") agreed to provide telemarketing and fulfillment services for the Improvements business under a services agreement with HSN for a period of three years. Effective June 28, 2004, the services agreement was extended an additional two years through June 27, 2006. The asset purchase agreement between the Company and HSN provided that if Keystone failed to perform its obligations during the first two years of the services contract, HSN could receive a reduction in the original purchase price of up to $2.0 million. An escrow fund of $3.0 million, which was withheld from the original proceeds of the sale, had been established for a period of two years under the terms of an escrow agreement between LWI Holdings, Inc. (a wholly-owned subsidiary of the Company), HSN and The Chase Manhattan Bank as a result of these contingencies. On March 27, 2003, the Company and HSN amended the asset purchase agreement to provide for the release of the remaining $2.0 million balance of the escrow fund and to terminate the related escrow agreement. By agreeing to the terms of the amendment, HSN forfeited its ability to receive a reduction in the original purchase price of up to $2.0 million if Keystone failed to perform its obligations during the first two years of the services contract. In consideration for the release, Keystone issued a credit to HSN for $100,000, which could be applied by HSN against any invoices of Keystone to HSN. This credit was utilized by HSN during the March 2003 billing period. On March 28, 2003, the remaining $2.0 million escrow balance was received by the Company, thus terminating the escrow agreement. The Company recognized a net gain on the sale of approximately $23.2 million, net of a non-cash goodwill charge of $6.1 million, in the second quarter of 2001. During fiscal 2002, the Company recognized approximately $0.6 million of the deferred gain consistent with the terms of the escrow agreement. The Company recognized the remaining net deferred gain of $1.9 million upon the receipt of the escrow balance on March 28, 2003. This gain was reported net of the costs incurred to provide the credit to HSN of approximately $0.1 million. American Stock Exchange Notification. The Company received a letter dated May 21, 2004 (the "Letter") from 29 the American Stock Exchange (the "Exchange") advising that a review of the Company's Form 10-K for the period ended December 27, 2003 indicates that the Company does not meet certain of the Exchange's continued listing standards as set forth in Part 10 of the Exchange's Company Guide. Specifically, the Company is not in compliance with Section 1003(a)(i) of the Company Guide with shareholders' equity of less than $2,000,000 and losses from continuing operations and/or net losses in two out of its three most recent fiscal years; and Section 1003(a)(ii) of the Company Guide with shareholders' equity of less than $4,000,000 and losses from continuing operations and/or net losses in three out of its four most recent fiscal years; and Section 1003(a)(iii) of the Company Guide with shareholders' equity of less than $6,000,000 and losses from continuing operations and/or net losses in its five most recent fiscal years. The Exchange requested that the Company contact the Exchange by June 4, 2004 to confirm receipt of the Letter, discuss any possible financial data of which the Exchange's staff may be unaware, and indicate whether or not the Company intends to submit a plan of compliance. In order to maintain its listing on the Exchange, the Company had to submit a plan to the American Stock Exchange by June 22, 2004, advising the Exchange of action it has taken, or will take, that would bring it into compliance with the continued listing standards of the Exchange by November 24, 2005 (18 months of receipt of the Letter). The Company submitted a plan to the Exchange on June 22, 2004 and on August 3, 2004 the Exchange notified the Company that it accepted the Company's plan of compliance and granted the Company an extension of time until November 21, 2005 to regain compliance with the continued listing standards. The Company will be subject to periodic review by Exchange staff during the extension period. Failure to make progress consistent with the plan or to regain compliance with the continued listing standards by the end of the extension period on November 21, 2005 could result in the Company being delisted from the Exchange. There can be no assurance that the Company will be able to maintain the listing of its Common Stock on the Exchange. General. At June 26, 2004, the Company had $0.4 million in cash and cash equivalents, compared with $2.3 million at December 27, 2003. Total cumulative borrowings, including financing under capital lease obligations, as of June 26, 2004, aggregated $19.2 million. Remaining availability under the Congress Credit Facility as of June 26, 2004 was $5.1 million. There were nominal short-term capital commitments (less than $0.1 million) at June 26, 2004. Management continues to focus on enhancing shareholder value through the exploration of various avenues that will strengthen the Company's financial position and results of operations. The Company continues to pursue opportunistic sales of certain assets and other financing alternatives. This would provide additional liquidity for operational requirements and potentially enable the Company to retire a portion of the Series C Participating Preferred Stock obligation. Management believes that the Company has sufficient liquidity and availability under its credit agreements to fund its planned operations through at least the next twelve months. See "Cautionary Statements" below. Continued flexibility among the Company's major vendors is critical to the maintenance of adequate liquidity as is compliance with the terms and provisions of the Congress Credit Facility and the Term Loan Facility as mentioned in Notes 10 and 14 of the Condensed Consolidated Financial Statements. USES OF ESTIMATES AND OTHER CRITICAL ACCOUNTING POLICIES The condensed consolidated financial statements include all subsidiaries of the Company, and all intercompany transactions and balances have been eliminated. The preparation of financial statements, in conformity with generally accepted accounting principles, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. See "Management's Discussion and Analysis of Consolidated Financial Condition and Results of Operations," found in the Company's Annual Report on Form 10-K for the fiscal year ended December 27, 2003, as amended, for additional information relating to the Company's use of estimates and other critical accounting policies. NEW ACCOUNTING PRONOUNCEMENTS The Company accounts for goodwill in accordance with SFAS No. 142, "Goodwill and Other Intangible Assets," which requires that goodwill no longer be amortized but reviewed for impairment if impairment indicators arise 30 and, at a minimum, annually. During the second quarters of 2004 and 2003, the Company completed its annual reviews of goodwill, which did not result in an impairment charge. In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity" ("SFAS 150"). SFAS 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability, many of which had been previously classified as equity or between the liabilities and equity sections of the Condensed Consolidated Balance Sheet. The provisions of SFAS 150 are effective for financial instruments entered into or modified after May 31, 2003, and otherwise are effective at the beginning of the first interim period beginning after June 15, 2003. The standard is to be implemented by reporting the cumulative effect of a change in accounting principle for financial instruments created before the issuance of SFAS 150 and still existing at the beginning of the interim period of adoption. The Company adopted the provisions of SFAS 150, which resulted in the reclassification of its Series B Participating Preferred Stock to a liability rather than between the liabilities and equity sections of the Condensed Consolidated Balance Sheet. Based upon the requirements set forth by SFAS 150, this reclassification was subject to implementation beginning on June 29, 2003. Upon implementation of SFAS 150, the Company reflected subsequent increases in liquidation preference as an increase in Total Liabilities with a corresponding reduction in capital in excess of par value because the Company has an accumulated deficit. Accretion was recorded as interest expense. On March 31, 2004, the Financial Accounting Standards Board ("FASB") issued Emerging Issues Task Force Issue No. 03-6, "Participating Securities and the Two-Class Method under FASB Statement No. 128" ("EITF 03-6"). SFAS 128 defines earnings per share ("EPS") as "the amount of earnings attributable to each share of common stock" and indicates that the objective of EPS is to measure the performance of an entity over the reporting period. SFAS 128 addresses conditions under which a participating security requires the use of the two-class method of computing EPS. The two-class method is an earnings allocation formula that treats a participating security as having rights to earnings that otherwise would have been available to common shareholders, but does not require the presentation of basic and diluted EPS for securities other than common stock. The Company's Series C Participating Preferred Stock is a participating security and, therefore, the Company calculates EPS utilizing the two-class method, however, it has chosen not to present basic and diluted EPS for its preferred stock. 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 27, 2003, as amended, and Note 9 of the Condensed Consolidated Financial Statements for additional information relating to new accounting pronouncements that the Company has adopted. OFF-BALANCE SHEET ARRANGEMENTS AND CONTRACTUAL OBLIGATIONS The Company has entered into no "off-balance sheet arrangements" within the meaning of the Securities Exchange Act of 1934, as amended, and the rules thereunder other than operating leases, which are in the normal course of business. Provided below is a tabular disclosure of contractual obligations as of June 26, 2004, as required by Item 303(a)(5) of SEC Regulation S-K. In addition to obligations recorded on the Company's Condensed Consolidated Balance Sheets as of June 26, 2004, the schedule includes purchase obligations, which are defined as legally binding and enforceable agreements to purchase goods or services that specify all significant terms (quantity, price and timing of transaction). 31 PAYMENT DUE BY PERIOD (IN THOUSANDS)
LESS THAN MORE THAN CONTRACTUAL OBLIGATIONS TOTAL 1 YEAR 1-3 YEARS 3-5 YEARS 5 YEARS ----------------------- ----- ------ --------- --------- ------- Debt Obligations, excluding the Series C Participating Preferred Stock $ 18,532 $ 11,739 $ 6,793 $ -- $ -- Total Minimum Lease Payments Under Capital Lease Obligations 707 524 182 1 -- Operating Lease Obligations 14,363 4,945 4,462 3,732 1,224 Operating Lease Obligations - Restructuring/Discontinued Operations 7,950 3,056 2,221 2,005 668 Purchase Obligations (a) 2,908 2,010 898 -- -- Other Long-Term Liabilities Reflected on the Registrant's Balance Sheet under GAAP (b) 72,689 -- -- 72,689 -- -------- -------- -------- ------ -------- Total $117,149 $ 22,274 $ 14,556 $78,427 $ 1,892 ======== ======== ======== ======= ========
(a) The Company's purchase obligations consist primarily of a total commitment of $2,000,000 to purchase telecommunication services during the period from May 1, 2004 through April 30, 2006, of which approximately $1,166,667 should be fulfilled during the next 12 months and the remaining $833,333 fulfilled by April 30, 2006; a total commitment of approximately $487,000 to purchase catalog photography services during the period from September 11, 2003 through September 10, 2005, of which approximately $172,000 had been fulfilled as of June 26, 2004, and of which approximately $250,000 should be fulfilled during the next twelve months and the remaining $65,000 fulfilled by September 10, 2005; a total commitment of $375,000 for list processing services representing the maximum exposure for a service contract which requires a three-month notice of termination for services costing $125,000 per month; a total commitment of $199,000 to purchase various packaging materials from several vendors during the next 12 months, under contracts wherein the vendors warehouse varying minimum and maximum levels of materials to ensure immediate availability; and several commitments totaling approximately $75,000 for various consulting services to be provided during the period August 2003 through July 2004, of which approximately $56,000 had been fulfilled as of June 26, 2004. (b) Represents Series C Participating Preferred Stock as disclosed in Note 12 to the Company's Condensed Consolidated Financial Statements. SEASONALITY The Company does not consider its business seasonal. The revenues for the Company are proportionally consistent for each quarter during a fiscal year. The percentage of annual revenues for the first, second, third and fourth quarters recognized by the Company, respectively, were as follows: 2003 - 24.5%, 25.6%, 23.5% and 26.4%; and 2002 - 23.9%, 24.9%, 23.1% and 28.2%. FORWARD-LOOKING STATEMENTS The following statements from above constitute forward-looking statements 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 the next twelve months." 32 CAUTIONARY STATEMENTS The following material identifies important factors that could cause actual results to differ materially from those expressed in the forward-looking statements identified above and in any other forward-looking statements contained elsewhere herein: - A 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 reduce unprofitable circulation and to effectively manage its customer lists. - The ability of the Company to achieve projected levels of sales and the ability of the Company to reduce costs commensurate 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. - A 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, catalog and direct marketing industries. The risk that key vendors or suppliers may reduce or withdraw trade credit to the Company, convert the Company to a cash basis or otherwise change credit terms, or require the Company to provide letters of credit or cash deposits to support its purchase of inventory, increasing the Company's cost of capital and impacting the Company's ability to obtain merchandise in a timely manner. The ability of the Company to find alternative vendors and suppliers on competitive terms if vendors or suppliers who exist cease doing business with the Company. - The inability of the Company to timely obtain and distribute merchandise, leading to an increase in backorders and cancellations. - Defaults under the Congress Credit Facility, or inadequacy of available borrowings thereunder, reducing or impairing the Company's ability to obtain letters of credit or other credit to support its purchase of inventory and support normal operations, impacting the Company's ability to obtain, market and sell merchandise in a timely manner. - The inadequacy of available borrowings under the Congress Credit Facility preventing the Company from paying vendors or suppliers in a timely fashion. - Defaults under the Term Loan Facility impacting the Company's ability to obtain, market and sell merchandise in a timely manner or preventing the Company from paying vendors or suppliers in a timely fashion. 33 - 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, affecting the ability of the Company to continue to make borrowings under the Congress Credit Facility. - Continuation of the Company's history of operating losses, and the incidence of costs associated with the Company's strategic business realignment program, resulting in the Company failing to comply with certain financial and other covenants contained in the Congress Credit Facility and/or the Term Loan Facility, including net worth, net working capital, capital expenditure and EBITDA covenants and the ability of the Company to obtain waivers from Congress and/or Chelsey Finance in the event that future internal and/or external events result in performance that results in noncompliance by the Company with the terms of the Congress Credit Facility and/or the Term Loan Facility requiring remediation. - 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 achieve its business plan. - The ability of the Company to maintain advance rates under the Congress Credit Facility that are at least as favorable as those obtained in the past due to market conditions affecting the value of the inventory which is periodically re-appraised in order to re-set such advance rates. - 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 ability of the Company to obtain certain types of insurance, including directors' and officers' liability insurance, or to accept reduced policy limits or coverage, or to incur substantially increased costs to obtain the same or similar coverage, due to recently enacted and proposed changes to laws and regulations affecting public companies, including the provisions of the Sarbanes-Oxley Act of 2002 and rules of the Securities and Exchange Commission thereunder. - 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 non-core or other assets due to market conditions or otherwise. - The inability of the Company to redeem the Series C Participating Preferred Stock. - The ability of the Company to maintain the listing of its Common Stock on the American Stock Exchange due to a failure to maintain $15 million of public float or otherwise. - 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, terminate or renegotiate the leases of its vacant facilities in Weehawken, New Jersey and other locations. - The ability of the Company to smoothly transition its operations at its leased fulfillment facility in LaCrosse, WI to its owned facility in Roanoke, VA. 34 - The ability of the Company to achieve a satisfactory resolution of the various class action lawsuits that are pending against it, including the Wilson case. The possibility that the Company may be required to post a significant bond or bonds in the Wilson case or the other class action lawsuits when appealing an adverse decision of the courts. - The ability of the Company to evaluate and implement the requirements of the Sarbanes-Oxley Act of 2002 and the rules of the Securities and Exchange Commission thereunder, as well as recent changes to listing standards by the American Stock Exchange, in a cost effective manner. - The ability of the Company to achieve cross channel synergies, create successful affiliate programs, effect profitable brand extensions or establish popular loyalty and buyers' club programs. - Uncertainty in the U.S. economy and decreases in consumer confidence leading to a slowdown in economic growth and spending resulting from the invasion of, war with and occupation of Iraq, which may result in future acts of terror. Such activities, either domestically or internationally, may affect the economy and consumer confidence and spending within the United States and adversely affect the Company's business. - Softness in demand for the Company's products. - The inability of the Company to continue to source goods from foreign sources, particularly India and Pakistan, leading to increased costs of sales. - The possibility that all or part of the summary judgment decision in the matter of Rakesh K. Kaul v. Hanover Direct, Inc. will be overturned on appeal. - Reductions in unprofitable circulation leading to loss of revenue, which is not offset by a reduction in expenses. - Any significant increase in the Company's return rate experience as a result of the recent change in its return policy or otherwise. - The inability of the Company to achieve its targeted annual conversion rate of buyers' club customers leading to a loss of the agreed-upon year-end bonus. - Any significant increase in the cost of down as a result of the Asian bird virus or otherwise. ITEM 3. QUANTITIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK INTEREST RATES: The Company's exposure to market risk relates to interest rate fluctuations for borrowings under the Congress revolving credit facility and its term financing facilities, which bear interest at variable rates, and the Term Loan Facility with Chelsey Finance, which bears interest at 5% above the prime rate publicly announced by Wachovia Bank, N.A. At June 26, 2004, outstanding principal balances under the Congress Credit Facility subject to variable rates of interest were approximately $13.4 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 26, 2004, would be approximately $0.13 million on an annual basis. In addition, the Company's exposure to market risk relates to customer response to the Company's merchandise offerings and circulation changes, effects of shifting patterns of e-commerce versus catalog purchases, costs associated with printing and mailing catalogs and fulfilling orders, effects of potential slowdowns or other disruptions in postal service, dependence on customers' seasonal buying patterns, fluctuations in foreign currency exchange rates, and the ability of the Company to reduce unprofitable circulation and effectively manage its customer lists. ITEM 4. CONTROLS AND PROCEDURES DISCLOSURE CONTROLS AND PROCEDURES. The Company's management, with the participation of the 35 Company's Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company's disclosure controls and procedures (as such term is detailed in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act")) as of the end of the period covered by this report. Based on such evaluation, the Company's Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, the Company's disclosure controls and procedures are effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by the Company in the reports it files or submits under the Exchange Act. INTERNAL CONTROL OVER FINANCIAL REPORTING. There have not been any changes in the Company's internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. 36 PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS A class action lawsuit was commenced on March 3, 2000 in the District Court in Sequoyah County, Oklahoma entitled Edwin L. Martin v. Hanover Direct, Inc. and John Does 1 through 10 ("Martin"), which 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 as a result of "insurance charges" paid to the Company by participants in the class action suit. 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. Plaintiff seeks an order (i) 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) enjoining the Company from imposing an insurance charge, (iv) awarding threefold damages of less than $75,000 per plaintiff and per class member, and (v) awarding attorneys' fees and costs. On July 23, 2001, the Court certified a class comprised of all persons in the United States who are customers of any catalog or catalog company owned by the Company and who at any time purchased a product from any such company and paid money which was designated to be an `insurance charge.' The Company filed an appeal of the class certification. On January 20, 2004, the plaintiff filed a motion for oral argument on the appeal of the class certification. The Company believes it has defenses against the claims and plans to conduct a vigorous defense of this action. The Company believes that a loss is not probable; therefore, no accrual for potential losses was deemed necessary. On August 15, 2001, the Company was served with a summons and four-count complaint entitled Teichman v. Hanover Direct, Inc., Hanover Brands, Inc., Hanover Direct Virginia, Inc., and Does 1-100 ("Teichman"), which was subsequently expanded to include other Hanover Direct, Inc. subsidiaries as defendants. The complaint was filed by a California resident in the Superior Court for the City and County of San Francisco seeking damages and other relief for herself and a class of all others similarly situated arising out of the insurance fee charged by catalogs and Internet sites operated by subsidiaries of the Company. On May 14, 2002, as a result of the Company having filed a Motion to Stay the Teichman action in favor of the previously-filed Martin action and a Motion to Dismiss the case against Hanover Direct, Inc., Hanover Brands, Inc., and Hanover Direct Virginia, Inc. for lack of personal jurisdiction, the Court (1) granted the Company's Motion to Stay the action in favor of the previously-filed Martin action, and (2) granted the Company's Motion to Quash service, leaving only LWI Holdings, Hanover Company Store, Kitchen & Home, and Silhouettes as defendants. The Company believes it has defenses against the claims and plans to conduct a vigorous defense of this action. The Company believes that a loss is not probable; therefore, no accrual for potential losses was deemed necessary. A class action lawsuit was commenced on February 13, 2002 in the Superior Court of the State of California, City and County of San Francisco 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"). 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 alleged that, for at least four years, members of the class had 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 restitution and disgorgement of all monies wrongfully collected and earned by Brawn, including interest and other gains, reimbursement of the insurance charge with interest, an order enjoining Brawn from imposing insurance on its order forms; and compensatory damages, attorneys' fees, pre-judgment interest and costs of the suit. (Plaintiff lost at trial on the tax issue and has not appealed it so it is no longer among the issues being litigated in this case.) On November 25, 2003, the Court, after a trial, entered judgment for the plaintiff and the class, requiring Brawn, by June 30, 2004, to refund insurance charges collected from consumers for the period from February 13, 1998 through January 15, 2003 with interest from the date paid. On April 14, 2004, the Court awarded plaintiff's counsel approximately $445,000 of attorneys' fees. On April 23, 2004, the Company filed a Motion to Stay the enforcement of the insurance fees judgment pending resolution of the appeal, including a request to extinguish a lien filed on April 2, 2004, and including a request for a determination that an appellate bond will not be required by the Company. This motion was heard on May 11, 2004 and granted, the Court 37 finding that enforcement of the judgment entered was stayed on January 23, 2004 when Brawn filed its Notice of Appeal. The Company has appealed the trial court's decision on the merits of the insurance fees issue as well as the decision on the attorneys' fees issue. On May 18, 2004, the Court of Appeals issued an Order consolidating the two appeals. The Company plans to conduct a vigorous defense of this action. The potential estimated exposure is in the range of $0 to $4.0 million. Based upon the Company's policy of evaluating accruals for legal liabilities, the Company has not established a reserve as a result of management determining that it is not probable that an unfavorable outcome will result. A class action lawsuit was commenced on October 28, 2002 in the Superior Court of New Jersey, Bergen County - Law Division entitled John Morris, individually and on behalf of all other persons & entities similarly situated v. Hanover Direct, Inc., and Hanover Brands, Inc. (referred to in this paragraph as "Hanover"). The plaintiff brought the action individually and on behalf of a class of all persons and entities in New Jersey who purchased merchandise from Hanover within six years prior to filing of the lawsuit and continuing to the date of judgment. On the basis of a purchase made by plaintiff in August 2002 of clothing from a Hanover men's division catalog, plaintiff alleged that Hanover had a policy and practice of improperly adding a charge for "insurance" to the orders it received, and concealed and failed to disclose the charge. Plaintiff claims that Hanover's conduct was in violation of the New Jersey Consumer Fraud Act as otherwise deceptive, misleading and unconscionable such as to constitute unjust enrichment of Hanover at the expense and to the detriment of plaintiff and the class and unconscionable per se under the Uniform Commercial Code for contracts related to the sale of goods. Plaintiff and the class seek damages equal to the amount of all insurance charges, interest thereon, treble and punitive damages, injunctive relief, costs and reasonable attorneys' fees, and such other relief as may be just, necessary and appropriate. On December 13, 2002, the Company filed a Motion to Stay the action pending resolution of the previously-filed Martin action in Oklahoma. The Court granted the Company's Motion to Stay and the case was stayed, and extended once, until March 31, 2004, at which time the stay was lifted. On April 30, 2004, the Company responded to Plaintiff's Amended Complaint. The case is in the discovery phase. The Company plans to conduct a vigorous defense of this action. The Company believes that a loss is not probable; therefore, no accrual for potential losses was deemed necessary. On June 28, 2001, Rakesh K. Kaul, a former President and Chief Executive Officer of the Company, filed a 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, among other things, severance payments of $2,531,352 and attorneys' fees and costs incurred in connection with the prosecution and defense of the lawsuit, and damages 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 case was removed to the United States District Court for the Southern District of New York whereupon Mr. Kaul amended his complaint to add ERISA claims. On October 11, 2001, the Company filed its Answer, Defenses and Counterclaim to the amended complaint, denying liability under each of Mr. Kaul's eight causes of action, raising several defenses and stating nine counterclaims of its own against Mr. Kaul including, among other things, (1) breach of contract; (2) breach of fiduciary duty; (3) unjust enrichment; and (4) unfair competition. The Company moved to amend its counterclaims, and the parties each moved for summary judgment. The Company requested judgment dismissing Mr. Kaul's claims and judgment awarding damages on the Company's claim for reimbursement of a tax loan. Mr. Kaul requested judgment dismissing certain of the Company's counterclaims and defenses. On January 7, 2004, the Court rendered an Opinion and Order dismissing in part and granting in part the motions on summary judgment. The Court: granted summary judgment in favor of the Company dismissing Mr. Kaul's claim for severance under his employment agreement on the ground that he failed to provide the Company with a general release; granted in part the Company's motion for summary judgment on Mr. Kaul's claim for attorneys' fees, finding as a matter of law that Mr. Kaul is not entitled to fees incurred in prosecuting this lawsuit but finding an issue of fact as to the amount of reasonable fees he may have incurred in seeking advice and representation in connection with the termination of his employment; granted summary judgment in favor of the Company dismissing Mr. Kaul's claims related to change in control benefits on the grounds that Mr. Kaul's participation in the plan was properly terminated when his employment was terminated, the plan was properly terminated, and the administrator and appeals committee properly denied Mr. Kaul's claim; granted summary judgment in favor of the Company dismissing Mr. Kaul's claim for a tandem bonus payment on the ground that payment is not owed to him; granted summary judgment in part and denied 38 summary judgment in part on Mr. Kaul's claims for vacation pay, deeming Mr. Kaul to have abandoned claims for vacation pay in excess of five weeks but finding him entitled to four weeks vacation pay based on the Company's policy and finding an issue of fact as to Mr. Kaul's claim for an additional week of vacation pay in dispute for 2000; and denied summary judgment on the Company's counterclaim for payment under a tax note based on disputed issues of fact. The Court dismissed the Company's affirmative defenses as largely moot and the Court: granted summary judgment in favor of Mr. Kaul dismissing certain of the Company's counterclaims. The Court denied in part and granted in part the Company's motion to amend its Answer and Counterclaims. The Court granted the Company's motion with respect to its claim for reimbursement of amounts paid to the Internal Revenue Service ("IRS") on Mr. Kaul's behalf. Only three claims remained in the case: (i) Mr. Kaul's claim for attorneys' fees pursuant to Section 12 of the employment agreement; (ii) Mr. Kaul's claim for an additional week of vacation pay in the amount of approximately $11,500; and (iii) the Company's counterclaim for $211,729 plus interest it paid to the IRS on Mr. Kaul's behalf. On or about July 13, 2004 a final judgment was entered whereby the Court dismissed the remaining claims (except for Mr. Kaul's claim to attorney's fees incurred in prosecuting and defending the law suit) and ordered a payment to Mr. Kaul in the amount of $45,946, representing four weeks of vacation pay, together with interest thereon from December 5, 2000. The parties have agreed to a final payment, including interest, in the amount of $60,856. The Court is expected to shortly issue a final judgment implementing its summary judgment Opinion. Each party shall have the right to appeal any aspect of that judgment. The Company has reserved $65,435 for payments due Mr. Kaul including the associated employer payroll taxes. Payment was made to Mr. Kaul on July 15, 2004 for the interest portion of the agreement and on July 16, 2004 for the four weeks vacation. The Company was named as one of 88 defendants in a patent infringement complaint filed on November 23, 2001 in the U.S. District Court in Arizona by the Lemelson Medical, Education & Research Foundation, Limited Partnership (the "Lemelson Foundation"). The complaint 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 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. On January 23, 2004, the Nevada Court entered judgment declaring that the claims of each of the patents at issue in the Nevada case, including all seven patents asserted by the Lemelson Foundation against the Company in the Arizona case, are unenforceable under the doctrine of prosecution laches, are invalid for lack of written description and enablement, and are not infringed by the bar code equipment manufacturers. The Lemelson Foundation filed a notice of appeal before the deadline of May 28, 2004. The Arizona court confirmed that the stay of the Arizona case will extend until the entry of a final, non-appealable judgment in the Nevada litigation. The Company has analyzed the merits of the issues raised by the complaint, notified vendors of its receipt of the complaint and letter, evaluated the merits of joining a joint-defense group, and had discussions with attorneys for the Lemelson Foundation regarding their license offer. The Company will not agree to a settlement at this time and thus has not established a reserve. 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 believes it has defenses against the claims and plans to conduct a vigorous defense of this action. The Company believes that a loss is not probable; therefore, no accrual for potential losses was deemed necessary. In early March 2003, the Company learned that one of its business units had engaged in certain travel transactions that may have constituted violations under the provisions of U.S. government regulations promulgated pursuant to 50 U.S.C. App. 1-44, which proscribe certain transactions related to travel to certain countries. The Company immediately commenced an inquiry into the matter, incurred resulting charges, made an initial voluntary disclosure to the appropriate U.S. government agency under its program for such disclosures and will submit to that agency a detailed report on the results of the inquiry. In addition, the Company has taken steps to ensure that all of its business units are acting in compliance with the travel and transaction restrictions and other requirements of all applicable U.S. government programs. Although the Company is uncertain of the extent of the penalties, if any, that may be imposed on it by virtue of the transactions being voluntarily disclosed, it does not currently believe that any such penalties will have a material effect on its business or financial condition. The Company believes that a loss is not probable; therefore, no accrual for potential losses was deemed necessary. 39 In addition, the Company is involved in various routine lawsuits of a nature that is deemed customary and incidental to its businesses. In the opinion of management, the ultimate disposition of these actions will not have a material adverse effect on the Company's financial position or results of operations. ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS In consideration for providing the $20 million Term Loan Facility to the Company, the Company will issue to Chelsey Finance a warrant (the "Common Stock Warrant") to purchase 30% of the fully diluted shares of Common Stock of the Company, which the Company believes would be approximately 10,247,210 shares of Common Stock (adjusted for the proposed one-for-ten reverse split of the Company's Common Stock) at an exercise price of $.01 per share. Pending shareholder approval of such issuance at the Company's Annual Meeting of Shareholders scheduled for August 12, 2004, on July 8, 2004, the Company issued to Chelsey Finance a warrant (the "Series D Preferred Warrant") to purchase 100 shares of a newly-issued series of nonvoting preferred stock of the Company, called Series D Participating Preferred Stock (the "Series D Preferred Stock"), that will be automatically exchanged for such Common Stock Warrant upon the receipt of shareholder approval of the issuance thereof at the Company's Annual Meeting of Shareholders scheduled for August 12, 2004. See Note 14 of Notes to Consolidated Financial Statements for a description of the terms of the Term Loan Facility and the Series D Preferred Stock. In connection with the closing of the Term Loan Facility, on July 8, 2004, the Company paid Chelsey a waiver fee equal to 1% of the liquidation preference of the Company's outstanding Series C Participating Preferred Stock, in Common Stock of the Company, issuing to Chelsey 4,344,762 additional shares of Common Stock (calculated based upon the fair market value of the Common Stock two business days prior to the closing date), in consideration for the waiver by Chelsey of its blockage rights over the issuance of senior securities. The Board of Directors of the Company determined that the value of the waiver was at least equal to the aggregate par value of the 4,344,762 shares of Common Stock issued to Chelsey. The Series D Preferred Stock Warrant issued to Chelsey Finance and the shares of Common Stock paid as a waiver fee to Chelsey were not publicly offered and there were no underwriters involved in their offering. The Company issued the Series D Preferred Stock Warrant to Chelsey Finance and the 4,344,762 shares of Common Stock to Chelsey pursuant to Section 4(2) of the Securities Act of 1933, as amended, and Regulation D promulgated thereunder as a transaction by the Company not involving a public offering. ITEM 5. OTHER INFORMATION AMERICAN STOCK EXCHANGE NOTIFICATION The Company received a letter dated May 21, 2004 (the "Letter") from the American Stock Exchange (the "Exchange") advising that a review of the Company's Form 10-K for the period ended December 27, 2003 indicates that the Company does not meet certain of the Exchange's continued listing standards as set forth in Part 10 of the Exchange's Company Guide. Specifically, the Company is not in compliance with Section 1003(a)(i) of the Company Guide with shareholders' equity of less than $2,000,000 and losses from continuing operations and/or net losses in two out of its three most recent fiscal years; and Section 1003(a)(ii) of the Company Guide with shareholders' equity of less than $4,000,000 and losses from continuing operations and/or net losses in three out of its four most recent fiscal years; and Section 1003(a)(iii) of the Company Guide with shareholders' equity of less than $6,000,000 and losses from continuing operations and/or net losses in its five most recent fiscal years. The Exchange requested that the Company contact the Exchange by June 4, 2004 to confirm receipt of the Letter, discuss any possible financial data of which the Exchange's staff may be unaware, and indicate whether or not the Company intends to submit a plan of compliance. In order to maintain its listing on the Exchange, the Company had to submit a plan to the American Stock Exchange by June 22, 2004, advising the Exchange of action it has taken, or will take, that would bring it into compliance with the continued listing standards of the Exchange by November 24, 2005 (18 months of receipt of the Letter). The Company submitted a plan to the Exchange on June 22, 2004 and on August 3, 2004 the Exchange notified the Company that it accepted the Company's plan of compliance and granted the Company an extension of time until November 21, 2005 to regain compliance with the continued listing standards. The Company will be subject to periodic review by Exchange staff during the extension period. Failure to make progress consistent with the plan or to regain compliance with the 40 continued listing standards by the end of the extension period on November 21, 2005 could result in the Company being delisted from the Exchange. There can be no assurance that the Company will be able to maintain the listing of its Common Stock on the Exchange. BOARD RESIGNATION On July 30, 2004, Basil P. Regan resigned as a member of the Company's Board of Directors. As a result, Mr. Regan has advised the Company that he will not be standing for reelection at the Company's August 12, 2004 Annual Meeting of Shareholders. Mr. Regan continues to have the right, which is required to be exercised as promptly as practicable, to appoint a designee to the Company's Board of Directors until November 30, 2005 pursuant to the Company's Corporate Governance Agreement dated as of November 30, 2003 among the Company, Chelsey Direct, LLC, Stuart Feldman, Regan Partners L.P., Regan International Fund Limited and Basil P. Regan so long as the Regan group collectively owns at least 29,128,762 shares of Common Stock of the Company (as adjusted for stock splits and the like). 41 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits: 3.1 Amendment to By-laws of the Company 10.1 Employment Agreement, dated as of May 5, 2004, between Wayne P. Garten and the Company 10.2 General Release and Covenant Not to Sue, dated as of May 5, 2004, between Thomas C. Shull and the Company 31.1 Certification signed by Wayne P. Garten 31.2 Certification signed by Charles E. Blue. 32.1 Certification signed by Wayne P. Garten and Charles E. Blue. (b) Reports on Form 8-K: 1.1 Form 8-K, filed March 29, 2004 -- reporting pursuant to Item 5 of such Form the filing of a Form 12b-25 Notification of Late Filing for its Annual Report on Form 10-K for the fiscal year ended December 27, 2003. 1.2 Form 8-K, filed April 2, 2004 -- reporting pursuant to Item 5 of such Form certain letters sent to Chelsey Direct, LLC. 1.3 Form 8-K, filed April 12, 2004 -- reporting pursuant to Item 7 of such Form (information furnished pursuant to Item 12 of such Form) the issuance of a press release announcing operating results for the fiscal year ended December 27, 2003. 1.4 Form 8-K, filed April 12, 2004 -- reporting pursuant to Item 5 of such Form the appointment of Paul S. Goodman as a director. 1.5 Form 8-K, filed April 13, 2004 -- reporting pursuant to Item 9 of such Form a statement of guidance as to where the Company sees fiscal year 2004. 1.6 Form 8-K, filed April 16, 2004 -- reporting pursuant to Item 9 of such Form an unofficial transcript of its conference call with management to review the operating results for the fiscal year ended December 27, 2003. 1.7 Form 8-K, filed May 6, 2004 -- reporting pursuant to Item 5 of such Form the resignation of Thomas C. Shull as Chairman of the Board, President and Chief Executive Officer of the Company and the election of William B. Wachtel as Chairman of the Board and Wayne P. Garten as President and Chief Executive Officer effective immediately. 1.8 Form 8-K, filed May 12, 2004 -- reporting pursuant to Items 7 and 9 of such Form (information furnished pursuant to Item 12 of such Form) the issuance of a press release announcing operating results for the thirteen weeks ended March 27, 2004. 1.9 Form 8-K, filed May 25, 2004 -- reporting pursuant to Item 5 of such Form the receipt of a letter dated May 21, 2004 from the American Stock Exchange as to the Company's compliance with the Exchange's continued listing standards. 2.0 Form 8-K, filed June 17, 2004 -- reporting pursuant to Items 5 and 7 of such Form the Company's signing of a commitment letter with Chelsey Direct LLC for a $20 million junior secured loan facility and an agreement in principle to amend its existing senior credit facility with Congress Financial Corporation and that it had notified the American Stock Exchange that it intends to submit a plan to the Exchange by June 22, 2004 to address its compliance with the Exchange's continued listing standards. 42 2.1 Form 8-K, filed July 12, 2004 -- reporting pursuant to Items 5 and 7 of such Form the closing and funding of the $20 million junior secured term loan facility with Chelsey Finance, LLC and the amendment to the Company's existing senior credit facility with Congress Financial Corporation. 2.2 Form 8-K, filed August 3, 2004 -- reporting pursuant to Items 5 and 7 of such Form the resignation of Basil P. Regan from the Company's Board of Directors effective July 30, 2004. 43 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. HANOVER DIRECT, INC. Registrant By: /s/ Charles E. Blue ---------------------------------------- Charles E. Blue Senior Vice President and Chief Financial Officer (On behalf of the Registrant and as principal financial officer) Date: August 10, 2004 44 EX-3.1 2 y99832exv3w1.txt AMENDMENT TO BY-LAWS Exhibit 3.1 HANOVER DIRECT, INC. AMENDMENT TO BYLAWS ADOPTED BY RESOLUTION OF THE BOARD OF DIRECTORS ON MAY 13, 2004 RESOLVED that the second sentence of Article II, Section 4(c) of the By-laws of the Company be and it hereby is amended to read as follows: "Special meetings may be called by or at the direction of the Chairman of the Board, if any, the Vice Chairman of the Board, if any, the Chairman of any standing committee of the Board of Directors, the President, or a majority of the directors in office. EX-10.1 3 y99832exv10w1.txt EMPLOYMENT AGREEMENT EXHIBIT 10.1 EMPLOYMENT AGREEMENT This Employment Agreement (this "Agreement") is made as of May 5, 2004 between Wayne P. Garten ("Executive") and Hanover Direct, Inc., a Delaware corporation (the "Company"). 1. Provision of Services. Executive shall serve as the Company's President and Chief Executive Officer (the "President/CEO") and as a member of the Company's Board of Directors (the "Board of Directors"). 2. Responsibilities. Executive shall act and serve during the term of this Agreement as the President and Chief Executive Officer of the Company and shall report to the Board of Directors. Executive's employment responsibilities will include those normally held by the president and chief executive officer of a corporation of a similar size and nature to the Company. Executive shall devote his full-time efforts in connection with his role as President and Chief Executive Officer and member of the Board of Directors. 3. Term. Subject to Section 6 of this Agreement, the term of this Agreement (the "Agreement Term") and the term for the services of Executive hereunder shall commence as of May 5, 2004 and shall terminate on May 5, 2006. 4. Compensation. As consideration for Executive's performance of services hereunder as the President/CEO, the following compensation shall be payable pursuant to this Agreement: (a) Executive shall receive base compensation at the rate of $600,000 per annum (the "Base Compensation"), payable in accordance with the Company's normal payroll policies. (b) The Company shall provide Executive with the employee benefits it provides to its other senior executives, including but not limited to 4 weeks of paid vacation per year, and Executive shall also be entitled to participate in such bonus plans with such targets as the Compensation Committee of the Board of Directors may approve in its sole discretion determined in a manner consistent with bonus opportunities afforded to other senior executives under such plans. (c) The Company shall reimburse Executive for his reasonable out-of-pocket expenses in performing services for the Company as President/CEO (such as travel, meals, communications and lodging) which are incurred during the Agreement Term on Company business. Executive shall submit invoices and documentation for such reimbursable expenses on a monthly basis, and the Company shall process payment of the same promptly and in accordance with its customary procedures. In addition, the Company shall reimburse Executive for up to $12,500 of attorneys' fees incurred by him in connection with legal advice relating to, and the negotiation of, this Agreement. 5. Stock Options. Subject to shareholder approval of a one for ten reverse stock split of the Company's Common Stock, the Company shall grant Executive 2 stock options (the "Executive Options") to purchase an aggregate of 2,000,000 prereverse split shares of the Company's Common Stock ("Shares"), each with an exercise price of $0.195 per Share. The Executive Options shall be comprised of 2 stock options - (i) an option for 1,000,000 Shares under the Company's 2000 Management Stock Option Plan, and (ii) an additional option for an additional 1,000,000 Shares, which option shall not be granted under a Company plan. The Executive Options shall be exercisable for 10 years and shall be subject to the terms and conditions set forth in the respective Stock Option Agreements annexed hereto. The Executive Options shall vest over a 2-year period. Upon the execution of this Agreement, the Executive Options shall be one-third vested. Thereafter, the remaining unvested portion of the Executive Options shall vest at the rate of 50% per year; provided that the Executive Options shall vest in their entirety and become fully exercisable upon the earliest to occur of: (i) Executive's resignation "For Good Reason" (as defined below), (ii) the Company's termination of Executive's services hereunder, other than "For Cause" (as defined below), or (iii) a "Change of Control" (as defined below) of the Company. To the extent the Executive Options vest and become exercisable pursuant to this Section 5, they shall remain exercisable (x) for the Executive Option granted under the Company's 2000 Management Stock Option Plan, for the 90 day period immediately following the date of the applicable resignation, termination or Change of Control, and (y) for the Executive Option not granted under a Company plan, for the 180 day period immediately following the date of the applicable resignation, termination or Change of Control. Any unvested portion of the Executive Options on the date of Executive's resignation or termination, as applicable, shall be forfeited. In the event of vesting of the Executive Options on account of a Change of Control, the Company shall use its reasonable best efforts to ensure that such vesting shall take place sufficiently in advance of the Change of Control (but subject to its occurrence) to permit Executive to take all steps reasonably necessary to exercise the Executive Options and to take such action with respect to the Shares purchased under the Executive Options so that those Shares may be treated in the same manner in connection with the Change of Control transaction as the Shares of other Company shareholders. To the extent not already covered by a registration statement on Form S-8 relating to the Company's 2000 Management Stock Option Plan, all Shares underlying the Executive Options shall be registered by the Company utilizing a Registration Statement on Form S-8 (or other similar form) prior to December 31, 2004. 5A. Definitions. For purposes of this Agreement, the following terms shall have the following meanings: 2 (a) "For Good Reason" shall mean the voluntary resignation by Executive of his employment with the Company on account of any of the following actions: (i) a substantial and material diminution of Executive's duties or responsibilities for the Company; provided, that if, following a Change in Control (as defined below) Executive is appointed to a position as President, Chief Executive Officer or Chief Operating Officer of the Company or its successor, or a subsidiary or affiliate of the Company or its successor, in each case reporting to the Chief Executive Officer of the Company or its successor, such appointment shall not be deemed a substantial and material diminution of his duties or responsibilities, (ii) any reduction of Executive's base salary (as in effect as of the first day of the Agreement Term), or (iii) the Company's (or a successor to the Company pursuant to a Change of Control) requiring Executive to regularly report to work at a facility that is more than 30 miles from Edgewater, New Jersey; provided, however, that in all cases, in order to terminate his employment with the Company For Good Reason, Executive must notify the Company in writing that Good Reason exists within 30 business days ("Business Days") of his knowledge of the event or events constituting Good Reason. The Company shall thereafter have 15 Business Days within which to cure Executive's otherwise Good Reason (the "Good Reason Cure Period"). Unless Executive's Good Reason is cured during the Good Reason Cure Period, his resignation For Good Reason shall become effective on the first Business Day following the conclusion of the Good Reason Cure Period. (b) "For Cause" shall mean the involuntary termination by the Company of Executive's employment with the Company on account of his (i) material breach of any of the material terms of the Agreement, (ii) willful and continued failure to perform his regular duties for the Company, (iii) commission of an act of fraud relating to and adversely affecting the Company, (iv) conviction of, or a plea of guilty or nolo contendere to, a felony, or (v) gross negligence in the performance of his duties which adversely affects the Company. Notwithstanding the foregoing, Executive shall not be terminated For Cause without (A) delivery of a written notice to Executive setting forth the reasons for the Company's intention to terminate Executive's employment hereunder For Cause; (B) the failure of Executive to cure the nonperformance, violation or misconduct described in the notice referred to in clause (A) of this paragraph, if cure thereof is possible, to the reasonable satisfaction of the Board of Directors, within 15 Business Days of Executive's receipt of such notice (the "For Cause Cure Period"); and (C) an opportunity for Executive, together with Executive's counsel, to be heard before the Board of Directors. (c) "Change of Control" shall mean the first to occur of any of the events described in clauses (i) through (iii) below, following the first day of the Agreement Term: 3 (i) When any "person" (as such term is used in Sections 13(d) and 14(d)(2) of the Securities Exchange Act of 1934, as amended) (a "Person") becomes, through an acquisition, the beneficial owner of shares of the Company having more than 50% of the total number of votes that may be cast for the election of directors of the Company (the "Voting Shares"); provided, however, that the following acquisitions shall not constitute a Change of Control: (A) if a Person owns less than 50% of the voting power of the Company and that Person's ownership increases above 50% solely by virtue of an acquisition of stock by the Company, then no Change of Control shall have occurred, unless and until that Person subsequently acquires one or more additional shares representing voting power of the Company; or (B) any acquisition by a Person who as of the first day of the Agreement Term owned at least 33% of the Voting Shares. (ii) (A) Notwithstanding the foregoing, a Change of Control will be deemed to occur upon the closing of any of the following (each, a "Transaction"): (I) any reorganization, merger, consolidation or other business combination of the Company; (II) any sale or any series of sales occurring on or after the date of this Agreement, involving all or substantially all of the Company's assets; or (III) a complete liquidation or dissolution of the Company. (B) Notwithstanding clause (ii)(A) above, neither of the following types of Transactions will be deemed to give rise to a Change of Control: (I) a Transaction involving only the Company and one or more of its subsidiaries; or (II) a Transaction (other than as described in clause (ii)(A)(II) of this definition) immediately following which the shareholders of the Company immediately prior to the Transaction continue to have a majority of the voting power in the resulting entity. (iii) When, within any 24 month period commencing on or after the first day of the Agreement Term, persons who were directors of the Company (each, a "Director") immediately before the beginning of such period (the "Incumbent Directors") shall cease (for any reason other than death or disability) to constitute at least a majority of the Board of Directors or the board of directors of any successor to the Company. For purposes of this clause (iii), any Director who was not a Director as of the first day of the Agreement Term shall be deemed to be an Incumbent Director if such Director was elected to the Board of Directors by, or on the recommendation of, or with the approval of, at least a majority of the members of the Board of Directors or its Nominating Committee who, at 4 the time of the vote, qualified as Incumbent Directors either actually or by prior operation of this clause (iii), and any persons (and their successors from time to time) who are designated by a holder which, as of the first day of the Agreement Term, held 33% or more of the Voting Shares, to stand for election and serve as Directors in lieu of other such designees serving as Directors on the first day of the Agreement Term shall be considered Incumbent Directors. Notwithstanding the foregoing, for purposes of this clause (iii), any director elected to the Board of Directors to avoid or settle a threatened or actual proxy contest shall not, under any circumstances, be deemed to be an Incumbent Director. (d) "Disability" shall mean the inability of Executive to perform his duties under this Agreement for 3 consecutive months or an aggregate of 180 days within a 2-year period. 6. Termination and Severance. The following provisions shall govern the termination of Executive's employment under this Agreement: (a) The Agreement, the Agreement Term, the term for services of Executive and the employment of Executive hereunder will terminate upon the first to occur of the following: (i) the third day after written notice by the Company to Executive that Executive's employment under this Agreement has been terminated For Cause following the end of the For Cause Cure Period; (ii) the tenth day after written notice by Executive to the Company that Executive's employment under this Agreement has been terminated pursuant to his resignation For Good Reason following the end of the Good Reason Cure Period; (iii) the expiration of the Agreement Term; (iv) the death or Disability of Executive; (v) the day the Company terminates Executive's employment under this Agreement other than For Cause; or (vi) the thirtieth day after written notice by Executive to the Company that the Executive's employment under this Agreement has been terminated pursuant to his resignation other than For Good Reason. (b) In the event of the termination of Executive's employment under this Agreement for any of the reasons provided in Section 6(a), Executive shall receive hereunder the Base Compensation through the end of the month in which the date of termination has occurred, plus a termination payment as follows: 5 (i) If the termination or resignation is pursuant to Section 6(a)(i), 6(a)(iv) or 6(a)(vi) above, no additional amount shall be due and owing to Executive; (ii) If the termination or resignation is pursuant to Section 6(a)(ii) or 6(a)(v) and the Executive has not received or become entitled to receive a Change of Control payment under Section 6(b)(iii), Executive shall be entitled to receive, subject to his continued compliance with the requirements of Sections 9 and 10 of this Agreement, the following severance payments (A) continued payments of his monthly Base Compensation for a period equal to 18 months payable in accordance with the Company's normal payroll practices and policies; and (B) the pro rated portion (based upon the number of days in the fiscal year prior to the effective date of termination) of bonuses earned for the fiscal year in which the effective date of termination occurs pursuant to the Company's bonus plans, as applicable (based upon the terms and conditions of the applicable bonus plan), as described in Section 4(b), accrued vacation and continued coverage under the Company's health, life insurance and long-term disability benefit plans for the 18-month period immediately following Executive's termination or resignation, as applicable. Any such bonus shall be paid to Executive, subject to his continued compliance with the requirements of Sections 9 and 10 of this Agreement, at such time as is consistent with the Company's customary practice. (iii) If a Change of Control occurs within the Agreement Term, then, subject to Section 6(b)(iv), Executive shall be entitled to receive a lump sum payment equal to 200% of his Base Compensation, such payment to be made within thirty days of the closing of the transaction resulting in the Change of Control. (iv) If a Change of Control occurs within the Agreement Term, then, if the Company so requests, as a condition to his entitlement to the payment under Section 6(b)(iii), Executive shall continue his employment hereunder until the end of the Agreement Term, provided that: (i) Executive continues as President, Chief Executive Officer or Chief Operating Officer of the Company or its successor or the Company's or its successor's subsidiary or affiliate; and (ii) he reports to the Chief Executive Officer of the Company or its successor. (v) If the termination is pursuant to Section 6(a)(iii) and the Executive has not received or become entitled to receive a payment under Section 6(b)(iii), then, at the end of the Agreement Term, he shall be entitled to receive, subject to Executive's continued compliance with the requirements of Sections 9 and 10 of this Agreement, 6 monthly severance payments at the rate of Executive's Base Compensation for a period of 18 months, payable in accordance with the Company's normal payroll practices and policies and continued coverage under the Company's health, life insurance and long-term disability benefit plans for the 18-month period immediately following the end of the Agreement Term. 7. Arbitration. Any dispute or other controversy arising under or in connection with this Agreement (except that the Company may, at its election, seek to enforce Executive's obligations under Section 9 and/or 10 of this Agreement in a court of competent jurisdiction) shall be settled exclusively by binding arbitration in New York, New York, in accordance with the Employment Dispute Resolution Rules then in effect with the American Arbitration Association. Judgment may be entered on the arbitrator's award in any court having jurisdiction. The Company shall pay all of Executive's attorneys' fees in connection with any arbitration brought by either of the parties hereto pursuant to this Section 7 in which Executive prevails. 8. Indemnity. If Executive is threatened with or made a party to, or called as a witness or deposed or subpoenaed in, any action, suit or other legal, administrative or governmental proceeding or other legal process by reason that Executive is or was deemed a consultant, officer, employee or other agent of the Company or any of its affiliates, the Company shall defend, indemnify and hold Executive harmless to the maximum extent allowed by applicable law and the Company's Certificate of Incorporation and By-Laws against all liabilities, obligations, losses, damages, penalties, actions, judgments, suits, claims, disbursements and expenses, including counsel fees reasonably incurred by Executive in connection therewith, to the extent the same are not paid under the Company's D&O insurance policies ("Indemnified Liability" or "Indemnified Liabilities"); provided however, that Executive shall not be entitled to indemnification hereunder to the extent any such liability, obligation, loss, damage, penalty, action, judgment, suit, claim, disbursement or expense results from the gross negligence, willful misconduct or criminal conviction or other conduct which bars indemnification under applicable law ("Misconduct") of Executive as determined by a court of competent jurisdiction. Payments under this indemnity in respect of indemnified settlements or judgments shall be paid at the time of final settlement or final judgment (from which no appeal may be taken), or, in respect of counsel fees or costs of defense, which shall be limited to one counsel, shall be paid at the time such fees or costs are incurred. The Company may require the Executive to deliver a written undertaking to return any amount advanced to him for indemnification hereunder if it shall thereafter be determined that indemnification is not available to Executive due to his Misconduct. This Section 8 shall survive the termination of this Agreement. 9. Confidentiality. Executive shall at all times both during his employment hereunder and after termination thereof regard and preserve as confidential all trade secrets and other confidential information pertaining to the business of the Company that 7 have been or may be obtained by Executive by reason of the performance of the terms of this Agreement. Executive agrees that all documents, reports, manuals, drawings, designs, tools, equipment, plans, proposals, marketing and sales plans, customer lists, or materials made by the Company or coming into Executive's possession by reason of his performance under this Agreement, are the property of the Company and shall not be used by Executive in any way prohibited by this Agreement. Except as expressly provided herein, during the Agreement Term and after termination thereof, Executive shall not deliver, reproduce, publish or in any way allow, after due care, information describing any trade secrets or other confidential documents or things to be delivered or used by any third party without specific direction or written consent of the Company or in response to lawful process. Immediately upon termination of this Agreement, Executive shall promptly deliver to the Company all documents, tools, equipment, drawings, blueprints, manuals, material and significant or confidential letters and notes, reports, price lists, customer lists and copies thereof, and all other materials relating to the Company's business and which are in the possession of or under the control of Executive. Confidential information as defined above shall exclude information or materials that become generally available to the public other than through disclosure by Executive in violation of this Agreement. This Section 9 shall survive the termination of the Agreement. 10. Nonsolicitation. During the Agreement Term and for a period ending on the later of (i) the period during which the Executive receives severance payments as provided herein, or (ii) one (1) year after the termination of Executive's employment with the Company, Executive and/or any person, firm, corporation or other entity which is controlled by Executive, shall not, without the prior written consent of the Company, personally or as an employee, owner, consultant, manager, associate, partner, agent or otherwise, or by means of any corporate or other entity solicit for employment or hire any employee of the Company or any of its subsidiaries. Executive acknowledges that the restrictions contained in this Section 10 are reasonable and necessary to protect the legitimate interests of the Company, do not cause the Executive or his affiliates undue hardship, and that any violation of any provision of this Section 10 will result in irreparable injury to the Company and that, therefore, the Company shall be entitled to preliminary and permanent injunctive relief in any court of competent jurisdiction and to an equitable accounting of all earnings, profits and other benefits arising from such violation, which right shall be cumulative and in addition to any other rights or remedies to which the Company may be entitled. This Section 10 shall survive the termination of the Agreement. 11. Miscellaneous. This Agreement shall be governed by and construed in accordance with the internal laws of the state of New York. 12. Modification. This Agreement may only be modified by mutual agreement. 8 13. Assignment. This Agreement is a personal service contract and may not be assigned by either party, except that the Company may assign this Agreement to its successor in interest in connection with a sale of assets, merger or similar transaction, or any Change of Control transaction, so long as the successor assumes the Company's obligations hereunder. 14. Notices. All notices required or permitted by this Agreement shall be in writing and shall be deemed received when personally delivered, or the next business day after deposit in overnight mail or five days after mailing by registered mail. Notices shall be sent to the parties at their addresses set forth below or to such different addresses as such parties shall direct by notice sent in accordance with this paragraph. If to Executive: Wayne P. Garten President and Chief Executive Officer Hanover Direct, Inc. 115 River Road, Building 10 Edgewater, New Jersey 07020 Email: wgarten@hanoverdirect.com with copies to: Daniel Pollack, Esq. Pollack & Kamanski 114 West 47th Street, 19th Floor New York, New York 10036 Fax.: 212-575-6560 Email: dapollack@pollacklawfirm.com If to the Company: Corporate Counsel Hanover Direct, Inc. 1500 Harbor Boulevard Weehawken, New Jersey 07087 Fax: 201-272-3498 and Chief Operating Officer Hanover Direct, Inc. 115 River Road, Building 10 Edgewater, New Jersey 07020 Fax: 201-272-3465 with copies to: 9 Sarah Hewitt, Esq. Brown Raysman Millstein Felder & Steiner LLP 900 Third Avenue, 21st Floor New York, New York 10022 Fax: 212-895-2900 Email: Shewitt@Brownraysman.com 15. Counterparts; Telecopy. This Agreement may be signed in two or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. This Agreement may be executed by telecopy signature which shall be deemed an original. 16. Successors and/or Assigns. Whenever in this Agreement either of the parties hereto is referred to, such reference shall be deemed to include the successors and/or permitted assigns and/or personal representatives of such party, and this Agreement shall inure to the benefit of and shall be binding on the parties hereto and the successors and/or permitted assigns and/or personal representatives of each such party. 17. Entire Agreement. This Agreement (together with the Stock Option Agreements annexed hereto) sets forth the entire agreement of the parties hereto in respect of the subject matter contained herein and supersedes all prior agreements, promises, covenants, arrangements, communications, representations or warranties, whether oral or written, by any officer, employee or representative of any party hereto. 18. No Conflict. Executive represents and warrants to the Company that neither the execution of this Agreement nor the performance of his obligations hereunder violate any agreement to which he is a party or by which he is otherwise bound. IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first above written. HANOVER DIRECT, INC. By: /s/ Michael D. Contino --------------------------------- Name: Michael D. Contino Title: Executive Vice President /s/ Wayne P. Garten --------------------------------------- Wayne P. Garten 10 EX-10.2 4 y99832exv10w2.txt GENERAL RELEASE AND COVENANT NOT TO SUE EXHIBIT 10.2 GENERAL RELEASE AND COVENANT NOT TO SUE THIS GENERAL RELEASE AND COVENANT NOT TO SUE (hereinafter referred to as the "Agreement"), made as of this 5th day of May, 2004, by and between Thomas C. Shull ("Mr. Shull"), residing at 28 Leeward Lane, Riverside, Connecticut 06878, and Hanover Direct, Inc., with a principal place of business at The Hudson River Pier, 115 River Road, Edgewater, New Jersey 07020 (the "Company"). WHEREAS, the Company and Mr. Shull are parties to an Employment Agreement dated as of September 1, 2002, as amended (the "Employment Agreement"); WHEREAS, notwithstanding the terms of the Employment Agreement, Mr. Shull's employment with the Company shall terminate effective May 5, 2004 and Mr. Shull has conditionally resigned from the Board of Directors of the Company effective such date (the "Termination Date"); and WHEREAS, the Company and Mr. Shull (the "parties") seek to dispose fully and finally of all issues which now exist or may arise between the parties from the commencement of Mr. Shull's relationship with the Company to the date of execution of this Agreement. NOW, THEREFORE, in consideration of the above recitals and in further consideration of the mutual promises and covenants set forth below, the parties hereto, intending to be legally bound, hereby agree as follows: 1. Termination and Termination Benefits. Mr. Shull's employment with the Company shall terminate effective the Termination Date and Mr. Shull shall unconditionally resign from the Board of Directors of the Company effective such date. The Company and Mr. Shull acknowledge, confirm and agree that (i) the termination of Mr. Shull's employment with the Company is by resignation following mutual discussion and agreement; and (ii) the termination of Mr. Shull's employment with the Company is not "For Cause" or "For Good Reason" as such terms are defined in the Employment Agreement. As consideration for Mr. Shull's agreement to be bound by the terms of this Agreement and in full and final settlement of all potential claims by Mr. Shull against the Company, including but not limited to claims arising under the Hanover Direct, Inc. Key Executive Eighteen Month Compensation Continuation Plan and the Employment Agreement, dated as of September 1, 2002, as amended, the Company agrees: (a) to pay to Mr. Shull the sum of $900,000 ("Severance"), as provided in clause (c) below; (b) for a period of eighteen (18) months from and after the Effective Date, to pay the cost of continuing Mr. Shull's group health and dental benefits under COBRA and Exec-U-Care plan coverage ("Benefits Continuation" and together with Severance, "Termination Benefits"); (c) The Severance shall be paid in multiple installments, the first installment in the amount of $300,000 to be paid on the Effective Date of this Agreement and the remaining amount of $600,000 to be payable in 16 installments of $35,625 payable every two weeks commencing May 21, 2004 with a final payment in the amount of $30,000 to be payable on or about December 31, 2004. The Benefits Continuation shall commence in the month following the Effective Date of this Agreement. The Termination Benefits shall be subject to all applicable federal, state and local withholding taxes and deductions and the Company has no express or implied obligation or duty to "gross-up" Mr. Shull for any of such tax or other payments that are the obligation of Mr. Shull; and (d) If any Severance pay described in paragraph 1(c) is not made on or before the date due, Mr. Shull shall provide written notice by facsimile to the President of the Company (facsimile no. 201-272-3465). If the failure to pay is not cured within five (5) business days of receipt by the Company of such notice, the entire unpaid balance of the $900,000 shall become due and owing immediately. 2. No Other Monies or Benefits Due or Payable. The parties agree that, except for the Termination Benefits and the reimbursement of previously submitted out of pocket expenses, no other monies or benefits will be due, become due or be paid to Mr. Shull by the Company, including without limitation, under any plan, policy, program or agreement with the Company, including without limitation the Employment Agreement, including without limitation, change in control benefits, transaction bonus, severance pay, salary continuation, incentive or bonus pay, profit sharing, commissions, notice pay, vacation pay, attorneys' fees or costs. 3. General Release. In consideration for the promises herein, Mr. Shull agrees to release, remise and forever discharge, and by these presents does, for himself, his heirs, executors, administrators and assigns (collectively referred to hereafter as "Releasors"), release, remise and forever discharge each of the Company, its past and present and future parent and affiliate corporations, partnerships and other entities, and their past and present and future divisions, subsidiaries and related companies, partnerships and other entities, and their successors and assigns, and the directors, officers, employees, shareholders, agents, partners, advisors and representatives of each of them, personally and as directors, officers, employees, shareholders, agents, partners, advisors and representatives and all benefit plans of the Company and the administrators of same (collectively referred to hereafter as the "Releasees"), of and from all manner of action and actions, causes and causes of action, sums of money, covenants, contracts, controversies, agreements, promises, damages, claims and demands whatsoever, in law or in equity, which Releasors ever had, may have had, now have or which they hereinafter can, shall or may have, whether known or unknown, asserted or unasserted, suspected or unsuspected, as a result of any act or omission which has occurred at any time up to and including the date of Mr. Shull's execution of this Agreement, including without limitation, claims, demands and causes of action under federal, state or local law or regulation, including without limitation, any rights to bring any demands, complaints, causes of action, claims and charges in any forum, judicial, administrative or quasi-judicial, arising out of, involving or related to any employment agreement, or other contract, side-letter, resolution, promise, policy or understanding of any kind, whether written or oral or express or implied, the right to bring any demands, complaints, causes of actions, claims and charges arising under any federal, state or local human or civil rights, wage, labor or employment law and/or regulation, including without limitation, the Age Discrimination in Employment Act ("ADEA"), 29 U.S.C. Sec. 626, the Older Workers' Benefit 2 Protection Act ("OWBPA"), 29 U.S.C. Sec. 626(f)(1), Title VII of the Civil Rights Act of 1964, as amended, 42 U.S.C. Sec. 1983, Employee Retirement Income Security Act of 1974 ("ERISA"), as amended, 29 U.S.C. Sec. 1001, et seq., the Rehabilitation Act of 1973, the Americans with Disabilities Act ("ADA"), 42 U.S.C. Sec. 12011, et. seq., the Family and Medical Leave Act ("FMLA"), and the right to bring demands, complaints, causes of action, grievances, claims and charges under any other federal, state or local law, statute, regulation or decision, including laws that prohibit discrimination on the basis of sex or age or disability or any claims for invasion of privacy, infliction of emotional distress, assault, misrepresentation, battery or other common law claims, and any claims, demands or causes of action for injunctive and declaratory relief, breach of contract, wrongful discharge, compensation for lost wages and benefits, emotional distress, compensatory and punitive damages and costs including attorneys' fees, expenses and costs of litigation, and such other and additional relief as may be appropriate. 4. Limited Release. In consideration for the promises herein, the Releasees agree to release, remise and forever discharge, and by these presents do, for themselves, their successors and assigns, release, remise and forever discharge Releasors of and from all manner of action and actions, causes and causes of action, sums of money, covenants, contracts, controversies, agreements, promises, damages, claims and demands, in law or in equity, solely related to (1) those matters brought before the Corporate Governance Committee of the Board of Directors of the Company in December 2003, (2) actions of Mr. Shull in his capacity as the CEO of the Company related or connected to asset sales or prospective asset sales and financing and refinancing matters and the process employed in connection therewith, including prospective redemptions, (3) actions of Mr. Shull in his capacity as the CEO of the Company related to existing litigation and administrative proceedings to which the Company is a party, (4) actions of Mr. Shull in his capacity as the CEO of the Company in supervision of operational matters, including treasury and accounting functions, labor and employee relations and vendor and customer issues, and (5) actions of Mr. Shull in his capacity as the CEO of the Company in connection with transactions and relationships with the Company's majority stockholder and its affiliates, including all communications connected or related thereto (excluding any securities law filings), including without limitation, claims, demands and causes of action under federal, state or local law or regulation, including without limitation, any rights to bring any demands, complaints, causes of action, claims and charges in any forum, judicial, administrative or quasi-judicial. 5. Covenant Not to Sue. Releasors further covenant and agree that they will forever forbear from pursuing any legal proceedings, administrative, judicial or quasi-judicial, and they will not in any other way make or continue to make any demands or claims against any of the Releasees based on actions or omissions that occurred at any time up to and including the date of Mr. Shull's execution of this Agreement. Releasees further covenant and agree that they will forever forbear from pursuing any legal proceedings, administrative, judicial or quasi-judicial, and they will not in any other way make or continue to make any demands or claims against Releasors solely related to the matters and actions described in clauses (1) through (5) of paragraph 4 above that occurred at any time up to and including the date of the Company's execution of this Agreement. 6. Presently Unknown Claims. Mr. Shull acknowledges that (a) he may subsequently discover facts in addition to or different from those that he now believes to be true with respect to 3 the claims or potential claims described above, and (b) that he may have sustained or may yet sustain costs or expenses that are presently unknown and that relate to those claims. Mr. Shull acknowledges, however, that he had negotiated, agreed upon and entered into this Agreement in light of that situation. 7. Mutual Nondisparagement. Mr. Shull agrees that he will not initiate action to harm the Company's name and reputation or that of its officers, directors, shareholders or agents and shall make no disparaging statements orally or in writing concerning the Company based on Mr. Shull's association as an employee or otherwise that occurred at any time up to and including the date of Mr. Shull's execution of this Agreement except as required by law or legal process. The Company agrees for itself and on behalf of its officers, directors, shareholders and agents that they will not initiate action to harm Mr. Shull's name and reputation and shall make no disparaging statements orally or in writing concerning Mr. Shull based on the Company's association as an employer or otherwise that occurred at any time up to and including the date of the Company's execution of this Agreement except as required by law or legal process. 8. No Assistance. Mr. Shull agrees that he shall not solicit, encourage, assist or participate in claims or litigation against the Releasees in any forum by any individual or entity, including any governmental or administrative agency or authority, except by subpoena or other court order or as required by law. 9. Survival. Notwithstanding anything contained in this Agreement to the contrary, this Agreement is in no way intended to and in no way shall effect the validity or enforceability of the Indemnity or Confidentiality provisions of the Employment Agreement or any provision of the General Release dated November 30, 2003 from Chelsey Direct, LLC to the Company and its officers and others benefiting Mr. Shull, which shall both specifically survive the termination of Mr. Shull's employment with the Company and shall not be superceded or modified or deemed to be superceded or modified in any respect by this Agreement; provided that, other than the Indemnity and Confidentiality provisions of the Employment Agreement and those provisions of the Employment Agreement relating to stock options, the balance of the Employment Agreement shall be terminated as of the Termination Date. 10. Cooperation. Following the Termination Date, Mr. Shull agrees: (a) To make himself available for a maximum of five business days per year for eighteen months from the date of this Agreement to respond to all reasonable inquiries by the Company, its management, employees, agents, attorneys, representatives and advisors regarding all matters associated with his employment at the Company including, without limitation, his prior responsibilities, and all the processes and procedures of which he acquired knowledge while employed by the Company. In this regard, the parties acknowledge and agree that in providing such responses Mr. Shull shall not be required to be present at the Company's offices on a regular basis, but Mr. Shull agrees to make himself available at reasonable times to meet by phone with the Company or its employees, agents, representatives and advisors. The Company shall reimburse Mr. Shull for any reasonable and necessary expenses he incurs in fulfilling this obligation. For purposes of this section, any phone discussion or appearance by Mr. Shull for any period of time in excess of one hour on any business day shall count as participation for a full business day. 4 (b) To make himself available for a maximum of five additional business days per year for eighteen months from the date of this Agreement without the requirement of being subpoenaed to confer with counsel by phone upon reasonable notice concerning any knowledge he had or may have with respect to actual and/or potential disputes arising out of the activities of the Company during his period of employment by the Company. The Company shall reimburse Mr. Shull for any reasonable and necessary expenses he incurs in fulfilling this obligation. For purposes of this section, any phone discussion or appearance by Mr. Shull for any period of time on any business day in excess of one hour shall count as participation for a full business day. (c) To submit to deposition and/or testimony and/or participate in an investigation by any government agency in accordance with the laws of the forum involved concerning any knowledge he has or may have with respect to actual and/or potential disputes or issues arising out of the activities of the Company during his period of employment by the Company. The Company shall reimburse Mr. Shull for any reasonable and necessary expenses he incurs in fulfilling this obligation. 11. Confidentiality. Mr. Shull agrees and covenants that the contents of this Agreement shall remain confidential and shall not be discussed with or divulged to any entity or entities, person or persons, including but not limited to employees or former employees of the Company; provided, however, that Mr. Shull may disclose the content of this Agreement: (a) to members of his immediate family and his legal, financial and personal advisors (provided such individuals agree not to divulge it) and (b) to the extent he is required or compelled by law to disclose this Agreement or its contents. Mr. Shull acknowledges, confirms and agrees that the Company may be required by disclose the content of this Agreement and to file a copy of this Agreement with the Securities and Exchange Commission pursuant to applicable securities laws. 12. Acknowledgement of Full and Final Release. Mr. Shull further represents that except for the obligations expressly provided herein, he understands and agrees that by his execution of this Agreement, he has fully and finally released all of his claims of every nature and kind against the Releasees whether known or unknown, asserted or unasserted, suspected or unsuspected, including punitive damages, claims for attorneys' fees, expenses and costs of litigation. 13. Attorneys' Fees. In the event either party proves that the other party has breached this Agreement, the breaching party will be responsible to pay all reasonable attorneys' fees and costs incurred by the non-breaching party in connection with its enforcement of this Agreement or related to the breach thereof. 14. Breach. Mr. Shull agrees that in the event he breaches (or threatens to breach) or otherwise violates any material term or condition of paragraphs 7, 9 (to the extent it incorporates by reference the Confidentiality provisions of the Employment Agreement) or 11 of this Agreement, the Company shall be entitled to obtain in a court of competent jurisdiction a temporary or permanent injunction enjoining and restraining him from committing, continuing to commit or threatening to commit any such violation or breach. 5 15. Review Period. Mr. Shull shall have up to twenty-one (21) days within which to review and consider this Agreement. In the event Mr. Shull fails to execute this Agreement and deliver same to the Company prior to the expiration of such twenty-one (21) day period, this Agreement and the terms offered herein shall automatically terminate and be deemed revoked for all purposes. 16. Revocation Period. Mr. Shull shall have up to seven (7) days following his execution of this Agreement within which to revoke it. If he chooses to revoke this Agreement, he must notify Lisa Green, Company Counsel, Hanover Direct, Inc., 1500 Harbor Boulevard, Weehawken, New Jersey 07087, in writing on or before the seventh day following the execution of this Agreement and state "I hereby revoke my acceptance of the Agreement." In the event this Agreement is revoked pursuant to this Paragraph, Mr. Shull shall not be eligible to nor shall he receive any of the Termination Benefits described in Paragraph 1 hereof and all of the terms and provisions of this Agreement shall be null and void and each of the parties to this Agreement shall have all of the rights and remedies available to it under the Employment Agreement or otherwise. In the event this Agreement is not revoked in the manner set forth herein, it shall become final and binding on the 8th day following Mr. Shull's execution of this Agreement (the "Effective Date"). 17. Severability. Mr. Shull specifically acknowledges that he has considered carefully all of the covenants outlined above and intends that each covenant shall be enforced fully in accordance with its terms. However, if, in any judicial proceeding, a court shall determine that such covenants are unenforceable for any reason, then the parties intend that such covenants shall be deemed to be limited in such manner as the court may determine to permit enforceability by such court and the remainder of this Agreement shall remain enforceable as executed. 18. Governing Law and Jurisdiction. This Agreement shall be governed by and construed under the laws of the State of New York. The parties agree to submit to the jurisdiction of state and federal courts in New York for the purposes of enforcing and/or resolving any disputes arising under this Agreement. 19. Entire Agreement. This Agreement constitutes the full and complete understanding between the parties. There are no other agreements or understandings, either oral or in writing, which are not reflected in this Agreement. Mr. Shull warrants and agrees that the Company has not made any other agreement, promise or assurance, except those expressed in this document, to induce or persuade Mr. Shull to enter into this Agreement. 20. No Modification. This Agreement shall not be modified or discharged, in whole or in part, except by agreement in writing signed by the parties hereto. 21. No Liability. It is understood and agreed that this Agreement is not to be construed as an admission of liability by the Company. 22. Counterparts. This Agreement may be signed in counterparts. 23. Notice Under the OWBPA. Mr. Shull represents that he has executed this Agreement knowingly and voluntarily. In particular, he represents that: 6 a. He is able to read the language, and understand the meaning and effect, of this Agreement; b. He has been advised in writing to consult with an attorney prior to signing this Agreement; c. He understands that he is waiving any right he may have to bring a claim against the Company under the Age Discrimination in Employment Act; d. He has had or could have had up to twenty-one (21) days to review and consider this Agreement and that, if he has executed it prior to the expiration of the 21-day period, he has done so of his own free will and without any duress or compulsion; and e. He understands that he has seven (7) days following execution of this Agreement within which to revoke it. [SIGNATURES ON THE FOLLOWING PAGE] 7 Agreed: Hanover Direct, Inc. /s/ Thomas C. Shull By: /s/ Wayne P. Garten - ------------------- -------------------------------- Thomas C. Shull Name: Wayne P. Garten Title: President and Chief Executive Officer Date: May 11, 2004 Date: May 11, 2004 8 EX-31.1 5 y99832exv31w1.txt CERTIFICATION EXHIBIT 31.1 CERTIFICATIONS I, Wayne P. Garten, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Hanover Direct, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. /s/ Wayne P. Garten ------------------------------------- Wayne P. Garten President and Chief Executive Officer Date: August 10, 2004 EX-31.2 6 y99832exv31w2.txt CERTIFICATION EXHIBIT 31.2 CERTIFICATIONS I, Charles E. Blue, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Hanover Direct, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. /s/ Charles E. Blue ------------------------------------- Charles E. Blue Senior Vice President and Chief Financial Officer Date: August 10, 2004 EX-32.1 7 y99832exv32w1.txt CERTIFICATION EXHIBIT 32.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 The undersigned, Wayne P. Garten, President and Chief Executive Officer, and Charles E. Blue, Senior Vice President and Chief Financial Officer, of Hanover Direct, Inc. (the "Company"), each hereby certifies that to his knowledge the Quarterly Report on Form 10-Q for the fiscal quarter ended June 26, 2004 of the Company filed with the Securities and Exchange Commission on the date hereof (the "Report") fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company for the period specified. Signed at the City of Edgewater, in the State of New Jersey, this 10th day of August, 2004. /s/ Wayne P. Garten ------------------------------------- Wayne P. Garten President and Chief Executive Officer /s/ Charles E. Blue ------------------------------------- Charles E. Blue Senior Vice President and Chief Financial Officer A signed original of this written statement required by Section 906 of the Sarbanes-Oxley Act of 2002 has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request. -----END PRIVACY-ENHANCED MESSAGE-----