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- --------------------------------------------------------------------------------UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K/A
AMENDMENT NO. 1
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 28, 200227, 2003
COMMISSION FILE NUMBER 1-12082
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HANOVER DIRECT, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE
(STATE OR OTHER JURISDICTION OF INCORPORATION OR ORGANIZATION)
115 RIVER ROAD, BUILDING 10, EDGEWATER, NEW JERSEY
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
13-0853260
(IRS EMPLOYER IDENTIFICATION NO.)
07020
(ZIP CODE)
(201) 863-7300
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
------------------- ---------------------
COMMON STOCK, $.66 2/3 PAR VALUE AMERICAN STOCK EXCHANGE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: None
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ][X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes [ ] No [X]
As of June 28, 2002,27, 2003, the last business day of the registrant's most
recently completed second fiscal quarter, the aggregate market value of the
voting and non-voting common equity held by non-affiliates of the registrant was
$17,443,928$15,069,965 (based on the closing price of the Common Stock on the American
Stock Exchange on June 28, 200227, 2003 of $0.25$0.27 per share; shares of Common Stock owned
by directors and officers of the Company are excluded from this calculation;
such exclusion does not represent a conclusion by the Company that all of such
directors and officers are affiliates of the Company).
As of March 20, 2003,16, 2004, the registrant had 138,315,800220,173,633 shares of Common Stock
outstanding (excluding treasury shares).
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DOCUMENTS INCORPORATED BY REFERENCE
The Company's definitive proxy statement to be filed by the Company
pursuant to Regulation 14A is incorporated into items 11, 12 and 13 of Part III
of this Form 10-K.
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EXPLANATORY NOTE
This Amendment No. 1 to ouron Form 10-K/A amends Items 10, 11, 12, 13 and 14 of
Part III and Exhibit 23.1 of Item 15 of Part IV of the Company's Annual Report
on Form 10-K for the fiscal year ended December 28, 2002, as originally27, 2003 filed with the
Securities and Exchange Commission on March 25, 2003, is being filed to
amend and reflect the restatement of our Consolidated Balance Sheets as of
December 28, 2002 and December 29, 2001 in order to comply with 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"). We have re-examined the provisions of our
credit facility and, based on EITF 95-22 and certain provisions in the credit
agreement, we are required to reclassify our revolving credit facility from
long-term to short-term debt, though the existing revolving loan facility does
not mature until January 31, 2007. As a result, we reclassified $8.8 million and
$13.5 million as of December 28, 2002 and December 29, 2001, respectively, from
long-term debt to short-term debt and capital lease obligations. See Note 6 and
Note 21 of Notes to Consolidated Financial Statements for further discussion.
Each item of the Annual Report on Form 10-K as filed on March 25, 2003 that was
affected by the restatement has been amended and restated.April 9, 2004. No attempt has been made in this Form 10-K/A to
modify or update otherany disclosures as presented in any other Items or Parts of the
original Form 10-K except as required to reflect the effects of the
restatement.
Part I -- Financing. The working capital and current ratios for the years
ended December 28, 2002 and December 29, 2001 were restated to $0.6 million,
1.01, and $7.4 million, 1.08, respectively, from $9.4 million, 1.12 and $20.9
million, 1.26, respectively, as originally reported.
Part II -- Item 6. Selected Financial Data -- Working capital was restated
for fiscal years 2002, 2001, 2000 and 1999 to $0.6 million, $7.4 million, $1.1
million and $12.8 million, respectively, from $9.4 million, $20.9 million, $16.8
million and $17.99 million, as originally reported.
Part II -- Item 7. Management's Discussion and Analysis of Consolidated
Financial Condition and Results of Operations-Liquidity and Capital
Resources-Amendments to Congress Loan and Security Agreement has been updated to
provide disclosure concerning the reclassification of the Company's revolving
loan facility pursuant to EITF 95-22.
Part II -- Item 7. Management's Discussion and Analysis of Consolidated
Financial Condition and Results of Operations-Liquidity and Capital
Resources-Restated that, of the aggregate borrowings of $25.1 million, $12.6
million is classified as short-term and $12.5 million is classified as
long-term, from $3.8 million classified as short-term and $21.3 million
classified as long-term, as originally reported.
Part II -- Item 7. Management's Discussion and Analysis of Consolidated
Financial Condition and Results of Operations-Liquidity and Capital
Resources-The working capital and current ratios for the years ended December
28, 2002 and December 29, 2001 were restated to $0.6 million and 1.01, and $7.4
million and 1.08, respectively, from $9.4 million and 1.12, and $20.9 million
and 1.26, respectively, as originally reported, and restated the short-term
borrowings of $3.8 million to $12.6 million and restated long-term borrowings of
$21.3 million to $12.5 million.
Part II -- Item 8. Financial Statements and Supplementary Data-auditors'
opinion updated to reflect restatement.
Part II -- Item 8. Financial Statements and Supplementary Data - A summary
of the effects of the restatement on our Consolidated Balance Sheets as of
December 28, 2002 and December 29, 2001 follows:
DECEMBER 28, 2002 DECEMBER 29, 2001
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AS PREVIOUSLY AS AS PREVIOUSLY AS
REPORTED RESTATED REPORTED RESTATED
--------------------------------------------------
(IN THOUSANDS)
Short-term debt and capital lease obligations.... $ 3,802 $ 12,621 $ 3,162 $ 16,685
Total current liabilities........................ $ 78,848 $ 87,667 $ 79,785 $ 93,308
Long-term debt................................... $ 21,327 $ 12,508 $ 26,548 $ 13,025
Total non-current liabilities.................... $ 27,714 $ 18,895 $ 36,781 $ 23,258
See Note 21 of Notes to Consolidated Financial Statements for further
discussion.
Part II -- Item 8. Financial Statements and Supplementary Data-restated
footnote 6-Restated aggregate annual principal payments required on debt
instruments as follows: 2003-$12.6 million and 2004-$12.5 million from 2003-$3.8
million and 2004-$21.3 million, as originally reported.
HANOVER DIRECT, INC.
FORM 10-K
FOR THE FISCAL YEAR ENDED DECEMBER 28, 2002
INDEX
PAGE
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PART I
ITEM 1. Business.................................................... 2
General................................................... 2
Direct Commerce........................................... 2
Business-to-Business...................................... 7
Credit Management......................................... 8
Financing................................................. 8
Additional Investments.................................... 10
Employees................................................. 13
Seasonality............................................... 13
Competition............................................... 14
Trademarks................................................ 14
Government Regulation..................................... 14
Listing Information....................................... 15
Web site Access to Information............................ 15
ITEM 2. Properties.................................................. 15
ITEM 3. Legal Proceedings........................................... 17
ITEM 4. Submission of Matters to a Vote of Security Holders......... 21
PART II
ITEM 5. Market for Registrant's Common Equity and Related
Stockholder Matters......................................... 22
ITEM 6. Selected Financial Data..................................... 23
ITEM 7. Management's Discussion and Analysis of Consolidated
Financial Condition and Results of Operations............... 24
Results of Operations..................................... 24
Liquidity and Capital Resources........................... 28
Uses of Estimates and Other Critical Accounting
Policies............................................... 32
New Accounting Pronouncements............................. 34
Off-Balance Sheet Arrangements............................ 34
Forward Looking Statements................................ 34
Cautionary Statements..................................... 35
ITEM 7A. Quantitative and Qualitative Disclosures about Market
Risk........................................................ 37
ITEM 8. Financial Statements and Supplementary Data................. 38
ITEM 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................... 86
PART III
ITEM 10. Directors and Executive Officers of the Registrant.......... 87
ITEM 11. Executive Compensation...................................... 91
ITEM 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters.................. 91
ITEM 13. Certain Relationships and Related Transactions.............. 91
ITEM 14. Controls and Procedures..................................... 91
PART IV
ITEM 15. Exhibits, Financial Statement Schedules and Reports on Form
8-K......................................................... 92
Signatures.................................................. 94
Exhibit Index............................................... 95
10-K.
PART I
ITEM 1. BUSINESS
GENERAL
Hanover Direct, Inc. (the "Company") provides quality, branded merchandise
through a portfolio of catalogs and e-commerce platforms to consumers, as well
as a comprehensive range of Internet, e-commerce and fulfillment services to
businesses.
The Company's direct commerce operations comprise its catalog and Web site
portfolio of home fashions, apparel and gift categories including, during 20022003,
Domestications, The Company Store, The Company Kids, Scandia Down, Silhouettes,
International Male, Undergear and Gump's By Mail. Each brand can be accessed on
the Internet individually by name. In addition, the Company owns Gump's, a
retail store based in San Francisco, California. In 2002, the Company integrated its The Company
Store and Domestications divisions, and also completed the integration of the
Gump's store and Gump's By Mail catalog divisions.
The Company's business-to-business operations comprise the third party
fulfillment business of Keystone Internet Services, LLC (formerly Keystone
Internet Services, Inc.), the Company's third party, end-to-end, fulfillment,
logistics and e-care provider.
The Company is incorporated in Delaware and its executive offices are
located at 115 River Road, Edgewater, New Jersey 07020. The Company's telephone
number is (201) 863-7300. The Company is a successor in interest to The Horn &
Hardart Company, a restaurant company founded in 1911, and Hanover House
Industries, Inc., founded in 1934.
Regan Partners, L.P. and Basil P. Regan own
approximately 28.0% of the Company's outstanding common stock.On or about May 19, 2003, Richemont Finance S.A. ("Richemont"), a Luxembourg company
owns("Richemont"), the then holder of approximately 21.3% of the Company's issued
and outstanding common stock (the "Common Stock") and all of the Company's
Series B Participating Preferred Stock (the "Series B Participating Preferred
Stock"), sold all of its shares of stock of the Company to Chelsey Direct, LLC,
a Delaware limited liability company ("Chelsey"). The Company entered into a
recapitalization agreement with Chelsey in November 2003 pursuant to which the
Company exchanged 564,819 shares of a newly issued Series C Participating
Preferred Stock (the "Series C Participating Preferred Stock") and 81,857,833
shares of newly issued Common Stock for the shares of Series B Participating
Preferred Stock held by Chelsey. As a result of such transaction, Chelsey became
the holder of approximately 50.6% of the Company's outstanding common stock and
all of the Company's Class BSeries C Participating Preferred Stock. Richemont is an affiliateCollectively, Basil
Regan and Regan Partners, L.P. ("Regan") are currently the holders of
Compagnie Financiere Richemont, A.G.,approximately 17.6% of the Company's Common Stock. Pursuant to a Swiss-based publicly traded luxury goods company.Corporate
Governance Agreement, Chelsey has the right to designate five (5) members and
Regan has the right to designate one (1) member of the nine (9) member Board of
Directors. See "Additional Investments -- Series C Participating Preferred
Stock" and "Item 10(a) -- Directors and Executive Officers of the Registrant."
DIRECT COMMERCE
General. The Company is a leading specialty direct marketer with a diverse
portfolio of branded home fashions, men's and women's apparel and gift products
marketed via direct mail-order catalogs, retail stores and connected Internet
Web sites.sites ("direct commerce"). The Company's catalog titles are organized into
four categories -- The Company Store Group, and the Women's Apparel, Men's Apparel and
Gift categories -- each consisting of one or more catalog/onlineInternet titles. All of these
categories utilize central purchasing and inventory management functions and the
Company's common systems platform, telemarketing, fulfillment, distribution and
administrative functions. During 2002,2003, the Company mailed approximately 191.2180.3
million catalogs,
(including certain catalogs relating to businesses of the Company that were
discontinued), answered more than 7.36.3 million customer service/order calls
and processed and shipped 6.86.4 million packages to customers.
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. (now Keystone Internet Services, LLC)
subsidiary agreed to provide telemarketing and fulfillment services for the
Improvements business under a service agreement with the buyer for a period of
three years. The Company is in negotiations to extend the term of the HSN
agreement for a period of two additional years to June 27, 2006.
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The asset purchase agreement between the Company and HSN providesprovided for a
reduction in the sale price if the performance of the Improvements business in
the 2001 fiscal year failsfailed to achieve a targeted EBITDA level as defined in the
agreement. The business achieved the targeted EBITDA level so no reduction in
the sale price was required. In addition, if Keystone Internet Services, Inc.
failsfailed to perform its obligations during the first two years of the services
contract, the purchaser canwas entitled to receive a reduction in the original
purchase price of up to $2.0 million. An escrow fund of $3.0 million, which was
withheld from the original proceeds of the sale of approximately $33.0 million,
was established for a period of two years under the terms of an escrow agreement
between LWI Holdings, Inc., HSN and The Chase Manhattan Bank as a result of
these contingencies. TheOn March 27, 2003, the Company and HSN amended the asset
purchase agreement to provide for the release of the remaining $2.0 million
balance inof the escrow fund at December 29, 2001 was
$2.6 million. During fiscal year 2002,
2
and to terminate the Company recognized approximately $0.6 million of the deferred gain
consistent withescrow agreement. By agreeing to
the terms of the escrow agreement. Proceeds of approximately
$0.3 million relatingamendment, HSN forfeited its ability to the deferred gain were received on each of July 2, 2002
and December 30, 2002. As of December 28, 2002, the balancereceive a reduction in
the escrow fundoriginal purchase price of up to $2 million if Keystone Internet Services
failed to perform its obligations during the first two years of the services
contract. In consideration for the release, Keystone Internet Services issued a
credit to HSN for $100,000, which could be applied by HSN against any invoices
of Keystone Internet Services to HSN. This credit was approximatelyutilized by HSN during the
March 2003 billing period. On March 28, 2003, the remaining $2.0 million and no claims had been made thereunder.escrow
balance was received by the Company, thus terminating the escrow agreement.
The Company reviews its portfolio of catalogs as well as new opportunities
to acquire or develop catalogs from time to time. In 2002, theThe Company did not
discontinue any of its businesses or print catalogs.catalogs in 2003.
In 2002, the Company discontinued certain
businesses, including the Encore catalog website. As the Company discontinued
mailing the Encore print catalog in 2001, the Encore business is now deemed a
terminated business.
During 2002, the Company integrated its The Company Store and
Domestications divisions, and also completed the integration of the Gump's store
and Gump's By Mail catalog divisions. In 2002, the Company closed a
telemarketing center and a product storage facility both located in San Diego,
California, and consolidated a portion of the Company'sits Hanover, Pennsylvania
fulfillment operations into itsthe Company's Roanoke, Virginia facility. TheIn March
2003, the Company intends
to closeclosed its Kindig Lane facility in Hanover, Pennsylvania and
movemoved its remaining operations there to the Company's facility in Roanoke,
Virginia by
March 31, 2003.Virginia.
The moveCompany responds to unsolicited expressions of interest for various of
its assets which it receives from time to time from third parties; however no
formal solicitation program has been completed with the exception thatestablished by the Company for the sale of
assets and no definitive agreements have been reached other than with respect to
the sale of the Company's Improvements business and its Kindig Lane facility in
prior years. The Recapitalization Agreement with Chelsey and the Certificate of
Designations of the Series C Participating Preferred Stock do not mandate the
sale of assets. However, management, with direction from the Board of Directors,
has taken the position that it will consider the sale of the Company's non-core
assets in order to redeem the outstanding Series C Participating Preferred Stock
so long as the sale of any individual asset or group of assets is removingfair to all
the Company's stakeholders from a financial point of view. The Company is
considering the sale of certain equipment.non-core assets although no definitive
agreements have been reached and no assurance can be given that such assets
will, in fact, be sold.
Each of the Company's specialty catalogs targets distinct market segments
offering a focused assortment of merchandise designed to meet the needs and
preferences of its target customers. Through market research and ongoing testing
of new products and concepts, each brand group determines each catalog's own
merchandise strategy, including appropriate price points, mailing plans and
presentation of its products. The Company is continuing its development of
exclusive or private label products for a number of its catalogs, including
Domestications, The Company Store, The Company Kids, Silhouettes, International
Male and Undergear, to further enhance the brand identity of the catalogs.
During 2002,2003, the Company sought to rely on its existing long-term customer
relationships to grow its existing brands and to extend the categories of
merchandise sold by its existing brands. Silhouettes expanded its offerings in
intimates, footwear and swimwear, Domestications expanded its offerings of home
accessories, Gump's San Francisco launched a Baby Gump's boutique and a packaged
foods department, and plans were made to emphasize several new categories of
merchandise. Gump's also implemented a strategy for unifying the merchandise
offering in all categories across all channels.
The Company's specialty catalogs typically range in size from approximately
24 to 96108 pages with fivesix to twenty-fourtwenty-five new editions per year depending on the
seasonality and fashion content of the products offered. Each edition may be
mailed several times each season with variations in format and content. Each
catalog employs the services of an outside creative agency or has its own
creative staff that is responsible for the
3
designs, layout, copy, feel and theme of the book. Generally, the initial
sourcing of new merchandise for a catalog begins twosix to fournine months before the
catalog is mailed. The Company has created commerce-enabled Web sites for each
of its catalogs, which offersoffer all of the catalog's merchandise and, in every
case, more extensive offerings than any single issue of a print catalog; takestake
catalog requests; and acceptsaccept orders for not only Web site merchandise but also
from any print catalog already mailed.
The following is a description of the Company's catalogsbrands in each of the
Company's four categories:
The Company Store Group:
Domestications is a leading home fashions catalogbrand offering affordable luxury
for every room in the home for today's value-oriented and style-conscious
consumer.
The Company Store is an upscale home fashions catalogbrand focused on high quality
down products and other private label and branded home furnishings.
The Company Kids offers both upscale apparel and furnishing focused towards
children.
Scandia Down is a nationally known retailerbrand specializing in luxury down
products and home fashions.
Women's Apparel:
Silhouettes is a leading fashion catalogbrand offering large size womenwomen's upscale
apparel and accessories.
3
Men's Apparel:
International Male offers contemporary men's fashions and accessories at
reasonable prices.
Undergear is a leader in fashionable and functional men's underwear,
workout wear and active wear.
Gift:
Gump's By Mail and Gump's San Francisco are luxury sources for discerning
customers of jewelry, gifts and home furnishings, as well as market leaders in
offering Asian inspired products.
Catalog Sales. Net sales, including postage and handling, through the
Company's catalogs was $343.7were $280.1 million for the fiscal year ended December 28,
2002,27,
2003, a decrease of $51.8$61.8 million or 13.1% excluding sales from18.1% compared with the Improvements
division that was sold on June 29, 2001.prior year. Overall
circulation for continuing business in fiscal year 20022003 decreased by 9.0%5.9% in
fiscal 20022003 primarily stemming from the Company's continued efforts to reduce
unprofitable circulation. In addition, the Company is currently analyzing the
extent of cannibalization of catalog sales by Internet sales. Two examples of
topics being researched are (1) what is the percentage of Internet customers who
received a catalog and selected the Internet as a vehicle for order placement
and (2) what drew the Internet customer to the Internet Web site if not a
catalog recipient. Acquiring customers through the Internet as opposed to
mailing them a catalog results in lower overall costs and increased
profitability for the Company.
Internet Sales. The Internet as a source of new customers continues to
grow in importance. Net sales, including postage and handling, through the
Internet improved to $87.3$108.6 million for the fiscal year ended December 28, 2002,27, 2003,
an increase of $20.4$21.2 million or 30.4%24.2%, over Internet sales in the prior fiscal
year, excluding sales from the Improvements division that was sold on June 29,
2001.year. As of December 28, 2002,27, 2003, Internet sales had reached 20.3%27.9% of brand sales
(total revenues less third party fulfillment sales and membership programs). The
Company maintains an active presence on the Internet by having a
commerce-enabled Web site for each of its catalogs which offers all of the
catalog's merchandise and, in every case, more extensive offerings than any
single issue of a print catalog; takes catalog requests, and accepts orders for
not only Web site merchandise but also from any print catalog already mailed.
The Web sitessite for each brand areis promoted within each catalog, in traditional
print media advertising, in TV commercials, and on third partythird-party Web sites.
During November 2002, Amazon.com began to offer Silhouettes, International
Male and Undergear merchandise within Amazon.com's Apparel & Accessories store
under a multi-year strategic alliance between the Company and Amazon.com. All
orders resulting from this alliance are electronically transferred to and
fulfilled by the Company. During the first quarter of 2003, Gump's jewelry and
Company Kids apparel
merchandise will joinjoined Silhouettes, International Male and Undergear within
Amazon.com's Apparel & Accessories store. During
4
September 2003, Domestications, The Company Store, and Gump's bedding, furniture
and home accessories were made available within Amazon.com's expanded Home
store.
The Company utilizes marketing opportunities available to it by posting its
catalog merchandise and accepting orders on third partythird-party Web sites, for which it
is charged a commission. The Company also undertakes relationships where third
party Web sites are paid for every click that leads to the Company's sites. In
addition to the arrangements with Amazon.com described above, third party Web
site advertising arrangements entered into by the Company include partnerships
with Yahoo, ArtSelect,ArtSelect.com, CatalogCity, e-centives,Decorative Product Source, Inktomi, Google,
MSN, NexTag, Overture, DealTime,Shopping.com, Linkshare and GiftCertificates.com.
Buyers' Clubs. In March 1999, the Company, through a newly formed
subsidiary, started up and promoted a discount buyers' club to consumers known
as "The Shopper's Edge." In exchange for an up-front membership fee, the
Shopper's Edge program enabled members to purchase a wide assortment of
merchandise at discounts that were not available through traditional retail
channels. Effective December 1999, the Company sold its interest in The
Shopper's Edge subsidiary to FAR Services, LLC, an unrelated third party, for a
nominal fair value based upon an independent appraisal.
In January 2001, the Company terminated its Agreement with FAR Services and
ceased the offering of memberships in The Shopper's Edge to its customers.
Members continued to have the ability to have their memberships automatically
renewed and billed unless canceled by the member. The last renewals of
memberships were processed in October 2001 by mutual agreement between the
Company and FAR Services as a result of the terms of the then-pending settlement
agreement between the Federal Trade Commission and Ira Smolev, the owner of FAR
Services. For the purpose of monitoring and processing refunds for the Company's
customers, the Company remained in its position as bookkeeper for the club
during 2001. The Company will continuecontinued to actively perform the function of
bookkeeper until April 2003, or the period of eighteen months beyond the time the last
member was renewed, since members are due refunds for cancellations which
4
might occur at any time during an annual membership and2003. The Company continues to administer surety bonds as
bookkeeper on behalf of The Shopper's Edge Club owner. During 2003, the number
of states on behalf of which bonds are held was reduced from six to two. They
continue to be secured by lettersa letter of credit, obtained with funds belonging to
the owner and held by the bookkeeper, are in place in six
states, and mustthat remain in place for six monthstwo and four
years beyond the last date of any membership.
In March 2001, the Company entered into a five-year marketing services
agreement with MemberWorks, Incorporated under which the Company's catalogs
market and offer a variety of MemberWorks membership programs for a wide variety
of goods and services to the Company's catalog customers when they call to place
an order. To the extent that the Company achieves a certain acceptance rate by
reading scripts to its customers, the Company is guaranteed a certain revenue
stream dependent upon the actual number of offers made. To the extent that the
program performs better than a pre-designated level, the Company will receive a
higher level of revenue than its guaranteed minimum. MemberWorks has the
exclusive rights to the first up-sell position on all merchandise order calls
made to the Company, after any cross-sells which the catalogs may make for their
own primary (or catalog-based) products, but before any offer for one of the
Company's pre-existing catalog-based membership clubs. The catalog companybrand may
choose not to read an up-sell script on all inbound order calls only due to
business necessities. Initially, prospective members participate in a 30-day
trial period that, unless canceled, is automatically converted into a full
membership term, which is one year in duration. Memberships are automatically
renewed at the end of each year unless canceled by the member. In early 2002,
the Company tested the offer of membership terms that were one month in
duration. Memberships arewere automatically renewed and billed at the end of each
month unless canceled by the member. The testCompany no longer offers monthly
memberships and the program was short and was discontinued butdiscontinued; however, there remain some
Company customers who are members of acontinue to renew the MemberWorks program on a month-to-month
membership term.
In December 2002, the Company entered into an agreement for Internet
marketing with MemberWorks, Incorporated under which the Company may conduct
marketing of MemberWorks membership programs to its Web site customers. It isNo
marketing was done under this agreement. In December 2003, the intentionCompany entered
into a new agreement for Internet marketing with MemberWorks on more favorable
terms. In the first quarter of 2004, the Company began to test the marketing of
MemberWorks programs on one Company Web site at first and intends to evaluate conversion
rates before making the decision to expand the
5
marketing to other Company Web sites or to terminate the agreement for Internet
marketing. On the Internet, the Company will offer MemberWorks programs to
customers immediately upon a customer reaching the order confirmation page after
placing an order. MemberWorks will pay for the initial
work required by the Company to design and implement the technology that will be
required to conduct Internet marketing of MemberWorks programs on the first
Company Web site. The Company's revenue share will provide for offers accepteda guaranteed
minimum revenue per page view. To the extent the program performs better than a
pre-designated level, the Company will be byreceive a calculation similar to that under the master MemberWorks agreement for telephone
promotion except that offershigher level of revenue than
its guaranteed minimum per page view. Offers to customers ofon the Company's Web
sites will not be counted for purposes of determining the guaranteed minimums
under the master MemberWorks agreement.
Customers may purchase memberships in a number of the Company's proprietary
buyers' clubBuyers'
Club programs for an annual fee. In addition to receivingThe Company defers revenue recognition for
membership fees received in its Buyers' Club programs until the cancellation
period ends. Thereafter, revenue net of actual cancellations is recognized on a
monthly basis over the remaining membership period. The Company also receives
commission revenue related to its solicitation of the MemberWorks membership
programs the
Company also receives commission revenue from sales ofand Magazine Direct magazine subscription programs on inbound order calls. For the MemberWorks program, the
Company is guaranteed a revenue stream dependent upon the actual number of
offers made. To the extent that the program performs better than a
pre-designated level, the Company will receive a higher level of revenue than
its guaranteed minimum. Revenue is recognized monthly based on the number of
acceptances received using a formula that has been contractually agreed upon by
the Company and MemberWorks.programs. The commission
revenue recognized by the Company for the Magazine Direct magazine program is on
a per-solicitation basis according to the number of solicitations made, with
additional revenue recognized if the customer accepts the solicitation.
InCollectively, the second quarteramount of revenues the Company recorded from these sources was
$5.7 million or 1.4% of net revenues, $5.1 million or 1.1% of net revenues, and
$4.8 million or 0.9% of net revenues for fiscal years 2003, 2002 and 2001,
respectively. As of May 2003, the Company will cease the offerdiscontinued its solicitation of the
Magazine Direct magazine program
on inbound order calls for the time being.program. The Company is considering newwill continue to consider opportunities to
offer new and different goods and services to its customers on inbound order
calls and the Company's Web sites from time to time, with the Company receiving
commission revenue related to its solicitations.
Marketing and Database Management. The Company maintains a proprietary
customer list currently containing approximately 6.35.9 million names of customers
who have purchased from one of the Company's catalogs or Internet Web sites within the
past 36 months. Approximately 2.62.4 million of the names on the list represent
customers who have made purchases from at least one of the Company's brands
within the last 12 months. The list contains name, gender, residence and
historical transaction data. This database is 5
selectively enhanced with
demographic, socioeconomic, lifestyle and purchase behavior overlays from other
sources. The Company also maintains a proprietary list of e-mail addresses
totaling approximately 1.72.2 million addresses.
The Company utilizes modeling and segmentation analysis to devise catalog
marketing and circulation strategies that are intended to maximize customer
contribution by catalog. This analysis is the basis for the Company's
determination of which of the Company's catalogs will be mailed and how
frequently to a particular customer, as well as the promotional incentive
content of the catalog(s) such customer receives.
The Company utilizes name lists rented from other mailers and compilers as
a primary source of new customers for the Company's catalogs. Many of the
catalogs participate in a consortium database of catalog buyers whereby new
customers are obtained by the periodic submission of desired customer buying
behavior and interests to the consortium and the subsequent rental of
non-duplicative names from the consortium. Other sources of new customers
include traditional print space advertisements and promotional inserts in
outbound merchandise packages.
On the Internet, the main sources of the Company's new customers are
through the brands' affiliate programs, through search engines, and a variety of
contractual Internet partnerships. An additional source of the Company's
internetInternet business is derived from print catalog mailings to prospective
customers.
During 2002, the Company expanded its relationship with Experian Marketing
Solutions, Inc. ("Experian"), under which Experian will act as the Company's
list cleaning and processing agent for all list usage purposes, to assist the
Company with its goal of reducing unprofitable circulation.
Purchasing. The Company's large sales volume permits it to achieve a
variety of purchasing efficiencies, including the ability to obtain prices and
terms that are more favorable than those available to smaller companies or than
would be available to the Company's individual catalogs were they to operate
independently. Major goods and services used by the Company are purchased or
leased from selected suppliers by its central buying staff. These goods and
services include paper, catalog printing and printing related services such as
order forms and color separations, communication systems including telephone
time and switching devices, packaging materials, expedited delivery services,
computers and associated network software and hardware.
The Company's telephone telemarketing phone service costs (both inbound and outbound
calls) are typically contracted for a two to three-year period. In the fourth
quarter of 1999, the Company entered into a two-year call center service
agreement with MCI WorldcomWorldCom and in the fourth quarter of 2001, the Company
revised its
6
agreement with MCI WorldCom to provide for a two-and-a-half-year extension
expiring during April 2004. Under the revised agreement, the Company obtained a
reduction in the rate it had been paying pursuant to the agreement entered into
in 1999. In connection with the revised agreement, the Company agreed to
guarantee minimum billing levels in the amount of $6.1 million for the 31 month31-month
service period and the Company has met and anticipates that it will continue to
meet such targets in the normal course of business. The Company has contracted
for additional services, some of which are redundant, from other service
providers in an effort to mitigate the possible effects of MCI WorldCom's
bankruptcy filing on the Company's service. In February 2004, the Company
entered into a 26-month call center service agreement with AT&T Corp. including
an option to renew for an additional year at the sole election of the Company.
This agreement includes a two-month "ramp-up" period covering the months of
March and April 2004, by the end of which services will be fully transitioned to
AT&T. In connection with this agreement, the Company has agreed to a guaranteed
net billing level of $1.0 million, after discounts, for each of the two
twelve-month periods following the "ramp-up" period.
The Company generally enters into annual arrangements for paper and
printing services with a limited number of suppliers. These arrangements permit
periodic price increases or decreases based on prevailing market conditions,
changes in supplier costs and continuous productivity improvements. For 2002,2003,
paper costs approximated 5.0%4.9% of the Company's net revenues. The Company
experienced a 14.4%4.5% decrease in paper prices during 2002.2003. The Company normally
experiences increased costs of sales and operating expenses as a result of the
general rate of inflation and commodity price fluctuations. Operating margins
are generally maintained through internal cost reductions and operating
efficiencies, and then through selective price increases where market conditions
permit.
Inventory Management. The Company's inventory management strategy is
designed to maintain inventory levels that provide optimum in-stock positions
while maximizing inventory turnover rates and minimizing the amount of unsold
merchandise at the end of each season. The Company manages inventory levels by
monitoring sales and fashion trends, making purchasing adjustments as necessary
and by promotional 6
sales. Additionally, the Company sells excess inventory
through special sale catalogs, sales/liquidation postings in brand Web sites,
e-auctions, its outlet stores and to jobbers.
The Company acquires products for resale in its catalogs from numerous
domestic and foreign vendors. No single third party source supplied more than
10% of the Company's products in 2002.2003. The Company's vendors are selected based
on their ability to reliably meet the Company's production and quality
requirements, as well as their financial strength and willingness to meet the
Company's needs on an ongoing basis.
At the end of fiscal 2003, the Company had received approximately $5.2
million in combined catalog and Internet orders that had not been shipped and
were not included in the net revenues of the Company. This amount was a decrease
of $0.3 million or 4.9% compared with the approximately $5.5 million of
unshipped orders existing at the end of fiscal 2002. These amounts consisted
mainly of backorders, orders awaiting credit card authorization, open dropship
orders and orders physically in the warehouse awaiting shipment to customers.
The Company fully expects to complete the shipment of these orders within the
2004 fiscal year.
Telemarketing and Distribution. The Company receives approximately 68.2%62.1%
of its orders through its toll-free telephone service, which offers customer
access seven days per week, 24 hours per day.
Telemarketing and Distribution.
The management information systems used by the Company are discussed below.
The Company mails its catalogs through the United States Postal Service ("USPS")
utilizing pre-sort, bulk mail and other discounts. Most of the Company's
packages are shipped through the USPS. Overall, catalog mailing and packagepackage-
shipping costs approximated 16.4%19.5% of the Company's net revenues in 2002. The2003. There
were no USPS implemented postage rate increases ranging from
13.5% for Priority Mail to 7.3% for Standard Mail effective June 30, 2002. These
increases did not have a material adverse effect on the Company's 2002 results
of operations. The Company mitigates the impact of postage rate increases by
utilizing lower rate structures by automatically weighing each parcel and
sorting and trucking packages to a number of USPS drop points throughout the
country.during 2003. The Company also utilizes United Parcel
Service and other delivery services. In 2002, the Company's contractual rates with United Parcel Service
remained the same as in 2001.January 2003 and 2004, United Parcel
Service increased its rates by 3.5% in January 2003 but the Company doesand 2.9%, respectively. The increase did not expect this increase to
have a material adverse effect on itsthe Company's 2003 results of operations. The
Company examines alternative shipping services with competitive rate structures
from time to time.
BUSINESS-TO-BUSINESS
General. The Company, through Keystone Internet Services, LLC
("Keystone"), provides back-end e-commerce transaction services to a roster of
Internet players.companies. Keystone's services range from fulfillment
7
and e-care to platform logistics products. Keystone also services the
logistical, IT and fulfillment needs of the Company's catalog operations.
Keystone comprises the Company's telemarketing, fulfillment and distribution
functions as well as its proprietary, fully integrated systems platform
internally known as Pegasus. That system is described under "Management
Information Systems" below. Other assets as of December 28, 200227, 2003 include threetwo
warehouse fulfillment centers, one leased temporary storage facility totaling
approximately 1.11.0 million square feet, and two telemarketing/e-care centers and
one satellite call center with over 670
agent positions. On February 28, 2002, the Company closed its telemarketing
facility in San Diego, California, which had 100approximately 750 agent positions.
Telemarketing. The Company has created a telephone network to link its
three primary telemarketing facilities in Hanover, Pennsylvania, York,
Pennsylvania and LaCrosse, Wisconsin. On February 28, 2002, the Company closed
its telemarketing facility in San Diego, California. The Company's telemarketing facilities
utilize state-of-the-art telephone switching equipment, which enables the
Company to route calls between telemarketing centers and thus provide prompt
customer service. In the fourth quarter of 2001, the Company extended its call
center services agreement with MCI WorldCom to provide that it would terminate
during April 2004. The Company has contracted for additional services, some of
which are redundant, from other service providers in an effort to mitigate the
possible effects of MCI WorldCom's bankruptcy filing on the Company's service.
In February 2004, the Company entered into a two-year call center service
agreement with AT&T Corp. including an option to renew for an additional year at
the sole election of the Company. This agreement is on more favorable terms than
the MCI WorldCom agreement. See "Direct Commerce -- Purchasing."
The Company trains its telemarketing service representatives to be
courteous, efficient and knowledgeable about the Company's products and those of
its third party customers. Telemarketing service representatives generally
receive 40 hours of training in selling products, services, systems and
communication skills through simulated as well as actual phone calls. A
substantial portion of the evaluation of telemarketing service representatives'
performance is based on how well the representative meets customer service
standards. While primarily trained with product knowledge to serve customers of
one or more specific catalogs, telemarketing service representatives also
receive cross training that enables them to take overflow calls from other
catalogs. The Company utilizes customer surveys as an important measure of
customer satisfaction.
7
Distribution. The Company presently operates threetwo distribution centers in
threetwo principal locations: one in Roanoke, Virginia one in Hanover,
Pennsylvania and one in LaCrosse,
Wisconsin. The Company uses these facilities to handle merchandise distribution
for its catalogs as well as its third party e-taile-commerce clients. See
"Properties."
Management Information Systems. All of the Company's catalogs are part of
its integrated mail order and catalog system operating on its mid-range computer
systems. Additionally, its fulfillment centers are part of the Company's
warehouse management system. The Company's systems have been designed to meet
its requirements as a high volume publisher of multiple catalogs. The Company is
continuing to devote resources to improving its systems.
The Company's software system is an on-line, real-time system, which is
used in managing all phases of the Company's operations and includes order
processing, fulfillment, inventory management, list management and reporting.
The software provides the Company with a flexible system that offers data
manipulation and in-depth reporting capabilities. The management information
systems are designed to permit the Company to achieve efficiencies in the way
its financial, merchandising, inventory, telemarketing, fulfillment and
accounting functions are performed.
Keystone Internet Services. Launched in 1998, Keystone Internet Services
initially serviced the needs of other direct marketers without back-end
fulfillment resources. Keystone currently offers e-commerce solutions and
services to a customer base of brand name manufacturers and retailers who lack
the end-to-end systems needed to enter e-commerce quickly, easily and
affordably.
Keystone offers its client baseclients the complete spectrum of six third party clientsfulfillment services
including List Services (Merge/ Purge, Hygiene, NCOA), paper/print services for
catalog production, telemarketing, data entry, distribution (Quality
Assurance/Quality Control, pick/pack/ship/returns), supply chain management and
such critical Information Technology services as of December
28, 2002, including HSN with respect to its Improvements business, the resources
needed on the "front-end" ranging from Web site creationdevelopment and
management to
Internet marketing to multi-channel marketing promotions to structured
financing. "Front-end" logistical services provided by Keystone include
telemarketinghosting, e-mail, voice response units, credit card authorization and e-care. Keystone can take orders off the Web and answer
e-mails as well as handlebilling,
order processing, credit card transaction processing,
customer databasewarehouse management systems, and systems programminginventory planning and
interface support. On
the "back-end," Keystone offers services including fulfillment, order
management, inventory management and facility management.8
control. All of this can be done using the Company's proprietary Pegasus
multi-channel, multi-title platform described above.
CREDIT MANAGEMENT
Several of the Company's catalogs, including Domestications, International
Male, Silhouettes and Gump's By Mail, offerhad previously offered their own private
label credit cards. In 1999, the Company entered into a new three-year account
purchase and credit card marketing and services agreement with Capital One
Services, Inc. and Capital One Bank under which Capital One providesprovided for the
sale and servicing of accounts receivable originating from the Company's private
label credit card program. The Company and Capital One have terminated their
agreement effectiveduring the second quarter of 2003. The Company continues its search
for a more economical provider of private label credit card services.
FINANCING
Changes to Congress Credit Facility. TheOn December 27, 2003, the Company's
credit facility, as amended (the "Congress Credit Facility"), with Congress
Financial Corporation ("Congress") provides the Company withcontained a maximum credit line, subject to
certain limitations, of up to $82.5 million (the "Congress$56.5 million. In October 2003, the Company
amended the Congress Credit Facility").Facility to extend the expiration thereof from
January 31, 2004 to January 31, 2007. The Congress Credit Facility, as amended, expires on January
31, 2004 and
comprises a revolving loan facility, a $17.5 million Tranche A Term Loan, and a
$8.4$6.3 million Tranche B Term Loan. Total cumulative borrowings however,under the Congress
Credit Facility are subject to limitations based upon specified percentages of
eligible receivables and eligible inventory, and the Company is required to
maintain $3.0 million of excess credit availability at all times. The Congress
Credit Facility as amended, is secured by all of the assets of the Company and places restrictions on
the incurrence of additional indebtedness and on the payment of common stock
dividends. 8
As of December 28, 2002,27, 2003, the revolving loan facility of $9.0 million
was recognized as a current liability on the Company's Consolidated Balance
Sheet. On or before April 30, 2004, the Company had $25.1 millionis required to enter into a
restatement of borrowings
outstanding under the amendedloan agreement with Congress Credit Facility comprising $8.8 million
underrequiring no changes to the
Revolving Loan Facility, $8.5 million underterms of the Tranche A Term Loan,
and $7.8 million under the Tranche B Term Loan. The Company may draw upon the
amended Congress Credit Facility to fund working capital requirements as needed.
In November 2001, the Company amendedcurrent agreement.
Under the Congress Credit Facility, the Company is required to waive
a default that resulted frommaintain
minimum net worth, working capital and EBITDA as defined throughout the calculationterm of
the EBITDA covenant requirement
and revised the definitionagreement. As of EBITDA to include the net income derived from the
sale of the Kindig Lane Property and the assets of the Improvements business. In
addition, the amendment required a reserve of $500,000 against the availability
under the Congress Credit Facility's borrowing terms and a fee of $500,000.
In March 2002,December 27, 2003, the Company amendedwas not in compliance with
the working capital covenant; however, it has subsequently received a waiver
from Congress addressing the deficiency. The Company was in compliance with all
other covenants as of December 27, 2003. There can be no assurance that Congress
will waive any future non-compliance by the Company with the financial and other
covenants contained in the Congress Credit Facility, which could result in a
default by the Company, allowing Congress to changeaccelerate the definition of Consolidated Net Worth such that, effective July 1, 2002, toamounts due under
the extent that the goodwill or intangible assetsfacility.
A summary of the Company and its
subsidiaries are impaired under the provisions of Statement of Financial
Accounting Standards No. 142, such write-off of assets would not be considered a
reduction of total assets for the purposes of computing Consolidated Net Worth.
The covenants relating to consolidated net working capital, consolidated net
worth and EBITDA and certain non-cash charges were also amended. In addition,
the amendment required a fee of $100,000.
On August 16, 2002, the Company amended the Congress Credit Facility to (i)
extend the term of the Tranche B Term Loan to January 31, 2004, (ii) increase by
$3,500,000 the borrowing reflected by the Tranche B Term Note to $8,410,714, and
(iii) make certain related technical amendments to the Congress Credit Facility.
The amendment required the payment of fees in the amount of $410,000.
In December 2002, the Company amended the Congress Credit Facility to amend
the definition of "Consolidated Net Income," "Consolidated Net Worth" and
"Consolidated Working Capital" to make certain adjustments thereto, depending on
the results of the Kaul litigation, to permit the payment to Richemont of
certain United States withholding taxes payable to Richemont in connection with
the Series B Preferred Stock, and to change certain borrowing sublimits. The
consolidated working capital, consolidated net worth and EBITDA covenants were
also established through the end of the term of the facility, and certain
technical amendments relating to the reorganization of certain of the Company's
subsidiaries were made. The amendment required the payment of fees in the amount
of $110,000.implemented during 2003 is as follows:
In February 2003, the Company amended the Congress Credit Facility to amend
the existing change in control Event of Default. The existing change in control
Event of Default under the Congress Credit Facility iswas based upon NAR Group
Limited, a former shareholder of the Company, ceasing to be the direct or
indirect beneficial owner of a sufficient number of issued and outstanding
shares of capital stock of the Company on a fully diluted basis to elect a
majority of the members of the Company's Board of Directors. This was replaced
during February 2003 with a new change in control Event of Default, which is
patterned on the Change In Control concepts in the Company's various Key
Executive Compensation Continuation Plans. The new Event of Default would be
triggered by certain transfers of assets, certain liquidations or dissolutions,
the acquisition by a person or group (other than a Permitted Holder, as defined)
of a majority of the total outstanding voting stock of the Company, and certain
changes in the composition of the Company's Board of Directors.
In April 2003, the Company amended the Congress Credit Facility to allow
the Company's chief financial officer or its corporate controller to certify the
financial statements required to be delivered to Congress under the Congress
Credit Facility, rather than the chief financial officer of each subsidiary
borrower or guarantor.
In August 2003, the Company amended the Congress Credit Facility to make
certain technical amendments thereto, including the amendment of the definition
of Consolidated Net Worth and the
9
temporary release of a $3.0 million availability reserve established thereunder.
The temporary release of the $3.0 million availability reserve was removed by
the end of fiscal year 2003. The amendment required the payment of fees in the
amount of $165,000.
In October 2003, the Company amended the Congress Credit Facility to extend
the expiration thereof from January 31, 2004 to January 31, 2007, to reduce the
amount of revolving loans available thereunder to $43.0 million, to make
adjustments to the sublimits available to the various borrowers thereunder, to
amend the EBITDA covenant to specify minimum levels of EBITDA that must be
achieved during the Company's fiscal years ending 2004, 2005 and 2006, to permit
the borrowing under certain circumstances of up to $1.0 million against certain
inventory in transit to locations in the United States, and to make certain
other technical amendments. The amendment required the payment of fees in the
amount of $650,000.
On November 4, 2003, the Company amended the Congress Credit Facility to
change the definition of Consolidated Net Worth so as to provide that for the
purposes of calculating such amount for the Company's fiscal year ending
December 27, 2003, the Company's net deferred tax assets in the amount of $11.3
million that are required to be fully reserved pursuant to Statement of
Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes"
("SFAS 109"), shall be added back for the purposes of determining the Company's
assets.
On November 25, 2003, the Company amended the Congress Credit Facility to
receive consent from Congress in regards to the Recapitalization Agreement with
Chelsey so that the Company could exchange 1,622,111 shares of Series B
Participating Preferred Stock held by Chelsey in consideration of the issuance
by the Company of 564,819 shares of newly issued Series C Participating
Preferred Stock and 81,857,833 shares of newly issued Common Stock to Chelsey.
In addition, the Company may repurchase, redeem or retire shares of its Series C
Participating Preferred Stock owned by Chelsey using a portion of the net
proceeds from any asset sales consummated after the implementation of all asset
sale lending adjustments. The Company also amended the Congress Credit Facility
to make certain technical amendments thereto, including the amendment of the
amounts of Consolidated Working Capital and Consolidated Net Worth. The
amendment required the payment of fees in the amount of $150,000.
The Company has 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 is required to reclassify its
revolving loan facility from long-term to short-term debt, though the existing
revolving loan facility does not mature until January 31, 2007. As a result, the
Company reclassified $8.8 million as of December 28, 2002 from Long-term debt to
Short-term debt and capital lease obligations that is classified as Current
liabilities. See Note 18 of Notes to Consolidated Financial Statements for
further discussion regarding the restatement of prior year borrowings
outstanding under the Congress Credit Facility.
As of December 27, 2003, the Company had $21.5 million of cumulative
borrowings outstanding under the Congress Credit Facility, comprising $9.0
million 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, $12.8 million is classified as short-term to
be paid within twelve months with $8.7 million classified as long-term on the
Company's Consolidated Balance Sheet. As of December 28, 2002, the Company had
$25.1 million of borrowings outstanding under the Congress Credit Facility
comprising $8.8 million under the revolving loan facility, bearing an interest
rate of 4.75%, $8.5 million under the Tranche A Term Loan, bearing an interest
rate of 5.0%, and $7.8 million under the Tranche B Term Loan, bearing an
interest rate of 13.0%.
The revolving loan facility bears interest at prime plus 0.5% or Eurodollar
plus 2.5%, the Tranche A Term Loans bear interest at prime plus 0.75% or
Eurodollar plus 3.5%, and the Tranche B Term Loans bear interest at prime plus
4.25%, but in no event less than 13.0%.
On March 25, 2004, the Company amended the Congress Credit Facility to
change the definition of Consolidated Net Worth, to amend the Consolidated
Working Capital and Consolidated Net Worth covenants to specify minimum levels
of Consolidated Working Capital and Consolidated Net Worth that must be
maintained during each month commencing January 2004, and to amend the EBITDA
covenant to specify
10
minimum levels of EBITDA that must be achieved during the Company's fiscal years
ending 2004, 2005 and 2006. The Company expects to maintain the minimum levels
of these covenants in future periods. In addition, the definition of "Event of
Default" was amended by replacing the Event of Default which would have occurred
on the occurrence of a material adverse change in the business, assets,
liabilities or condition of the Company and its subsidiaries, with an Event of
Default which would occur if certain specific events, such as a decrease in
consolidated revenues beyond certain specified levels or aging of inventory or
accounts payable beyond certain specified levels, were to occur.
Based on the provisions of EITF 95-22 and certain provisions in the credit
agreement, the Company is required to classify its revolving loan facility as
short-term debt. See Note 18 for further discussion regarding the restatement of
prior year borrowings outstanding under the Congress Credit Facility.
The Company is considering replacing the Congress Credit Facility with a
new senior loan facility from a major financial institution with more favorable
terms. However, there can be no assurance that such a facility will be found.
The Company is also considering a sale-lease back of its principal warehouse and
distribution center, the funds from which would be used to reduce the Company's
debt, although no definitive agreements have been reached. There can be no
assurance that the Company will engage in such a transaction.
Richemont Transaction; Series A and B Participating Preferred Stock. On
August 24, 2000, the Company issued 1.4 million shares of preferred stock
designated as Series A Cumulative Participating Preferred Stock (the "Series A
Participating Preferred Stock") to Richemont, the then holder of approximately
47.9% of the Company's Common Stock, for $70.0$70 million. The Series A Participating
Preferred Stock is described below under "Additional Investments."had a par value of $0.01 per share and a liquidation preference
of $50.00 per share and was recorded net of issuance costs of $2.3 million. The
issuance costs were being accreted as an additional dividend over a five-year
period ending on the mandatory redemption date. Dividends were cumulative and
accrued at an annual rate of 15%, or $7.50 per share, and were payable quarterly
either in cash or in-kind through the issuance of additional Series A
Participating Preferred Stock. Cash dividend payments were required for dividend
payment dates occurring after February 1, 2004. As of September 30, 2001, the
Company has filedaccrued dividends of $12,389,700, and reserved 247,794 additional shares
of Series A Participating Preferred Stock for the payment of such dividends.
In-kind dividends and issuance cost accretion were charged against additional
paid-in capital, with a certificatecorresponding increase in Delaware eliminatingthe carrying amount of the
Series A Participating Preferred Stock. Cash dividends were also reflected as a
charge to additional paid-in capital, however, no adjustment to the carrying
amount of the Series A Participating Preferred Stock from its
certificatewas made. The Series A
Participating Preferred Stock was generally non-voting, except if dividends had
been in arrears and unpaid for four quarterly periods, whether or not
consecutive. The holder of incorporation.the Series A Participating Preferred Stock was
entitled to receive additional participating dividends in the event any
dividends were declared or paid, or any other distribution was made, with
respect to the Common Stock of the Company. The additional dividends would be
equal to the applicable percentage of the amount of the dividends or
distributions payable in respect of one share of Common Stock. In the event of a
liquidation or dissolution of the Company, the holder of the Series A
Participating Preferred Stock would be paid an amount equal to $50.00 per share
of Series A Participating Preferred Stock plus the amount of any accrued and
unpaid dividends, before any payments to other shareholders.
The Company could redeem the Series A Participating Preferred Stock in
whole at any time and the holder of the Series A Participating Preferred Stock
could elect to cause the Company to redeem all or any of such holder's Series A
Participating Preferred Stock under certain circumstances involving a change of
control, asset disposition or equity sale. Mandatory redemption of the Series A
Participating Preferred Stock by the Company was required on August 23, 2005
(the "Final Redemption Date") at a redemption price of $50.00 per share of
Series A Participating Preferred Stock plus the amount of any accrued and unpaid
dividends.
On December 19, 2001, the Company consummated a transaction with Richemont
(the "Richemont Transaction") in which. In the Richemont Transaction, the Company
repurchased from Richemont all of the outstanding shares of the Series A
Participating Preferred Stock and 74,098,769 shares of the common stockCommon Stock of the
Company held by Richemont in return for the issuance to Richemont of 1,622,111
shares of newly
creatednewly-created Series B Participating Preferred Stock (the "Series B
Participating Preferred Stock") and the reimbursement of expenses of $1 million
to Richemont. The Richemont
Transaction was made pursuant to an Agreement (the "Richemont Agreement"), dated
as of December 19, 2001, between the Company and Richemont. Richemont agreed, as part of the Richemont Transaction,transaction, to
911
forego any claim it had to the accrued but unpaid dividends on the Series A
Participating Preferred Stock. The Richemont Transaction was made pursuant to an
Agreement (the "Agreement"), dated as of December 19, 2001, between the Company
and Richemont. As part of the Richemont Transaction, the Company (i) released
Richemont, the individuals appointed by Richemont to the Board of Directors of
the Company and certain of their respective affiliates and representatives
(collectively, the "Richemont Group") from any claims by or in the right of the
Company against any member of the Richemont Group thatwhich arise out of Richemont's
acts or omissions as a stockholder of or lender to the Company or the acts or
omissions of any Richemont board designee in his capacity as such and (ii)
entered into an Indemnification Agreement (the "Indemnification Agreement") with
Richemont pursuant to which the Company agreed to indemnify each member of the
Richemont Group from any losses suffered as a result of any third party claim
thatwhich is based upon Richemont's acts as a stockholder of or lender to the
Company or the acts or omissions of any Richemont board designee in his capacity
as such. The Indemnification Agreement is not limited as to term and does not
include any limitations on maximum future payments thereunder. The termsimpact of the
Richemont Transaction was to reflect the reduction of the Series A Participating
Preferred Stock for the then carrying amount of $82.4 million and the issuance
of Series B Participating Preferred Stock in the amount of $76.8 million, which
was equal to the aggregate liquidation preference of the Series B Participating
Preferred Stock on December 19, 2001. In addition, the par value of $49.4
million of the Common Stock repurchased by the Company and subsequently retired
was reflected as a reduction of Common Stock, with an offsetting increase to
capital in excess of par value. The Company recorded a net decrease in
shareholders' deficiency of $5.6 million as a result of the Richemont
Transaction.
The shares of the Series A Participating Preferred Stock that were
repurchased from Richemont represented all of the outstanding shares of such
series. The Company filed a certificate in Delaware eliminating the Series A
Participating Preferred Stock from its Certificate of Incorporation.
Chelsey Transaction; Series C Participating Preferred Stock. On or about
May 19, 2003, Richemont sold to Chelsey all of Richemont's securities in the
Company consisting of 29,446,888 shares of Common Stock and 1,622,111 shares of
Series B Participating Stock (the Common Stock, together with the Participating
Preferred Stock, the "Shares") for a purchase price equal to $40 million. The
Company was not a party to such transaction. On November 30, 2003, the Company
consummated a transaction with Chelsey (the "Recapitalization") in which the
Company exchanged 564,819 shares of a newly issued Series C Participating
Preferred Stock and 81,857,833 shares of newly issued Common Stock for the
1,622,111 shares of Series B Participating Preferred Stock then held by Chelsey,
reconstituted the Board of Directors of the Company and settled certain
outstanding litigation between the Company and Chelsey. The Company filed a
certificate in Delaware eliminating the Series B Participating Preferred Stock
from its Certificate of Incorporation. Immediately prior to the consummation of
the transaction, Chelsey was the holder of 29,446,888 shares of Common Stock and
1,622,111 shares of Series B Participating Preferred Stock having 10 votes per
share. Thus, based on 138,315,800 shares of Common Stock outstanding immediately
prior to the consummation of the transaction, Chelsey was the beneficial owner
of approximately 21.2% of the Company's outstanding Common Stock and 29.5% of
the Company's outstanding voting securities. Immediately after the consummation
of the transaction, Chelsey was the holder of 111,304,721 shares of Common Stock
(representing approximately 50.6% of the outstanding common shares) and 564,819
shares of the 100 votes per share Series C Participating Preferred Stock. Thus,
based on 220,173,633 shares of Common Stock and 564,819 shares of Series C
Participating Preferred Stock outstanding immediately after the consummation of
the transaction, Chelsey was entitled to cast 167,786,621 votes on all matters
on which the stockholders vote, or approximately 60.6% of the total number of
votes entitled to be cast. The terms and conditions of the Recapitalization were
set forth in a Recapitalization Agreement, dated as of November 18, 2003,
between the Company, Regan Partners and Chelsey (see Note 8 of the Company's
Consolidated Financial Statements). In connection with the Recapitalization, the
Company also entered into a registration rights agreement with Chelsey and
Stuart Feldman and a corporate governance agreement with Chelsey and Regan
Partners and Chelsey and Regan Partners entered into a voting agreement (see
"Item 10. Directors and Executive Officers of the Registrant").
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
12
$0.01 per share. The holders of the Series C Participating Preferred Stock are
described below under "Additional Investments."
General. At December 28, 2002,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 such Series C Participating Preferred Stock. In addition, in the event
that the Company had $0.8 million in cash and
cash equivalents compared with $1.1 million at December 29, 2001. Working
capital and current ratios at December 28, 2002 were $0.6 million and 1.01 to 1
versus $7.4 million and 1.08 to 1 at December 29, 2001. Total cumulative
borrowings, including financingdefaults on its obligations under capital lease obligations, asthe Certificate of
December
28, 2002, aggregated $25.1 million, $12.5 million of which is classified as
long-term. Remaining availability underDesignations, the Recapitalization Agreement or the Congress Credit Facility,
asthen the holders of December 28, 2002 was $18.2 million. There were nominal capital commitments
(less than $0.1 million) at December 28, 2002.
ADDITIONAL INVESTMENTSthe Series BC Participating Preferred Stock. On December 24, 2001,Stock, voting as parta
class, shall be entitled to elect twice the number of directors as comprised the
Richemont Transaction,Board of Directors on the Company issueddefault date, and sold 1,622,111 sharessuch additional directors shall be
elected by the holders of preferred stock designated asrecord of Series BC Participating Preferred Stock par value $0.01 per
share,as
set forth in a private placement to Richemont.the Certificate of Designations.
In the event of the liquidation, dissolution or winding up of the Company,
the holders of the Series BC Participating Preferred Stock are entitled to a
liquidation preference (the "Liquidation Preference"), which was initially $47.36of $100 per share.
During each period set forth in the table below, the Liquidation Preference
shall equal theshare or an aggregate amount set forth opposite such period:
LIQUIDATION PREFERENCE
PERIOD PER SHARE TOTAL VALUE
- ------ ---------------------- ---------------
March 1, 2002 - May 31, 2002...................... $49.15 $ 79,726,755.65
June 1, 2002 - August 31, 2002.................... $51.31 $ 83,230,515.41
September 1, 2002 - November 30, 2002............. $53.89 $ 87,415,561.79
December 1, 2002 - February 28, 2003.............. $56.95 $ 92,379,221.45
March 1, 2003 - May 31, 2003...................... $60.54 $ 98,202,599.94
June 1, 2003 - August 31, 2003.................... $64.74 $105,015,466.14
September 1, 2003 - November 30, 2003............. $69.64 $112,963,810.04
December 1, 2003 - February 29, 2004.............. $72.25 $117,197,519.75
March 1, 2004 - May 31, 2004...................... $74.96 $121,593,440.56
June 1, 2004 - August 31, 2004.................... $77.77 $126,151,572.47
September 1, 2004 - November 30, 2004............. $80.69 $130,888,136,59
December 1, 2004 - February 28, 2005.............. $83.72 $135,803,132.92
March 1, 2005 - May 31, 2005...................... $86.85 $140,880,340.35
June 1, 2005 - August 23, 2005.................... $90.11 $146,168,422.21
As a result, beginning November 30, 2003, the aggregate Liquidation
Preference of the Series B Preferred Stock$56,481,900.
Commencing January 1, 2006, dividends will be effectively equal to the
aggregate liquidation preference of the Class A Preferred Stock previously held
by Richemont. For each increase in liquidation preference, the Company will
reflect the
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change as an increase in the Series B Preferred Stock with a corresponding
reduction in additional paid-in capital. Such accretion will be recorded as a
reduction of net income available to common shareholders.
The holders of the Series B Preferred Stock are entitled to ten votes per
share on any matter on which the common stock votes. In addition, in the event
that the Company defaults in its obligations under the Richemont Agreement, the
Certificate of Designations of the Series B Preferred Stock or its agreements
with Congress, or in the event that the Company fails to redeem at least 811,056
shares of Series B Preferred Stock by August 31, 2003, then the holders of the
Series B Preferred Stock, voting as a class, shall be entitled to elect two
members to the Board of Directors of the Company.
Dividendspayable quarterly on the
Series BC Participating Preferred Stock are required to be paid whenever
aat the rate of 6% per annum, with the
preferred dividend is declaredrate increasing by 1 1/2% per annum on the common stock. The amount of any dividend on the
Series B Preferred Stock shall be determined by multiplying (i) the amount
obtained by dividing the amounteach anniversary of
the dividend oncommencement date until redeemed. At the common stock byCompany's option, in lieu
of cash dividends, the then
current fair market value ofCompany 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 Company's credit
agreement with Congress Financial Corporation currently prohibits the payment of
common stockdividends.
The Series C Participating Preferred Stock may be redeemed in whole and (ii)not
in part, except as set forth below, at the Liquidation
Preferenceoption of the Series B Preferred Stock.Company at any time for
the liquidation preference and any accrued and unpaid dividends (the "Redemption
Price"). The Series BC Participating Preferred Stock mustwill be redeemed by the
Company on August 23,
2005 consistent withJanuary 1, 2009 (the "Mandatory Redemption Date") for the requirementRedemption
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, the Series C Participating Preferred Stock will be entitled to elect one-
half ( 1/2) of the Delaware General Corporation Law.
TheCompany's Board of Directors. Notwithstanding the foregoing,
the Company maywill redeem all or less than allthe maximum number of the then outstanding shares of Series BC Participating
Preferred Stock at any time prioras possible with the net proceeds of certain asset and equity
sales not required to that date. Atbe used to repay Congress Financial Corporation pursuant
to the optionterms of the holders thereof, the Company must redeem the Series B Preferred Stock upon a
Change of Control or upon the consummation of an Asset Disposition or Equity
Sale (all as defined in the Certificate of Designations of the Series B
Preferred Stock). The redemption price for the Series B Preferred Stock upon a
Change of Control or upon the consummation of an Asset Disposition or Equity
Sale is the then applicable Liquidation Preference of the Series B Preferred
Stock plus the amount of any declared but unpaid dividends on the Series B
Preferred Stock. The Company's obligation to redeem the Series B Preferred Stock
upon an Asset Disposition or an Equity Sale is subject19th Amendment to the satisfaction of
certain conditions set forth inLoan and Security Agreement with
Congress Financial Corporation (as modified by the Certificate of Designations.
The Certificate of Designations of29th Amendment to the Series B Preferred Stock provides
that, for so long as Richemont is the holder of at least 25% of the then
outstanding shares of Series B Preferred Stock, it shallLoan
and Security Agreement), and Chelsey will be entitledrequired to appoint
a non-voting observer to attend all meetings of the Board of Directors and any
committees thereof.accept such
redemptions.
Pursuant to the terms of the Certificate of Designations of the Series BC
Preferred Stock, the Company's obligation to pay dividends on or redeem the
Series BC Participating Preferred Stock is subject to its compliance with its
agreements with Congress.
The Congress Credit Facility requires that the proceeds from certain
asset sales byBecause its Series B Participating Preferred Stock was mandatorily
redeemable and thus accounted for as a liability, the Company be paid to Congress before any such proceeds are used
to redeemaccounted for the
exchange of 1,622,111 outstanding shares of its Series B Preferred Stock.
During autumn 2002, Company management conducted a strategic reviewStock held by
Chelsey for the issuance of 564,819 shares of newly-created Series C
Participating Preferred Stock and 81,857,833 additional shares of Common Stock
of the Company's businessCompany to Chelsey in accordance with SFAS No. 15 "Accounting by Debtors
and operations.Creditors for Troubled Debt Restructuring." As part of such, review, Company management
considered the Company's obligations under the Richemont Agreement and the
Company's prospects and options for redemption$107.5 million
carrying value of the Series B Participating Preferred SharesStock 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 Richemont pursuant thereto in accordance with the Richemont Agreement
terms. The review took into account the resultsChelsey as of the Company's strategic
business realignment program in 2001 and 2002, the relative strengths and
weaknesses of the Company's competitive positionconsummation
date and the economic and business
climate, including the depressed business environment for mergers and
acquisitions.
As a resulttotal maximum potential cash payments of this review, Company management and the Company's Board of
Directors have concludedapproximately $72.7
million that it is unlikely that the Company willcould be able to
accumulate sufficient capital, surplus, or other assets under Delaware corporate
law or to obtain sufficient debt financing to either:
1. Redeem at least 811,056 shares of the Series B Preferred Stock by
August 31, 2003, as allowed for by the Richemont Agreement, thereby
resulting in the occurrence of a "Voting Trigger" which will allow
Richemont to have the option of electing two members to the Company's Board
of Directors; or
2. Redeem all of the shares of Series B Preferred Stock by August 31,
2005, as required by the Richemont Agreement, thereby obligating the
Company to take all measures permitted under the Delaware General
Corporation Law to increase the amount of its capital and surplus legally
available to
11
redeem the Series B Preferred Shares, without a material improvement in
either the business environment for mergers and acquisitions or other
factors, unforeseeable at the time.
Management believes that the Company has sufficient liquidity and
availability under its credit agreement to fund its planned operations through
at least January 31, 2004. Management will be required to successfully
renegotiate the renewal of the Congress Credit Facility or successfully replace
the facility with another institution. The unlikelihood that the Company will be
able to redeem the Series B Preferred Shares is not expected to limit the
ability of the Company to use current and future net earnings or cash flow to
satisfy its obligations to creditors and vendors. In addition, the redemption
price of the Series B Preferred Stock does not accrete after August 31, 2005.
Company management met with representatives of Richemont on October 30,
2002 and outlined the results of management's strategic review in the context of
the Company's obligations to Richemont under the Richemont Agreement, and
discussed an alternative to the method for the redemption of the Series B
Preferred Shares. Under this alternative proposal, that the Company had
previously presented to Richemont, the Company would exchange two business
divisions, Silhouettes and Gump's, for all of Richemont's Series B Preferred
Shares (the "Proposal").
Pursuantmade pursuant to the terms of the Richemont Agreement, the redemption value of
the Series B Preferred Shares as of the date of the Proposal was $87 million.
Management based the Proposal terms on a valuation of Silhouettes and Gump's
using the valuation multiple employed in USA Network's June 2001 purchase of the
Company's Improvements business division. The Proposal also included a
willingness on the part of the Company to provide continued fulfillment services
for Silhouettes and Gump's on terms to be negotiated. On November 18, 2002, a
representative of Richemont confirmed in writing to the Company that Richemont
rejected the Proposal. Representatives of Richemont have indicated that it has
no interest in the proffered assets and disputes their valuation implied in the
Company's Proposal.
The Company will continue to explore all reasonable opportunities to redeem
and retire the Series B Preferred Stock.
For Federal income tax purposes, the increases in the Liquidation
Preference of the Series B Preferred Stock are considered distributions, by the
Company to Richemont, deemed made on the commencement dates of the quarterly
increases, as discussed above. These distributions may be taxable dividends to
Richemont, provided the Company has accumulated or current earnings and profits
("E&P") for each year in which the distributions are deemed to be made. Under
the terms of the Richemont Transaction, the Company is obligated to reimburse
Richemont for any U.S. income tax incurred pursuant to the Richemont
Transaction. Based on the Company's past income tax filings and its current
income tax position, the Company has an E&P deficit as of December 28, 2002.
Accordingly, the Company has not incurred a tax reimbursement obligation for
year 2002. The Company must have current E&P in years 2003, 2004 or 2005 to
incur a tax reimbursement obligation from the scheduled increases in Liquidation
Preference. If the Company does not have current E&P in one of those years, no
tax reimbursement obligation would exist for that particular year. The Company
does not have the ability to project the exact future tax reimbursement
obligation, however, it has estimated the potential obligation to be in the
range of $0 to $23.1 million.
Series A CumulativeC Participating
Preferred Stock. On August 24, 2000,Since the Company issued and sold 1.4 million shares of preferred stock designated as
Series A Cumulative Participating Preferred Stock in a private placement (not
involving the use of underwriters or other placement agents) to Richemont, which
then owned approximately 47.9% of the Company's outstanding common stock, for an
aggregate purchase price of $70.0 million in cash. There were no underwriting
discounts or commissions related to such sale. The rights of the holders of the
Company's common stock were limited or qualified by such issuance and sale.
The Series A Preferred Stock had a parcarrying value, of $0.01 per share, and a
liquidation preference of $50.00 per share, and was recorded net of issuance costs of
$2.3 million. The issuance costs wereapproximately $1.3 million, exceeded these amounts by approximately $13.9
million, pursuant to SFAS No. 15, such excess was determined to be accreted as a dividend over
a five-year period ending on the mandatory redemption date. Dividends are
cumulative"gain" and accrue at an annual rate of 15%, or $7.50 per share, and are
payable quarterly either in cash or in-kind through the issuance of additional
Series A Preferred Stock. Cash dividend payments were required for dividend
12
payment dates occurring after February 1, 2004. As of December 30, 2000, the
Company accreted dividends of $3.8 million, and reserved 75,498 additional
shares of Series A Preferred Stock for the payment of such dividend. In-kind
dividends and issuance cost accretion are charged against additional paid-in
capital, with a corresponding increase in the carrying amount of
the Series A
Preferred Stock. Cash dividends were also reflected as a charge to additional
paid-in capital, however, no adjustment to the carrying amount of the Series AC Participating Preferred Stock was made. The Series A Preferred Stock was generally non-voting,
except if dividends have been in arrears and unpaid for four quarterly periods,
whether or not consecutive. The holder of the Series A Preferred Stock would
then have the exclusive right to elect two directors of the Company until such
time as all such cumulative dividends accumulated on the Series A Preferred
Stock have been paid in full. Furthermore, the holder of the Series A Preferred
Stock was entitled to receive additional participating dividends in the event
any dividends are declared or paid on, or any other distribution is made with
respect to, the common stock of the Company. The additional dividends would be
equal to 6150% ofrecorded 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 dividends or distributions payable in
respect of one share of common stock. In the event of a liquidation or
dissolutiontime of the exchange and, as a result, a related party, the
"gain" was recorded in equity.
13
General. At December 27, 2003, the Company the holder ofhad $2.3 million in cash and
cash equivalents compared with $0.8 million at December 28, 2002. Working
capital and current ratio at December 27, 2003 were $(2.0) million and 0.97 to
1. Total cumulative borrowings, including financing under capital lease
obligations and excluding the Series A Preferred Stock would be
paid an amount equal to $50.00 per share of Series A Preferred Stock plus the
amount of any accrued and unpaid dividends, before any payments to other
stockholders.
The Company could redeem the Series A Preferred Stock in whole at any time
and the holder of the Series A Preferred Stock could elect to cause the Company
to redeem all or any of such holder's Series A Preferred Stock under certain
circumstances involving a change of control, asset disposition or equity sale.
Mandatory redemption of the Series A Preferred Stock by the Company was required
on August 23, 2005 (the "Final Redemption Date") at a redemption price of $50.00
per share of Series A Preferred Stock plus the amount of any accrued and unpaid
dividends. If, at the Final Redemption Date, the Company did not have sufficient
capital and surplus legally available to redeem all the outstanding shares of
the Series A Preferred Stock, the Company would be required to take all measures
permitted under the Delaware General Corporation Law to increase the amount of
its capital and surplus legally available and to redeem as many shares of the
Series AC Participating Preferred Stock, as it may legally redeem. Thereafter,of
December 27, 2003, aggregated $22.5 million, $9.0 million of which is classified
as funds become
available,long-term. Remaining availability under the Company would be requiredCongress Credit Facility as of
December 27, 2003 was $9.9 million. The liquidation preference relating to redeem as many additional shares of the
Series AC Participating Preferred Stock as it legally can, until it has redeemed all
remaining outstanding shares of the Series A Preferred Stock.
On December 19, 2001, as part of the Richemont Transaction, the Company
repurchased from Richemont all of the outstanding shares of the Series A
Preferred Stock. Richemont agreed, as part of the transaction, to forego any
claim it had to the accrued but unpaid dividends on the Series A Preferred
Stock. The Company has filed a certificate in Delaware eliminating the Series A
Preferred Stock from its certificate of incorporation.27, 2003 was $56.5
million. There were nominal capital commitments (less than $0.2 million) at
December 27, 2003.
EMPLOYEES
As of December 28, 2002,27, 2003, the Company employed approximately 1,8301,722 people on
a full-time basis and approximately 291192 people on a part-time basis. The number
of part-time employees at December 28, 200227, 2003 reflects a temporary increase in
headcount necessary to fill the seasonal increase in orders during the holiday
season. Approximately 226209 of the Company's employees at one of its subsidiaries
are represented by a union. The Company entered into a new agreement with The
Union of Needletrades, Industrial and Textile Employees (UNITE!) in March 2003,
which expires on February 26, 2006. The Company believes its relations with its
employees are good.
During the fiscal year ended December 28, 2002,27, 2003, the Company eliminated a
total of approximately 30139 FTE positions, including approximately 12two positions
at or above the level of director, which included open positions that were
eliminated. The Company made prospective payments to separated employees either
weekly or bi-weekly, based upon each person's previous payment schedule.
SEASONALITY
The Company does not consider its business seasonal. The revenues and
business for the Company are proportionally consistent for each quarter during a
fiscal year. The percentage of annual revenues for the first, 13
second, third and
fourth quarters recognized by the Company were as follows: 2003 -- 24.7%, 25.5%,
23.3% and 26.5%; 2002 -- 23.9%, 24.9%, 23.2% and 28.0%; and 2001 -- 27.1%,
25.1%, 22.1% and 25.7%;
and 2000 -- 21.6%, 23.8%, 23.3% and 31.3%.
COMPETITION
The Company believes that the principal bases upon which it competes in its
direct commerce business are quality, value, service, proprietary product
offerings, catalog design, web site design, convenience, speed and efficiency.
The Company's catalogs compete with other mail order catalogs, both specialty
and general, and retail stores, including department stores, specialty stores
and discount stores such as JC Penney, Spiegel and Pottery Barn, among catalogs,
and JC Penney, Target, Bed, Bath & Beyond and Bloomingdale's, among brick and
mortar stores. Competitors also exist in each of the Company's catalog specialty
areas of women's apparel, home fashions, men's apparel and gifts such as J.Crew,
Jockey, Calvin Klein, 2xist, Joe Boxer, Blair menswear and JockeyBachrach, in the
men's apparel category, Lane Bryant, Roaman's and Jessica London in the women's
apparel category, and Linen Source, Pottery Barn and BrylaneHome in the home
fashions category. The Gump's store in San Francisco competes with Neiman
Marcus, Tiffany, Horchow, Williams Sonoma and Crate & Barrel. A number of the
Company's competitors have substantially greater financial, distribution and
marketing resources than the Company.
The Company is maintaining an active e-commerce enabled Internet Web site
presence for all of its catalogs. A substantial number of each of the Company's
catalog competitors maintain an active e-commerce enabled Internet webWeb site
presence as well. A number of such competitors have substantially greater
financial, distribution and marketing resources than the Company. Sales from the
Internet for Web site merchandisers grew in 2002. In addition,
the Company has entered into third party Web site advertising arrangements,
including with Amazon.com, as described above under "Direct Commerce -- Internet
Sales." The Company believes in the future of the Internet and online commerce,
including the marketing opportunities arising from this medium, and has directed
part of its marketing focus, resources and manpower to that end. The Company has
recently expanded its arrangements with Amazon.com.
The Company believes that the principal bases upon which it competes in its
business-to-business sector are value, service, flexibility, scalability,
convenience and efficiency. The Company's third party fulfillment business
competes with Clientlogic, NewRoads, and NewRoads, amongstNational Fulfillment Services, among
others. A number
14
of the Company's competitors have substantially greater financial, distribution
and marketing resources than the Company.
TRADEMARKS
Each of the Company's catalogs has its own federally registered trademarks
that are owned by The Company Store Group, LLC and its subsidiaries. The Company
Store Group, LLC and its subsidiaries also own numerous trademarks, copyrights
and service marks on logos, products and catalog offerings. The Company and its
subsidiaries also have protected various trademarks internationally. The Company
and its subsidiaries vigorously protect such marks.
GOVERNMENT REGULATION
The Company is subject to Federal Trade Commission regulations governing
its advertising and trade practices, Consumer Product Safety Commission
regulations governing the safety of the products it sells in its catalogs and other regulations
relating to the sale of merchandise to its customers. The Company is also
subject to the Department of Treasury -- Customs regulations with respect to any
goods it directly imports.
The imposition of a sales and use tax collection obligation on out-of-state
catalog companies in states to which they ship products was the subject of a
case decided in 1994 by the United States Supreme Court. While the Court
reaffirmed an earlier decision that allowed direct marketers to make sales into
states where they do not have a physical presence without collecting sales taxes
with respect to such sales, the Court further noted that Congress has the power
to change this law. The Company believes that it collects sales tax in all
jurisdictions where it is currently required to do so.
14
LISTING INFORMATION
By letter dated May 2, 2001, the American Stock Exchange (the "Exchange")
notified the Company that it was below certain of the Exchange's continued
listing guidelines set forth in the Exchange's Company Guide. The Exchange
instituted a review of the Company's eligibility for continuing listing of the
Company's common stock on the Exchange. On January 17, 2002, the Company
received a letter dated January 9, 2002 from the Exchange confirming that the
American Stock Exchange determined to continue the Company's listing on the
Exchange pending quarterly reviews of the Company's compliance with the steps of
its strategic business realignment program. This determination was made subject
to the Company's favorable progress in satisfying the Exchange's guidelines for
continued listing and to the Exchange's periodic review of the Company's
Securities and Exchange Commission and other filings.
On November 11, 2002, the Company received a letter dated November 8, 2002
from the Exchange updating its position regarding the Company's compliance with
certain of the Exchange's continued listing standards as set forth in Part 10 of
the Exchange's Company Guide. Although the Company had been making favorable
progress in satisfying the Exchange's guidelines for continued listing based on
its compliance with the steps of its strategic business realignment program
shared with the Exchange in 2001 and updated in 2002, the Exchange informed the
Company that it had now become strictly subject to the procedures and
requirements of Part 10 of the Company Guide. Specifically, the Company must not
fall below the requirements of:of : (i) Section 1003(a)(i) 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; (ii) Section
1003(a)(ii) 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 (iii) Section 1003(a)(iii) 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 submit a
plan to the Exchange by December 11, 2002, advising the Exchange of action it
has taken, or will take, that would bring it into compliance with the continued
listing standards by December 28, 2003. The Company submitted a plan to the
Exchange on December 11, 2002 in an effort to maintain the listing of the
Company's common stock on the Exchange.
On January 28, 2003, the Company received a letter from the Exchange
confirming that, as of the date of the letter, the Company had evidenced
compliance with the requirements necessary for continued listing on the
Exchange. Such compliance resulted from a recent rule change by the Exchange
approved by the Securities and Exchange Commission related to continued listing
on the basis of compliance with total market capitalization or total assets and
revenues standards as alternatives to shareholders' equity standards such as
15
the requirement for each listed company to maintain $15 million in public float.
The letter is subject to changes in the American Stock Exchange Rules that might
supersede the letter or require the Exchange to re-evaluate its position.
WEB SITE ACCESS TO INFORMATION
The Company's internet address is www.hanoverdirect.com.
The Company recently began to make available free of charge on or through
its webWeb site its annual report on Form 10-K, quarterly reports on Form 10-Q,
current reports on Form 8-K, and all amendments to those reports as soon as
reasonably practicable after such material is electronically filed with or
furnished to the Securities and Exchange Commission. Prior thereto, the Company
voluntarily provided electronic or paper copies of its filings free of charge
upon request, which it will continue to do.
ITEM 2. PROPERTIES
The Company's subsidiaries own and operate the following properties:
- A 775,000 square foot warehouse and fulfillment facility located in
Roanoke, Virginia,Virginia;
- A 48,000 square foot administrationadministrative and telemarketing facility located in
LaCrosse, Wisconsin,Wisconsin; and
15
- A 150,000 square foot home fashion manufacturing facility located in
LaCrosse, Wisconsin used to produce down filled comforters for sale under
"The Company Store" and "Scandia Down" brand names.
Each of these properties is subject to a mortgage in favor of the Company's
lender, Congress Financial Corporation.
In addition, the Company or its subsidiaries lease the following
properties:
- An 85,000 square foot building formerly used as corporate headquarters
and administrative offices located in Weehawken, New Jersey under a
15-year lease expiring in May 2005, of which approximately 37,000 square
feet are occupied by the Company, approximately 18,000 square feet are
subleased, and the remaining 30,000 square feet are available for
sublease,sublease;
- A 30,00028,700 square foot corporate headquarters and administrationadministrative offices
located in Edgewater, New Jersey under a lease expiring in May 2005, of
which approximately 16,000 square feet is occupied by the Company,
approximately 2,600 square feet are subleased, and the remaining 11,40010,100
square feet are available for sublease,sublease;
- SevenSix properties currently or formerly used as outlet stores located in
California, Pennsylvania and Wisconsin having approximately 68,00055,400 square
feet of space in the aggregate, with leases running through December
2005. The two retail stores in California have been closed, as to which
theclosed. The Company
currently subleases the 6,200 square feet and holds for sublease
approximately 5,000 square feet,of space in San Diego. The Los
Angeles store lease expired in August 2003;
- A 64,00065,100 square foot retail and office facility which includes the Gump's
retail store in San Francisco, California under two leases that expire
during April 2010, of which approximately 37,00037,800 square feet are occupied
by the Company, approximately 20,0009,100 square feet are subleased, and the
remaining 7,00018,200 square feet together with an additional 10,250 square
feet for which the current sublease expires during July 2003, are available for sublease,sublease. In addition the
Company has leased 2,400 square feet of storage space relating to the
Gump's retail store, expiring March 2008;
- A 185,000 square foot warehouse and fulfillment facility located in
LaCrosse, Wisconsin under a lease expiring in December 2003,2004; and
- A 123,000117,900 square foot telemarketing, customer service and administrative
facility located in Hanover, Pennsylvania, under a lease that was
extended during 2002 and that now expires on December 31, 2004.
Additionally, the Company utilizes a temporary storage facility of 72,000
square feet under a lease expiring September 30, 2004 in Roanoke, Virginia to
house merchandise during the holiday selling period and leases an additional
satellite telemarketing facility of 11,000 square feet in York, Pennsylvania
under a lease expiring July 31, 2006. The Company also leases a 34,000 square
foot facility used for storage under a lease expiring August 31, 2004 in La
Crosse, Wisconsin. In addition, the Company leases a 30,000 square foot
satellite administrationadministrative facility in San Diego, California under a lease expiring AprilFebruary
28, 2005. On February 28,
16
2002, the Company terminated the telemarketing operations conducted at such
facility. Currently, the Company occupies approximately 16,000 square feet,
approximately 5,00012,000 square feet are subleased, and the remaining 9,0002,000 square
feet are available for sublease.
On May 3, 2001, the Company sold its 277,500 square foot warehouse and
fulfillment facility in Hanover, Pennsylvania (the "Kindig Lane Property") and
certain equipment located therein for $4.7 million to an unrelated third party.
The Company has continued to use the Kindig Lane Property under a month-to-month
lease agreement with the third party, and will continue to lease a portionthe term of the Kindig Lane Propertylast month to expire on a month-to-month basis until
April 4, 2003. Effective March 1,31, 2003, the Company has transitioned a portion of the
fulfillment operations from the leasedclosed its Kindig Lane
Propertyfacility and moved its remaining operations there to its ownedthe Company's facility in
Roanoke, Virginia.
During 2002, the Company entered into an agreement with the landlord and
the sublandlord to terminate its sublease of the Company's closed 497,200 square
foot warehouse and telemarketing facility located in Maumelle, Arkansas. The
agreement provided for the payment by the Company to the sublandlord of
$1,600,000, plus taxes through April 30, 2002 in the amount of $198,000. The
Company made all of the
16
payments during May 2002. Upon the satisfaction by the Company of all of its
obligations under the agreement, the sublease terminated and the Company was
released from all further obligations under the sublease. The Company's
previously established reserves for Maumelle, Arkansas were adequate based upon
the terms of the final settlement agreement.
ITEM 3. LEGAL PROCEEDINGS
A class action lawsuit was commenced on March 3, 2000 entitled Edwin L.
Martin v. Hanover Direct, Inc. and John Does 1 through 10, bearing case no.
CJ2000-177 in the State Court of Oklahoma (District Court in and for Sequoyah
County). Plaintiff commenced the action on behalf of himself and a class of
persons who have at any time purchased a product from the Company and paid for
an "insurance charge." The complaint sets forth claims for breach of contract,
unjust enrichment, recovery of money paid absent consideration, fraud and a
claim under the New Jersey Consumer Fraud Act. The complaint alleges that the
Company charges its customers for delivery insurance even though, among other
things, the Company's common carriers already provide insurance and the
insurance charge provides no benefit to the Company's customers. Plaintiff also
seeks a declaratory judgment as to the validity of the delivery insurance. The
damages sought are (i) an order directing the Company to return to the plaintiff
and class members the "unlawful revenue" derived from the insurance charges,
(ii) declaring the rights of the parties, (iii) permanently enjoining the
Company from imposing the insurance charge, (iv) awarding threefold damages of
less than $75,000 per plaintiff and per class member, and (v) attorneys' fees
and costs. On April 12, 2001, the Court held a hearing on plaintiff's class
certification motion. Subsequent to the April 12, 2001 hearing on plaintiff's
class certification motion, plaintiff filed a motion to amend the definition of
the class. On July 23, 2001, plaintiff's class certification motion was granted,
defining the class as "All persons in the United States who are customers of any
catalog or catalog company owned by Hanover Direct, Inc. and who have at any
time purchased a product from such company and paid money which was designated
to be an 'insurance' charge." On August 21, 2001, the Company filed an appeal of
the order with the Oklahoma Supreme Court and subsequently moved to stay
proceedings in the district court pending resolution of the appeal. The appeal
has been fully briefed. At a subsequent status hearing, the parties agreed that
issues pertaining to notice to the class would be stayed pending resolution of
the appeal, that certain other issues would be subject to limited discovery, and
that the issue of a stay for any remaining issues would be resolved if and when
such issues arise. Oral argument on the appeal, if scheduled, is not expected
until the first half of 2003. The Company believes it has defenses against the
claims and plans to conduct a vigorous defense of this action.
On August 15, 2001, the Company was served with a summons and four-count
complaint filed in Superior Court for the City and County of San Francisco,
California, entitled Teichman v. Hanover Direct, Inc., Hanover Brands, Inc.,
Hanover Direct Virginia, Inc., and Does 1-100. The complaint was filed by a
California resident, seeking damages and other relief for herself and a class of
all others similarly situated, arising out of the insurance fee charged by
catalogs and internet sites operated by subsidiaries of the Company. Defendants,
including the Company, have filed motions to dismiss based on a lack of personal
jurisdiction over them. In January 2002, plaintiff sought leave to name six
additional entities: International Male, Domestications Kitchen & Garden,
Silhouettes, Hanover Company Store, Kitchen & Home, and Domestications as co-
defendants. On March 12, 2002, the Company was served with the First Amended
Complaint in which plaintiff named as defendants the Company, Hanover Brands,
Hanover Direct Virginia, LWI Holdings, Hanover Company Store, Kitchen and Home,
and Silhouettes. On April 15, 2002, the Company filed a Motion to Stay the
Teichman action in favor of the previously filed Martin action and also filed a
Motion to quash service of summons for lack of personal jurisdiction on behalf
of defendants Hanover Direct, Inc., Hanover Brands, Inc. and Hanover Direct
Virginia, Inc. On May 14, 2002, the Court (1) granted the Company's Motion to
quash service on behalf of Hanover Direct, Hanover Brands, and Hanover Direct
Virginia, leaving only LWI Holdings, Hanover Company Store, Kitchen & Home, and
Silhouettes, as defendants, and (2) granted the Company's Motion to Stay the
action in favor of the previously filed Oklahoma action, so nothing will proceed
on this case against the remaining entities until the Oklahoma case is decided.
The Company believes it has defenses against the claims. The Company plans to
conduct a vigorous defense of this action.
17
A class action lawsuit was commenced on February 13, 2002 entitled Jacq
Wilson, suing on behalf of himself, all others similarly situated, and the
general public v. Brawn of California, Inc. dba International Male and
Undergear, and Does 1-100 ("Brawn") in the Superior Court of the State of
California, City and County of San Francisco. Does 1-100 are internet and
catalog direct marketers offering a selection of men's clothing, sundries, and
shoes who advertise within California and nationwide. The complaint alleges that
for at least four years, members of the class have been charged an unlawful,
unfair, and fraudulent insurance fee and tax on orders sent to them by Brawn;
that Brawn was engaged in untrue, deceptive and misleading advertising in that
it was not lawfully required or permitted to collect insurance, tax and sales
tax from customers in California; and that Brawn has engaged in acts of unfair
competition under the state's Business and Professions Code. Plaintiff and the
class seek (i) restitution and disgorgement of all monies wrongfully collected
and earned by Brawn, including interest and other gains made on account of these
practices, including reimbursement in the amount of the insurance, tax and sales
tax collected unlawfully, together with interest, (ii) an order enjoining Brawn
from charging customers insurance and tax on its order forms and/or from
charging tax on the delivery, shipping and insurance charges, (iii) an order
directing Brawn to notify the California State Board of Equalization of the
failure to pay the correct amount of tax to the state and to take appropriate
steps to provide the state with the information needed for audit, and (iv)
compensatory damages, attorneys' fees, pre-judgment interest, and costs of the
suit. The claims of the individually named plaintiff and for each member of the
class amount to less than $75,000. On April 15, 2002, the Company filed a Motion
to Stay the Wilson action in favor of the previously filed Martin action. On May
14, 2002, the Court heard the argument in the Company's Motion to Stay the
action in favor of the Oklahoma action, denying the motion. In October 2002, the
Court granted the Company's motion for leave to amend the answer. Discovery is
proceeding. A mandatory settlement conference has been scheduled for April 4,
2003 and trial is currently scheduled for April 14, 2003. The Company plans to
conduct a vigorous defense of this action.
A class action lawsuit was commenced on February 20, 2002 entitled Argonaut
Consumer Rights Advocates Inc., suing on behalf of the General Public v. Gump's
By Mail, Inc. ("Gump's"), and Does 1-100 in the Superior Court of the State of
California, City and County of San Francisco. The plaintiff is a non-profit
public benefit corporation suing under the California Business and Profession
Code. Does 1-100 would include persons whose activities include the direct sale
of tangible personal property to California consumers including the type of
merchandise that Gump's -- the store and the catalog -- sell, by telephone, mail
order, and sales through the web sites www.gumpsbymail.com and www.gumps.com.
The complaint alleges that for at least four years members of the class have
been charged an unlawful, unfair, and fraudulent tax and "sales tax" on their
orders in violation of California law and court decisions, including the state
Revenue and Taxation Code, Civil Code, and the California Board of Equalization;
that Gump's engages in unfair business practices; that Gump's engaged in untrue
and misleading advertising in that it was not lawfully required to collect tax
and sales tax from customers in California; is not lawfully required or
permitted to add tax and sales tax on separately stated shipping or delivery
charges to California consumers; and that it does not add the appropriate or
applicable or specific correct tax or sales tax to its orders. Plaintiff and the
class seek (i) restitution of all tax and sales tax charged by Gump's on each
transaction and/or restitution of tax and sales tax charged on the shipping
charges; (ii) an order enjoining Gump's from charging customers for tax on
orders or from charging tax on the shipping charges; and (iii) attorneys' fees,
pre-judgment interest on the sums refunded, and costs of the suit. On April 15,
2002, the Company filed an Answer and Separate Affirmative Defenses to the
complaint, generally denying the allegations of the complaint and each and every
cause of action alleged, and denying that plaintiff has been damaged or is
entitled to any relief whatsoever. On September 19, 2002, the Company filed a
motion for leave to file an amended answer, containing several additional
affirmative defenses based on the proposition that the proper defendant in this
litigation (if any) is the California State Board of Equalization, not the
Company, and that plaintiff failed to exhaust its administrative remedies prior
to filing suit. That motion was granted. At the request of the plaintiff, this
case was dismissed with prejudice by the court on March 17, 2003.
A class action lawsuit was commenced on March 5, 2002 entitled Argonaut
Consumer Rights Advocates Inc., suing on behalf of the General Public v.
Domestications LLC, and Does 1-100 ("Domestications") in the Superior Court of
the State of California, City and County of San Francisco. The plaintiff is a
non-profit public benefit corporation suing under the California Business and
Profession Code. Does 1-100 would include
18
persons responsible for the conduct alleged in the complaint, including the
direct sale of tangible personal property to California consumers including the
type of merchandise that Domestications sells, by telephone, mail order, and
sales through the web site www.domestications.com. The plaintiff claims that for
at least four years members of the class have been charged an unlawful, unfair,
and fraudulent tax and sales tax for different rates and amounts on the catalog
and internet orders on the total amount of goods, tax and sales tax on shipping
charges, which are not subject to tax or sales tax under California law, in
violation of California law and court decisions, including the state Revenue and
Taxation Code, Civil Code, and the California Board of Equalization; that
Domestications engages in unfair business practices; and that Domestications
engaged in untrue and misleading advertising in that it was not lawfully
required to collect tax and sales tax from customers in California. Plaintiff
and the class seek (i) restitution of all sums, interest and other gains made on
account of these practices; (ii) prejudgment interest on all sums wrongfully
collected; (iii) an order enjoining Domestications from charging customers for
tax on their orders and/or from charging tax on the shipping charges; and (iv)
attorneys' fees and costs of the suit. The Company filed an Answer and Separate
Affirmative Defenses to the Complaint, generally denying the allegations of the
Complaint and each and every cause of action alleged, and denying that plaintiff
has been damaged or is entitled to any relief whatsoever. Discovery is now
proceeding. On September 19, 2002, the Company filed a motion for leave to file
an amended answer, containing several additional affirmative defenses based on
the proposition that the proper defendant in this litigation (if any) is the
California State Board of Equalization, not the Company, and that plaintiff
failed to exhaust its administrative remedies prior to filing suit. That motion
was granted. On February 28, 2003, the Company filed a notice of motion and
memorandum of points and authorities in support of its motion for summary
judgment setting forth that Plaintiff's claims are without merit and incorrect
as a matter of law. At the request of the plaintiff, this case was dismissed
with prejudice by the court on March 17, 2003.
A class action lawsuit was commenced on October 28, 2002 entitled John
Morris, individually and on behalf of all other persons & entities similarly
situated v. Hanover Direct, Inc., and Hanover Brands, Inc. (referred to here as
"Hanover"), No. L 8830-02 in the Superior Court of New Jersey, Bergen
County -- Law Division. The plaintiff brings 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 certain clothing from Hanover (which was from a men's
division catalog, the only ones which retained the insurance line item in 2002),
Plaintiff claims that for at least six years, Hanover maintained a policy and
practice of adding a charge for "insurance" to the orders it received and
concealed and failed to disclose its policy with respect to all class members.
Plaintiff claims that Hanover's conduct was (i) in violation of the New Jersey
Consumer Fraud Act, as otherwise deceptive, misleading and unconscionable; (ii)
such as to constitute Unjust Enrichment of Hanover at the expense and to the
detriment of plaintiff and the class; and (iii) 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 Morris
action in favor of the previously filed Martin action. Plaintiff then filed an
Amended Complaint adding International Male as a defendant. The Company's
response to the Amended Complaint was filed on February 5, 2003. Plaintiff's
response brief was filed March 17, 2003, and the Company's reply brief is due on
March 31, 2003. Hearing on the motion to stay is expected to take place on April
4, 2003. The Company plans to conduct a vigorous defense of this action.
On June 28, 2001, Rakesh K. Kaul, the Company's former President and Chief
Executive Officer, filed a five-count complaint (the "Complaint") in New York
State Court against the Company, seeking damages and other relief arising out of
his separation of employment from the Company, including severance payments of
$2,531,352 plus the cost of employee benefits, attorneys' fees and costs
incurred in connection with the enforcement of his rights under his employment
agreement with the Company, payment of $298,650 for 13 weeks of accrued and
unused vacation, damages in the amount of $3,583,800, or, in the alternative, a
declaratory judgment from the court that he is entitled to all change of control
benefits under the "Hanover Direct, Inc. Thirty-Six Month Salary Continuation
Plan," and damages in the amount of $1,396,066 or $850,000 due to the Company's
purported breach of the terms of the "Long-Term Incentive Plan for Rakesh
19
K. Kaul" by failing to pay him a "tandem bonus" he alleges was due and payable
to him within the 30 days following his resignation. The Company removed the
case to the U.S. District Court for the Southern District of New York on July
25, 2001. Mr. Kaul filed an Amended Complaint ("Amended Complaint") in the U.S.
District Court for the Southern District of New York on September 18, 2001. The
Amended Complaint repeats many of the claims made in the original Complaint and
adds ERISA claims. On October 11, 2001, the Company filed its Answer, Defenses
and Counterclaims to the Amended Complaint, denying liability under each and
every of Mr. Kaul's causes of action, challenging all substantive assertions,
raising several defenses and stating nine counterclaims against Mr. Kaul. The
counterclaims include (1) breach of contract; (2) breach of the Non-Competition
and Confidentiality Agreement with the Company; (3) breach of fiduciary duty;
(4) unfair competition; and (5) unjust enrichment. The Company seeks damages,
including, without limitation, the $341,803 in severance pay and car allowance
Mr. Kaul received following his resignation, $412,336 for amounts paid to Mr.
Kaul for car allowance and related benefits, the cost of a long-term disability
policy, and certain payments made to personal attorneys and consultants retained
by Mr. Kaul during his employment, $43,847 for certain services the Company
provided and certain expenses the Company incurred, relating to the renovation
and leasing of office space occupied by Mr. Kaul's spouse at 115 River Road,
Edgewater, New Jersey, the Company's current headquarters, $211,729 on a tax
loan to Mr. Kaul outstanding since 1997 and interest, compensatory and punitive
damages and attorneys' fees. The case is pending. The discovery period has
closed, the Company has moved to amend its counterclaims, and the parties have
each moved for summary judgment. The Company seeks summary judgment: 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 of, among other things,
claims for change of control benefits; dismissing Mr. Kaul's claim for
attorneys' fees on the grounds that they are not authorized under his employment
agreement; dismissing Mr. Kaul's claims related to change in control benefits
based on an administrative decision that he is not entitled to continued
participation in the plan or to future benefits thereunder; dismissing Mr.
Kaul's claim for a tandem bonus payment on the ground that no payment is owing;
dismissing Mr. Kaul's claim for vacation payments based on Company policy
regarding carry over vacation; and seeking judgment on the Company's
counterclaim for unjust enrichment based on Mr. Kaul's failure to pay under a
tax note. Mr. Kaul seeks summary judgment: dismissing the Company's defenses and
counterclaims relating to a release on the grounds that he tendered a release or
that the Company is estopped from requiring him to do so; the Company's defenses
and counterclaims relating to his alleged violations of his non-compete and
confidentiality obligations on the grounds that he did not breach the
obligations as defined in the agreement; and the Company's claims based on his
alleged breach of fiduciary duty, including those based on his monthly car
allowance payments and the leased space to his wife, on the grounds that he was
entitled to the car payments and did not involve himself in or make
misrepresentations in connection with the leased space. The Company has
concurrently moved to amend its Answer and Counterclaims to state a claim that
it had cause for terminating Mr. Kaul's employment based on, among other things,
after acquired evidence that Mr. Kaul received a monthly car allowance and other
benefits totaling $412,336 that had not been authorized by the Company's Board
of Directors and that his wife's lease and related expense was not properly
authorized by the Company's Board of Directors, and to clarify or amend the
scope of the Company's counterclaims for reimbursement. The briefing on the
motions is completed and the parties are awaiting the decision of the Court. No
trial date has been set. It is too early to determine the potential outcome,
which could have a material impact on the Company's results of operations when
resolved in a future period.
In June 1994, a complaint was filed in the Supreme Court of the State of
New York, County of New York, by Donald Schupak, the former President, CEO and
Chairman of the Board of Directors of The Horn & Hardart Company, the corporate
predecessor to the Company, against the Company and Alan Grant Quasha. The
complaint asserted claims for alleged breaches of an agreement dated February
25, 1992 between Mr. Schupak and the Company (the "Agreement"), and for alleged
tortious interference with the Agreement by Mr. Quasha. Mr. Schupak sought
compensatory damages in an amount, which is estimated to be not more than
$400,000, and punitive damages in the amount of $10 million; applicable
interest, incidental and consequential damages, plus costs and disbursements,
the expenses of the litigation and reasonable attorneys' fees. In addition,
based on the alleged breaches of the Agreement by the Company, Mr. Schupak
sought a "parachute" payment of approximately $3 million under an earlier
agreement with the Company that he
20
allegedly had waived in consideration of the Company's performance of its
obligations under the Agreement. The Company filed an answer to the complaint on
September 7, 1994. Discovery then commenced and documents were exchanged. Each
of the parties filed a motion for summary judgment at the end of 1995, and both
motions were denied in the spring of 1996. In April 1996, due to health problems
then being experienced by Mr. Schupak, the Court ordered that the case be marked
"off calendar" until plaintiff recovered and was able to proceed with the
litigation. In September 2002, more than six years later, Mr. Schupak filed a
motion to restore the case to the Court's calendar. The Company filed papers in
opposition to the motion on October 10, 2002, asserting that the motion should
be denied on the ground that plaintiff failed to timely comply with the terms of
the Court's order concerning restoration and, alternatively, on the ground of
laches. The plaintiff filed reply papers on November 4, 2002. On November 20,
2002, the court denied Schupak's motion to restore the case to the calendar as
"unnecessary and moot" on the ground that the case had been improperly marked
off calendar in the first instance, ruled that the case therefore remained
"active," and fixed a trial date of March 4, 2003. On January 27, 2003, the
parties reached agreement fully and finally settling all of Schupak's claims in
consideration of a payment by the Company and the exchange of mutual general
releases.
The Company was named as one of 88 defendants in a patent infringement
complaint filed on November 23, 2001 by the Lemelson Medical, Education &
Research Foundation, Limited Partnership (the "Lemelson Foundation"). The
complaint, filed in the U.S. District Court in Arizona, was not served on the
Company until March 2002. In the complaint, the Lemelson Foundation accuses the
named defendants of infringing seven U.S. patents which allegedly cover
"automatic identification" technology through the defendants' use of methods for
scanning production markings such as bar codes. The Company received a letter
dated November 27, 2001 from attorneys for the Lemelson Foundation notifying the
Company of the complaint and offering a license. The Court entered a stay of the
case on March 20, 2002, requested by the Lemelson Foundation, pending the
outcome of a related case in Nevada being fought by bar code manufacturers. The
trial in the Nevada case began on November 18, 2002 and ended on January 17,
2003. The parties in the Nevada case are now required to submit post trial
briefs on or before May 16, 2003, and a decision is expected two months or more
thereafter. The Order for the stay in the Lemelson case provides that the
Company need not answer the complaint, although it has the option to do so. The
Company has been invited to join a common interest/joint-defense group
consisting of defendants named in the complaint as well as in other actions
brought by the Lemelson Foundation. The Company is currently in the process of
analyzing the merits of the issues raised by the complaint, notifying vendors of
its receipt of the complaint and letter, evaluating the merits of joining the
joint-defense group, and having discussions with attorneys for the Lemelson
Foundation regarding the license offer. A preliminary estimate of the royalties
and attorneys' fees which the Company may pay if it decides to accept the
license offer from the Lemelson Foundation range from about $125,000 to
$400,000. The Company has decided to gather further information, but will not
agree to a settlement at this time, and thus, has not established a reserve.
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. See Note 19 to the Company's Consolidated Financial
Statements.
See also Note 17 of Notes to Consolidated Financial Statements for the
years ended December 28, 2002, December 29, 2001 and December 30, 2000 elsewhere
herein.
In addition, the Company is involved in various routine lawsuits of a
nature, which are deemed customary and incidental to its businesses. In the
opinion of management, the ultimate disposition of these actions will not have a
material adverse effect on the Company's financial position or results of
operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
21
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's common stock trades on the American Stock Exchange under the
symbol "HNV." The following table sets forth, for the periods shown, the high
and low sale prices of the Company's common stock as reported on the American
Stock Exchange Composite Tape. As of March 20, 2003, the Company had 138,315,800
shares of common stock outstanding (net of treasury shares). Of these,
29,446,888 shares were held directly or indirectly by Richemont, 38,778,350
shares were held by Basil P. Regan or Regan Partners L.P., and 57,174 shares
were held by other directors and officers of the Company. As a result,
70,033,388 shares of common stock were held by public shareholders. There were
approximately 3,650 holders of record of common stock.
HIGH LOW
----- -----
FISCAL 2002
First Quarter (Dec. 30, 2001 to March 30, 2002)........... $0.52 $0.36
Second Quarter (March 31, 2002 to June 29, 2002).......... $0.44 $0.23
Third Quarter (June 30, 2002 to Sept. 28, 2002)........... $0.34 $0.19
Fourth Quarter (Sept. 29, 2002 to Dec. 28, 2002).......... $0.28 $0.18
FISCAL 2001
First Quarter (Dec. 31, 2000 to March 31, 2001)........... $0.56 $0.28
Second Quarter (April 1, 2001 to June 30, 2001)........... $0.34 $0.12
Third Quarter (July 1, 2001 to Sept. 29, 2001)............ $0.37 $0.17
Fourth Quarter (Sept. 30, 2001 to Dec. 29, 2001).......... $0.35 $0.24
The Company is restricted from paying dividends on its common stock or from
acquiring its capital stock by certain debt covenants contained in agreements to
which the Company is a party.
22
ITEM 6. SELECTED FINANCIAL DATA
The following table presents selected financial data for each of the fiscal
years indicated:
2002 2001 2000 1999 1998
-------- -------- -------- -------- --------
(IN THOUSANDS OF DOLLARS, EXCEPT PER SHARE DATA)
INCOME STATEMENT DATA:
Net Revenues............................ $457,644 $532,165 $603,014 $549,852 $546,114
Special charges (credit)................ 4,398 11,277 19,126 144 (485)
Loss from operations.................... (432) (23,965) (70,552) (13,756) (16,807)
Gain on sale of Improvements business... (570) (23,240) -- -- --
Gain on sale of Kindig Lane Property.... -- (1,529) -- -- --
Gain on sale of The Shopper's Edge...... -- -- -- (4,343) --
Gain on sale of Austad's................ -- -- -- (967) --
Income (loss) before interest and income
taxes................................. 138 804 (70,552) (8,446) (16,807)
Interest expense, net................... 5,477 6,529 10,083 7,338 7,778
Net loss................................ (9,130) (5,845) (80,800) (16,314) (25,595)
Preferred stock dividends and
accretion............................. 15,556 10,745 4,015 634 578
-------- -------- -------- -------- --------
Net loss applicable to common
stockholders.......................... $(24,686) $(16,590) $(84,815) $(16,948) $(26,163)
-------- -------- -------- -------- --------
PER SHARE:
Net loss per common share -- basic and
diluted............................... $ (.18) $ (.08) $ (.40) $ (.08) $ (.13)
-------- -------- -------- -------- --------
WEIGHTED AVERAGE NUMBER OF SHARES
OUTSTANDING (IN THOUSANDS):
Basic................................... 138,280 210,536 213,252 210,719 206,508
-------- -------- -------- -------- --------
Diluted................................. 138,280 210,536 213,252 210,719 206,508
-------- -------- -------- -------- --------
AS RESTATED AS RESTATED AS RESTATED AS RESTATED
2002 2001 2000 1999 1998
----------- ----------- ----------- ----------- -----------
(IN THOUSANDS OF DOLLARS)
BALANCE SHEET DATA (END OF PERIOD):
Working capital (1).................. $ 620 $ 7,412 $ 1,123 $ 12,788 $ 43,929
Total assets (1)..................... 140,100 157,661 203,019 191,419 218,870
Total debt (1)....................... 25,129 29,710 39,036 42,835 58,859
Redeemable Series A Preferred
Stock.............................. -- -- 71,628 -- --
Redeemable Series B Preferred
Stock.............................. 92,379 76,823 -- -- --
Shareholders' (deficiency) equity.... (58,841) (35,728) (24,452) 53,865 66,470
- ---------------
(1) The amount for 1998 includes both a receivable and an obligation under
receivables financing of $18,998, pursuant to SFAS No. 125.
There were no cash dividends declared on the Common Stock in any of the periods
presented.
See Note 21 of Notes to Consolidated Financial Statements for more
information regarding the restatements.
See notes to Consolidated Financial Statements.
23
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following table sets forth, for the fiscal years indicated, the
percentage relationship to revenues of certain items in the Company's
Consolidated Statements of Income (Loss):
FISCAL YEAR
2002 2001 2000
----- ----------- -----
Net revenues............................................. 100.0% 100.0% 100.0%
Cost of sales and operating expenses..................... 63.5 63.8 67.2
Write-down of inventory of discontinued catalogs......... -- -- 0.3
Special charges.......................................... 0.9 2.1 3.2
Selling expenses......................................... 23.0 26.5 25.4
General and administrative expenses...................... 11.4 10.7 14.1
Depreciation and amortization............................ 1.2 1.4 1.5
Gain on sale of Improvements Catalog..................... (0.1) (4.4) --
Gain on sale of Kindig Lane Property..................... -- (0.3) --
Income (loss) before interest and income taxes........... 0.1 0.2 (11.7)
Interest expense, net.................................... 1.2 1.2 1.7
Provision for deferred federal income taxes.............. 0.8 -- --
Provision for state income taxes......................... -- -- --
Net loss................................................. (2.0)% (1.1)% (13.4)%
RESULTS OF OPERATIONS
2002 COMPARED WITH 2001
Net Loss. The Company reported a net loss of $9.1 million or $.18 per
share for the year ended December 28, 2002 compared with a net loss of $5.8
million or $.08 per share for the comparable period in the fiscal year 2001. The
per share amounts were calculated after deducting preferred dividends and
accretion of $15.6 million and $10.7 million in fiscal years 2002 and 2001,
respectively. The weighted average number of shares of common stock outstanding
was 138,280,196 and 210,535,959 for the fiscal years ended December 28, 2002 and
December 29, 2001, respectively. This decrease in weighted average shares was
pursuant to the terms of the Richemont Transaction consummated on December 19,
2001 (see Notes 7 and 8 to the Company's Consolidated Financial Statements). The
increased loss of $3.3 million resulted from the recording of $24.8 million in
gains during fiscal year 2001 related to the sale of the Company's Improvements
business and the Kindig Lane Property and a $3.7 million reduction to the
carrying value of the deferred tax asset in fiscal year 2002. This deferred tax
asset adjustment was based on a reassessment of the Company's ability to utilize
certain net operating losses prior to their expiration. The impact of the
deferred tax asset adjustment was mitigated by cost reductions, primarily in
selling expenses.
Net Revenues. Net revenues decreased $74.6 million or 14.0% for the year
ended December 28, 2002 to $457.6 million from $532.2 million for a comparable
period in 2001. This decrease was due in part to the sale of the Improvements
business on June 29, 2001, which accounted for $34.1 million of the reduction.
The discontinuance of the Domestications Kitchen & Garden, Kitchen & Home,
Encore and Turiya catalogs contributed an additional $6.4 million to the
reduction. Revenues for continuing businesses in fiscal year 2002 decreased by
$34.1 million or 6.9%. Overall circulation for the continuing businesses
decreased by 9.0% from the prior year with almost all of the decrease in the
continuing revenues stemming from efforts to reduce unprofitable circulation.
Internet sales have now reached 20.3% of combined internet and catalog revenues
for the Company's four categories and have improved by $20.4 million or 30.4% to
$87.3 million from $66.9 million in 2001, excluding sales from the Improvements
business that was sold during 2001.
Cost of Sales and Operating Expenses. Cost of sales and operating expenses
decreased to 63.5% of net revenues for the year ended December 28, 2002 as
compared with 63.8% of net revenues for the comparable period in 2001. The
slight decrease over the prior year was due to the reduction of fixed costs
incurred
24
primarily by the Company's fulfillment operations. While substantial reductions
were realized during 2001, costs as a percentage of net revenues held constant
in most areas except for fulfillment, which continued to decline as the on-going
implementation of the Company's strategic business realignment program
continued. Total merchandise cost, as a percent of net revenues, held constant
with the prior year.
Special Charges. In December 2000, the Company began a strategic business
realignment program that resulted in the recording of special charges for
severance, facility exit costs and fixed asset write-offs. Special charges
recorded in fiscal years 2002, 2001, and 2000 relating to the strategic business
realignment program were $4.4 million, $11.3 million, and $19.1 million,
respectively. The actions related to the strategic business realignment program
were taken in an effort to direct the Company's resources primarily towards a
return to profitability.
In the first quarter of 2002, special charges relating to the strategic
business realignment program were recorded in the amount of $0.2 million. These
charges consisted primarily of severance costs related to the elimination of an
additional 10 FTE positions and costs associated with the Company's decision to
close a product storage facility located in San Diego, California. In September
2002, the Company continued to execute this plan through the integration of The
Company Store and Domestications divisions. As a result of the continued actions
needed to execute these plans, during the third quarter of 2002, an additional
$1.5 million of special charges was recorded. Of this amount, $1.3 million
consisted of additional facility exit costs resulting primarily from the
integration of The Company Store and Domestications divisions, causing
management to reassess its plan to consolidate its office space at the corporate
offices in New Jersey. The additional $0.2 million consisted of further
severance costs for an individual relating to the Company's strategic business
realignment program.
In the fourth quarter of 2002, special charges totaling $2.7 million were
recorded. Of this amount, $1.5 million was related to severance costs, including
$1.2 million for two of the Company's senior management members, $0.2 million
associated with the consolidation of a portion of the Company's Hanover,
Pennsylvania fulfillment operations into its Roanoke, Virginia facility, and
$0.1 million of additional severance costs and adjustments pertaining to the
Company's previous strategic business realignment initiatives. The remaining
$1.2 million consisted primarily of a $0.4 million credit reflecting the
reduction of the deferred rental liabilities applicable to the portions of the
facilities previously included in the Company's strategic business realignment
program and a $1.6 million charge in order to properly reflect the current
marketability of such facilities in the rental markets.
Selling Expenses. Selling expenses decreased to 23.0% of net revenues for
the year ended December 28, 2002 from 26.5% for the comparable period in 2001,
primarily due to a shift in focus resulting in the elimination of mailing to
unprofitable circulation lists. In addition to lower circulation, favorable
paper prices were obtained, which have also contributed to the decline in
selling expenses over the prior year.
General and Administrative Expenses. General and administrative expenses
decreased by $4.5 million in 2002 over the prior year. The reductions reflect
the elimination of a significant number of FTE positions across all departments,
which began late in 2000 as part of the Company's strategic business realignment
program and have continued through December 28, 2002. This reduction was
achieved even after absorbing in excess of $3.5 million in costs associated with
the Company's litigation defense against Rakesh Kaul and the Company's
litigation defense and settlement against Donald Schupak during 2002. As a
percentage of net revenues, general and administrative expenses rose to 11.4% in
2002 from 10.7% for the comparable period in 2001. The total increase was
attributable to the expense incurred by the Company to defend and settle
litigation brought by Donald Schupak, and the expense incurred by the Company to
defend itself against litigation brought by Rakesh Kaul.
Depreciation and Amortization. Depreciation and amortization decreased to
1.2% of net revenues for the year ended December 28, 2002 from 1.4% for the
comparable period in 2001. The decrease was primarily due to capital
expenditures that have become fully amortized and the elimination of goodwill
amortization resulting from the implementation of SFAS 142 at the beginning of
fiscal 2002.
25
Loss from Operations. The Company's loss from operations decreased $23.6
million to $0.4 million for the year ended December 28, 2002 from a loss of
$24.0 million for the comparable period in 2001.
Gain on Sale of the Improvements Business. During fiscal 2002, the Company
recognized approximately $0.6 million of deferred gain consistent with the terms
of the escrow agreement relating to the Improvements sale. The recognition of
additional gain of up to approximately $2.0 million has been deferred until the
contingencies described in the escrow agreement expire, which will occur no
later than the middle of the 2003 fiscal year. As of December 28, 2002, no
claims had been made against the escrow.
Interest Expense, Net. Interest expense, net for the year ended December
28, 2002 decreased $1.1 million to $5.5 million and is attributable to lower
average borrowings over the last nine months of 2002 coupled with a reduction in
interest rates. This reduction is partially offset by an increase in the
amortization of deferred financing costs relating to the Company's amendments to
the Congress Credit Facility.
Income Taxes. For year ended December 28, 2002, the Company reduced the
carrying value of its deferred tax asset. This deferred tax asset adjustment was
based on a reassessment of the Company's ability to utilize certain net
operating losses prior to their expiration.
EBITDA COMPARISON SCHEDULE
The following table reflects the view utilized by Company management to
monitor the business (in thousands):
FISCAL YEAR
2002 2001 2000
------- ----------- --------
INCOME (LOSS) BEFORE INTEREST & TAXES....................... $ 138 $ 804 $(70,552)
Add: Depreciation and amortization.......................... 5,650 7,430 9,090
------- -------- --------
EARNINGS BEFORE INTEREST, TAXES, DEPRECIATION & AMORTIZATION
(EBITDA).................................................. 5,788 8,234 (61,462)
Add: Stock option amortization expense...................... 1,332 1,841 5,175
------- -------- --------
EBITDA AS DEFINED FOR DEBT COVENANT......................... 7,120 10,075 (56,287)
Less: Gain on sale of Improvements business................. (570) (23,240) --
Less: Gain on sale of Kindig Lane Facility.................. -- (1,529) --
Add: Special charges........................................ 4,398 11,277 19,126
Add: Write-down inventory of discontinued catalogs.......... -- -- 2,048
Add: Extraordinary litigation
Kaul litigation........................................... 2,871 -- 5,212
Shupack litigation........................................ 636 -- --
------- -------- --------
COMPARATIVE EBITDA.......................................... $14,455 $ (3,417) $(29,901)
======= ======== ========
Management believes that Earnings Before Interest, Taxes, Depreciation and
Amortization (EBITDA) offers a useful tool in addition to traditional GAAP tools
to measure operational cash flow. Management utilizes comparative EBITDA to
evaluate the Company's performance independent of other factors such as gain on
sale of businesses, special charges and litigation expenses as reflected in the
table above.
2001 COMPARED WITH 2000
Net Loss. The Company reported a net loss of $5.8 million or $.08 per
share for the fiscal year ended December 29, 2001 compared with a net loss of
$80.8 million or $.40 per share for the fiscal year ended December 30, 2000. The
per share amounts were calculated after deducting preferred dividends and
accretion of $10.7 million in 2001 and $4.0 million in 2000. As part of a
transaction consummated with Richemont in
26
December 2001 (see Notes 7 and 8 to the Company's Consolidated Financial
Statements), Richemont agreed to forego any claim that it had to accrued but
unpaid dividends on the Series A Preferred Stock in exchange for the issuance of
Series B Preferred Stock. This transaction resulted in a decrease in
shareholders' deficiency of $5.6 million. The weighted average number of shares
outstanding was 210,535,959 and 213,251,945 for 2001 and 2000, respectively.
This decrease in weighted average shares was due to the conversion of 1,530,000
issued common shares into treasury shares.
Compared with the comparable period in 2000, the $75.0 million decrease in
net loss was primarily due to:
i. gain on sale of the Improvements business;
ii. gain on sale of the Kindig Lane Property;
iii. decreased special charges related to the Company's strategic
business realignment program;
iv. decreased cost of sales and operating expenses;
v. decreased general and administrative expenses; and
vi. a reduction in interest expense.
Net Revenues. Net revenues decreased $70.8 million (11.7%) for the year
ended December 29, 2001 to $532.2 million from $603.0 million for the comparable
period in 2000. This decrease was in part due to the sale of the Improvements
business on June 29, 2001, which accounted for $27.6 million of the reduction in
revenues in 2001. An additional portion of the drop in revenues amounting to
$7.8 million is attributed to the Company's decision to scale back on its third
party business by focusing only on profitable operations. The discontinuance of
the Domestications Kitchen & Garden, Encore, Kitchen & Home and Turiya catalogs
contributed $21.2 million to the reduction of net revenues in 2001. The balance
of the net revenues decrease can be attributable to softness in demand related
to both the International Male and Gump's brands.
Cost of Sales and Operating Expenses. Cost of sales and operating expenses
decreased to 63.8% of net revenues for the year ended December 29, 2001 as
compared to 67.2% of net revenues for the comparable period in 2000. This change
is partially due to an increase in the amount of direct import merchandise,
which has a favorable impact on merchandise cost as a percent of net revenues
and accounted for 0.8% of the percentage drop. The balance of the reduction of
3.4% of costs as a percentage of net revenues can be primarily attributed to the
significant reduction in operating costs that have resulted from actions taken
in connection with the Company's strategic business realignment program. The
largest reductions occurred in the areas of fixed costs associated with the
Company's fulfillment centers and information systems. These reductions in
costs, however, were partially offset by higher postage costs as a percent of
net revenues.
Special Charges. In December 2000, the Company developed a plan to
strategically realign the business and direct the Company's resources primarily
towards growth in Hanover Brands while at the same time reducing costs in all
areas of the business and eliminating investment activities that had not
generated sufficient revenues to produce profitable returns. As a result of
actions needed to execute this plan, the Company recorded a special charge of
$19.1 million in fiscal 2000 to cover costs related to severance, facility exit
costs and fixed asset write-offs. In fiscal year 2001, the Company took
additional actions towards implementing the strategic business realignment
program that included:
- The sale of the Kindig Lane Property;
- The closing of the San Diego Telemarketing Center;
- Reduction of full-time equivalent positions across all business units;
and
- Relocation of certain operating and administrative functions from its
office facility in Weehawken, New Jersey to Edgewater, New Jersey.
These additional actions resulted in special charges of $11.3 million to
cover costs related to severance, facility exit costs and fixed asset
write-offs.
27
Selling Expenses. Selling expenses increased to 26.5% of revenues for the
year ended December 29, 2001 from 25.4% for the comparable period in 2000
primarily due to the under-performance of catalog mailings during the second
quarter period.
General and Administrative Expenses. General and Administrative expenses
decreased by $28.2 million in 2001 which accounted for a significant portion of
the Company's reduction in its net loss for the year. As a percentage of net
revenues, general and administrative expenses dropped to 10.7% in 2001 from a
high of 14.1% experienced in 2000. The reduction in costs is primarily
attributable to the elimination of a significant number of FTE positions across
all departments which began late in 2000 as part of the Company's strategic
business realignment program and continued throughout the year 2001. Although
the reductions in general and administrative costs occurred throughout all
overhead areas, the largest reduction in the amount of approximately $8.6
million can be attributed to the decision to eliminate the erizon investment
activities and the related overhead established to support them.
Depreciation and Amortization. Depreciation and amortization decreased to
1.4% of net revenues for the year ended December 29, 2001 from 1.5% for the
comparable period in 2000. The decrease is a result of the complete amortization
of a major computer system in the year 2000 as well as the write-down of fixed
assets in connection with the Company's strategic business realignment program
in the year 2001.
Loss from Operations. The Company's loss from operations decreased by
$46.6 million to $24.0 million for the year ended December 29, 2001 from a loss
of $70.6 million for the year ended December 30, 2000.
Gain on Sale of the Improvements Business and the Kindig Lane
Property. The combined gain on sales of the Improvements business and the
Kindig Lane Property represented 4.7% of net revenues for the year ended
December 29, 2001 and accounted for $24.8 million of the reduction in the
Company's net loss for the year. The Company recognized a $23.2 million net gain
on the sale of the Improvements business in the second quarter of 2001, which
represents the excess of the net proceeds from the sale over the net assets
acquired by HSN, the goodwill associated with the Improvements business and
expenses related to the transaction. The Company realized a net gain on the sale
of the Kindig Lane Property of approximately $1.5 million, which included the
sale price net of selling expenses in excess of the net book value of assets
sold.
Interest Expense, Net. Interest expense, net decreased $3.6 million to
$6.5 million which is attributable to lower average borrowings over the last
nine months of 2001 coupled with a reduction in interest rates.
Income Taxes. The income tax provision for the year ended December 29,
2001 was consistent with the provision in fiscal 2000.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities. For the year ended December 28,
2002, net cash provided by operating activities was $4.7 million. Decreases,
primarily in accounts receivable, prepaid catalog costs, and inventory,
contributed to positive cash flow from operating activities. This positive cash
flow was partially offset by funds being used to reduce accounts payable and
other long-term liabilities. Net losses, when adjusted for depreciation,
amortization and other non-cash items, resulted in an additional $2.7 million of
operating cash provided for the period.
Net cash provided by investing activities. For the year ended December 28,
2002, net cash provided by investing activities was $0.1 million. This was
primarily due to $0.6 million of proceeds received relating to the deferred gain
associated with the sale of the Improvements business and $0.2 million of
proceeds received from disposals of property and equipment resulting from the
termination of the sublease at the Company's warehouse and telemarketing
facility located in Maumelle, Arkansas. These proceeds were offset by $0.7
million of capital expenditures, consisting primarily of upgrades in equipment
located at the Roanoke, Virginia distribution center and various computer
software applications.
Net cash used in financing activities. For the year ended December 28,
2002, net cash used in financing activities was $5.1 million. Payments to reduce
both Congress Tranche A and Tranche B Term Loan facilities were $3.3 million and
payments of the Congress Revolving Loan facility were $4.7 million. In addition,
the
28
Company paid $0.7 million in fees to amend the Congress Credit Facility (see
Note 6 to the Company's Consolidated Financial Statements) and $0.1 million in
capital lease payments. These payments were partially offset by additional
borrowings of $3.5 million made under the amended Congress Tranche B Term Loan
facility.
Congress Credit Facility. On March 24, 2000, the Company amended its
credit facility with Congress to provide the Company with a maximum credit line,
subject to certain limitations, of up to $82.5 million. The Congress Credit
Facility, as amended, expires on January 31, 2004 and comprises a revolving loan
facility, a $17.5 million Tranche A Term Loan and a $8.4 million Tranche B Term
Loan. Total cumulative borrowings under the Congress Credit Facility, however,
are subject to limitations based upon specified percentages of eligible
receivables and eligible inventory, and the Company is required to maintain $3.0
million of excess credit availability at all times. The Congress Credit
Facility, as amended, is secured by all the assets of the Company and places
restrictions on the incurrence of additional indebtedness and on the payment of
common stock dividends.
Under the Congress Credit Facility, the Company is required to maintain
minimum net worth, working capital, and EBITDA as defined throughout the terms
of the agreement. In March 2002, the Company amended the Congress Credit
Facility to amend the definition of Consolidated Net Worth such that, effective
July 1, 2002, to the extent that any goodwill or intangible assets of the
Company and its subsidiaries were deemed to be impaired under the provisions of
SFAS 142, such write-off of assets would not be considered a reduction of total
assets for the purposes of computing consolidated net worth. The Company
obtained the services of an independent appraisal firm during the second quarter
ended June 29, 2002 to evaluate whether there had been any goodwill transition
impairment. The results of the appraisal indicated no goodwill transition
impairment based upon the requirements set forth in SFAS 142. The covenants
relating to consolidated net working capital, consolidated net worth and EBITDA
and certain non-cash charges were also amended. The amendment required the
payment of a fee of $100,000 by the Company.
On August 16, 2002, the Company amended the Congress Credit Facility to (i)
extend the term of the Tranche B Term Loan to January 31, 2004, (ii) increase by
$3,500,000 the borrowing reflected by the Tranche B Term Note to $8,410,714, and
(iii) make certain related technical amendments to the Congress Credit Facility.
The amendment required the payment of fees in the amount of $410,000 by the
Company.
In December 2002, the Company amended the Congress Credit Facility to
change the definition of "Consolidated Net Income," "Consolidated Net Worth" and
"Consolidated Working Capital" to make certain adjustments thereto, depending on
the results of the Kaul litigation, to permit the payment to Richemont of
certain United States withholding taxes payable to Richemont in connection with
the Series B Preferred Stock, and to change certain borrowing sublimits. The
consolidated working capital, consolidated net worth and EBITDA covenants were
also established through the end of the term of the facility, and certain
technical amendments relating to the reorganization of certain of the Company's
subsidiaries were made. The amendment required the payment of fees in the amount
of $110,000.
In February 2003, the Company amended the Congress Credit Facility to amend
the existing change in control Event of Default. The existing change in control
Event of Default under the Congress Credit Facility is based upon NAR Group
Limited, a former shareholder of the Company, ceasing to be the direct or
indirect beneficial owner of a sufficient number of issued and outstanding
shares of capital stock of the Company on a fully diluted basis to elect a
majority of the members of the Company's Board of Directors. This was replaced
during February 2003 with a new change in control Event of Default, which is
patterned on the Change In Control concepts in the Company's various Key
Executive Compensation Continuation Plans. The new Event of Default would be
triggered by certain transfers of assets, certain liquidations or dissolutions,
the acquisition by a person or group (other than a Permitted Holder, as defined)
of a majority of the total outstanding voting stock of the Company, and certain
changes in the composition of the Company's Board of Directors.
The Company has re-examined the provisions of the Congress Credit Facility
and, based on EITF 95-22 and certain provisions in the credit agreement, the
Company is required to reclassify its revolving loan facility from long-term to
short-term debt, though the existing credit facility does not mature until
January 31, 2007.
29
As a result, the Company reclassified $8.8 million and $13.5 million as of
December 28, 2002 and December 29, 2001, respectively, from long-term debt to
short-term debt and capital lease obligations.
As of December 28, 2002, the Company had $25.1 million of cumulative
borrowings outstanding under the Congress Credit Facility, comprising $8.8
million under the revolving loan facility, bearing an interest rate of 4.75%,
$8.5 million under the Tranche A Term Loan, bearing an interest rate of 5.0%,
and $7.8 million under the Tranche B Term Loan, bearing an interest rate of
13.0%. Of the aggregate borrowings of $25.1 million, $12.6 million is classified
as short-term while $12.5 million is classified as long-term on the Company's
Consolidated Balance Sheet. As of December 29, 2001, the Company had $29.6
million of borrowings outstanding under the Congress Credit Facility comprising
$13.5 million under the revolving loan facility, bearing an interest rate of
5.25%, and $10.5 million, bearing an interest rate of 5.50%, and $5.6 million,
bearing an interest rate of 13.00%, of Tranche A Term Loans and Tranche B Term
Loans, respectively.
Achievement of the Company's strategic business realignment program is
critical to the maintenance of adequate liquidity, as is compliance with the
terms and provisions of the Congress Credit Facility and the Company's ability
to operate effectively during the 2003 fiscal year. In the event of a softer
than expected economic climate, management has available several courses of
action to maintain liquidity and help maintain compliance with financial
covenants, including selective reductions in catalog circulation, additional
expense reductions and sales of non-core assets.
Series B Cumulative Participating Preferred Stock. During autumn 2002,
Company management conducted a strategic review of the Company's business and
operations. As part of such review, Company management considered the Company's
obligations under the Richemont Agreement and the Company's prospects and
options for redemption of the Series B Preferred Shares issued to Richemont
pursuant thereto in accordance with the Richemont Agreement terms. The review
took into account the results of the Company's strategic business realignment
program in 2001 and 2002, the relative strengths and weaknesses of the Company's
competitive position and the economic and business climate, including the
depressed business environment for mergers and acquisitions.
As a result of this review, Company management and the Company's Board of
Directors have concluded that it is unlikely that the Company will be able to
accumulate sufficient capital, surplus, or other assets under Delaware corporate
law or to obtain sufficient debt financing to either:
1. Redeem at least 811,056 shares of the Series B Preferred Stock by
August 31, 2003, as allowed for by the Richemont Agreement, thereby
resulting in the occurrence of a "Voting Trigger" which will allow
Richemont to have the option of electing two members to the Company's Board
of Directors; or
2. Redeem all of the shares of Series B Preferred Stock by August 31,
2005, as required by the Richemont Agreement, thereby obligating the
Company to take all measures permitted under the Delaware General
Corporation Law to increase the amount of its capital and surplus legally
available to redeem the Series B Preferred Shares, without a material
improvement in either the business environment for mergers and acquisitions
or other factors, unforeseeable at the time.
Management believes that the Company has sufficient liquidity and
availability under its credit agreement to fund its planned operations through
at least January 31, 2004. Management will be required to successfully
renegotiate the renewal of the Congress Credit Facility or successfully replace
the facility with another institution. The unlikelihood that the Company will be
able to redeem the Series B Preferred Shares is not expected to limit the
ability of the Company to use current and future net earnings or cash flow to
satisfy its obligations to creditors and vendors. In addition, the redemption
price of the Series B Preferred Stock does not accrete after August 31, 2005.
Sale of the 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) agreed to provide telemarketing
and fulfillment services for the Improvements business under a services
agreement with the buyer for a period of three years.
30
The asset purchase agreement between the Company and HSN provides that if
Keystone Internet Services, Inc. fails to perform its obligations during the
first two years of the services contract, the purchaser can receive a reduction
in the original purchase price of up to $2.0 million. An escrow fund of $3.0
million, which was withheld from the original proceeds of the sale, has been
established for a period of two years under the terms of an escrow agreement
between LWI Holdings, Inc., HSN and The Chase Manhattan Bank as a result of
these contingencies. The balance in the escrow fund at December 29, 2001 was
$2.6 million. As of December 28, 2002, the balance in the escrow fund was $2.0
million, and there were no claims against the escrow.
The Company recognized a net gain on the sale of approximately $23.2
million in fiscal year 2001, which represents the excess of the net proceeds
from the sale over the net assets assumed by HSN, the goodwill associated with
the Improvements business and expenses related to the transaction. During fiscal
year 2002, the Company recognized approximately $0.6 million of the deferred
gain consistent with the terms of the escrow agreement. Proceeds of
approximately $0.3 million relating to the deferred gain were received on each
of July 2, 2002 and December 30, 2002. The recognition of an additional gain of
up to approximately $2.0 million has been deferred until the contingencies
described above expire, which will occur no later than the middle of the 2003
fiscal year.
American Stock Exchange Notification. By letter dated May 2, 2001, the
American Stock Exchange notified the Company that it was below certain of the
Exchange's continued listing guidelines set forth in the Exchange's Company
Guide. The Exchange instituted a review of the Company's eligibility for
continuing listing of the Company's common stock on the Exchange. On January 17,
2002, the Company received a letter dated January 9, 2002 from the Exchange
confirming that the American Stock Exchange determined to continue the Company's
listing on the Exchange pending quarterly reviews of the Company's compliance
with the steps of its strategic business realignment program. This determination
was made subject to the Company's favorable progress in satisfying the
Exchange's guidelines for continued listing and to the Exchange's periodic
review of the Company's Securities and Exchange Commission and other filings.
On November 11, 2002, the Company received a letter dated November 8, 2002
from the Exchange updating its position regarding the Company's compliance with
certain of the Exchange's continued listing standards as set forth in Part 10 of
the Exchange's Company Guide. Although the Company had been making favorable
progress in satisfying the Exchange's guidelines for continued listing based on
its compliance with the steps of its strategic business realignment program
shared with the Exchange in 2001 and updated in 2002, the Exchange informed the
Company that it had now become strictly subject to the procedures and
requirements of Part 10 of the Company Guide. Specifically, the Company must not
fall below the requirements of: (i) Section 1003(a)(i) 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; (ii) Section 1003(a)(ii) 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 (iii) Section 1003(a)(iii) 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 submit a plan to the
Exchange by December 11, 2002, advising the Exchange of action it has taken, or
will take, that would bring it into compliance with the continued listing
standards by December 28, 2003. The Company submitted a plan to the Exchange on
December 11, 2002 in an effort to maintain the listing of the Company's common
stock on the Exchange.
On January 28, 2003, the Company received a letter from the Exchange
confirming that, as of the date of the letter, the Company had evidenced
compliance with the requirements necessary for continued listing on the
Exchange. Such compliance resulted from a recent rule change by the Exchange
approved by the Securities and Exchange Commission related to continued listing
on the basis of compliance with total market capitalization or total assets and
revenues standards as alternatives to shareholders' equity standards such as the
requirement for each listed company to maintain $15 million in public float. The
letter is subject to changes in the American Stock Exchange Rules that might
supersede the letter or require the Exchange to re-evaluate its position.
31
General. At December 28, 2002, the Company had $0.8 million in cash and
cash equivalents, compared with $1.1 million at December 29, 2001. Working
capital and current ratios at December 28, 2002 were $0.6 million and 1.01 to 1
versus $7.4 million and 1.08 to 1 at December 29, 2001. Total cumulative
borrowings, including financing under capital lease obligations, as of December
28, 2002, aggregated $25.1 million, of which $12.6 million is classified as
short-term and $12.5 million is classified as long-term. Remaining availability
under the Congress Revolving Loan Facility as of December 28, 2002 was $18.2
million. There were nominal capital commitments (less than $0.1 million) at
December 28, 2002.
On March 22, 2002, the Postal Rate Commission approved a settlement that
allowed postal rates to increase an average of 7.7% on June 30, 2002. The
Company had anticipated this action in its 2002 planning process and has been
accommodating the increased cost as part of its normal business operations. The
Company has implemented cost conservation measures, such as reduced paper
weights and trim size changes, as a way of mitigating such cost increases.
Management believes that the Company has sufficient liquidity and
availability under its credit agreement to fund its planned operations through
at least January 31, 2004. Management will be required to successfully
renegotiate the renewal of the Congress Credit Facility or successfully replace
the facility with another institution on or prior to that date. Achievement of
the cost saving and other objectives of the Company's strategic business
realignment program is critical to the maintenance of adequate liquidity as is
compliance with the terms and provisions of the Congress Credit Facility as
mentioned in Note 6, Long-Term Debt, to the Consolidated Financial Statements.
USE OF ESTIMATES AND OTHER CRITICAL ACCOUNTING POLICIES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities at the date of the financial statements and revenues and expenses
during the period. Significant accounting policies employed by the Company,
including the use of estimates, are presented in the Notes to Consolidated
Financial Statements.
On April 30, 2002, the Securities and Exchange Commission issued a proposed
rule to improve the financial statement disclosure of accounting estimates and
critical accounting policies used by companies in the presentation of their
financial condition, changes in financial condition or results of operations.
Critical accounting policies are those that are most important to the portrayal
of the Company's financial condition and results of operations, and require
management's most difficult, subjective or complex judgments, as a result of the
need to make estimates about the effect of matters that are inherently
uncertain. The Company's most critical accounting policies, discussed below,
pertain to revenue recognition, inventory valuation, catalog costs, reserves
related to the Company's strategic business realignment program and the
Company's deferred tax asset. Actual results could differ from estimates used in
employing the critical accounting policies, although the Company does not
believe that any differences would materially affect its financial condition or
results of operations.
Revenue Recognition -- The Company's revenue recognition policy includes
the use of estimates of the future amount of returns to be received on the
current period's sales. These estimates of future returns are determined using
historical measures including the amount of time between the shipment of a
product and its return (return lag -- rounded up to the nearest whole week), the
overall rate of return, and the average product margin associated with the
returned products. Returns estimates are calculated for each catalog brand and
are used to determine each individual brand's returns reserve. The Company's
total returns reserve at the end of the fiscal years 2002, 2001 and 2000 was
$1.9 million, $2.8 million and $3.4 million, respectively. Net Revenues and Cost
of Sales and Operating Expenses on the Company's Consolidated Statements of
Income (Loss), as well as Accrued Liabilities on the Consolidated Balance
Sheets, are impacted by the returns reserve calculations.
Inventory Valuation -- The Company's inventory valuation policy includes
the use of estimates regarding the future amount of inventory that will be
liquidated at a price less than the cost of the merchandise (obsolescence
reserve), and the amount of freight-in expense associated with the inventory
on-hand
32
(capitalized freight). These amounts are included in total inventory recorded on
the Company's Consolidated Balance Sheets. The Company's obsolescence reserve is
determined using the estimated amount of overstock inventory that will need to
be sold below cost and an estimate of the method of liquidating this merchandise
(each method generates a different level of cost recovery). The estimated amount
of overstock inventory is determined using current and historical sales trends
for each category of inventory as well as the content of future catalog offers
that will be produced by the Company. An estimate of the percentage of
freight-in expense associated with each dollar of inventory on-hand is used in
calculating the amount of freight expense to include in the Company's inventory
value. Different percentage estimates are developed for inventory purchased from
foreign and domestic sources. The estimates used to determine the Company's
inventory valuation affect the balance of Inventory on the Company's
Consolidated Balance Sheets and Cost of Sales and Operating Expenses on the
Company's Consolidated Statements of Income (Loss).
Catalog Costs -- An estimate of the future sales dollars to be generated
from each individual catalog drop is used in the Company's catalog costs policy.
The estimate of future sales is calculated for each catalog drop using
historical trends for similar catalog drops mailed in prior periods as well as
the overall current sales trend for the catalog brand. This estimate is compared
with the actual sales generated-to-date for the catalog drop to determine the
percentage of total catalog costs to be classified as prepaid on the Company's
Balance Sheet. Prepaid Catalog Costs on the Consolidated Balance Sheets and
Selling Expenses on the Consolidated Statements of Income (Loss) are affected by
these estimates.
Reserves related to the Company's strategic business realignment program
and other Accrued Liabilities -- The reserves established by the Company related
to its strategic business realignment program include estimates primarily
associated with the potential subleasing of leased properties which have been
vacated by the Company. The properties which have available space for subleasing
as of December 28, 2002 include the corporate headquarters and administrative
offices located in Weehawken, New Jersey and Edgewater, New Jersey; the retail
and office facility which includes the Gump's retail store in San Francisco,
California; the telemarketing and administrative facility located in San Diego,
California; and the retail store facility in Los Angeles, California. The
overall reserves for leased properties that have been vacated by the Company are
developed using estimates that include the potential ability to sublet leased
but unoccupied properties, the length of time needed to obtain suitable tenants
and the amount of rent to be received for the sublet. Real estate broker
representations regarding current and future market conditions are sometimes
used in estimating these items. Current Accrued Liabilities and Other
Non-Current Liabilities on the Company's Consolidated Balance Sheets and Special
Charges on the Company's Consolidated Statements of Income (Loss) are impacted
by these estimates.
The most significant estimates involved in evaluating the Company's Accrued
Liabilities are used in the determination of the Rakesh Kaul litigation accrual.
In calculating this accrual, the Company has used estimates including the
likelihood that this case will reach the trial stage, the legal expenses
associated with continuing this legal action, the ultimate outcome of the case,
and the amounts to be awarded if the outcome is not in the Company's favor.
These estimates have been developed and approved by the Company's Senior
Management. Accrued Liabilities on the Consolidated Balance Sheets and General
and Administrative Expenses on the Consolidated Statements of Income (Loss) are
affected by these estimates.
Reserves related to employee health and welfare claims -- The Company
maintains a self-insurance program related to losses and liabilities associated
with employee health and welfare claims. Stop-loss coverage is held on both an
aggregate and individual claim basis; thereby, limiting the amount of losses the
Company will experience. Losses are accrued based upon estimates of the
aggregate liability for claims incurred using the Company's experience patterns.
General and Administrative Expenses on the Consolidated Statement of Income
(Loss) and Accrued liabilities on the Consolidated Balance Sheet are affected by
these estimates.
Deferred Tax Asset -- In determining the Company's net deferred tax asset,
projections concerning the future utilization of the Company's net operating
loss carryforwards are employed. These projections involve evaluations of the
Company's future operating plans and ability to generate taxable income, as well
as future economic conditions and the Company's future competitive environment.
For the year ended December 28,
33
2002, the carrying value of the deferred tax asset was adjusted based on a
reassessment of the Company's ability to utilize certain net operating losses
prior to their expiration. The change in the Company's projections and the
effect on the Company's 2002 fiscal year-end financial statements is presented
in the Notes to Consolidated Financial Statements (Note 13). The Deferred Tax
Asset and Deferred Tax Liability on the Company's Consolidated Balance Sheets
and the Provision for Deferred Federal Income Taxes on the Company's
Consolidated Statements of Income (Loss) are impacted by these projections.
NEW ACCOUNTING PRONOUNCEMENTS
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" ("FAS 146"). FAS 146 nullifies
Emerging Issues Task Force Issue No. 94-3 ("EITF 94-3"). FAS 146 requires that a
liability for a cost associated with an exit or disposal activity be recognized
when the liability is incurred whereas, under EITF 94-3, the liability was
recognized at the commitment date to an exit plan. The Company is required to
adopt the provisions of FAS 146 effective for exit or disposal activities
initiated after December 31, 2002.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure -- An Amendment of SFAS No. 123" ("FAS
148"). FAS 148 provides alternative methods of transition for a voluntary change
to the fair value-based method of accounting for stock-based employee
compensation. Since 1996, the Company has accounted for its stock-based
compensation to employees using the fair value-based methodology under SFAS No.
123, thus there has been no effect on the Company's results of operations or
financial position. In addition, FAS 148 amends the disclosure requirements of
SFAS No. 123 to require prominent disclosures in both annual and interim
financial statements about the method of accounting for stock-based employee
compensation and the effect of the method used on reported results. The Company
has concluded they are in compliance with these required prominent disclosures.
In January 2003, the Securities and Exchange Commission issued a new
disclosure regulation, "Conditions for Use of Non-GAAP Financial Measures"
("Regulation G"), which is effective for all public disclosures and filings made
after March 28, 2003. Regulation G requires public companies that disclose or
release information containing financial measures that are not in accordance
with generally accepted accounting principles ("GAAP") to include in the
disclosure or release a presentation of the most directly comparable GAAP
financial measure and a reconciliation of the disclosed non-GAAP financial
measure to the most directly comparable GAAP financial measure. The Company will
be adopting Regulation G in fiscal 2003 and is currently evaluating the impact
of this adoption on its financial disclosures.
OFF-BALANCE SHEET ARRANGEMENTS
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.
FORWARD-LOOKING STATEMENTS
The following statements 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 agreement to fund its planned operations through
at least January 31, 2004."
"The unlikelihood that the Company will be able to redeem the Series B
Preferred Shares is not expected to limit the ability of the Company to use
current and future net earnings or cash flow to satisfy its obligations to
creditors and vendors."
34
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:
- The recent general deterioration in economic conditions in the United
States leading to reduced consumer confidence, reduced disposable income
and increased competitive activity and the business failure of companies
in the retail, catalog and direct marketing industries. Such economic
conditions leading to a reduction in consumer spending generally and
in-home fashions specifically, and leading to a reduction in consumer
spending specifically with reference to other types of merchandise the
Company offers in its catalogs or over the Internet, or which are offered
by the Company's third party fulfillment clients.
- Customer response to the Company's merchandise offerings and circulation
changes; effects of shifting patterns of e-commerce versus catalog
purchases; costs associated with printing and mailing catalogs and
fulfilling orders; effects of potential slowdowns or other disruptions in
postal service; dependence on customers' seasonal buying patterns; and
fluctuations in foreign currency exchange rates. The ability of the
Company to 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 commensurately with sales
projections. Increases in postage, printing and paper prices and/or the
inability of the Company to reduce expenses generally as required for
profitability and/or increase prices of the Company's merchandise to
offset expense increases.
- The failure of the Internet generally to achieve the projections for it
with respect to growth of e-commerce or otherwise, and the failure of the
Company to increase Internet sales. The success of the Amazon.com
venture. The imposition of regulatory, tax or other requirements with
respect to Internet sales. Actual or perceived technological difficulties
or security issues with respect to conducting e-commerce over the
Internet generally or through the Company's Web sites or those of its
third party fulfillment clients specifically.
- The ability of the Company to attract and retain management and employees
generally and specifically with the requisite experience in e-commerce,
Internet and direct marketing businesses. The ability of employees of the
Company who have been promoted as a result of the Company's strategic
business realignment program to perform the responsibilities of their new
positions.
- The recent general deterioration in economic conditions in the United
States leading to key vendors and suppliers reducing or withdrawing trade
credit to companies in the retail, 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.
- Continued compliance by the Company with and the enforcement by Congress
of financial and other covenants and limitations contained in the
Congress Credit Facility, including net worth, net working capital,
capital expenditure and EBITDA covenants, and limitations based upon
specified percentages of eligible receivables and eligible inventory, and
the requirement that the Company maintain
35
$3.0 million of excess credit availability at all times, affecting the
ability of the Company to continue to make borrowings under the Congress
Credit Facility.
- Continuation of the Company's history of operating losses, and the
incidence of costs associated with the Company's strategic business
realignment program, resulting in the Company failing to comply with
certain financial and other covenants contained in the Congress Credit
Facility, including net worth, net working capital, capital expenditure
and EBITDA covenants and the ability of the Company to obtain waivers
from Congress in the event that future internal and/or external events
result in performance which results in noncompliance by the Company with
the terms of the Congress Credit Facility requiring remediation.
- The ability of the Company to complete the Company's strategic business
realignment program, including the integration of the Domestications and
The Company Store divisions and the integration of the Gump's(R) store
and the Gump's By Mail(R) catalog divisions, within the time periods
anticipated by the Company. The ability of the Company to realize the
aggregate cost savings and other objectives anticipated in connection
with the strategic business realignment program, or within the time
periods anticipated therefor. The aggregate costs of effecting the
strategic business realignment program may be greater than the amounts
anticipated by the Company.
- The ability of the Company to 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.
- Inability of the Company to timely replace its existing private label
credit card agreement, and to transition its existing credit card
customers to a new private label credit card issuer.
- 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 ability of the Company to extend the term of the Congress Credit
Facility beyond January 31, 2004, its scheduled expiration date, or
obtain other credit facilities on the expiration of the Congress Credit
Facility on terms at least as favorable as those under the Congress
Credit Facility.
- The 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 assets due to market
conditions or otherwise.
- The Company's dependence up to August 24, 2000 on Richemont and its
affiliates for financial support and the fact that they are not under any
obligation ever to provide any additional support in the future.
- The ability of the Company to redeem the Series B Preferred Stock
currently held by Richemont on a timely basis, or at all.
- The ability of the Company to maintain the listing of its Common Stock on
the American Stock Exchange.
36
- 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 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 proposed 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 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.
- The inability of the Company to continue to source goods from foreign
sources, particularly India and Pakistan, as a result of a war with Iraq
or otherwise leading to increased costs of sales.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
INTEREST RATES: The Company's exposure to market risk relates to interest
rate fluctuations for borrowings under the Congress revolving credit facility
and its term financing facility, which bear interest at variable rates. At
December 28, 2002, outstanding principal balances under these facilities subject
to variable rates of interest were approximately $17.3 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 December 28,
2002, would be approximately $0.17 million on an annual basis.
37
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Hanover Direct, Inc.:
We have audited the accompanying consolidated balance sheet of Hanover
Direct, Inc. as of December 28, 2002 and the related consolidated statements of
income (loss), shareholders' deficiency, and cash flows for the year then ended.
In connection with our audit of the consolidated financial statements, we also
have audited the financial statement schedule for the year ended December 28,
2002 as listed in the accompanying index. These consolidated financial
statements and financial statement schedule are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements and financial statement schedule based on our
audit. The 2001 and 2000 financial statements and financial statement schedule
of Hanover Direct, Inc. as listed in the accompanying index were audited by
other auditors who have ceased operations. Those auditors expressed an
unqualified opinion on those financial statements and financial statement
schedule in their report dated March 16, 2002.
We conducted our audit in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Hanover
Direct, Inc. as of December 28, 2002 and the results of its operations and its
cash flows for the year then ended, in conformity with accounting principles
generally accepted in the United States of America. Also, in our opinion, the
related financial statement schedule for the year ended December 28, 2002, when
considered in relation to the basic consolidated financial statements taken as a
whole, presents fairly, in all material respects, the information set forth
therein.
As described in Note 21, the Company's consolidated balance sheets as of
December 28, 2002 have been restated to classify certain debt as current. As
discussed above, the 2001 financial statements of Hanover Direct, Inc. were
audited by other auditors who have ceased operations. As described in Note 21,
these financial statements have been amended to reflect the restatement of the
consolidated balance sheet as of December 29, 2001 in order to classify certain
debt as current. We have audited the adjustments that were applied to restate
the December 29, 2001 balance sheet. In our opinion, such adjustments are
appropriate and have been properly applied. However, we were not engaged to
audit, review or apply any procedures to the 2001 financial statements of
Hanover Direct, Inc. other than with respect to such adjustments and,
accordingly, we do not express an opinion or any other form of assurance on the
2001 financial statements taken as a whole.
As discussed in Note 1 to the consolidated financial statements, Hanover
Direct, Inc. in 2002 adopted the provisions of the Financial Accounting
Standards Board's Statement of Financial Accounting Standards No. 142, "Goodwill
and Other Intangible Assets."
KPMG LLP
New York, New York
March 25, 2003, except as to
note 21, which is as of
April 2, 2004
38
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders of Hanover Direct, Inc.:
We have audited the accompanying consolidated balance sheets of Hanover
Direct, Inc. (a Delaware corporation) as of December 29, 2001 and December 30,
2000, and the related consolidated statements of income (loss), shareholder's
equity (deficit) and cash flows for each of the three fiscal years in the period
ended December 29, 2001. These consolidated financial statements and schedule
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these consolidated financial statements and schedule based
on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion. In our opinion, the financial statements referred to above
present fairly, in all material respects, the financial position of Hanover
Direct, Inc. and subsidiaries as of December 29, 2001 and December 30, 2000 and
the results of their operations and their cash flows for each of the three
fiscal years in the period ended December 29, 2001 in conformity with accounting
principles generally accepted in the United States.
Our audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedule of valuation and qualifying
accounts is presented for purposes of complying with the Securities and Exchange
Commission's rules and is not part of the basic financial statements. The
schedule has been subjected to the auditing procedures applied in the audit of
the basic financial statements and, in our opinion, fairly states in all
material respects the financial data required to be set forth therein in
relation to the basic financial statements taken as a whole.
ARTHUR ANDERSEN LLP
New York, New York
March 16, 2002
THIS IS A COPY OF A REPORT ISSUED BY ARTHUR ANDERSEN LLP, OUR FORMER INDEPENDENT
AUDITORS, AS OF THE DATE INDICATED ABOVE, AND HAS NOT BEEN REISSUED BY ARTHUR
ANDERSEN LLP SINCE THAT DATE.
39
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 28, 2002 AND DECEMBER 29, 2001
AS RESTATED
---------------------------
DECEMBER 28, DECEMBER 29,
2002 2001
------------ ------------
(IN THOUSANDS OF DOLLARS,
EXCEPT SHARE AMOUNTS)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents................................. $ 785 $ 1,121
Accounts receivable, net of allowance for doubtful
accounts of $1,560 in 2002 and $2,117 in 2001........... 16,945 19,456
Inventories............................................... 53,131 59,223
Prepaid catalog costs..................................... 13,459 14,620
Deferred tax asset, net................................... -- 3,300
Other current assets...................................... 3,967 3,000
--------- ---------
Total Current Assets.................................... 88,287 100,720
--------- ---------
PROPERTY AND EQUIPMENT, AT COST:
Land...................................................... 4,395 4,509
Buildings and building improvements....................... 18,205 18,205
Leasehold improvements.................................... 9,915 12,466
Furniture, fixtures and equipment......................... 56,094 59,287
--------- ---------
88,609 94,467
Accumulated depreciation and amortization................. (59,376) (60,235)
--------- ---------
Property and equipment, net............................... 29,233 34,232
--------- ---------
Goodwill, net............................................. 9,278 9,278
Deferred tax asset, net................................... 12,400 11,700
Other assets.............................................. 902 1,731
--------- ---------
Total Assets............................................ $ 140,100 $ 157,661
========= =========
LIABILITIES AND SHAREHOLDERS' DEFICIENCY
CURRENT LIABILITIES:
Short-term debt and capital lease obligations............. $ 12,621 $ 16,685
Accounts payable.......................................... 42,873 46,348
Accrued liabilities....................................... 26,351 25,132
Customer prepayments and credits.......................... 4,722 5,143
Deferred tax liability.................................... 1,100 --
--------- ---------
Total Current Liabilities............................... 87,667 93,308
--------- ---------
NON-CURRENT LIABILITIES:
Long-term debt............................................ 12,508 13,025
Other..................................................... 6,387 10,233
--------- ---------
Total Non-current Liabilities........................... 18,895 23,258
--------- ---------
Total Liabilities....................................... 106,562 116,566
--------- ---------
SERIES B REDEEMABLE PREFERRED STOCK, authorized, issued and
outstanding, 1,622,111 shares at December 28, 2002 and
December 29, 2001......................................... 92,379 76,823
--------- ---------
SHAREHOLDERS' DEFICIENCY:
Common Stock, $.66 2/3 par value, authorized 300,000,000
shares; 140,436,729 shares issued and outstanding at
December 28, 2002 and 140,336,729 shares issued and
outstanding at December 29, 2001........................ 93,625 93,558
Capital in excess of par value.............................. 337,507 351,558
Accumulated deficiency...................................... (486,627) (477,497)
--------- ---------
(55,495) (32,381)
Less:
Treasury stock, at cost (2,120,929 shares at December 28,
2002 and 2,100,929 shares at December 29, 2001)........... (2,996) (2,942)
Notes receivable from sale of Common Stock.................. (350) (405)
--------- ---------
Total Shareholders' Deficiency.......................... (58,841) (35,728)
--------- ---------
Total Liabilities and Shareholders' Deficiency.......... $ 140,100 $ 157,661
========= =========
See notes to Consolidated Financial Statements.
40
CONSOLIDATED STATEMENTS OF INCOME (LOSS)
FOR THE YEARS ENDED DECEMBER 28, 2002, DECEMBER 29, 2001 AND DECEMBER 30, 2000
2002 2001 2000
--------- --------- ---------
(IN THOUSANDS OF DOLLARS, EXCEPT
PER SHARE AMOUNTS)
NET REVENUES................................................ $457,644 $532,165 $603,014
-------- -------- --------
OPERATING COSTS AND EXPENSES:
Cost of sales and operating expenses...................... 290,531 339,556 404,959
Write-down of inventory of discontinued catalogs.......... -- -- 2,048
Special charges........................................... 4,398 11,277 19,126
Selling expenses.......................................... 105,239 141,140 153,462
General and administrative expenses....................... 52,258 56,727 84,881
Depreciation and amortization............................. 5,650 7,430 9,090
-------- -------- --------
458,076 556,130 673,566
-------- -------- --------
LOSS FROM OPERATIONS........................................ (432) (23,965) (70,552)
Gain on sale of Improvements.............................. (570) (23,240) --
Gain on sale of Kindig Lane Property...................... -- (1,529) --
-------- -------- --------
INCOME (LOSS) BEFORE INTEREST AND INCOME TAXES.............. 138 804 (70,552)
Interest expense, net..................................... 5,477 6,529 10,083
-------- -------- --------
LOSS BEFORE INCOME TAXES.................................... (5,339) (5,725) (80,635)
Provision for deferred federal income taxes............... 3,700 -- --
Provision for state income taxes.......................... 91 120 165
-------- -------- --------
NET LOSS AND COMPREHENSIVE LOSS............................. (9,130) (5,845) (80,800)
Preferred stock dividends................................. 15,556 10,745 4,015
-------- -------- --------
NET LOSS APPLICABLE TO COMMON SHAREHOLDERS.................. $(24,686) $(16,590) $(84,815)
======== ======== ========
NET LOSS PER COMMON SHARE:
Net loss per common share -- basic and diluted............ $ (.18) $ (.08) $ (.40)
======== ======== ========
Weighted average common shares outstanding -- basic and
diluted (thousands).................................... 138,280 210,536 213,252
======== ======== ========
See notes to Consolidated Financial Statements.
41
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 28, 2002, DECEMBER 29, 2001 AND DECEMBER 30, 2000
2002 2001 2000
------- -------- --------
(IN THOUSANDS OF DOLLARS)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss.................................................. $(9,130) $ (5,845) $(80,800)
Adjustments to reconcile net loss to net cash provided
(used) by operating activities:
Depreciation and amortization, including deferred
fees.................................................. 7,203 8,112 11,271
Provision for doubtful accounts......................... 304 91 4,947
Special charges......................................... 18 3,254 19,126
Deferred tax asset...................................... 3,700
Write-down of inventory of discontinued catalogs........ -- -- 2,048
Gain on the sale of Improvements........................ (570) (23,240) --
Gain on the sale of Kindig Lane Property................ -- (1,529) --
Gain on the sale of property and equipment.............. (167) -- --
Compensation expense related to stock options........... 1,332 1,841 5,175
Changes in assets and liabilities
Accounts receivable..................................... 2,207 7,398 (3,363)
Inventories............................................. 6,092 7,077 (16,844)
Prepaid catalog costs................................... 1,161 4,456 (2,779)
Accounts payable........................................ (3,475) (12,818) 4,309
Accrued liabilities..................................... 1,219 (11,117) 2,119
Customer prepayments and credits........................ (421) (300) 1,180
Other, net.............................................. (4,814) 1,400 1,803
------- -------- --------
Net cash provided (used) by operating activities.......... 4,659 (21,220) (51,808)
------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisitions of property and equipment.................. (639) (1,627) (14,581)
Proceeds from sale of Improvements...................... 570 30,036 --
Proceeds from sale of Kindig Lane Property.............. -- 4,671 --
Proceeds from disposal of property and equipment........ 169 -- --
Proceeds from sale Blue Ridge Associates................ -- -- 988
------- -------- --------
Net cash provided (used) by investing activities.......... 100 33,080 (13,593)
------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net (payments) borrowings under Congress revolving loan
facility.............................................. (4,704) (2,189) 12,810
Borrowings under Congress Tranche A term loan
facility.............................................. -- -- 5,200
Borrowings under Congress Tranche B term loan
facility.............................................. 3,500 -- 7,500
Payments under Congress Tranche A term loan facility.... (1,991) (5,208) (2,074)
Payments under Congress Tranche B term loan facility.... (1,314) (1,069) (806)
Payments of 7.5% convertible debentures................. -- (751) --
Payments of long-term debt and capital lease
obligations........................................... (104) (90) (24,130)
Net proceeds from issuance of preferred stock........... -- -- 67,700
Payment of debt issuance costs.......................... (722) (3,095) (2,770)
Payment of preferred stock dividends.................... -- -- (920)
Proceeds from issuance of common stock.................. 25 -- 847
Series B Preferred Stock transaction cost adjustment.... 215 -- --
Other, net.............................................. -- (28) 886
------- -------- --------
Net cash (used) provided by financing activities.......... (5,095) (12,430) 64,243
------- -------- --------
Net decrease in cash and cash equivalents................. (336) (570) (1,158)
Cash and cash equivalents at the beginning of the year.... 1,121 1,691 2,849
------- -------- --------
Cash and cash equivalents at the end of the year.......... $ 785 $ 1,121 $ 1,691
======= ======== ========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the year for:
Interest................................................ $ 3,405 $ 5,286 $ 7,723
Income taxes............................................ $ 193 $ 150 $ 414
Non-cash investing and financing activities:
Series B Preferred Stock redemption price increase...... $15,556 $ -- $ --
Redemption of Series B Preferred Stock.................. $ -- $ -- $ 6,350
Stock dividend and accretion Series A Cumulative
Participating Preferred Stock......................... $ -- $ 10,745 $ 3,927
Redemption of Series A Cumulative Participating
Preferred Stock and Accrued Stock Dividends........... $ -- $ 82,390 $ --
Issuance of Series B Preferred Stock.................... $ -- $ 76,823 $ --
Tandem share expirations................................ $ 55 $ 719 $ 394
Capital lease obligations............................... $ 32 $ 9 $ --
See notes to Consolidated Financial Statements.
42
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' DEFICIENCY
FOR THE YEARS ENDED DECEMBER 28, 2002, DECEMBER 29, 2001 AND DECEMBER 30, 2000
PREFERRED STOCK
SERIES B COMMON STOCK
CONVERTIBLE $.66 2/3 PER VALUE CAPITAL
---------------- ------------------ IN EXCESS OF ACCUM.
SHARES AMOUNT SHARES AMOUNT PAR VALUE (DEFICIT)
------ ------- ------- -------- ------------ ---------
(IN THOUSANDS OF DOLLARS AND SHARES)
BALANCE AT DECEMBER 25, 1999....... 635 $ 6,318 211,520 $141,013 $301,088 $(390,763)
==== ======= ======= ======== ======== =========
Net loss applicable to common
shareholders..................... (84,815)
Preferred stock accretion.......... 32 (152) 152
Preferred stock dividend........... (3,775) 3,775
Stock options granted.............. 5,175
Cash received for Tandem
receivable.......................
Tandem note write-down.............
Issuance of Common Stock for
employee stock plan.............. 713 476 371
Tandem share expirations...........
Conversion to Common Stock......... (635) (6,350) 2,192 1,462 4,888
---- ------- ------- -------- -------- ---------
BALANCE AT DECEMBER 30, 2000....... -- $ -- 214,425 $142,951 $307,595 $(471,651)
==== ======= ======= ======== ======== =========
Net loss applicable to common
shareholders..................... (16,590)
Preferred stock accretion.......... (2,129) 2,129
Preferred stock dividend........... (8,615) 8,615
Stock options granted.............. 1,841
Issuance of Common Stock for
employee stock plan.............. 10 7 (5)
Tandem share expirations...........
Retirement of Treasury Shares......
Preferred stock issuance costs..... (2,095)
Conversion to Preferred Stock...... (74,098) (49,400) 54,966
---- ------- ------- -------- -------- ---------
BALANCE AT DECEMBER 29, 2001....... -- $ -- 140,337 $ 93,558 $351,558 $(477,497)
==== ======= ======= ======== ======== =========
Net loss applicable to common
shareholders..................... (24,686)
Series B preferred stock
liquidation preference accrual... (15,556) 15,556
Stock options granted.............. 1,332
Issuance of Common Stock for
employee stock plan.............. 100 67 (42)
Tandem share expirations...........
Series B preferred stock issuance
cost adjustment.................. 215
---- ------- ------- -------- -------- ---------
BALANCE AT DECEMBER 28, 2002....... -- $ -- 140,437 $ 93,625 $337,507 $(486,627)
==== ======= ======= ======== ======== =========
NOTES
RECEIVABLE
TREASURY STOCK FROM SALE
---------------- OF COMMON
SHARES AMOUNT STOCK TOTAL
------ ------- ---------- --------
(IN THOUSANDS OF DOLLARS AND SHARES)
BALANCE AT DECEMBER 25, 1999....... (652) $(1,829) $(1,962) $ 53,865
====== ======= ======= ========
Net loss applicable to common
shareholders..................... (84,815)
Preferred stock accretion.......... 32
Preferred stock dividend........... --
Stock options granted.............. 5,175
Cash received for Tandem
receivable....................... 10 10
Tandem note write-down............. 434 434
Issuance of Common Stock for
employee stock plan.............. 847
Tandem share expirations........... (77) (394) 394 --
Conversion to Common Stock......... --
------ ------- ------- --------
BALANCE AT DECEMBER 30, 2000....... (729) $(2,223) $(1,124) $(24,452)
====== ======= ======= ========
Net loss applicable to common
shareholders..................... (16,590)
Preferred stock accretion.......... --
Preferred stock dividend........... --
Stock options granted.............. 1,841
Issuance of Common Stock for
employee stock plan.............. 2
Tandem share expirations........... (1,530) (719) 719 --
Retirement of Treasury Shares...... 158 -- --
Preferred stock issuance costs..... (2,095)
Conversion to Preferred Stock...... 5,566
------ ------- ------- --------
BALANCE AT DECEMBER 29, 2001....... (2,101) $(2,942) $ (405) $(35,728)
====== ======= ======= ========
Net loss applicable to common
shareholders..................... (24,686)
Series B preferred stock
liquidation preference accrual... --
Stock options granted.............. 1,332
Issuance of Common Stock for
employee stock plan.............. 25
Tandem share expirations........... (20) (54) 54 --
Series B preferred stock issuance
cost adjustment.................. 1 216
------ ------- ------- --------
BALANCE AT DECEMBER 28, 2002....... (2,121) $(2,996) $ (350) $(58,841)
====== ======= ======= ========
See notes to Consolidated Financial Statements.
43
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 28, 2002, DECEMBER 29, 2001 AND DECEMBER 30, 2000
1. BACKGROUND OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations -- Hanover Direct, Inc., a Delaware corporation (the
"Company"), is a specialty direct marketer, that markets a diverse portfolio of
branded home fashions, men's and women's apparel, and gift products, through
mail-order catalogs and connected Internet Web sites directly to the consumer
("direct commerce"). In addition, the Company continues to service existing
third party clients with business-to-business (B-to-B) e-commerce transaction
services. These services include a full range of order processing, customer
care, customer information, and shipping and distribution services.
The Company utilizes a fully integrated system and operations support
platform initially developed to manage the Company's wide variety of
catalog/Internet product offerings. This infrastructure is being utilized by the
aforementioned B-to-B e-commerce transaction services on behalf of third party
clients. Due to the strategic business realignment effective December 30, 2000
pursuant to SFAS No. 131, "Disclosures about Segments of an Enterprise and
Related Information" (Note 10), the Company began to report results for the
consolidated operations of Hanover Direct, Inc. as one segment commencing with
the fiscal year 2001.
Basis of Presentation -- The consolidated financial statements include all
subsidiaries of the Company, and all intercompany transactions and balances have
been eliminated. The preparation of financial statements, in conformity with
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. Certain
prior year amounts have been reclassified to conform to the current year's
presentation.
Fiscal Year -- The Company operates on a 52 or 53-week fiscal year, ending
on the last Saturday in December. The years ended December 28, 2002 and December
29, 2001 were reported as 52-week years. The year ended December 30, 2000 was a
53-week year. Had fiscal 2000 been a 52-week year, the total revenue would have
decreased by $5.2 million, net income would have decreased by $0.2 million and
net loss per common share would not have changed.
Cash and Cash Equivalents -- Cash includes cash equivalents consisting of
highly liquid investments with an original maturity of ninety days or less.
Inventories -- Inventories consist principally of merchandise held for
resale and are stated at the lower of cost or market. Cost, which is determined
using the first-in, first-out (FIFO) method, includes the cost of the product as
well as freight-in charges. The Company considers slow moving inventory to be
surplus and calculates a loss on the impairment as the difference between an
individual item's cost and the net proceeds anticipated to be received upon
disposal. The Company utilizes various liquidation vehicles to dispose of aged
catalog inventory including special sales catalogs, sales sections in other
catalogs, sales sections on the Company's Internet Web sites, and liquidations
through off-price merchants. Such inventory is written down to its net
realizable value, if the expected proceeds of disposal are less than the cost of
the merchandise.
Prepaid Catalog Costs -- Prepaid catalog costs consist of direct response
advertising costs related to catalog production and mailing. In accordance with
SOP 93-7, "Reporting on Advertising Costs," these costs are deferred and
amortized as selling expenses over the estimated period in which the sales
related to such advertising are generated. Total catalog expense was $104.1
million, $139.2 million and $150.4 million for fiscal years 2002, 2001 and 2000,
respectively.
Depreciation and Amortization -- Depreciation and amortization of property
and equipment is computed on the straight-line method over the following lives:
buildings and building improvements, 30-40 years; furniture, fixtures and
equipment, 3-10 years; and leasehold improvements, over the estimated useful
lives or the terms of the related leases, whichever is shorter. Repairs and
maintenance are expensed as incurred.
44
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Goodwill, Net -- In July 2001, the Financial Accounting Standards Board
issued Statements of Financial Accounting Standards No. 141, "Business
Combinations" ("SFAS 141") and No. 142, "Goodwill and Other Intangible Assets"
("SFAS 142"). SFAS 141 requires all business combinations initiated after June
30, 2001 to be accounted for using the purchase method. Under SFAS 142, goodwill
and intangible assets with indefinite lives are no longer amortized but are
reviewed annually (or more frequently if impairment indicators arise) for
impairment. Separable intangible assets that are not deemed to have indefinite
lives will continue to be amortized over their useful lives (but with no maximum
life). Prior to the adoption of SFAS 142, the excess of cost over the net assets
of acquired businesses was amortized on a straight-line basis over periods of up
to forty years.
Goodwill relates to the International Male and the Gump's brands and the
net balance at December 28, 2002 is $9.3 million. The Company adopted SFAS 142
effective January 1, 2002 and, as a result, the quarters ended March 30, 2002,
June 29, 2002, and September 28, 2002 did not include an amortization charge for
goodwill. The Company obtained the services of an independent appraisal firm
during the second quarter ended June 29, 2002 to evaluate whether there was any
goodwill impairment upon adoption of SFAS 142. The results of the appraisal
indicated no goodwill transition impairment based upon the requirements set
forth in SFAS 142.
If the provisions under SFAS 142 had been implemented for the years ended
December 29, 2001 and December 30, 2000 and the Company had not included an
amortization charge for goodwill, the Company's net loss would have decreased as
follows (in thousands of dollars, except per share amounts):
DECEMBER 29, DECEMBER 30,
2001 2000
------------ ------------
Net loss................................................ $(5,845) $(80,800)
Exclusion of goodwill amortization per SFAS 142......... 430 521
------- --------
Net loss under provisions of SFAS 142................... $(5,415) $(80,279)
======= ========
Net loss per share under provisions of SFAS
142 -- basic and diluted................................ $ (.08) $ (.40)
======= ========
Impairment of Long-lived Assets -- In accordance with Statement of
Financial Accounting Standards ("SFAS") No. 144, "Accounting for the Impairment
or Disposal of Long-lived Assets," the Company reviews long-lived assets, other
than goodwill, for impairment whenever events indicate that the carrying amount
of such assets may not be fully recoverable. The Company performs non-discounted
cash flow analyses to determine if impairment exists. If impairment is
determined to exist, any related impairment loss is calculated based on fair
value, which is generally based on discounted future cash flows. Impairment
losses on assets to be disposed, if any, are based on the estimated proceeds to
be received, less costs of disposal.
Reserves related to the Company's strategic business realignment
program -- Reserves have been established for leased properties vacated by the
Company and currently subleased or available for sublease. For leases with
remaining terms of greater than one year, the Company records charges on a
discounted basis to reflect the present value of such costs to be incurred.
Properties for which reserves have been recorded include portions of the
corporate headquarters and administrative offices located in Weehawken, New
Jersey and in Edgewater, New Jersey; the Gump's retail store located in San
Francisco, California; the telemarketing and administration facility in San
Diego, California; and the retail store facility located in Los Angeles,
California.
Reserves related to employee health and welfare claims -- The Company
maintains a self-insurance program related to losses and liabilities associated
with employee health and welfare claims. Stop-loss coverage is held on both an
aggregate and individual claim basis; thereby, limiting the amount of losses the
Company will experience. Losses are accrued based upon estimates of the
aggregate liability for claims incurred using the Company's experience patterns.
General and Administrative Expenses on the Consolidated Statement of Income
(Loss) and Accrued liabilities on the Consolidated Balance Sheet are affected by
these estimates.
45
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Stock-Based Compensation -- The Company accounts for its stock-based
compensation to employees using the fair value-based methodology under SFAS No.
123, "Accounting for Stock-Based Compensation."
Income Taxes -- The Company accounts for income taxes in accordance with
SFAS No. 109, "Accounting for Income Taxes." SFAS No. 109 requires an asset and
liability approach for financial accounting and reporting of income taxes. The
provision for income taxes is based on income after adjustment for those
temporary and permanent items that are not considered in the determination of
taxable income. The gross deferred tax asset is the total tax benefit available
from net operating loss carryovers and reversals of temporary differences. A
valuation allowance is calculated, based on the Company's projections of its
future taxable income, to establish the amount of deferred tax asset that the
Company is expected to utilize on a "more-likely-than-not" basis. The valuation
of the Company's deferred tax asset was changed in 2002 based on a reassessment
of the Company's ability to utilize certain net operating losses prior to their
expiration.
Net Loss Per Share -- Net loss per share is computed using the weighted
average number of common shares outstanding in accordance with the provisions of
SFAS No. 128, "Earnings Per Share." The weighted average number of shares used
in the calculation for both basic and diluted net loss per share for fiscal
years 2002, 2001 and 2000 was 138,280,196, 210,535,959 and 213,251,945 shares,
respectively. Diluted earnings per share equals basic earnings per share as the
dilutive calculation for preferred stock and stock options would have an
anti-dilutive impact as a result of the net losses incurred during fiscal years
2002, 2001 and 2000. The number of potentially dilutive securities excluded from
the calculation of diluted earnings per share were 2,541,843, 978,253, and
2,678,492 common share equivalents that represent options to purchase common
stock in each of the three fiscal years 2002, 2001 and 2000, respectively.
Revenue Recognition --
-- Direct Commerce: The Company recognizes revenue, net of estimated
returns, upon shipment of merchandise to customers. Postage and handling charges
billed to customers are also recognized as revenue upon shipment of related
merchandise. The Company accrues for expected future returns at the time of sale
based upon a combination of historical and current trends.
-- Membership Services: Customers may purchase memberships in a number of
the Company's Buyers' Club programs for an annual fee. The Company defers
revenue recognition for membership fees received in its Buyers' Club programs
until the cancellation period ends. Thereafter, revenue is recognized on a
monthly basis over the remaining membership period. The Company also receives
commission revenue related to its solicitation of the MemberWorks membership
programs and Magazine Direct magazine subscription programs. For the
MemberWorks, the Company is guaranteed a revenue stream dependent upon the
actual number of offers made. To the extent that the program performs better
than a pre-designated level, the Company will receive a higher level of revenue
than its guaranteed minimum. Revenue is recognized monthly based on the number
of acceptances received using a formula that has been contractually agreed upon
by the Company and MemberWorks. The commission revenue recognized by the Company
for the Magazine Direct magazine program is on a per-solicitation basis
according to the number of solicitations made, with additional revenue
recognized if the customer accepts the solicitation. Collectively, the amount of
revenues the Company recorded from these sources was $5.1 million or 1.1% of net
revenues, $4.8 million or 0.9% of net revenues, and $0.9 million or 0.2% of net
revenues for fiscal years 2002, 2001 and 2000, respectively. In the second
quarter of 2003, the Company will cease the offer of the Magazine Direct
magazine program for the time being. The Company is considering new
opportunities to offer new and different goods and services to its customers on
inbound order calls from time to time, with the Company receiving commission
revenue related to its solicitations.
-- B-to-B Services: Revenues from the Company's e-commerce transaction
services are recognized as the related services are provided. Customers are
charged on an activity unit basis, which applies a contractually specified rate
according to the type of transaction service performed. Revenues recorded from
the Company's B-to-B services were $20.1 million or 4.4% of net revenues, $22.2
million or 4.2% of net revenues, and $29.8 million or 4.9% of net revenues for
fiscal years 2002, 2001 and 2000, respectively.
46
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Fair Value of Financial Instruments -- The carrying amounts for cash and
cash equivalents, accounts receivable, accounts payable and the short-term debt
and capital lease obligations approximate fair value due to the short maturities
of these instruments. Additionally, the current value of long-term debt also
approximates fair value, as this debt bears interest at prevailing market rates.
NEW ACCOUNTING PRONOUNCEMENTS
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" ("FAS 146"). FAS 146 nullifies
Emerging Issues Task Force Issue No. 94-3 ("EITF 94-3"). FAS 146 requires that a
liability for a cost associated with an exit or disposal activity be recognized
when the liability is incurred whereas, under EITF 94-3, the liability was
recognized at the commitment date to an exit plan. The Company is required to
adopt the provisions of FAS 146 effective for exit or disposal activities
initiated after December 31, 2002.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure -- An Amendment of SFAS No. 123" ("FAS
148"). FAS 148 provides alternative methods of transition for a voluntary change
to the fair value-based method of accounting for stock-based employee
compensation. Since 1996, the Company has accounted for its stock-based
compensation to employees using the fair value-based methodology under SFAS No.
123, thus there has been no effect on the Company's results of operations or
financial position. In addition, FAS 148 amends the disclosure requirements of
SFAS No. 123 to require prominent disclosures in both annual and interim
financial statements about the method of accounting for stock-based employee
compensation and the effect of the method used on reported results. The Company
has concluded it is in compliance with these required prominent disclosures.
In January 2003, the Securities and Exchange Commission issued a new
disclosure regulation, "Conditions for Use of Non-GAAP Financial Measures"
("Regulation G") which is effective for all public disclosures and filings made
after March 28, 2003. Regulation G requires public companies that disclose or
release information containing financial measures that are not in accordance
with generally accepted accounting principles ("GAAP") to include in the
disclosure or release, a presentation of the most directly comparable GAAP
financial measure and a reconciliation of the disclosed non-GAAP financial
measure to the most directly comparable GAAP financial measure. The Company will
be adopting Regulation G in fiscal 2003 and is currently evaluating the impact
of this adoption on its financial disclosures.
2. DIVESTITURES
During 2001, the Company sold the following businesses and assets:
Sale of the 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) agreed to provide telemarketing
and fulfillment services for the Improvements business under a services
agreement with the buyer for a period of three years.
The asset purchase agreement between the Company and HSN provides that if
Keystone Internet Services, Inc. fails to perform its obligations during the
first two years of the services contract, the purchaser can receive a reduction
in the original purchase price of up to $2.0 million. An escrow fund of $3.0
million, which was withheld from the original proceeds of the sale, has been
established for a period of two years under the terms of an escrow agreement
between LWI Holdings, Inc., HSN and The Chase Manhattan Bank as a result of
these contingencies. The balance in the escrow fund at December 29, 2001 was
$2.6 million. As of December 28, 2002, the balance in the escrow fund was $2.0
million, and there were no claims against the escrow.
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, which represents the excess of the net proceeds
47
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
from the sale over the net assets acquired by HSN, the goodwill associated with
the Improvements business and expenses related to the transaction. During fiscal
2002, the Company recognized approximately $0.6 million of the deferred gain
consistent with the terms of the escrow agreement. Proceeds related to the
deferred gain were received on July 2, 2002 and December 30, 2002 for $0.3
million and $0.3 million, respectively. The recognition of the additional gain
of up to approximately $2.0 million has been deferred until the contingencies
described above expire, which will occur no later than the middle of the 2003
fiscal year.
Sale of Kindig Lane Property: On May 3, 2001, as part of the Company's
strategic business realignment program, the Company sold its fulfillment
warehouse in Hanover, Pennsylvania (the "Kindig Lane Property") and certain
equipment located therein for $4.7 million to an unrelated third party.
Substantially all of the net proceeds of the sale were paid to Congress,
pursuant to the terms of the Congress Credit Facility, and applied to a partial
repayment of the Tranche A Term Loan made to Hanover Direct Pennsylvania, Inc.,
an affiliate of the Company, and to a partial repayment of the indebtedness
under the Congress Credit Facility. The Company realized a net gain on the sale
of approximately $1.5 million, which included the sale price net of selling
expenses in excess of the net book value of assets sold. The Company has
continued to use the Kindig Lane Property under a lease agreement with the third
party, and will lease a portion of the Kindig Lane Property until April 4, 2003.
Effective March 1, 2003, the Company has transitioned a portion of the
fulfillment operations from the leased Kindig Lane Property to its own facility
in Roanoke, Virginia.
During 1999, the Company sold the following businesses and assets.
Transactions related to these sales impact the fiscal years 2002, 2001 and 2000,
which are presented:
The Shopper's Edge: In March 1999, the Company, through a newly formed
subsidiary, established and promoted a discount buyers' club to consumers known
as "The Shopper's Edge." In exchange for an up-front membership fee, the
Shopper's Edge program enabled members to purchase a wide assortment of
merchandise at discounts that were not available through traditional retail
channels. Initially, prospective members participated in a 45-day trial period
that, unless canceled, was automatically converted into a full membership term,
which was one year in duration. Memberships were automatically renewed at the
end of each term unless canceled by the member. Effective December 1999, the
Company sold its interest in the Shopper's Edge subsidiary to an unrelated third
party for a nominal fair value based upon an independent appraisal. The Company
entered into a solicitation services agreement with the purchaser whereby the
Company provided solicitation services for the program and received commissions
for member acceptances based on a fixed fee per member basis, adjusted for
cancellation rates on a prospective basis. For the fiscal years ended 2002, 2001
and 2000, the Company received approximately $0.4 million, $2.5 million and $5.0
million of fee revenue, respectively, for solicitation services provided.
Blue Ridge Associates -- In January 1994, the Company purchased for $1.1
million a 50% interest in Blue Ridge Associates ("Blue Ridge"), a partnership
which owns an apparel distribution center in Roanoke, Virginia. The remaining
50% interest is held by an unrelated third party. This investment is accounted
for under the equity method of accounting. The Company's investment in Blue
Ridge was approximately $0.8 million at December 25, 1999. In December 1996, the
Company consolidated the fulfillment and telemarketing activities handled at
this facility into its home fashion distribution facility in Roanoke, Virginia,
and attempted to sublease the vacated space. In April 1999, the Company sublet
the vacated premises to an unrelated third party for a five-year period expiring
in April 2004. In February 2000, the Company sold its partnership interest in
Blue Ridge to the holder of the other 50% for $0.8 million, which approximated
the Company's carrying value of the investment.
3. SPECIAL CHARGES
In December 2000, the Company began a strategic business realignment
program that resulted in the recording of special charges for severance,
facility exit costs and fixed asset write-offs. Special charges recorded in
fiscal years 2002, 2001 and 2000 relating to the strategic business realignment
program were $4.4 million, $11.3 million and $19.1 million, respectively. The
actions related to the strategic business
48
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
realignment program were taken in an effort to direct the Company's resources
primarily towards a loss reduction strategy and return to profitability.
For fiscal year 2000, the $19.1 million of special charges consisted of
severance ($5.0 million), facility exit costs ($5.9 million) and fixed asset
write-offs ($8.2 million, of which $7.2 million is non-cash) related to the
Company's previously announced strategic business realignment program which
included (1) the elimination of approximately 285 full-time equivalent ("FTE")
positions across all its business units; (2) the closure of the Company's Always
in Style business; (3) the discontinuance by Hanover Brands of the under-
performing Turiya, Kitchen & Home and Domestications Kitchen & Garden catalogs
while incorporating some of the product offerings within continuing catalogs;
(4) the termination by Hanover Brands of its marketing agreement with Compagnie
de la Chine; (5) the closure by Hanover Brands of certain retail outlets and a
satellite facility in New Jersey; (6) the closure of its leased fulfillment and
telemarketing facility in Maumelle, Arkansas; and (7) the immediate cessation of
the operations of Desius LLC.
Such actions were taken in an effort to direct the Company's resources
primarily towards continued profitable growth in Hanover Brands while reducing
costs in all areas of the business and eliminating investment activities that
had not yet generated sufficient revenue to produce profitable returns. The
Company intended to consolidate the Maumelle operations within its remaining
facilities and to provide the bulk of its fulfillment services for third party
clients of its Keystone Internet Services, Inc. ("Keystone") subsidiary within
its existing operations. The consolidation of Keystone's activities in other
facilities was intended to provide a better opportunity to focus resources,
particularly customer service support, on clients to service their needs.
For 2001, the $11.3 million of special charges were related to the
strategic business realignment program that was initiated at the end of 2000 and
consisted of severance ($4.2 million), facility exit costs ($3.8 million) and
asset write-offs ($3.3 million, all of which is non-cash).
In December 2001, the Company made a decision as part of the continuing
implementation of the strategic business realignment program, to close its San
Diego telemarketing center in the first quarter of 2002. Accordingly, severance
costs include $0.3 million for associates of the telemarketing center whose jobs
were eliminated as a result. In addition severance costs recorded for the year
include $0.4 million for associates of the Kindig Lane Property whose jobs were
eliminated as a result of the sale of the facility in May 2001. The remainder of
the severance charges recorded in 2001, which amounted to $3.5 million,
represents the elimination of 442 FTE positions across all divisions of the
Company's business as part of the strategic business realignment program. In
October 2001, the Company determined it was more cost effective to relocate
certain of its operating and administrative functions from the first floor of
its facility in Weehawken, New Jersey to a previously closed space in Edgewater,
New Jersey and attempted to sublet the space vacated in Weehawken, New Jersey.
This amendment of the original plan resulted in an additional charge of $0.8
million for facility exit costs and a charge of $0.6 million for the write-off
of fixed assets related to the Weehawken location. In addition, special charges
totaling $0.2 million were recorded, primarily related to loan forgiveness of
certain of the severed associates.
In addition, the exit of the Maumelle and Kindig Lane buildings, as well as
the closing of the San Diego telemarketing center, resulted in special charges
of $3.7 million in addition to the aforementioned severance costs. The charges
related to the exit of the Maumelle facility included a $1.1 million addition to
the estimated loss on the lease provision and a $1.9 million fixed asset
write-down. The exit charges for the Kindig Lane Property building consisted of
a $0.5 million write-off for the impairment in value of the fixed assets located
in that facility. Finally, the costs associated with closing the San Diego
telemarketing center included a write-down for the fixed assets of $0.1 million,
and a lease provision for the facility of $0.1 million.
The special charges recorded in 2001 also included $1.8 million to revise
estimated losses provided for sublease arrangements in connection with a retail
outlet store in San Diego that was previously closed and office facilities
located in San Francisco, California. The Company reduced its estimated loss on
the San Diego store lease by $0.4 million reflecting the locating of a subtenant
quicker than originally expected. This
49
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
was more than offset by the charge required for anticipated losses on sublease
arrangements for the San Francisco office space resulting from declining market
values in that area of the country.
In May 2002, the Company entered into an agreement with the landlord and
the sublandlord to terminate its sublease of the Company's closed 497,200 square
foot warehouse and telemarketing facility located in Maumelle, Arkansas. The
agreement provided for the payment by the Company to the sublandlord of $1.6
million plus taxes through April 30, 2002 in the amount of $0.2 million. The
Company made all of the payments in four weekly installments between May 2, 2002
and May 24, 2002. Upon the satisfaction by the Company of all of its obligations
under the agreement, the sublease terminated and the Company was released from
all further obligations under the sublease. The Company's previously established
reserves for Maumelle, Arkansas were adequate based upon the terms of the final
settlement agreement.
In the first quarter of 2002, special charges relating to the strategic
business realignment program were recorded in the amount of $0.2 million. These
charges consisted primarily of severance costs related to the elimination of an
additional 10 FTE positions and costs associated with the Company's decision to
close a product storage facility located in San Diego, California. In September
2002, the Company continued to execute this program through the integration of
its The Company Store and Domestications divisions. As a result of the continued
actions needed to execute these plans, during the third quarter of 2002, an
additional $1.5 million of special charges were recorded. Of this amount, $1.3
million consisted of additional facility exit costs resulting primarily from the
integration of The Company Store and Domestications divisions, causing
management to reassess its plan to consolidate its office space utilization at
the corporate offices in New Jersey. The additional $0.2 million consisted of
further severance costs for an individual relating to the Company's strategic
business realignment program.
In the fourth quarter of 2002, special charges totaling $2.7 million were
recorded. Of this amount, $1.5 million was for severance costs, including $1.2
million for two of the Company's senior management members, $0.2 million was
associated with the elimination of 32 FTE positions in the Company's Hanover,
Pennsylvania fulfillment operation as a result of its consolidation into the
Company's Roanoke, Virginia facility in March 2003, and $0.1 million was for
additional severance costs and adjustments pertaining to the Company's previous
strategic business realignment initiatives. The remaining $1.2 million consisted
primarily of a $0.4 million credit reflecting the reduction of the deferred
rental liabilities applicable to the portions of the facilities previously
included in the Company's strategic business realignment program, and a $1.6
million charge in order to properly reflect the current marketability of such
facilities in the rental markets.
At December 28, 2002 and December 30, 2001, liabilities of $3.3 million and
$7.3 million, respectively, were included within Accrued Liabilities, and
liabilities of $4.7 million and $3.8 million, respectively, were included within
Other Non-Current Liabilities. These liabilities relate to future payments in
connection with the Company's strategic business realignment program and consist
of the following (in thousands):
SEVERANCE & REAL ESTATE INFORMATION
PERSONNEL LEASE & TECHNOLOGY
COSTS EXIT COSTS LEASES TOTAL
----------- ----------- ----------- -------
Balance at December 29, 1999.............. $ -- $ 2,299 $ -- $ 2,299
2000 Expenses............................. 5,073 5,862 1,043 11,978
Paid in 2000.............................. (651) (603) -- (1,254)
------- ------- ------ -------
Balance at December 30, 2000.............. 4,422 7,558 1,043 13,023
2001 Expenses............................. 4,135 3,828 -- 7,963
Paid in 2001.............................. (6,011) (3,249) (670) (9,930)
------- ------- ------ -------
Balance at December 29, 2001.............. 2,546 8,137 373 11,056
2002 Expenses............................. 1,817 2,952 -- 4,769
Paid in 2002.............................. (2,911) (4,672) (210) (7,793)
------- ------- ------ -------
Balance at December 28, 2002.............. $ 1,452 $ 6,417 $ 163 $ 8,032
======= ======= ====== =======
50
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
A summary of the liability related to Real Estate Lease and Exit Costs, by
location, as of the end of 2002 and 2001, is as follows (in thousands):
DECEMBER 28, DECEMBER 29,
2002 2001
------------ ------------
Gumps facility, San Francisco, CA........................... $3,349 $3,014
Corporate facility, Weehawken, NJ........................... 2,325 2,248
Corporate facility, Edgewater, NJ........................... 439 --
Administrative and telemarketing facility, San Diego, CA.... 179 123
Retail store facilities, Los Angeles and San Diego, CA...... 125 451
Fulfillment facility, Maumelle, AK.......................... -- 2,301
------ ------
Total Lease and Exit Cost Liability......................... $6,417 $8,137
====== ======
4. WRITE-DOWN OF INVENTORY OF DISCONTINUED CATALOGS
In the fourth quarter of 2000, the Company made a decision to discontinue
three catalog brands, Domestications Kitchen & Garden, Turiya and Kitchen &
Home. These catalog brands generated revenues of $0.0 million, $4.7 million, and
$18.4 million in 2002, 2001 and 2000, respectively. In 2000, the Company
recorded provisions of approximately $2.0 million related to the write-down of
inventory associated with these catalogs to their net realizable value based
upon the planned liquidation of such inventory, and $0.7 million related to the
acceleration of the amortization of prepaid catalog costs associated with the
discontinuance of these catalogs' operations based upon their estimated
realizability relative to the wind-down plan in 2001. At December 28, 2002,
there was no inventory remaining for these catalog brands.
5. ACCRUED LIABILITIES
Accrued liabilities consist of the following (in thousands):
DECEMBER 28, DECEMBER 29,
2002 2001
------------ ------------
Special charges............................................. $ 3,327 $ 7,291
Reserve for future sales returns............................ 1,888 2,764
Compensation and benefits................................... 11,614 8,456
Income and other taxes...................................... 1,003 1,098
Litigation and other........................................ 8,519 5,523
------- -------
Total.................................................. $26,351 $25,132
======= =======
51
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
6. DEBT
Debt consists of the following (in thousands):
AS RESTATED
---------------------------
DECEMBER 28, DECEMBER 29,
2002 2001
------------ ------------
Congress facility -- Term loans............................. $12,479 $13,016
Capital lease obligations................................... 29 9
------- -------
Long-term debt............................................ $12,508 $13,025
Congress facility:
Term loans -- Current portion............................. $ 3,792 $ 3,060
Revolver.................................................. 8,819 13,523
Capital lease obligations -- Current portion................ 10 102
------- -------
Short-term debt........................................ $12,621 $16,685
------- -------
Total debt............................................. $25,129 $29,710
======= =======
Changes to Congress Credit Facility -- On December 28, 2002, the Company's
credit facility (the "Congress Credit Facility") with Congress Financial
Corporation ("Congress") contained a maximum credit line, subject to certain
limitations, of up to $82.5 million. The Congress Credit Facility, as amended,
expires on January 31, 2004 and comprises a revolving loan facility, a $17.5
million Tranche A Term Loan, and a $8.4 million Tranche B Term Loan. Total
cumulative borrowings under the Congress Credit Facility are subject to
limitations based upon specified percentages of eligible receivables and
eligible inventory, and the Company is required to maintain $3.0 million of
excess credit availability at all times. The Congress Credit Facility is secured
by all of the assets of the Company and places restrictions on the incurrence of
additional indebtedness and on the payment of common stock dividends. Management
will be required to successfully renegotiate the renewal of the Congress Credit
Facility or successfully replace the facility with another institution.
Under the Congress Credit Facility, the Company is required to maintain
minimum net worth, working capital and EBITDA as defined throughout the terms of
the agreement. As of December 28, 2002, the Company was in compliance with these
covenants.
In March 2002, the Company amended the Congress Credit Facility to amend
the definition of Consolidated Net Worth such that, effective July 1, 2002, to
the extent that any goodwill or intangible assets of the Company and its
subsidiaries were deemed to be impaired under the provisions of SFAS 142, such
write-off of assets would not be considered a reduction of total assets for the
purposes of computing consolidated net worth. The Company obtained the services
of an independent appraisal firm during the second quarter ended June 29, 2002
to evaluate whether there had been any goodwill transition impairment. The
results of the appraisal indicated no goodwill transition impairment based upon
the requirements set forth in SFAS 142. The covenants relating to consolidated
net working capital, consolidated net worth and EBITDA and certain non-cash
charges were also amended. The amendment required the payment of a fee of
$100,000 by the Company.
On August 16, 2002, the Company amended the Congress Credit Facility to (i)
extend the term of the Tranche B Term Loan to January 31, 2004, (ii) increase by
$3,500,000 the borrowing reflected by the Tranche B Term Note to $8,410,714, and
(iii) make certain related technical amendments to the Congress Credit Facility.
The amendment required the payment of fees in the amount of $410,000 by the
Company.
In December 2002, the Company amended the Congress Credit Facility to amend
the definitions of "Consolidated Net Income," "Consolidated Net Worth" and
"Consolidated Working Capital" to make certain adjustments thereto, depending on
the results of the Kaul litigation, to permit the payment to
52
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Richemont of certain United States withholding taxes payable to Richemont in
connection with the Series B Preferred Stock, and to change certain borrowing
sublimits. The consolidated working capital, consolidated net worth and EBITDA
covenants were also established through the end of the term of the facility, and
certain technical amendments relating to the reorganization of certain of the
Company's subsidiaries were made. The amendment required the payment of fees in
the amount of $110,000 by the Company.
In February 2003, the Company amended the Congress Credit Facility to amend
the existing change in control Event of Default. The existing change in control
Event of Default under the Congress Credit Facility is based upon NAR Group
Limited, a former shareholder of the Company, ceasing to be the direct or
indirect beneficial owner of a sufficient number of issued and outstanding
shares of capital stock of the Company on a fully diluted basis to elect a
majority of the members of the Company's Board of Directors. This was replaced
during February 2003 with a new change in control Event of Default, which is
patterned on the Change In Control concepts in the Company's various Key
Executive Compensation Continuation Plans. The new Event of Default would be
triggered by certain transfers of assets, certain liquidations or dissolutions,
the acquisition by a person or group (other than a Permitted Holder, as defined)
of a majority of the total outstanding voting stock of the Company, and certain
changes in the composition of the Company's Board of Directors.
The Company has re-examined the provisions of the Congress Credit Facility.
Based on the applicable accounting rules and certain provisions in the credit
agreement, the Company is required to reclassify its revolving loan facility
from long-term to short-term debt, though the existing credit facility does not
mature until January 31, 2007. As a result, the Company reclassified $8.8
million and $13.5 million as of December 28, 2002 and December 29, 2001,
respectively, from long-term debt to short-term debt and capital lease
obligations.
As of December 28, 2002, the Company had $25.1 million of cumulative
borrowings outstanding under the Congress Credit Facility, comprising $8.8
million under the revolving loan facility, bearing an interest rate of 4.75%,
$8.5 million under the Tranche A Term Loan, bearing an interest rate of 5.0%,
and $7.8 million under the Tranche B Term Loan, bearing an interest rate of
13.0%. Of the aggregate borrowings, $12.6 million is classified as short-term on
the Company's Consolidated Balance Sheet. As of December 29, 2001, the Company
had $29.6 million of borrowings outstanding under the Congress Credit Facility
comprising $13.5 million under the revolving loan facility, bearing an interest
rate of 5.25%, and $10.5 million, bearing an interest rate of 5.50%, and $5.6
million, bearing an interest rate of 13.00%, of Tranche A Term Loans and Tranche
B Term Loans, respectively.
The revolving loan facility bears interest at prime plus 0.5% or Eurodollar
plus 2.5%, the Tranche A Term Loans bear interest at prime plus 0.75% or
Eurodollar plus 3.5%, and the Tranche B Term Loans bear interest at prime plus
4.25%, but in no event less than 13.0%.
Achievement of the Company's strategic business realignment program is
critical to the maintenance of adequate liquidity, as is compliance with the
terms and provisions of the Congress Credit Facility and the Company's ability
to operate effectively during the 2003 fiscal year. In the event of a softer
than expected economic climate, management has available several courses of
action to maintain liquidity and help maintain compliance with financial
covenants, including selective reductions in catalog circulation, additional
expense reductions and sales of non-core assets.
General -- At December 28, 2002, the aggregate annual principal payments
required on debt instruments are as follows (in thousands): 2003 -- $12,621;
2004 -- $12,489; 2005 -- $10; 2006 -- $5; and thereafter -- $4. Management will
be required to successfully renegotiate the renewal of the Congress Credit
Facility or successfully replace the facility with another institution.
7. SERIES A CUMULATIVE PARTICIPATING PREFERRED STOCK
On August 24, 2000, the Company issued 1.4 million shares of preferred
stock designated as Series A Cumulative Participating Preferred Stock (the
"Series A Preferred Stock") to Richemont, the then holder of approximately 47.9%
of the Company's Common Stock, for $70 million. The Series A Preferred Stock had
a par value of $0.01 per share and a liquidation preference of $50.00 per share
and was recorded net of issuance
53
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
costs of $2.3 million. The issuance costs were being accreted as an additional
dividend over a five-year period ending on the mandatory redemption date.
Dividends were cumulative and accrued at an annual rate of 15%, or $7.50 per
share, and were payable quarterly either in cash or in-kind through the issuance
of additional Series A Preferred Stock. Cash dividend payments were required for
dividend payment dates occurring after February 1, 2004. As of September 30,
2001, the Company accrued dividends of $12,389,700, and reserved 247,794
additional shares of Series A Preferred Stock for the payment of such dividends.
In-kind dividends and issuance cost accretion were charged against additional
paid-in capital, with a corresponding increase in the carrying amount of the
Series A Preferred Stock. Cash dividends were also reflected as a charge to
additional paid-in capital, however, no adjustment to the carrying amount of the
Series A Preferred Stock was made. The Series A Preferred Stock was generally
non-voting, except if dividends had been in arrears and unpaid for four
quarterly periods, whether or not consecutive. The holder of the Series A
Preferred Stock was entitled to receive additional participating dividends in
the event any dividends were declared or paid, or any other distribution was
made, with respect to the Common Stock of the Company. The additional dividends
would be equal to the applicable percentage of the amount of the dividends or
distributions payable in respect of one share of Common Stock. In the event of a
liquidation or dissolution of the Company, the holder of the Series A Preferred
Stock would be paid an amount equal to $50.00 per share of Series A Preferred
Stock plus the amount of any accrued and unpaid dividends, before any payments
to other shareholders.
The Company could redeem the Series A Preferred Stock in whole at any time
and the holder of the Series A Preferred Stock could elect to cause the Company
to redeem all or any of such holder's Series A Preferred Stock under certain
circumstances involving a change of control, asset disposition or equity sale.
Mandatory redemption of the Series A Preferred Stock by the Company was required
on August 23, 2005 (the "Final Redemption Date") at a redemption price of $50.00
per share of Series A Preferred Stock plus the amount of any accrued and unpaid
dividends.
On December 19, 2001, the Company consummated a transaction with Richemont
(the "Richemont Transaction"). In the Richemont Transaction, the Company
repurchased from Richemont all of the outstanding shares of the Series A
Preferred Stock and 74,098,769 shares of the Common Stock of the Company held by
Richemont in return for the issuance to Richemont of 1,622,111 shares of
newly-created Series B Participating Preferred Stock (the "Series B Preferred
Stock") and the reimbursement of expenses of $1 million to Richemont. Richemont
agreed, as part of the transaction, to forego any claim it had to the accrued
but unpaid dividends on the Series A Preferred Stock. The Richemont Transaction
was made pursuant to an Agreement (the "Agreement"), dated as of December 19,
2001, between the Company and Richemont. As part of the Richemont Transaction,
the Company (i) released Richemont, the individuals appointed by Richemont to
the Board of Directors of the Company and certain of their respective affiliates
and representatives (collectively, the "Richemont Group") from any claims by or
in the right of the Company against any member of the Richemont Group which
arise out of Richemont's acts or omissions as a stockholder of or lender to the
Company or the acts or omissions of any Richemont board designee in his capacity
as such and (ii) entered into an Indemnification Agreement (the "Indemnification
Agreement") with Richemont pursuant to which the Company agreed to indemnify
each member of the Richemont Group from any losses suffered as a result of any
third party claim which is based upon Richemont's acts as a stockholder of or
lender to the Company or the acts or omissions of any Richemont board designee
in his capacity as such. The Indemnification Agreement is not limited as to term
and does not include any limitations on maximum future payments thereunder. The
impact of the Richemont Transaction was to reflect the reduction of the Series A
Preferred Stock for the then carrying amount of $82.4 million and the issuance
of Series B Preferred Stock in the amount of $76.8 million which was equal to
the aggregate liquidation preference of the Series B Preferred Stock on December
19, 2001. In addition, the par value of $49.4 million of the Common Stock
repurchased by the Company and subsequently retired was reflected as a reduction
of Common Stock, with an offsetting increase to capital in excess of par value.
The Company recorded a net decrease in shareholders' deficiency of $5.6 million
as a result of the Richemont Transaction.
54
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The shares of the Series A Preferred Stock that were repurchased from
Richemont represented all of the outstanding shares of such series. The Company
has filed a certificate in Delaware eliminating the Series A Preferred Stock
from its certificate of incorporation.
8. SERIES B CUMULATIVE PARTICIPATING PREFERRED STOCK
On December 19, 2001, as part of the Richemont Transaction, the Company
issued to Richemont 1,622,111 shares of Series B Participating Preferred Stock.
The Series B Preferred Stock has a par value of $0.01 per share.
The holders of the Series B Preferred Stock are entitled to ten votes per
share on any matter on which the Common Stock votes. In addition, in the event
that the Company defaults on its obligations arising in connection with the
Richemont Transaction, the Certificate of Designations of the Series B Preferred
Stock or its agreements with Congress, or in the event that the Company fails to
redeem at least 811,056 shares of Series B Preferred Stock by August 31, 2003,
then the holders of the Series B Preferred Stock, voting as a class, shall be
entitled to elect two members to the Board of Directors of the Company.
In the event of the liquidation, dissolution or winding up of the Company,
the holders of the Series B Preferred Stock are entitled to a liquidation
preference (the "Liquidation Preference"), which was initially $47.36 per share.
During each period set forth in the table below, the Liquidation Preference
shall equal the amount set forth opposite such period:
LIQUIDATION
PREFERENCE
PERIOD PER SHARE TOTAL VALUE
- ------ ----------- ---------------
March 1, 2002 -- May 31, 2002............................ $49.15 $ 79,726,755.65
June 1, 2002 -- August 31, 2002.......................... $51.31 $ 83,230,515.41
September 1, 2002 - November 30, 2002.................... $53.89 $ 87,415,561.79
December 1, 2002 -- February 28, 2003.................... $56.95 $ 92,379,221.45
March 1, 2003 -- May 31, 2003............................ $60.54 $ 98,202,599.94
June 1, 2003 -- August 31, 2003.......................... $64.74 $105,015,466.14
September 1, 2003 -- November 30, 2003................... $69.64 $112,963,810.04
December 1, 2003 -- February 29, 2004.................... $72.25 $117,197,519.75
March 1, 2004 -- May 31, 2004............................ $74.96 $121,593,440.56
June 1, 2004 -- August 31, 2004.......................... $77.77 $126,151,572.47
September 1, 2004 -- November 30, 2004................... $80.69 $130,888,136.59
December 1, 2004 -- February 28, 2005.................... $83.72 $135,803,132.92
March 1, 2005 -- May 31, 2005............................ $86.85 $140,880,340.35
June 1, 2005 -- August 23, 2005.......................... $90.11 $146,168,422.21
As a result, beginning November 30, 2003, the aggregate Liquidation
Preference of the Series B Preferred Stock will be effectively equal to the
aggregate liquidation preference of the Class A Preferred Stock previously held
by Richemont (See Note 7). For each increase in liquidation preference, the
Company will reflect the change as an increase in the Series B Preferred Stock
with a corresponding reduction in capital in excess of par value. Such accretion
will be recorded as a reduction of net income available to common shareholders.
Dividends on the Series B Preferred Stock are required to be paid whenever
a dividend is declared on the Common Stock. The amount of any dividend on the
Series B Preferred Stock shall be determined by multiplying (i) the amount
obtained by dividing the amount of the dividend on the Common Stock by the then
current fair market value of a share of Common Stock and (ii) the Liquidation
Preference of the Series B Preferred Stock.
55
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Series B Preferred Stock must be redeemed by the Company on August 23,
2005 consistent with Delaware General Corporation Law. The Company may redeem
all or less than all of the then outstanding shares of Series B Preferred Stock
at any time prior to that date. At the option of the holders thereof, the
Company must redeem the Series B Preferred Stock upon a Change of Control or
upon the consummation of an Asset Disposition or Equity Sale (all as defined in
the Certificate of Designations of the Series B Preferred Stock). The redemption
price for the Series B Preferred Stock upon a Change of Control or upon the
consummation of an Asset Disposition or Equity Sale is the then applicable
Liquidation Preference of the Series B Preferred Stock plus the amount of any
declared but unpaid dividends on the Series B Preferred Stock. The Company's
obligation to redeem the Series B Preferred Stock upon an Asset Disposition or
an Equity Sale is subject to the satisfaction of certain conditions set forth in
the Certificate of Designations of the Series B Preferred Stock.
The Certificate of Designations of the Series B Preferred Stock provides
that, for so long as Richemont is the holder of at least 25% of the then
outstanding shares of Series B Preferred Stock, it shall be entitled to appoint
a non-voting observer to attend all meetings of the Board of Directors and any
committees thereof. To date, Richemont has not appointed such an observer.
Pursuant to the terms of the Certificate of Designations of the Series B
Preferred Stock, the Company's obligation to pay dividends on or redeem the
Series B Preferred Stock is subject to its compliance with its agreements with
Congress.
During autumn 2002, Company management conducted a strategic review of the
Company's business and operations. As part of such review, Company management
considered the Company's obligations under the Richemont Agreement and the
Company's prospects and options for redemption of the Series B Preferred Shares
issued to Richemont pursuant thereto in accordance with the Richemont Agreement
terms. The review took into account the results of the Company's strategic
business realignment program in 2001 and 2002, the relative strengths and
weaknesses of the Company's competitive position and the economic and business
climate, including the depressed business environment for mergers and
acquisitions.
As a result of this review, Company management and the Company's Board of
Directors have concluded that it is unlikely that the Company will be able to
accumulate sufficient capital, surplus, or other assets under Delaware corporate
law or to obtain sufficient debt financing to either:
1. Redeem at least 811,056 shares of the Series B Preferred Stock by
August 31, 2003, as allowed for by the Richemont Agreement, thereby
resulting in the occurrence of a "Voting Trigger" which will allow
Richemont to have the option of electing two members to the Company's Board
of Directors; or
2. Redeem all of the shares of Series B Preferred Stock by August 31,
2005, as required by the Richemont Agreement, thereby obligating the
Company to take all measures permitted under the Delaware General
Corporation Law to increase the amount of its capital and surplus legally
available to redeem the Series B Preferred Shares, without a material
improvement in either the business environment for mergers and acquisitions
or other factors, unforeseeable at the time.
Management believes that the Company has sufficient liquidity and
availability under its credit agreement to fund its planned operations through
at least January 31, 2004. The unlikelihood that the Company will be able to
redeem the Series B Preferred Shares is not expected to limit the ability of the
Company to use current and future net earnings or cash flow to satisfy its
obligations to creditors and vendors. In addition, the redemption price of the
Series B Preferred Stock does not accrete after August 31, 2005.
Company management met with representatives of Richemont on October 30,
2002 and outlined the results of management's strategic review in the context of
the Company's obligations to Richemont under the Richemont Agreement, and
discussed an alternative to the method for the redemption of the Series B
Preferred Shares. Under this alternative proposal, that the Company had
previously presented to Richemont, the Company would exchange two business
divisions, Silhouettes and Gump's, for all of Richemont's Series B Preferred
Shares (the "Proposal").
56
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Pursuant to the terms of the Richemont Agreement, the redemption value of
the Series B Preferred Shares as of the date of the Proposal was $87 million.
Management based the Proposal terms on a valuation of Silhouettes and Gump's
using the valuation multiple employed in USA Network's June 2001 purchase of the
Company's Improvements business division. The Proposal also included a
willingness on the part of the Company to provide continued fulfillment services
for Silhouettes and Gump's on terms to be negotiated. On November 18, 2002, a
representative of Richemont confirmed in writing to the Company that Richemont
rejected the Proposal. Representatives of Richemont have indicated that it has
no interest in the proffered assets and disputes their valuation implied in the
Company's Proposal.
The Company will continue to explore all reasonable opportunities to redeem
and retire the Series B Preferred Stock.
For Federal income tax purposes, the increases in the Liquidation
Preference of the Series B Preferred Stock are considered distributions, by the
Company to Richemont, deemed made on the commencement dates of the quarterly
increases, as discussed above. These distributions may be taxable dividends to
Richemont, provided the Company has accumulated or current earnings and profits
("E&P") for each year in which the distributions are deemed to be made. Under
the terms of the Richemont Transaction, the Company is obligated to reimburse
Richemont for any U.S. income tax incurred pursuant to the Richemont
Transaction. Based on the Company's past income tax filings and its current
income tax position, the Company has an E&P deficit as of December 28, 2002.
Accordingly, the Company has not incurred a tax reimbursement obligation for
year 2002. The Company must have current E&P in years 2003, 2004 or 2005 to
incur a tax reimbursement obligation from the scheduled increases in Liquidation
Preference. If the Company does not have current E&P in one of those years, no
tax reimbursement obligation would exist for that particular year. The Company
does not have the ability to project the exact future tax reimbursement
obligation, however, it has estimated the potential obligation to be in the
range of $0 to $23.1 million.
9. CAPITAL STOCK
Richemont Transaction -- On December 19, 2001, as part of the Richemont
Transaction, the Company repurchased from Richemont 74,098,759 shares of the
Common Stock of the Company held by Richemont. As part of the transaction,
Richemont revoked the proxy that it then held to vote 4,289,000 shares of Common
Stock, which were owned by a third party.
General -- At December 28, 2002 and December 29, 2001, there were
140,436,729 and 140,336,729 shares of Common Stock issued and outstanding (net
of treasury shares), respectively. Additionally, an aggregate of 14,650,270
shares of Common Stock were reserved for issuance pursuant to the exercise of
outstanding options at December 28, 2002.
Treasury stock consisted of 2,120,929 and 2,100,929 shares of Common Stock
at December 28, 2002 and December 29, 2001, respectively. During fiscal year
2002 and 2001, the Company retained 20,000 and 1,530,000 shares, respectively,
of outstanding Common Stock held in escrow on behalf of certain participants in
the Company's Executive Equity Incentive Plan whose rights, under the terms of
the plan, expired during 2002 and 2001.
Dividend Restrictions -- The Company is restricted from paying dividends on
its Common Stock or from acquiring its capital stock by certain debt covenants
contained in agreements to which the Company is a party.
10. SEGMENT REPORTING
In prior years the Company reported two separate operating and reporting
segments: direct commerce and business-to-business ("B-to-B") e-commerce
transaction services. In conjunction with the Company's previously announced
strategic business realignment program, the Company has (1) terminated an
intercompany services agreement effective December 30, 2000, (2) ceased the
Desius LLC business operations and (3) closed the leased fulfillment and
telemarketing facility in Maumelle, Arkansas. As a result of these
57
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
actions, the Company's business-to-business revenues from fiscal 2001 and beyond
are expected to be reduced and for the foreseeable future will be limited to
third party clients serviced by Keystone Internet Services, LLC. Taken in
conjunction with the Company's announced intention to direct resources primarily
towards growth in core brands, these actions have caused the Company, pursuant
to SFAS 131, to report results for the consolidated operations of Hanover
Direct, Inc. as one segment commencing in fiscal year 2001.
11. CHANGES IN MANAGEMENT AND EMPLOYMENT
Shull Employment Agreement. Effective December 5, 2000, Thomas C. Shull,
Meridian Ventures, LLC, a limited liability company controlled by Mr. Shull
("Meridian"), and the Company entered into a Services Agreement (the "December
2000 Services Agreement"). The December 2000 Services Agreement was replaced by
a subsequent services agreement, dated as of August 1, 2001 (the "August 2001
Services Agreement"), among Mr. Shull, Meridian and the Company, and a Services
Agreement, dated as of December 14, 2001 (the "2001 Services Agreement"), among
Mr. Shull, Meridian, and the Company. The 2001 Services Agreement was replaced
effective September 1, 2002 by an Employment Agreement between Mr. Shull and the
Company, dated as of September 1, 2002, as amended by Amendment No. 1 thereto
dated as of September 1, 2002 (as amended, the "2002 Employment Agreement"),
pursuant to which Mr. Shull is employed by the Company as its President and
Chief Executive Officer, as described below.
The term of the 2002 Employment Agreement began on September 1, 2002 and
will terminate on September 30, 2004 (the "Shull Employment Agreement Term").
Under the 2002 Employment Agreement, Mr. Shull is to receive from the
Company base compensation equal to $900,000 per annum, payable at the rate of
$75,000 per month ("Base Compensation"). Mr. Shull is to be provided with
participation in the Company's employee benefit plans, including but not limited
to the Company's Key Executive Eighteen Month Compensation Continuation Plan
(the "Change of Control Plan") and its transaction bonus program. The Company is
also to reimburse Mr. Shull for his reasonable out-of-pocket expenses incurred
in connection with his employment by the Company.
Under the 2002 Employment Agreement, the Company paid the remaining unpaid
$300,000 of Mr. Shull's fiscal 2001 bonus under the Company's 2001 Management
Incentive Plan in December 2002. Mr. Shull shall receive the same bonus amount
for fiscal 2002 under the Company's 2002 Management Incentive Plan as all other
Level 8 participants (as defined in such plan) receive under such plan for such
period, subject to all of the terms and conditions applicable generally to Level
8 participants thereunder. Mr. Shull shall earn annual bonuses for fiscal 2003
and 2004 under such plans as the Company's Compensation Committee may approve in
a manner consistent with bonuses awarded to other senior executives under such
plans.
Under the 2002 Employment Agreement, the Company made two installment
payments in September and November to satisfy the obligation of $450,000 to Mr.
Shull previously due to be paid to Meridian on June 30, 2002. In addition, the
Company has agreed to make two equal lump sum cash payments of $225,000 each to
Mr. Shull on March 31, 2003 and September 30, 2004, provided the 2002 Employment
Agreement has not terminated due to Willful Misconduct (as defined in the 2002
Employment Agreement) or material breach thereof by Mr. Shull, or Mr. Shull's
death or permanent disability. Such payments shall be made notwithstanding any
other termination of the Employment Agreement on or prior to such date or as a
result of another event constituting a Change of Control.
Under the 2002 Employment Agreement, upon the closing of any transaction
which constitutes a "change of control" thereunder, provided that Mr. Shull is
then employed by the Company, the Company will be required to make a lump sum
cash payment to Mr. Shull on the date of such closing pursuant to the Change of
Control Plan, the Company's transaction bonus program and the Company's
Management Incentive Plans for the applicable fiscal year. Any such lump sum
payment would be in lieu of (i) any cash payment under the 2002 Employment
Agreement as a result of a termination thereof upon the first day after the
acquisition of the Company (whether by merger or the acquisition of all of its
outstanding capital stock) or
58
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
the tenth day after the sale or any series of sales since April 27, 2001
involving an aggregate of 50% or more of the market value of the Company's
assets (for this purpose under the 2002 Employment Agreement, such 50% amount
shall be deemed to be $107.6 million), and (ii) the aggregate amount of Base
Compensation to which Mr. Shull would have otherwise been entitled through the
end of the Shull Employment Agreement Term.
Under the 2002 Employment Agreement, additional amounts are payable to Mr.
Shull by the Company under certain circumstances upon the termination of the
2002 Employment Agreement. If the termination is on account of the expiration of
the 2002 Employment Agreement Term, Mr. Shull shall be entitled to receive such
amount of bonus as may be payable pursuant to the Company's applicable bonus
plan as well as employee benefits such as accrued vacation and insurance in
accordance with the Company's customary practice. If the termination is on
account of the Company's material breach of the 2002 Employment Agreement or the
Company's termination of the 2002 Employment Agreement where there has been no
Willful Misconduct (as defined in the 2002 Employment Agreement) or material
breach thereof by Mr. Shull, Mr. Shull shall be entitled to receive (i) a lump
sum payment equal to the aggregate amount of Base Compensation to which he would
have otherwise been entitled through the end of the 2002 Employment Agreement
Term (not to exceed 18 months of such Base Compensation), plus (ii) such
additional amount, if any, in severance pay which, when combined with the amount
payable pursuant to clause (i) equals 18 months of Base Compensation and such
amount of bonus as may be payable pursuant to the Company's 2002 Management
Incentive Plan or other bonus plan, as applicable (based upon the termination
date and the terms and conditions of the applicable bonus plan), as described in
paragraph 4(b), as well as such amounts as may be unpaid under the second
preceding paragraph and employee benefits such as accrued vacation and insurance
in accordance with the Company's customary practice. If the termination is on
account of the acquisition of the Company (whether by merger or the acquisition
of all of its outstanding capital stock) or the sale or any series of sales
since April 27, 2001 involving an aggregate of 50% or more of the market value
of the Company's assets (for this purpose under the 2002 Employment Agreement,
such 50% amount shall be deemed to be $107.6 million) and the amount realized in
the transaction is less than $0.50 per common share (or the equivalent of $0.50
per common share), and if and only if the Change of Control Plan shall not then
be in effect, Mr. Shull shall be entitled to receive a lump sum payment equal to
the aggregate amount of Base Compensation to which he would have otherwise been
entitled through the end of the Shull Employment Agreement Term. If the
termination is on account of the acquisition of the Company (whether by merger
or the acquisition of all of its outstanding capital stock) or the sale or any
series of sales since April 27, 2001 involving an aggregate of 50% or more of
the market value of the Company's assets (for this purpose under the 2002
Employment Agreement, such 50% amount shall be deemed to be $107.6 million) and
the amount realized in the transaction equals or exceeds $0.50 per common share
(or the equivalent of $0.50 per common share), and if and only if the Change of
Control Plan shall not then be in effect, Mr. Shull shall be entitled to receive
a lump sum payment equal to the greater of the Base Compensation to which he
would have otherwise been entitled through the end of the Shull Employment
Agreement Term or $1,000,000. If the termination is on account of an acquisition
or sale of the Company (whether by merger or the acquisition of all of its
outstanding capital stock) or the sale or any series of sales since April 27,
2001 involving an aggregate of 50% or more of the market value of the Company's
assets (for this purpose under the 2002 Employment Agreement, such 50% amount
shall be deemed to be $107.6 million) and the Change of Control Plan shall then
be in effect, Mr. Shull shall only be entitled to receive his benefit under the
Change of Control Plan.
Under the 2002 Employment Agreement, the Company is required to maintain
directors' and officers' liability insurance for Mr. Shull during the 2002
Employment Agreement Term. The Company is also required to indemnify Mr. Shull
in certain circumstances.
Amended Thomas C. Shull Stock Option Award Agreements. During December
2000, the Company entered into a stock option agreement with Thomas C. Shull to
evidence the grant to Mr. Shull of an option to purchase 2.7 million shares of
the Company's common stock (the "Shull 2000 Stock Option Agreement"). Effective
as of September 1, 2002, the Company has amended the Shull 2000 Stock Option
Agreement to
59
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(i) extend the final expiration date for the stock option under the Shull 2000
Stock Option Agreement to June 30, 2005, and (ii) replace all references therein
to the December 2000 Services Agreement with references to the 2002 Employment
Agreement.
During December 2001, the Company entered into a stock option agreement
with Mr. Shull to evidence the grant to Mr. Shull of an option to purchase
500,000 shares of the Company's common stock under the Company's 2000 Management
Stock Option Plan (the "Shull 2001 Stock Option Agreement"). Effective as of
September 1, 2002, the Company has amended the Shull 2001 Stock Option Agreement
to (i) provide that any shares purchased by Mr. Shull under the Shull 2001 Stock
Option Agreement would not be saleable until September 30, 2004, and (ii)
replace all references therein to the 2001 Services Agreement with references to
the 2002 Employment Agreement.
Amended Thomas C. Shull Transaction Bonus Letter. During May 2001, Thomas
C. Shull entered into a letter agreement with the Company (the "Shull
Transaction Bonus Letter") under which he would be paid a bonus on the
occurrence of certain transactions involving the sale of certain of the
Company's businesses. Effective as of September 1, 2002, the Company has amended
the Shull Transaction Bonus Letter to (i) increase the amount of Shull's agreed
to base salary for purposes of the transaction bonus payable thereunder from
$600,000 to $900,000, and (ii) replace all references therein to the December
2000 Services Agreement with references to the 2002 Employment Agreement.
Issuance of Stock Options. On August 8, 2002, the Company issued options
to purchase 3,750,000 shares of the Company's Common Stock to certain Management
Incentive Plan ("MIP") Level 7 and 8 employees, including various executive
officers, at a price of $0.24 per share under the Company's 2000 Management
Stock Option Plan. In addition, on August 8, 2002, the Company authorized the
President to grant options to purchase up to an aggregate of 1,045,000 and
1,366,000 shares of the Company's Common Stock to certain MIP Level 4 and MIP
Level 5 and 6 employees, respectively, at a price of $0.24 per share under the
Company's 2000 Management Stock Option Plan.
On October 2, 2002, the Company issued options to purchase 600,000 shares
of the Company's Common Stock to an Executive Vice President at a price of $0.27
per share under the Company's 2000 Management Stock Option Plan.
Charles F. Messina. During September 2002, Charles F. Messina resigned as
Executive Vice President, Chief Administrative Officer and Secretary of the
Company. In connection with such resignation, the Company and Mr. Messina
entered into a severance agreement dated September 30, 2002 providing for cash
payments of $884,500 and other benefits that were accrued in the fourth quarter
of 2002.
Brian C. Harriss. Brian C. Harriss was appointed Executive Vice
President -- Human Resources and Legal and Secretary of the Company effective
December 2, 2002. Prior to January 2002, Mr. Harriss had served the Company as
Executive Vice President and Chief Financial Officer. In connection with such
appointment, Mr. Harriss and the Company have terminated a severance agreement
entered into during January 2002 at the time of Mr. Harriss's resignation from
the Company, and Mr. Harriss has waived his rights to certain payments under
such severance agreement.
Other Executives. In October 2002, the Company entered into arrangements
with Edward M. Lambert, Brian C. Harriss and Michael D. Contino (the
"Compensation Continuation Agreements") pursuant to which it agreed to provide
eighteen months of severance pay, COBRA reimbursement and Exec-U-Care plan
coverage in the event their employment with the Company is terminated either by
the Company "For Cause" or by them "For Good Reason" (as such terms are
defined).
On November 6, 2002, the Company entered into an arrangement with Frank
Lengers pursuant to which it agreed to provide twelve months of severance pay,
COBRA reimbursement and Exec-U-Care plan coverage in the event his employment
with the Company is terminated either by the Company "For Cause" or by Mr.
Lengers "For Good Reason" (as such terms are defined).
60
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Hanover Direct, Inc. Key Executive Eighteen-Month Compensation Continuation
Plan. Effective April 27, 2001, the Company terminated the Hanover Direct, Inc.
Key Executive Thirty-Six Month Compensation Continuation Plan and the Hanover
Direct, Inc. Key Executive Twenty-Four Month Compensation Plan. Effective April
27, 2001, the Company established the Hanover Direct, Inc. Key Executive
Eighteen Month Compensation Continuation Plan (the "Executive Plan") for its
Chief Executive Officer, corporate executive vice presidents, corporate senior
vice presidents, strategic unit presidents, and other employees selected by its
Chief Executive Officer. The purpose of the Executive Plan is to attract and
retain key management personnel by reducing uncertainty and providing greater
personal security in the event of a Change of Control. For purposes of the
Executive Plan, a "Change of Control" will occur: (i) when any person becomes,
through an acquisition, the beneficial owner of shares of the Company having at
least 50% of the total number of votes that may be cast for the election of
directors of the Company (the "Voting Shares"); provided, however, that the
following acquisitions shall not constitute a Change of Control: (a) if a person
owns less than 50% of the voting power of the Company and that person's
ownership increases above 50% solely by virtue of an acquisition of stock by the
Company, then no Change of Control will 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 date of
the establishment of the Executive Plan owned at least 33% of the Voting Shares;
(ii)(a) notwithstanding the foregoing, a Change of Control will occur when the
shareholders of the Company approve any of the following (each, a
"Transaction"): (I) any reorganization, merger, consolidation or other business
combination of the Company; (II) any sale of 50% or more of the market value of
the Company's assets (for this purpose, 50% is deemed to be $107.6 million; or
(III) a complete liquidation or dissolution of the Company; (b) notwithstanding
(ii)(a), shareholder approval of either of the following types of Transactions
will not give rise to a Change of Control: (I) a Transaction involving only the
Company and one or more of its subsidiaries; or (II) a Transaction immediately
following which the shareholders of the Company immediately prior to the
Transaction continue to have a majority of the voting power in the resulting
entity; (iii) when, within any 24 month period, persons who were directors of
the Company (each, a "Director") immediately before the beginning of such period
(the "Incumbent Directors") 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 (iii), any
Director who was not a Director as of the effective date of the Executive Plan
will be deemed to be an Incumbent Director if such Director was elected to the
Board of Directors by, or on the recommendation of, or with the approval of, at
least a majority of the members of the Board of Directors or the nominating
committee who, at the time of the vote, qualified as Incumbent Directors either
actually or by prior operation of (iii), and any persons (and their successors
from time to time) who are designated by a holder of 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 effective date of the Executive Plan shall
be considered Incumbent Directors. Notwithstanding the foregoing, any director
elected to the Board of Directors to avoid or settle a threatened or actual
proxy contest shall not, under any circumstances, be deemed to be an Incumbent
Director); or (iv) when the Company sells, assigns or transfers more than 50% of
its interest in, or the assets of, one or more of its subsidiaries (each, a
"Sold Subsidiary" and, collectively, the "Sold Subsidiaries"); provided,
however, that such a sale, assignment or transfer will constitute a Change of
Control only for: (a) the Executive Plan participants who are employees of that
Sold Subsidiary; and (b) the Executive Plan participants who are employees of a
direct or indirect parent company of one or more Sold Subsidiaries, and then
only if: (I) the gross assets of such parent company's Sold Subsidiaries
constitute more than 50% of the gross assets of such parent company (calculated
on a consolidated basis with the direct and indirect subsidiaries of such parent
company and with reference to the most recent balance sheets of the Sold
Subsidiaries and the parent company); (II) the property, plant and equipment of
such parent company's Sold Subsidiaries constitute more than 50% of the
property, plant and equipment of such parent company (calculated on a
consolidated basis with the direct and indirect subsidiaries of such parent
company and with reference to the most recent balance sheets of the Sold
Subsidiaries and the parent company); or (III) in the case of a publicly-traded
parent company, the ratio (as of the date a binding agreement for the sale is
entered) of (x) the capitalization (based on the sale price) of such parent
company's Sold Subsidiaries, to (y) the market capitalization of such
61
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
parent company, is greater than 0.50. (For purposes of (iv), a Transaction shall
be deemed to involve the sale of more than 50% of a company's assets if: (a) the
gross assets being sold constitute more than 50% of the gross assets of the
Company as stated on the most recent balance sheet of the Company; (b) the
property, plant and equipment being sold constitute more than 50% of the
property, plant and equipment of the Company as stated on the most recent
balance sheet of the Company; or (c) in the case of a publicly-traded company,
the ratio (as of the date a binding agreement for the sale is entered) of (x)
the capitalization (based on the sale price) of the division, subsidiary or
business unit being sold, to (y) the market capitalization of the Company, is
greater than 0.50. For purposes of this (iv), no Change of Control will be
deemed to have occurred if, immediately following a sale, assignment or transfer
by the Company of more than 50% of its interest in, or the assets of, a Sold
Subsidiary, any shareholder of the Company owning 33% or more of the voting
power of the Company immediately prior to such transactions, owns no less than
the equivalent percentage of the voting power of the Sold Subsidiary.)
Under the Executive Plan, an Executive Plan participant shall be entitled
to Change of Control Benefits under the Executive Plan solely if there occurs a
Change of Control and thereafter the Company terminates his/her employment other
than For Cause (as defined in the Executive Plan) or the participant voluntarily
terminates his/her employment with the Company For Good Reason (as defined in
the Executive Plan), in either case, solely during the 2-year period immediately
following the Change of Control. A participant will not be entitled to Change of
Control Benefits under the Executive Plan if: (i) he/she voluntarily terminates
his/her employment with the Company or has his/her employment with the Company
terminated by the Company, in either case, prior to a Change of Control, (ii)
he/she voluntarily terminates employment with the Company following a Change of
Control but other than For Good Reason, (iii) he/she is terminated by the
Company following a Change of Control For Cause, (iv) has his/her employment
with the Company terminated solely on account of his/her death, (v) he/she
voluntarily or involuntarily terminates his/her employment with the Company
following a Change of Control as a result of his/her Disability (as defined in
the Executive Plan), or (vi) his/her employment with the Company is terminated
by the Company upon or following a Change of Control but where he/she receives
an offer of comparable employment, regardless of whether the participant accepts
the offer of comparable employment.
The Change of Control Benefits under the Executive Plan are as follows: (i)
an amount equal to 18 months of the participant's annualized base salary; (ii)
an amount equal to the product of 18 multiplied by the applicable monthly
premium that would be charged by the Company for COBRA continuation coverage for
the participant, the participant's spouse and the dependents of the participant
under the Company's group health plan in which the participant was participating
and with the coverage elected by the participant, in each case immediately prior
to the time of the participant's termination of employment with the Company;
(iii) an amount equal to 18 months of the participant's car allowance then in
effect as of the date of the termination of the participant's employment with
the Company; and (iv) an amount equal to the cost of 12 months of
executive-level outplacement services at a major outplacement services firm.
Transaction Bonus Letters. During May 2001, each of Charles F. Messina,
Thomas C. Shull, Jeffrey Potts, Brian C. Harriss and Michael D. Contino, and
during November 2002, each of Edward M. Lambert and Brian C. Harriss (each, a
"Participant") entered into a letter agreement with the Company (a "Transaction
Bonus Letter") under which the Participant would be paid a bonus on the
occurrence of certain transactions involving the sale of certain of the
Company's businesses. In addition, Mr. Shull is a party to a "Letter Agreement"
with the Company, dated April 30, 2001, pursuant to which, following the
termination of the December 2000 Services Agreement, in the event he is
terminated without cause during any period of his continued employment as the
Chief Executive Officer of the Company, he shall be paid one year of his annual
base salary (the "Shull Termination Payment"). Effective June 1, 2001, the
Company amended the Executive Plan to provide that, notwithstanding anything to
the contrary contained in the Executive Plan, Section 10.2 of the Executive Plan
shall not be effective with respect to the payment of (i) a Participant's
"Transaction Bonuses," and/or (ii) the Shull Termination Payment. The payment of
any such "Transaction Bonus" to any of the Participants, and/or the payment of
the Shull Termination Payment, shall be paid in
62
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
addition to, and not in lieu of, any Change of Control Benefit payable to any
Participant or Mr. Shull pursuant to the terms of the Executive Plan. In
conjunction with his resignation as Executive Vice President and Chief Financial
Officer, Mr. Harris has released any claims that he may have against the Company
under his Transaction Bonus Letter. The remaining Transaction Bonus Letters,
other than the Transaction Bonus Letter with Mr. Potts and Mr. Messina, remain
in effect.
Letter Agreement with Mr. Shull and Meridian. -- On April 30, 2001, Mr.
Shull, Meridian and the Company entered into a letter agreement (the "Letter
Agreement") specifying Mr. Shull's rights under the Executive Plan, which are
discussed above. Under the Letter Agreement, Mr. Shull and Meridian agreed that,
so long as the Executive Plan is in effect and Mr. Shull is a Participant
thereunder, Meridian and Mr. Shull will accept the Change in Control Benefits
provided for in the Executive Plan in lieu of the compensation contemplated by
the December 2000 Services Agreement between them (which benefits amounts will
not be offset against the December 2000 flat fee provided for in the December
2000 Services Agreement and shall be payable at such times and in such amounts
as provided in the Executive Plan rather than in a lump sum payable within five
business days after the termination date of the December 2000 Services Agreement
as contemplated by the December 2000 Services Agreement). For purposes of the
change in control benefits under the Executive Plan and the Letter Agreement,
Mr. Shull's annualized base salary is $600,000. In addition to the benefits
provided by the December 2000 Services Agreement, Mr. Shull and those persons
named in the December 2000 Services Agreement shall also be entitled to the
optional cash out of stock options as provided in the Executive Plan. Under the
Letter Agreement, Mr. Shull is also entitled to payment of one year annual base
salary in the event he is terminated without cause during any period of his
continued employment as the Chief Executive Officer of the Company following the
termination of the December 2000 Services Agreement. The participation and
benefits to which Mr. Shull is entitled under the Executive Plan shall also
survive the termination of the December 2000 Services Agreement pursuant to the
terms thereof in the event that Mr. Shull is still employed as the Chief
Executive Officer of the Company and is a Participant under the Executive Plan.
Should the Executive Plan no longer be in effect or Mr. Shull no longer be a
Participant thereunder, Meridian and Mr. Shull shall continue to be entitled to
the compensation contemplated by the December 2000 Services Agreement. The
Letter Agreement was superseded by the 2002 Employment Agreement.
Hanover Direct, Inc. Directors Change of Control Plan. -- Effective May 3,
2001, the Company's Board of Directors established the Hanover Direct, Inc.
Directors Change of Control Plan (the "Directors Plan") for all Directors of the
Company except for (i) any Director who is also an employee of the Company for
purposes of the Federal Insurance Contributions Act; or (ii) any persons (and
their successors from time to time) who are designated by a holder of
thirty-three percent (33%) or more of the Voting Shares to stand for election
and serve as a Director. For purposes of the Directors Plan, a "Change of
Control" will occur upon the occurrence of any of the events specified in item
(i), (ii) or (iii) of the definition of "Change in Control" under the Executive
Plan, as discussed above.
A participant in the Directors Plan shall be entitled to receive a Change
of Control Payment under the Directors Plan if there occurs a Change of Control
and he/she is a Director on the effective date of such Change of Control. A
Change of Control Payment under the Directors Plan shall be an amount equal to
the greater of (i) $40,000 or (ii) 150% of the sum of the annual retainer fee,
meeting fees and per diem fees paid to a Director for his/her service on the
Board of Directors of the Company during the 12-month period immediately
preceding the effective date of the Change of Control.
2002 Directors' Option Plan. Effective January 1, 2002, the 2002 Stock
Option Plan for Directors was amended to increase the annual service award for
Directors who are not employees of the Company from 25,000 to 35,000 options to
purchase shares of Common Stock.
63
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
12. EMPLOYEE BENEFIT PLANS
The Company maintains several defined contribution (401-k) plans that are
available to all employees of the Company and provide employees with the option
of investing in the Company's Common Stock. The Company matches a percentage of
employee contributions to the plans up to $10,000. Matching contributions for
all plans were $0.5 million, $0.6 million and $0.8 million for fiscal years
2002, 2001 and 2000, respectively.
13. INCOME TAXES
At December 28, 2002, the Company had net operating loss carry forwards
("NOLs") totaling $368.6 million, which expire as follows: 2003 -- $14.6
million, 2004 -- $14.3 million, 2005 -- $20.6 million, 2006 -- $46.9 million,
2007 -- $27.7 million, 2010 -- $24.6 million, 2011 -- $64.9 million,
2012 -- $30.0 million, 2018 -- $24.8 million, 2019 -- $19.6 million,
2020 -- $60.0 million, 2021 -- $8.6 million and 2022 -- $12.0 million. The
Company's available NOL for tax purposes consists of $74.1 million of NOL
subject to a $4.0 million annual limitation under Section 382 of the Internal
Revenue Code of 1986 and $294.5 million of NOL not subject to a limitation. The
unused portion of the $4.0 million annual limitation for any year may be carried
forward to succeeding years to increase the annual limitation for those
succeeding years.
SFAS No. 109, "Accounting for Income Taxes," requires that the future tax
benefit of such NOLs be recorded as an asset to the extent that management
assesses the utilization of such NOLs to be "more-likely-than-not." Based upon
the Company's assessment of numerous factors, including its future operating
plans, management has reduced its estimate of the NOL that it believes the
Company will be able to utilize. For the year ended December 28, 2002, the
carrying value of the deferred tax asset was adjusted based on a reassessment of
the Company's ability to utilize certain net operating losses prior to their
expiration. Accordingly, management has reduced the net deferred tax asset to
$11.3 million (net of a valuation allowance of $128.0 million and the $1.1
million deferred tax liability), as of December 28, 2002, from $15.0 million
(net of a valuation allowance of $121.6 million), as of December 29, 2001 via a
$3.7 million deferred Federal income tax provision. Management believes that the
$12.4 million deferred tax asset (excluding the $1.1 million deferred tax
liability) represents a "more-likely-than-not" estimate of the future
utilization of the NOL and the reversal of temporary differences. Management
will continue to routinely evaluate the likelihood of future profits and the
necessity of future adjustments to the deferred tax asset valuation allowance.
Realization of the future tax benefits is dependent on the Company's
ability to generate taxable income within the carry forward period and the
periods in which net temporary differences reverse. Future levels of operating
income and taxable income are dependent upon general economic conditions,
competitive pressures on sales and margins, postal and other delivery rates, and
other factors beyond the Company's control. Accordingly, no assurance can be
given that sufficient taxable income will be generated for utilization of NOLs
and reversals of temporary differences.
The Company's Federal income tax provision was $3.7 million of deferred
income tax for 2002, and zero for fiscal 2001 and 2000. The Company's provision
for state income taxes was $0.1 million in 2002, $0.1 million in 2001, and $0.2
million in 2000.
64
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
A reconciliation of the Company's net loss for financial statement purposes
to taxable loss for the years ended December 28, 2002, December 29, 2001 and
December 30, 2000 is as follows (in thousands):
YEAR ENDING
-----------------------------
2002 2001 2000
-------- ------- --------
Loss before income taxes.................................... $ (5,339) $(5,725) $(80,635)
Differences between income before taxes for financial
statement purposes and taxable income:
State income taxes.......................................... (91) (120) (165)
Permanent differences....................................... 4,248 1,986 7,484
Net change in temporary differences......................... (10,844) (4,737) 13,360
-------- ------- --------
Taxable loss................................................ $(12,026) $(8,596) $(59,956)
======== ======= ========
The components of the net deferred tax asset at December 28, 2002 are as
follows (in millions):
NON-
CURRENT CURRENT TOTAL
------- ------- ------
DEFERRED TAX ASSETS
Federal tax NOL and business tax credit carry forwards...... $ 1.7 $127.5 $129.2
Allowance for doubtful accounts............................. 0.5 -- 0.5
Inventories................................................. 0.2 -- 0.2
Property and equipment...................................... -- 4.1 4.1
Mailing lists and trademarks................................ -- 0.3 0.3
Accrued liabilities......................................... 4.3 0.7 5.0
Customer prepayments and credits............................ 1.6 -- 1.6
Deferred gain on sale of Improvements catalog............... 0.7 -- 0.7
Deferred credits............................................ -- 1.5 1.5
Other....................................................... 0.4 -- 0.4
----- ------ ------
Total....................................................... 9.4 134.1 143.5
Valuation allowance......................................... 7.6 120.4 128.0
----- ------ ------
Deferred tax asset, net of valuation allowance.............. 1.8 13.7 15.5
DEFERRED TAX LIABILITIES
Prepaid catalog costs....................................... (2.9) -- (2.9)
Excess of net assets of acquired business................... -- (1.3) (1.3)
----- ------ ------
Total....................................................... (2.9) (1.3) (4.2)
----- ------ ------
Net deferred tax (liability) asset.......................... $(1.1) $ 12.4 $ 11.3
===== ====== ======
The Company has established a valuation allowance for a portion of the
deferred tax asset due to the limitation on the utilization of the NOL and the
Company's estimate of the future utilization of the NOL.
65
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Tax expense for each of the three fiscal years presented differs from the
amount computed by applying the Federal statutory tax rate due to the following:
2002 2001 2000
PERCENT PERCENT PERCENT
OF PRE-TAX OF PRE-TAX OF PRE-TAX
LOSS LOSS LOSS
---------- ---------- ----------
Tax benefit at Federal statutory rate....................... (35.0)% (35.0)% (35.0)%
State and local taxes, net of Federal benefit............... 1.1 0.5 0.1
Permanent differences:
$1 million salary limit and stock option compensation..... 23.9 3.4 1.8
Other permanent differences............................... 4.0 0.8 1.4
Change in valuation allowance............................... 77.0 31.1 31.9
----- ----- -----
Tax benefit at effective tax rate........................... 71.0% 0.8% 0.2%
===== ===== =====
14. LEASES
Certain leases to which the Company is a party provide for payment of real
estate taxes and common area maintenance by the Company. Most leases are
accounted for as operating leases and include various renewal options with
specified minimum rentals. Rental expense for operating leases related to
continuing operations, net of sublease income, was as follows (in thousands):
YEAR ENDED
--------------------------
2002 2001 2000
------ ------- -------
Minimum rentals by lease type:
Land and building......................................... $4,682 $ 6,030 $ 8,363
Computer equipment........................................ 3,516 4,510 4,987
Plant, office and other................................... 446 500 460
------ ------- -------
Minimum rentals............................................. $8,644 $11,040 $13,810
Sublease income............................................. (53) (22) (13)
------ ------- -------
Net minimum rentals......................................... $8,591 $11,018 $13,797
====== ======= =======
66
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Future minimum lease payments under non-cancelable operating and capital
leases relating to continuing operations that have initial or remaining terms in
excess of one year and which extend to 2010, together with the present value of
the net minimum lease payments as of December 28, 2002, are as follows (in
thousands):
OPERATING CAPITAL TOTAL
YEAR ENDING LEASES LEASES LEASES
- ----------- --------- ------- -------
2003...................................................... $ 6,709 $13 $ 6,722
2004...................................................... 4,682 12 4,694
2005...................................................... 2,513 8 2,521
2006...................................................... 1,756 8 1,764
2007...................................................... 1,668 5 1,673
Thereafter (extending to 2010)............................ 3,614 0 3,614
------- --- -------
Total minimum lease payments...................... $20,942 $46 $20,988
======= =======
Less amount representing interest(a)...................... 7
---
Present value of minimum lease payments................... $39
===
- ---------------
(a) Amount necessary to reduce net minimum lease payments to present value
calculated at the Company's incremental borrowing rate at the inception of
the leases.
Future minimum lease payments under non-cancelable operating leases by
lease type as of December 28, 2002, are as follows (in thousands):
LAND PLANT,
AND COMPUTER OFFICE AND
YEAR ENDING BUILDINGS EQUIPMENT OTHER TOTAL
- ----------- --------- --------- ---------- -------
2003............................................... $ 4,622 $1,787 $300 $ 6,709
2004............................................... 3,900 590 192 4,682
2005............................................... 2,393 43 77 2,513
2006............................................... 1,748 -- 8 1,756
2007............................................... 1,668 -- -- 1,668
Thereafter......................................... 3,614 -- -- 3,614
------- ------ ---- -------
Total minimum lease payments............... $17,945 $2,420 $577 $20,942
======= ====== ==== =======
The Company has established reserves for certain future minimum lease
payments under noncancelable operating leases due to restructuring of business
operations related to such leases. The future commitments under such leases, net
of related sublease income under noncancelable subleases, are as follows (in
thousands):
MINIMUM
LEASE SUBLEASE NET LEASE
YEAR ENDING COMMITMENTS INCOME COMMITMENTS
- ----------- ----------- -------- -----------
2003.................................................... $ 3,260 $(1,232) $2,028
2004.................................................... 2,971 (984) 1,987
2005.................................................... 1,612 (431) 1,181
2006.................................................... 1,002 (196) 806
2007.................................................... 1,002 (120) 882
Thereafter.............................................. 2,172 (259) 1,913
------- ------- ------
Total minimum lease payments.................... $12,019 $(3,222) $8,797
======= ======= ======
67
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The future minimum lease payments under non-cancelable leases that remain
from the Company's discontinued restaurant operations as of December 28, 2002
are as follows (in thousands):
MINIMUM
LEASE SUBLEASE
YEAR ENDING PAYMENTS INCOME
- ----------- -------- --------
2003...................................................... $ 476 $ (419)
2004...................................................... 476 (416)
2005...................................................... 381 (341)
2006...................................................... 72 (87)
------ -------
Total minimum lease payments...................... $1,405 $(1,263)
====== =======
15. STOCK-BASED COMPENSATION PLANS
The Company has established several stock-based compensation plans for the
benefit of its officers and employees. As discussed in the Summary of
Significant Accounting Policies (Note 1), the Company applies the
fair-value-based methodology of SFAS No. 123 and, accordingly, has recorded
stock compensation expense of $1.3 million, $1.8 million and $5.2 million for
fiscal 2002, 2001 and 2000, respectively. The effects of applying SFAS No. 123
for recognizing compensation costs are not indicative of future amounts. The
information below details each of the Company's stock compensation plans,
including any changes during the years presented.
1999 Stock Option Plan for Directors -- During August 1999, the Board of
Directors adopted the 1999 Stock Option Plan for Directors providing stock
options to purchase shares of Common Stock of the Company to certain eligible
directors who were neither employees of the Company nor non-resident aliens (the
"Directors' Option Plan"). The Directors' Option Plan was ratified by the
Company's shareholders at the 2000 Annual Meeting of Shareholders. The Company
may issue stock options to purchase up to 700,000 shares of Common Stock to
eligible directors at an exercise price equal to the fair market value as of the
date of grant. An eligible director shall receive a stock option grant to
purchase 50,000 shares of Common Stock as of the effective date of his/her
initial appointment or election to the Board of Directors. Furthermore, on each
Award Date, defined as August 4, 2000 or August 3, 2001, eligible directors were
granted stock options to purchase an additional 10,000 shares of Common Stock.
Stock options granted have terms of 10 years and shall vest and become
exercisable over three (3) years from the date of grant; however, in the event
of a change in control, options shall vest and become exercisable immediately.
Payment for shares purchased upon exercise of options shall be in cash or stock
of the Company.
68
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Options outstanding, granted and the weighted average exercise prices under
the Directors' Option Plan are as follows:
1999 STOCK OPTION PLAN FOR DIRECTORS
2002 2001 2000
------------------- -------------------- --------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
-------- -------- --------- -------- --------- --------
Options outstanding, beginning
of period.................... 370,000 $1.78 420,000 $2.13 -- $ --
Granted................... 50,000 .38 80,000 .30 540,000 2.15
Exercised................. -- -- -- -- -- --
Forfeited................. -- -- (130,000) 1.98 (120,000) 2.25
-------- --------- ---------
Options outstanding, end of
period....................... 420,000 $1.62 370,000 $1.78 420,000 $2.13
======== ===== ========= ===== ========= =====
Options exercisable, end of
period....................... 316,667 $2.02 253,332 $2.15 116,667 $2.35
======== ===== ========= ===== ========= =====
Weighted average fair value of
options granted.............. $ .29 $ .22 $ 1.07
======== ========= =========
The fair value of each option granted is estimated on the date of grant
using the Black-Scholes option-pricing model. The weighted average assumptions
for grants in fiscal 2002 and 2001 under the Directors' Option Plan were as
follows: risk-free interest rate of 4.70% and 4.88%, expected volatility of
89.28% and 83.93%, expected life of six years, and no expected dividends.
The following table summarizes information about stock options outstanding
at December 28, 2002 under the Directors' Option Plan:
1999 STOCK OPTION PLAN FOR DIRECTORS
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------------- -----------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
EXERCISE PRICES OUTSTANDING LIFE PRICE EXERCISABLE PRICE
- --------------- ----------- ----------- -------- ----------- --------
$0.20.......................... 20,000 8.6 $0.20 6,667 $0.20
$0.36.......................... 50,000 8.6 $0.36 16,667 $0.36
$0.38.......................... 50,000 9.0 $0.38 -- $0.38
$1.00.......................... 50,000 3.9 $1.00 43,333 $1.00
$2.35.......................... 250,000 3.5 $2.35 250,000 $2.35
------- -------
420,000 5.0 $1.62 316,667 $2.02
======= === ===== ======= =====
2002 Stock Option Plan for Directors -- During 2002, the Board of Directors
adopted the 2002 Stock Option Plan for Directors providing stock options to
purchase shares of Common Stock of the Company to certain non-employee directors
(the "2002 Directors' Option Plan"). The 2002 Directors' Option Plan was
ratified by the Company's shareholders at the 2002 Annual Meeting of
Shareholders and was amended during November 2002. The Company may issue stock
options to purchase up to 500,000 shares of Common Stock to eligible directors
at an exercise price equal to the fair market value as of the date of grant. An
eligible director shall receive a stock option grant to purchase 50,000 shares
of Common Stock as of the effective date of his/her initial appointment or
election to the Board of Directors. On each Award Date, defined as August 2,
2002, August 1, 2003, or August 3, 2004, eligible directors are to be granted
stock options to purchase
69
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
additional shares of Common Stock. On August 2, 2002, each eligible director was
granted stock options to purchase an additional 25,000 shares of Common Stock.
For the August 1, 2003 and August 3, 2004 Award Dates, each eligible director is
to be granted stock options to purchase an additional 35,000 shares of Common
Stock. Stock options granted have terms of 10 years and shall vest and become
exercisable over three (3) years from the date of grant; however, in the event
of a change in control, options shall vest and become exercisable immediately.
Payment for shares purchased upon exercise of options shall be in cash or stock
of the Company.
Options outstanding, granted and the weighted average exercise prices under
the 2002 Directors' Option Plan are as follows:
2002 STOCK OPTION PLAN FOR DIRECTORS
2002
-------------------
WEIGHTED
AVERAGE
EXERCISE
SHARES PRICE
-------- --------
Options outstanding, beginning of period.................... -- $ --
Granted................................................ 100,000 .23
Exercised.............................................. -- --
Forfeited.............................................. -- --
--------
Options outstanding, end of period.......................... 100,000 $.23
======== ====
Options exercisable, end of period.......................... -- $ --
======== ====
Weighted average fair value of options granted.............. $ .16
========
The fair value of each option granted is estimated on the date of grant
using the Black-Scholes option-pricing model. The weighted average assumptions
for grants in fiscal 2002 under the 2002 Directors' Option Plan were as follows:
risk-free interest rate of 3.76%, expected volatility of 89.36%, expected life
of six years, and no expected dividends.
The following table summarizes information about stock options outstanding
at December 28, 2002 under the 2002 Directors' Option Plan:
2002 STOCK OPTION PLAN FOR DIRECTORS
OPTIONS OUTSTANDING
-------------------------------------- OPTIONS EXERCISABLE
WEIGHTED -----------------------
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
EXERCISE PRICE OUTSTANDING LIFE PRICE EXERCISABLE PRICE
- -------------- ----------- ----------- -------- ----------- --------
$.23........................... 100,000 9.6 $.23 -- $.23
------- ----
100,000 9.6 $.23 -- $.23
======= === ==== ==== ====
1993 Executive Equity Incentive Plan -- In December 1992, the Board of
Directors adopted the 1993 Executive Equity Incentive Plan (the "Incentive
Plan"). The Incentive Plan was approved by the Company's shareholders at the
1993 Annual Meeting of Shareholders. The Incentive Plan encouraged executives to
acquire and retain a significant ownership stake in the Company. Under the
Incentive Plan, executives were given an opportunity to purchase shares of
Common Stock with up to 80% of the purchase price financed with a six-year full
recourse Company loan, which bore interest at the mid-term applicable federal
rate as determined by the Internal Revenue Service. The Incentive Plan
participants purchased shares of Common Stock at prices ranging from $0.69 to
$4.94, with the Company accepting notes bearing interest at rates ranging from
5.00% to 7.75%. For each share of stock an employee purchased, he/she received
stock options
70
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
to acquire two additional shares of Common Stock, up to a maximum of 250,000
shares in the aggregate. The stock options, which were granted by the
Compensation Committee of the Board of Directors, vested after three years and
expired after six years. On December 31, 1996, the Incentive Plan was terminated
in accordance with its terms, and no additional Common Stock was purchased or
stock options granted. As of December 29, 2001, no stock options remained
outstanding or exercisable related to the Incentive Plan.
Changes in options outstanding, expressed in numbers of shares, for the
Incentive Plan for 2000 and 2001 are as follows:
1993 EXECUTIVE EQUITY INCENTIVE PLAN
2001 2000
------------------- --------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
EXERCISE EXERCISE
OPTIONS PRICE OPTIONS PRICE
------- -------- -------- --------
Options outstanding, beginning of period........... 80,000 $1.72 454,000 $1.13
Exercised.......................................... -- -- (274,000) 1.00
Forfeited.......................................... (80,000) 1.72 (100,000) 1.00
------- --------
Options outstanding, end of period................. -- -- 80,000 $1.72
======= ===== ======== =====
Options exercisable, end of period................. -- -- 80,000 $1.72
======= ===== ======== =====
Changes to the notes receivable principal balances related to the Incentive
Plan are as follows:
2002 2001 2000
-------- -------- ---------
Notes Receivable balance, beginning of period............... $313,400 $324,400 $ 655,500
Payments.................................................... -- -- (9,600)
Forfeitures................................................. (44,000) (11,000) (321,500)
-------- -------- ---------
Notes Receivable balance, end of period..................... $269,400 $313,400 $ 324,400
======== ======== =========
Collateral was held in escrow on behalf of each participant, encompassing
20,000 shares, 20,000 shares, and 80,000 shares of the Company's Common Stock in
fiscal years 2002, 2001, and 2000, respectively. This collateral was transferred
to and retained by the Company in satisfaction of the aforementioned promissory
notes, which were no longer required to be settled. The Company recorded these
shares as treasury stock. Furthermore, the related participants forfeited their
initial 20% cash down payment, which was required for entry into the Incentive
Plan.
Management Stock Option Plans -- The Company approved for issuance to
employees 20,000,000 shares of the Company's Common Stock pursuant to the
Company's 2000 Management Stock Option Plan and 7,000,000 shares of the
Company's Common Stock pursuant the Company's 1996 Stock Option Plan. Under both
plans, the option exercise price is equal to the fair market value as of the
date of grant. However, for stock options granted to an employee owning more
than 10% of the total combined voting power of all classes of Company stock, the
exercise price is equal to 110% of the fair market value of the Company's Common
Stock as of the grant date. Stock options granted to an individual employee
under the 2000 Management Stock Option Plan may not exceed 1,000,000 shares of
the Company's Common Stock. Stock options granted to an individual employee
under the 1996 Stock Option Plan may not exceed 500,000 shares of the Company's
Common Stock and may be performance-based. All options granted must be
specifically identified as incentive stock options or non-qualified stock
options, as defined in the Internal Revenue Code. Furthermore, the aggregate
fair market value of Common Stock for which an employee is granted incentive
stock options that first became exercisable during any given calendar year shall
be limited to $100,000. To the extent such limitation is exceeded, the option
shall be treated as a non-qualified stock option. Stock options may be
71
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
granted for terms not to exceed 10 years and shall be exercisable in accordance
with the terms and conditions specified in each option agreement. In the case of
an employee who owns stock possessing more than 10% of the total combined voting
power of all classes of stock, the options must become exercisable within 5
years. Payment for shares purchased upon exercise of options shall be in cash or
stock of the Company.
For both the 1996 and 2000 management Stock Option Plans, options
outstanding, granted and the weighted average exercise prices are as follows:
1996 AND 2000 MANAGEMENT STOCK OPTION PLANS
2002 2001 2000
----------------------- ----------------------- -----------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
----------- -------- ----------- -------- ----------- --------
Options outstanding,
beginning of
period............. 3,962,778 $2.46 9,240,947 $2.41 5,927,984 $1.99
Granted......... 6,761,000 .24 30,000 .20 5,459,000 2.71
Exercised....... -- -- (10,000) .20 (414,537) 1.10
Forfeited....... (1,493,508) 2.60 (5,298,169) 2.36 (1,731,500) 2.26
----------- ----------- -----------
Options outstanding,
end of period...... 9,230,270 $ .81 3,962,778 $2.46 9,240,947 $2.41
=========== ===== =========== ===== =========== =====
Options exercisable,
end of period...... 1,913,270 $2.18 2,406,362 $2.12 3,235,167 $1.82
=========== ===== =========== ===== =========== =====
Weighted average fair
value of options
granted............ $ .18 $ .15 $ 1.60
=========== =========== ===========
The fair value of each option granted is estimated on the date of grant
using the Black-Scholes option-pricing model. The weighted average assumptions
for grants in fiscal 2002, 2001 and 2000 are as follows: risk-free interest rate
of 3.81%, 4.96% and 5.60%, respectively, expected volatility of 89.58%, 83.93%
and 56.85%, respectively, expected lives of six years for fiscal years 2002,
2001 and 2000, and no expected dividends.
The following table summarizes information about stock options outstanding
at December 28, 2002 under both the 1996 and 2000 management Stock Option Plans:
1996 AND 2000 MANAGEMENT STOCK OPTION PLANS
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------------- -----------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
RANGE OF EXERCISE PRICES OUTSTANDING LIFE PRICE EXERCISABLE PRICE
- ------------------------ ----------- ----------- -------- ----------- --------
$ .20 to $1.01.............. 7,379,107 9.0 $ .30 598,107 $ .92
$1.43 to $1.75.............. 243,332 2.2 $1.49 230,832 $1.48
$2.37 to $2.94.............. 219,000 4.2 $2.47 199,500 $2.45
$3.00 to $3.50.............. 1,388,831 5.8 $3.17 884,831 $3.16
--------- ----- ---------
9,230,270 8.2 $ .81 1,913,270 $2.18
========= === ===== ========= =====
The Chief Executive Officer Stock Option Plans -- Stock-based plans were
granted in 1996 for the benefit of Rakesh K. Kaul, the former Chief Executive
Officer of the Company (the "CEO"). In each of the plans,
72
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
the option price represents the average of the low and high fair market values
of the Common Stock on August 23, 1996, the date of the closing of the Company's
1996 Rights Offering.
On December 5, 2000, the CEO resigned, resulting in the right to exercise
the outstanding options for 12 months thereafter. No options were exercised by
the CEO on or before December 5, 2001. There were no options outstanding and
exercisable under these plans as of December 28, 2002.
The details of the plans are as follows:
The CEO Tandem Plan -- Pursuant to the Company's Tandem Plan (the "Tandem
Plan"), the right to purchase an aggregate of 1,000,000 shares of Common Stock
and an option to purchase 2,000,000 shares of Common Stock was approved for
issuance to the CEO. The option was subject to anti-dilution provisions and due
to the Company's 1996 Rights Offering was adjusted to 1,510,000 shares of Common
Stock and 3,020,000 options. Due to the resignation of the CEO in December 2000,
1,510,000 Tandem Plan shares of Common Stock were transferred and, to date, the
Company has treated the transfers as satisfying a promissory note of
approximately $0.7 million owed by the CEO to the Company. The Company recorded
these shares as treasury stock. There were no options outstanding and
exercisable under the Tandem Plan at December 28, 2002.
The CEO Performance Year Plan -- Pursuant to the Company's Performance Year
Plan (the "Performance Plan"), an option to purchase an aggregate of 1,000,000
shares of Common Stock was approved for issuance to the CEO in 1996. The options
were based upon performance as defined by the Compensation Committee of the
Board of Directors. Should a performance target not be attained, the option is
carried over to the succeeding year in conjunction with that year's option until
the expiration date. The options expire 10 years from the date of grant and vest
over four years. Payment for shares purchased upon the exercise of the options
shall be in cash or stock of the Company. Due to the resignation of the CEO on
December 5, 2000 and the absence of an exercise of the outstanding options for
12 months thereafter, the options were forfeited on December 5, 2001. No options
were outstanding and exercisable under the Performance Plan at December 28,
2002.
The CEO Closing Price Option Plan -- Pursuant to the Company's Closing
Price Option Plan (the "Closing Price Plan"), an option to purchase an aggregate
of 2,000,000 shares of Common Stock was approved for issuance to the CEO in
1996. The options expire 10 years from the date of grant and will become vested
upon the Company's stock price reaching a specific target over a consecutive
91-calendar day period as defined by the Compensation Committee of the Board of
Directors. In May 1998, the Compensation Committee of the Board of Directors
reduced the target per share market price at which the Company's Common Stock
had to trade in consideration of the dilutive effect of the increase in
outstanding shares from the date of the grant. The performance period has a
range of six years beginning August 23, 1996, the date of the closing of the
1996 Rights Offering. Due to the resignation of the CEO on December 5, 2000 and
the absence of an exercise of the outstanding options for 12 months thereafter,
the options were forfeited on December 5, 2001. No options were outstanding and
exercisable under the Closing Price Plan at December 28, 2002.
The CEO Six Year Stock Option Plan -- Pursuant to NAR's Six Year Stock
Option Plan (the "Six Year Plan"), an option to purchase an aggregate of 250,000
shares of Common Stock was granted to the CEO by NAR Group Limited ("NAR") in
1996. The option is subject to anti-dilution provisions and due to the Company's
1996 Rights Offering was adjusted to 377,500 option shares. The options expire
six years from the date of grant and vest after one year. Due to the resignation
of the CEO on December 5, 2000 and the absence of an exercise of the outstanding
options for 12 months thereafter, the options were forfeited on December 5,
2001. No options were outstanding and exercisable under the Six Year Plan at
December 28, 2002.
The CEO Seven Year Stock Option Plan -- Pursuant to NAR's Seven Year Stock
Option Plan (the "Seven Year Plan"), an option to purchase an aggregate of
250,000 shares of Common Stock was granted to the CEO by NAR in 1996. The option
is subject to anti-dilution provisions and due to the Company's 1996
73
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Rights Offering was adjusted to 377,500 option shares. The options expire seven
years from the date of grant and vest after two years. Due to the resignation of
the CEO on December 5, 2000 and the absence of an exercise of the outstanding
options for 12 months thereafter, the options were forfeited on December 5,
2001. No options were outstanding and exercisable under the Seven Year Plan at
December 28, 2002.
The CEO Eight Year Stock Option Plan -- Pursuant to NAR's Eight Year Stock
Option Plan (the "Eight Year Plan"), an option to purchase an aggregate of
250,000 shares of Common Stock was granted to the CEO by NAR in 1996. The option
is subject to anti-dilution provisions and due to the Company's 1996 Rights
Offering was adjusted to 377,500 option shares. The options expire eight years
from the date of grant and vest after three years. Due to the resignation of the
CEO on December 5, 2000 and the absence of an exercise of the outstanding
options for 12 months thereafter, the options were forfeited on December 5,
2001. No options were outstanding and exercisable under the Eight Year Plan at
December 28, 2002.
The CEO Nine Year Stock Option Plan -- Pursuant to NAR's Nine Year Stock
Option Plan (the "Nine Year Plan"), an option to purchase an aggregate of
250,000 shares of Common Stock was granted to the CEO by NAR in 1996. The option
was subject to anti-dilution provisions and due to the Company's 1996 Rights
Offering was adjusted to 377,500 option shares. The options expire nine years
from the date of grant and vest after four years. Due to the resignation of the
CEO on December 5, 2000 and the absence of an exercise of the outstanding
options for 12 months thereafter, the options were forfeited on December 5,
2001. No options were outstanding and exercisable under the Nine Year Plan at
December 28, 2002.
For the combined CEO Stock Option Plans, options outstanding, granted and
the weighted average exercise prices are as follows:
CEO STOCK OPTION PLANS
2002 2001 2000
----------------- --------------------- --------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
------ -------- ---------- -------- --------- --------
Options outstanding,
beginning of period..... -- -- 7,530,000 $1.16 7,530,000 $1.16
Forfeited................. -- -- (7,530,000) -- -- --
---- ---------- ---------
Options outstanding,
end of period........... -- -- -- -- 7,530,000 $1.16
==== ==== ========== ===== ========= =====
Options exercisable,
end of period........... -- -- -- -- 7,040,000 $1.16
==== ==== ========== ===== ========= =====
An Executive Employment Agreement entered into by the Company and the CEO
on March 6, 2000 provided the CEO with the option to purchase 6% of the common
stock of erizon, Inc. at the estimated fair market value on the date of the
grant, which option was to vest in equal parts over a four-year period and to
expire ten years from the date of grant. The Company recorded no compensation
expense for the years ended December 28, 2002 and December 29, 2001, and $.8
million during the year ended December 30, 2000, related to this option grant.
The fair value of options at the date of grant was estimated to be $62,000 per
share based on the following assumptions: risk-free interest rate of 6.0%,
expected life of 4 years, expected volatility of 54.8%, and no expected
dividends.
As described more fully in Note 17, the Company is currently involved in
litigation with the CEO, regarding, among other issues, the amount of cash and
benefits to which the CEO may have been entitled, if any, as a result of his
resignation on December 5, 2000. The litigation is in the summary judgement
phase; however, it is not certain at this time what the impact of his
resignation will have on all of the option plans described above.
74
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
OTHER STOCK AWARDS
During 1997, the Company granted, and the Compensation Committee of the
Board of Directors approved, non-qualified options to certain employees for the
purchase of an aggregate of 1,000,000 shares of the Company's Common Stock. The
options vested over three years and are due to expire in 2003. The options have
an exercise price of $0.75 and a remaining contractual life as of December 28,
2002 of 0.2 years. The fair value of the options at the date of grant was
estimated to be $0.52 based on the following weighted average assumptions:
risk-free interest rate of 6.48%, expected life of four years, expected
volatility of 59.40%, and no expected dividends. In June 2001, 809,000 options
that had not been exercised were forfeited by certain employees. As of December
28, 2002, there were no options outstanding and exercisable.
Meridian Options -- During December 2000, the Company granted, and the
Company's Board of Directors approved, options ("2000 Meridian Options") for the
purchase of an aggregate of 4,000,000 shares of Common Stock with an exercise
price of $0.25 per share. These options have been allocated as follows: Thomas
C. Shull, 2,700,000 shares; Paul Jen, 500,000 shares; John F. Shull, 500,000
shares; Evan M. Dudik, 200,000 shares; and Peter Schweinfurth, 100,000 shares.
In December 2001, an additional Services Agreement (the "2001 Services
Agreement") was entered into by the Company by and among Meridian, Mr. Shull,
and the Company. Under the 2001 Services Agreement, the 2000 Meridian Options
terminate in the event that the Services Agreement is terminated (i) the tenth
day after written notice by the Company to Meridian and Mr. Shull of material
breach of the Services Agreement by Meridian or Mr. Shull or willful misconduct
by Meridian or Mr. Shull, or (ii) upon the death or permanent disability of Mr.
Shull. The 2000 Meridian Options vested and became exercisable on December 4,
2001 for all 2000 Meridian Options, except one-half of Mr. Shull's 2000 Meridian
Options, which vested and became exercisable on June 30, 2002. Effective as of
September 1, 2002, the Company amended the stock option agreement with Mr. Shull
for his 2,700,000 2000 Meridian Stock Options to (i) extend the final expiration
date for such stock options to June 30, 2005, and (ii) replace all references
therein to the December 2000 Services Agreement with references to the
employment agreement between Mr. Shull and the Company, which became effective
on September 1, 2002.
The fair value of the 2000 Meridian Options was estimated to be $0.07 cents
per share at the date of grant based on the following assumptions: risk-free
interest rate of 6.0%, expected life of 1.5 years, expected volatility of 54.0%,
and no expected dividends.
During December 2001, the Company granted to Meridian, and the Company's
Board of Directors approved, options to Meridian ("2001 Meridian Options") for
the purchase of an additional 1,000,000 shares of Common Stock with an exercise
price of $0.30. These options have been allocated as follows: Thomas C. Shull,
500,000 shares; Edward M. Lambert, 300,000 shares; Paul Jen, 100,000 shares; and
John F. Shull, 100,000 shares. Under the 2001 Services Agreement, the 2001
Meridian Options granted terminate in the event that the 2001 Services Agreement
is terminated (i) the tenth day after written notice by the Company to Meridian
and Mr. Shull of material breach of the 2001 Services Agreement by Meridian or
Mr. Shull or willful misconduct by Meridian or Mr. Shull, or (ii) upon the death
or permanent disability of Mr. Shull. The 2001 Meridian Options will vest and
become exercisable on March 31, 2003. Effective as of September 1, 2002, the
Company amended the stock option agreement with Mr. Shull for his 500,000 2001
Meridian Options to (i) extend the final expiration date for such stock options
to June 30, 2005, and (ii) replace all references therein to the 2001 Services
Agreement with references to the 2002 Employment Agreement.
The fair value of the 2001 Meridian Options was estimated to be $0.16 cents
per share at the date of grant based on the following assumptions: risk-free
interest rate of 2.82%, expected life of 1.25 years, expected volatility of
129.73%, and no expected dividends.
75
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Options outstanding, granted and the weighted average exercise price under
the combined 2000 Meridian Options and the 2001 Meridian Options are as follows:
MERIDIAN OPTION PLANS
2002 2001 2000
-------------------- --------------------- ---------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
--------- -------- ---------- -------- ---------- --------
Options outstanding,
beginning of period........ 5,000,000 $.26 4,000,000 $.25 -- --
Granted................. -- -- 1,000,000 .30 4,000,000 $.25
Exercised............... (100,000) .25 -- -- -- --
Forfeited............... -- -- -- -- -- --
--------- ---------- ----------
Options outstanding, end of
period..................... 4,900,000 $.26 5,000,000 $.26 4,000,000 $.25
========= ==== ========== ==== ========== ====
Options exercisable, end of
period..................... 3,900,000 $.25 2,650,000 $.25 -- --
========= ==== ========== ==== ========== ====
Weighted average fair value
of options granted......... -- $ .16 $ .07
========= ========== ==========
The following table summarizes information about stock options outstanding
and exercisable at December 28, 2002 under the combined 2000 Meridian Options
and the 2001 Meridian Options:
MERIDIAN OPTION PLANS
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------ ----------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
RANGE OF EXERCISE PRICES OUTSTANDING LIFE PRICE EXERCISABLE PRICE
- ------------------------ ----------- ----------- -------- ----------- --------
$0.25.............................. 3,900,000 2.0 $.25 3,900,000 $.25
$0.30.............................. 1,000,000 3.3 $.30 -- --
--------- ---------
4,900,000 2.3 $.26 -- $.25
========= === ==== ========= ====
16. RELATED PARTY TRANSACTIONS
At December 28, 2002, Richemont Finance S.A. ("Richemont"), a Luxembourg
company, owned approximately 21.3% of the Company's Common Stock outstanding and
100% of the Company's Series B Preferred Stock through direct and indirect
ownership.
At December 28, 2002, current and former officers and executives of the
Company owed the Company approximately $0.3 million, excluding accrued interest,
under the 1993 Executive Equity Incentive Plan. These amounts due to the Company
bear interest at rates ranging from 5.54% to 7.75% and are due or will be due
during 2003.
On November 6, 2002, the Company entered into a Compensation Continuation
Agreement with Mr. Lengers. See Note 11.
During October 2002, the Company entered into the Compensation Continuation
Agreements with Mr. Lambert, Mr. Harriss and Mr. Contino. See Note 11.
76
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
During September 2002, the Company entered into a severance agreement with
Mr. Messina. See Note 11.
As of September 1, 2002, Mr. Shull and the Company entered into the 2002
Employment Agreement. See Note 11.
During January 2002, at the time of Mr. Harriss's resignation from the
Company as Executive Vice President and Chief Financial Officer, the Company and
Mr. Harriss entered into a severance agreement. In connection with Mr. Harriss's
appointment as Executive Vice President -- Human Resources and Legal and
Secretary of the Company effective December 2, 2002, Mr. Harriss waived his
rights to certain payments under such severance agreement.
17. COMMITMENTS AND CONTINGENCIES
A class action lawsuit was commenced on March 3, 2000 entitled Edwin L.
Martin v. Hanover Direct, Inc. and John Does 1 through 10, bearing case no.
CJ2000-177 in the State Court of Oklahoma (District Court in and for Sequoyah
County). Plaintiff commenced the action on behalf of himself and a class of
persons who have at any time purchased a product from the Company and paid for
an "insurance charge." The complaint sets forth claims for breach of contract,
unjust enrichment, recovery of money paid absent consideration, fraud and a
claim under the New Jersey Consumer Fraud Act. The complaint alleges that the
Company charges its customers for delivery insurance even though, among other
things, the Company's common carriers already provide insurance and the
insurance charge provides no benefit to the Company's customers. Plaintiff also
seeks a declaratory judgment as to the validity of the delivery insurance. The
damages sought are (i) an order directing the Company to return to the plaintiff
and class members the "unlawful revenue" derived from the insurance charges,
(ii) declaring the rights of the parties, (iii) permanently enjoining the
Company from imposing the insurance charge, (iv) awarding threefold damages of
less than $75,000 per plaintiff and per class member, and (v) attorneys' fees
and costs. On April 12, 2001, the Court held a hearing on plaintiff's class
certification motion. Subsequent to the April 12, 2001 hearing on plaintiff's
class certification motion, plaintiff filed a motion to amend the definition of
the class. On July 23, 2001, plaintiff's class certification motion was granted,
defining the class as "All persons in the United States who are customers of any
catalog or catalog company owned by Hanover Direct, Inc. and who have at any
time purchased a product from such company and paid money that was designated to
be an "insurance'"insurance" charge." On August 21, 2001, the Company filed an appeal of the
order with the Oklahoma Supreme Court and subsequently moved to stay proceedings
in the district court pending resolution of the appeal. The appeal has been
fully briefed. At a subsequent status hearing, the parties agreed that issues
pertaining to notice to the class would be stayed pending resolution of the
appeal, that certain other issues would be subject to limited discovery, and
that the issue of a stay for any remaining issues would be resolved if and when
such issues arise. OralOn January 20, 2004, the plaintiff filed a motion for oral
argument onwith the appeal, if scheduled, is not expected
until the first half of 2003.Court. The Company believes it has defenses against the claims
and plans to conduct a vigorous defense of this action.
On August 15, 2001, the Company was served with a summons and four-count
complaint filed in Superior Court for the City and County of San Francisco,
California, entitled Teichman v. Hanover Direct, Inc., Hanover Brands, Inc.,
Hanover Direct Virginia, Inc., and Does 1-100. The complaint was filed by a
California resident, seeking damages and other relief for herself and a class of
all others similarly situated, arising out of the insurance fee charged by
catalogs and internetInternet sites operated by subsidiaries of the Company. Defendants,
including the Company, have filed motions to dismiss based on a lack of personal
jurisdiction over them. In January 2002, plaintiff sought leave to name six
additional entities: International Male, Domestications Kitchen & Garden,
Silhouettes, Hanover Company Store, Kitchen & Home, and Domestications as
co-
defendants.co-defendants. On March 12, 2002, the Company was served with the First Amended
Complaint in which plaintiff named as defendants the Company, Hanover Brands,
Hanover Direct Virginia, LWI Holdings, Hanover Company Store, Kitchen and Home,
and Silhouettes. On April 15, 2002, the Company filed a Motion to Stay the
Teichman action in favor of the previously filed Martin action and also filed a
Motion to quash service of summons for lack of personal jurisdiction on behalf
of defendants Hanover Direct, Inc., 77
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Hanover Brands, Inc. and Hanover Direct
Virginia, Inc. On May 14, 2002, the Court (1) granted the Company's Motion to
quash service on behalf of Hanover Direct, Hanover Brands, and Hanover Direct
Virginia, leaving only LWI Holdings, Hanover Company Store, Kitchen & Home, and
Silhouettes, as defendants, and (2) granted the Company's Motion to Stay the
action in favor of the previously filed
17
Oklahoma action, so nothing will proceed on this case against the remaining
entities until the Oklahoma case is decided. The Company believes it has
defenses against the claims. The Company plans to conduct a vigorous defense of
this action.
A class action lawsuit was commenced on February 13, 2002 entitled Jacq
Wilson, suing on behalf of himself, all others similarly situated, and the
general public v. Brawn of California, Inc. dba International Male and
Undergear, and Does 1-100 ("Brawn") in the Superior Court of the State of
California, City and County of San Francisco. Does 1-100 are internet and
catalog direct marketers offering a selection of men's clothing, sundries, and
shoes who advertise within California and nationwide. The complaint alleges that
for at least four years, members of the class have been charged an unlawful,
unfair, and fraudulent insurance fee and tax on orders sent to them by Brawn;
that Brawn was engaged in untrue, deceptive and misleading advertising in that
it was not lawfully required or permitted to collect insurance, tax and sales
tax from customers in California; and that Brawn has engaged in acts of unfair
competition under the state's Business and Professions Code. Plaintiff and the
class seek (i) restitution and disgorgement of all monies wrongfully collected
and earned by Brawn, including interest and other gains made on account of these
practices, including reimbursement in the amount of the insurance, tax and sales
tax collected unlawfully, together with interest, (ii) an order enjoining Brawn
from charging customers insurance and tax on its order forms and/or from
charging tax on the delivery, shipping and insurance charges, (iii) an order
directing Brawn to notify the California State Board of Equalization of the
failure to pay the correct amount of tax to the state and to take appropriate
steps to provide the state with the information needed for audit, and (iv)
compensatory damages, attorneys' fees, pre-judgment interest, and costs of the
suit. The claims of the individually named plaintiff and for each member of the
class amount to less than $75,000. On April 15, 2002, the Company filed a Motion
to Stay the Wilson action in favor of the previously filed Martin action. On May
14, 2002, the Court hearddenied the argument in the Company's Motion to StayStay. The Wilson case proceeded to
trial before the action in favorHonorable Diane Elan Wick of the Oklahoma action, denyingSuperior Court of California
for the motion. In October 2002,County of San Francisco, and the Judge, sitting without a jury, heard
evidence from April 15-17, 2003. On November 25, 2003, the Court, grantedafter hearing
evidence and considering post-trial submissions from the Company'sparties, entered
judgment in plaintiff's favor, requiring Brawn 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. Plaintiff did not
prevail on the tax issues. The trial court reserved the issue of whether
plaintiff's counsel was entitled to attorney's fees and, if so, in what amount.
On January 12, 2004, plaintiff filed a motion for leaverequesting approximately $740,000
in attorneys' fees and costs. On February 27, 2004, the Company filed its
response to amendthat motion. Plaintiff filed a reply brief on March 13, 2004. A
hearing was held on plaintiff's motion on March 18, 2004. The Company expects
that the answer. Discovery is
proceeding. A mandatory settlement conferencejudge may rule on that motion before the end of May, 2004. The Company
has been scheduled for April 4,
2003appealed the trial court's decision on the merits of the insurance fees
issue and trial is currently scheduled for April 14, 2003. The Company plans to conduct a vigorous defense of this action.action including
contesting plaintiff's counsel's entitlement to the fees and costs requested.
The Company's opening brief in the Court of Appeals will be due on May 17, 2004.
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 due to management determining that it is
not probable that an unfavorable outcome will result. See Item 7. Management's
Discussion and Analysis of Consolidated Financial Condition and Results of
Operations for more information regarding the Company's accrued liabilities
policy.
A class action lawsuit was commenced on February 20, 2002 entitled Argonaut
Consumer Rights Advocates Inc., suing on behalf of the General Public v. Gump's
By Mail, Inc. ("Gump's"), and Does 1-100 in the Superior Court of the State of
California, City and County of San Francisco. The plaintiff is a non-profit
public benefit corporation suing under the California Business and Profession
Code. Does 1-100 would include persons whose activities include the direct sale
of tangible personal property to California consumers including the type of
merchandise that Gump's -- the store and the catalog -- sell, by telephone, mail
order, and sales through the web sites www.gumpsbymail.com and www.gumps.com.
The complaint alleges that for at least four years members of the class have
been charged an unlawful, unfair, and fraudulent tax and "sales tax" on their
orders in violation of California law and court decisions, including the state
Revenue and Taxation Code, Civil Code, and the California Board of Equalization;
that Gump's engages in unfair business practices; that Gump's engaged in untrue
and misleading advertising in that it was not lawfully required to collect tax
and sales tax from customers in California; is not lawfully required or
permitted to add tax and sales tax on
18
separately stated shipping or delivery charges to California consumers; and that
it does not add the appropriate or applicable or specific correct tax or sales
tax to its orders. Plaintiff and the class seek (i) restitution of all tax and
sales tax charged by Gump's on each transaction and/or restitution of tax and
sales tax charged on the shipping charges; (ii) an order enjoining Gump's from
charging customers for tax on orders or from charging tax on the shipping
charges; and (iii) attorneys' fees, pre-judgment interest on the sums refunded,
and costs of the suit. On April 15, 2002, the Company filed an Answer and
Separate Affirmative Defenses to the complaint, generally denying the
allegations of the complaint and each and every cause of action alleged, and
denying that plaintiff has been damaged or is entitled to any relief whatsoever.
On September 19, 2002, the
78
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Company filed a motion for leave to file an amended
answer, containing several additional affirmative defenses based on the
proposition that the proper defendant in this litigation (if any) is the
California State Board of Equalization, not the Company, and that plaintiff
failed to exhaust its administrative remedies prior to filing suit. That motion
was granted. At the request of the plaintiff, this case was dismissed with
prejudice by the court on March 17, 2003.
A class action lawsuit was commenced on March 5, 2002 entitled Argonaut
Consumer Rights Advocates Inc., suing on behalf of the General Public v.
Domestications LLC, and Does 1-100 ("Domestications") in the Superior Court of
the State of California, City and County of San Francisco. The plaintiff is a
non-profit public benefit corporation suing under the California Business and
Profession Code. Does 1-100 would include persons responsible for the conduct
alleged in the complaint, including the direct sale of tangible personal
property to California consumers including the type of merchandise that
Domestications sells, by telephone, mail order, and sales through the web site
www.domestications.com. The plaintiff claims that for at least four years
members of the class have been charged an unlawful, unfair, and fraudulent tax
and sales tax for different rates and amounts on the catalog and internet orders
on the total amount of goods, tax and sales tax on shipping charges, which are
not subject to tax or sales tax under California law, in violation of California
law and court decisions, including the state Revenue and Taxation Code, Civil
Code, and the California Board of Equalization; that Domestications engages in
unfair business practices; and that Domestications engaged in untrue and
misleading advertising in that it was not lawfully required to collect tax and
sales tax from customers in California. Plaintiff and the class seek (i)
restitution of all sums, interest and other gains made on account of these
practices; (ii) prejudgment interest on all sums wrongfully collected; (iii) an
order enjoining Domestications from charging customers for tax on their orders
and/or from charging tax on the shipping charges; and (iv) attorneys' fees and
costs of the suit. The Company filed an Answer and Separate Affirmative Defenses
to the Complaint, generally denying the allegations of the Complaint and each
and every cause of action alleged, and denying that plaintiff has been damaged
or is entitled to any relief whatsoever. Discovery is now proceeding. On
September 19, 2002, the Company filed a motion for leave to file an amended
answer, containing several additional affirmative defenses based on the
proposition that the proper defendant in this litigation (if any) is the
California State Board of Equalization, not the Company, and that plaintiff
failed to exhaust its administrative remedies prior to filing suit. That motion
was granted. On February 28, 2003, the Company filed a notice of motion and
memorandum of points and authorities in support of its motion for summary
judgment setting forth that Plaintiff's claims are without merit and incorrect
as a matter of law. At the request of the plaintiff, this case was dismissed
with prejudice by the court on March 17, 2003.
A class action lawsuit was commenced on October 28, 2002 entitled John
Morris, individually and on behalf of all other persons & entities similarly
situated v. Hanover Direct, Inc., and Hanover Brands, Inc. (referred to here as
"Hanover"), No. L 8830-02 in the Superior Court of New Jersey, Bergen
County -- Law Division. The plaintiff brings 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 certain clothing from Hanover (which was from a men's
division catalog, the only ones which retained the insurance line item in 2002),
Plaintiff claims that for at least six years, Hanover maintained a policy and
practice of adding a charge for "insurance" to the orders it received and
concealed and failed to disclose its policy with respect to all class members.
Plaintiff claims that Hanover's conduct was (i) in violation of the New Jersey
Consumer Fraud Act, as otherwise deceptive, misleading and unconscionable; (ii)
such as to constitute Unjust Enrichment of Hanover at the expense and to the
detriment of plaintiff and the class; and (iii) unconscionable per se under
19
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
Morris action in favor of the previously filed Martin action. Plaintiff then
filed an Amended Complaint adding International Male as a defendant. The Company's
response to the Amended Complaint was filed on February 5, 2003. Plaintiff's
response brief was
79
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
filed March 17, 2003, and the Company's reply brief is due on March 31, 2003.
Hearing on
the motion to stay is expected to taketook place on April 4,June 5, 2003. The Court granted the Company's
Motions to Stay the action and the case was stayed first until December 31, 2003
and subsequently until March 31, 2004. The Company plans to conduct a vigorous
defense of this action.
On June 28, 2001, Rakesh K. Kaul, the Company's former President and Chief Executive
Officer of Hanover Direct, Inc., a Delaware corporation (the "Company"), filed a
five-count complaint (the "Complaint") in New York State Court against the
Company, seeking damages and other relief arising out of his separation of
employment from the Company, including severance payments of $2,531,352 plus the
cost of employee benefits, attorneys' fees and costs incurred in connection with
the enforcement of his rights under his employment agreement with the Company,
payment of $298,650 for 13 weeks of accrued and unused vacation, damages in the
amount of $3,583,800, or, in the alternative, a declaratory judgment from the
court that he is entitled to all change of control benefits under the "Hanover
Direct, Inc. Thirty-Six Month Salary Continuation Plan," and damages in the
amount of $1,396,066 or $850,000 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 within the 30 days
following his resignation. The Company removed the case to the U.S. District
Court for the Southern District of New York on July 25, 2001. Mr. Kaul filed an
Amended Complaint ("Amended Complaint") in the U.S. District Court for the
Southern District of New York on September 18, 2001. The Amended Complaint
repeats many of the claims made in the original Complaint and adds ERISA claims.
On October 11, 2001, the Company filed its Answer, Defenses and
Counterclaims to the Amended Complaint, denying liability under each and every
of Mr. Kaul's causes of action, challenging all substantive assertions, raising
several defenses and stating nine counterclaims against Mr. Kaul. The
counterclaims include (1) breach of contract; (2) breach of the Non-Competition
and Confidentiality Agreement with the Company; (3) breach of fiduciary duty;
(4) unfair competition; and (5) unjust enrichment. The Company seeks damages,
including, without limitation, the $341,803 in severance pay and car allowance
Mr. Kaul received following his resignation, $412,336 for amounts paid to Mr.
Kaul for car allowance and related benefits, the cost of a long-term disability
policy, and certain payments made to personal attorneys and consultants retained
by Mr. Kaul during his employment, $43,847 for certain services the Company
provided and certain expenses the Company incurred, relating to the renovation
and leasing of office space occupied by Mr. Kaul's spouse at 115 River Road,
Edgewater, New Jersey, the Company's current headquarters, $211,729 on a tax
loan to Mr. Kaul outstanding since 1997 and interest, compensatory and punitive
damages and attorneys' fees. The case is pending. The discovery period has
closed, the Company has moved to amend its counterclaims, and
the parties have
each moved for summary judgment.
The Company seekssought summary judgment: 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 of, among other things, claims for change of
control benefits; dismissing Mr. Kaul's claim for attorneys' fees on the grounds
that they are not authorized under his employment agreement; dismissing Mr.
Kaul's claims related to change in control benefits based on an administrative
decision that he is not entitled to continued participation in the plan or to
future benefits thereunder; dismissing Mr. Kaul's claim for a tandem bonus
payment on the ground that no payment is owing; dismissing Mr. Kaul's claim for
vacation payments based on Company policy regarding carry over vacation; and
seeking judgment on the Company's counterclaim for unjust enrichment based on
Mr. Kaul's failure to pay under a tax note. Mr. Kaul seeks summary judgment:
dismissing the Company's defenses and counterclaims relating to a release on the
grounds that he tendered a release or that the Company is estopped from
requiring him to do so; dismissing the Company's defenses and counterclaims
relating to his alleged violations of his non-compete and confidentiality
obligations on the grounds that he did not breach the obligations as defined in
the agreement; and dismissing the Company's claims based on his alleged breach
of fiduciary duty, including those based on his monthly car allowance payments
and the leased space to his wife, on the grounds that he was entitled to the car
payments and did not involve himself in or make misrepresentations in connection
with the leased space. The Company has
20
concurrently moved to amend its Answer and Counterclaims to state a claim that
it had cause for terminating Mr. Kaul's employment based on, among other things,
after acquired evidence that Mr. Kaul received a monthly car allowance and other
benefits totaling $412,336 that had not been authorized by the Company's Board
of Directors and that his wife's lease and related expense was not properly
authorized by the Company's Board of Directors, and to clarify or amend the
scope of the Company's counterclaims for 80
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
reimbursement.
The briefing on the motions is completed andOn January 7, 2004, the parties are
awaitingreceived the decision of the Court. No trial date has been set. ItThe
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 too earlynot entitled to determinefees incurred in prosecuting
this lawsuit but finding an issue of fact as to the potential outcome, which couldamount 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
material impacttandem bonus payment on the ground that payment is not owed to him; granted
summary judgment in part and denied 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 resultspolicy and finding an issue of operations when resolvedfact 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 future period.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 the Company's
counterclaims relating to his non-compete and confidentiality obligations on the
ground that there is no evidence of actual damage to the Company resulting from
Mr. Kaul's alleged violations of those obligations; granted summary judgment in
favor of Mr. Kaul on the Company's breach of contract and breach of fiduciary
duty claims, including those based on his monthly car allowance payments and the
leased space to his wife, on the grounds that he did not breach his fiduciary
duties in accepting the car payments and would not be unjustly enriched if he
kept them, and on the ground that the Company would not be able to prove fraud
in connection with the leased space based on the circumstances, including Mr.
Kaul's disclosures.
The Court denied in part and granted in part the Company's motion to amend
its Answer and Counterclaims. The Court denied the Company's motion for leave to
state a claim that it had acquired evidence of cause for terminating Mr. Kaul's
employment based on certain reimbursements on the ground that the payments were
authorized, but 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 remain 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. As a result of the favorable outcome of the summary
judgment decision by the District Court dismissing several of Mr. Kaul's claims,
the Company reduced its legal accrual related to this case by $3.3 million in
the fourth quarter. This reduction is reflected in the General and
Administrative expenses on the Company's Consolidated Statements of Income
(Loss) as well as Accrued liabilities and Other non-current liabilities on the
Consolidated Balance Sheets. Unless a settlement can be reached, the claim for
attorneys' fees will be tried to the Court without a jury while the remaining
two claims will be tried to a jury. After final judgment issues, each party will
have the right to appeal any aspect of the judgment.
In June 1994, a complaint was filed in the Supreme Court of the State of
New York, County of New York, by Donald Schupak, the former President, CEO and
Chairman of the Board of Directors of The Horn & Hardart Company, the corporate
predecessor to the Company, against the Company and Alan Grant Quasha. The
complaint asserted claims for alleged breaches of an agreement dated February
25, 1992 between Mr. Schupak and the Company (the "Agreement"), and for alleged
tortious interference with the Agreement by Mr. Quasha. Mr. Schupak sought
compensatory damages in an amount, which was estimated to be not more than
$400,000, and punitive damages in the amount of $10 million; applicable
interest, incidental and
21
consequential damages, plus costs and disbursements, the expenses of the
litigation and reasonable attorneys' fees. In addition, based on the alleged
breaches of the Agreement by the Company, Mr. Schupak sought a "parachute"
payment of approximately $3 million under an earlier agreement with the Company
that he allegedly had waived in consideration of the Company's performance of
its obligations under the Agreement. The Company filed an answer to the
complaint on September 7, 1994. Discovery then commenced and documents were
exchanged. Each of the parties filed a motion for summary judgment at the end of
1995, and both motions were denied in the spring of 1996. In April 1996, due to
health problems then being experienced by Mr. Schupak, the Court ordered that
the case be marked "off calendar" until plaintiff recovered and was able to
proceed with the litigation. In September 2002, more than six years later, Mr.
Schupak filed a motion to restore the case to the Court's calendar. The Company
filed papers in opposition to the motion on October 10, 2002, asserting that the
motion should be denied on the ground that plaintiff failed to timely comply
with the terms of the Court's order concerning restoration and, alternatively,
on the ground of laches. The plaintiff filed reply papers on November 4, 2002.
On November 20, 2002, the court denied Mr. Schupak's motion to restore the case
to the calendar as "unnecessary and moot" on the ground that the case had been
improperly marked off calendar in the first instance, ruled that the case
therefore remained "active," and fixed a trial date of March 4, 2003. On January
27, 2003, the parties reached agreement fully and finally settling all of Mr.
Schupak's claims in consideration of a payment of $185,000 by the Company and
the exchange of mutual general releases.
The Company was named as one of 88 defendants in a patent infringement
complaint filed on November 23, 2001 by the Lemelson Medical, Education &
Research Foundation, Limited Partnership (the "Lemelson Foundation"). The
complaint, filed in the U.S. District Court in Arizona, was not served on the
Company until March 2002. In the complaint, the Lemelson Foundation accuses the
named defendants of infringing seven U.S. patents, which allegedly cover
"automatic identification" technology through the defendants' use of methods for
scanning production markings such as bar codes. The Company received a letter
dated November 27, 2001 from attorneys for the Lemelson Foundation notifying the
Company of the complaint and offering a license. The Court entered a stay of the
case on March 20, 2002, requested by the Lemelson Foundation, pending the
outcome of a related case in Nevada being fought by bar code manufacturers. The
trial in the Nevada case began on November 18, 2002 and ended on January 17,
2003. The parties in the Nevada case are now required to submit post trial
briefs on or before May 16, 2003, and a decision is expected two months or more
thereafter. The Orderorder for the stay in the Lemelson case involving the Company provides that the Company
need not answer the complaint, although it has the option to do so. The Company
has beenwas invited to join a common interest/joint-defense group consisting of
defendants named in the complaint as well as in other actions brought by the
Lemelson Foundation. The Company is currentlytrial in the processNevada case began on November 18, 2002 and
ended on January 17, 2003. On January 23, 2004, following extensive briefing by
the parties, the Nevada Court entered judgment declaring that the claims of analyzingeach
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. Subject to the results of any appeal that may be filed
by the parties to the Nevada litigation, the judgment of the Nevada court should
preclude assertion of each of the affected patents against all parties,
including the Company in the Arizona case. Counsel is now monitoring the Nevada
and Arizona cases in order to determine a suitable moment for moving for
dismissal of the Lemelson Foundation's claims. The Company has analyzed the
merits of the issues raised by the complaint, notifyingnotified vendors of its receipt of
the complaint and letter, evaluatingevaluated the merits of joining the joint-defense
group, and havinghad discussions with attorneys for the Lemelson Foundation regarding
the license offer. A preliminary estimate of the royalties
and attorneys' fees which the Company may pay if it decides to accept the
license offer from the Lemelson Foundation range from about $125,000 to
$400,000. The Company has decided to gather further information, but will not agree to a settlement at this time and
thus has not established a reserve.
81
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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. See Note 19.16 to the Company's Consolidated Financial
Statements.
On July 17, 2003, the Company filed an action in the Supreme Court of the
State of New York, County of New York (Index No. 03/602269) against Richemont
and Chelsey seeking a declaratory judgment as to whether Richemont improperly
transferred all of Richemont's securities in the Company consisting of the
Shares to Chelsey on or about May 19, 2003 and whether the Company could
properly recognize the transfer
22
of those Shares from Richemont to Chelsey under federal and/or state law. On
July 29, 2003, Chelsey answered the Company's complaint, alleged certain
affirmative defenses and raised three counterclaims against the Company,
including Delaware law requiring the registration of the Shares, damages,
including attorney's fees, for the failure to register the Shares, and tortious
interference with contract. Chelsey also moved for a preliminary injunction
directing the Company to register the ownership of the Shares in Chelsey's name.
Chelsey later moved for summary judgment dismissing the Company's complaint.
Subsequently, Chelsey moved to compel production of certain documents and for
sanctions and/or costs. On August 28, 2003, Richemont moved to dismiss the
Company's complaint. It subsequently filed a motion seeking sanctions and/or
costs against the Company. On October 27, 2003, the Court granted Chelsey's
motion for summary judgment and Richemont's motion to dismiss and ordered that
judgment be entered dismissing the case in its entirety. The Court also denied
Chelsey's and Richemont's motions for sanctions and Chelsey's motion to compel
production of certain documents.
On November 10, 2003, the Company signed a Memorandum of Understanding with
Chelsey and Regan Partners, L.P. setting forth the agreement in principle to
recapitalize the Company, reconstitute the Board of Directors and settle
outstanding litigation between the Company and Chelsey. The Memorandum of
Understanding had been approved by the Transactions Committee of the Board of
Directors of the Company. 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 transaction with Chelsey was
unanimously approved by the members of the Board of Directors of the Company and
the members of the Transactions Committee of the Board of Directors.
In addition, the Company is involved in various routine lawsuits of a
nature which are deemed customary and incidental to its businesses. In the
opinion of management, the ultimate disposition of these actions will not have a
material adverse effect on the Company's financial position or results of
operations.
18. AMERICAN STOCK EXCHANGE NOTIFICATIONITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
23
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock trades on the American Stock Exchange under the
symbol "HNV." The following table sets forth, for the periods shown, the high
and low sale prices of the Company's Common Stock as reported on the American
Stock Exchange Composite Tape. As of March 16, 2004, the Company had 220,173,633
shares of Common Stock outstanding (net of treasury shares). Of these,
111,465,621 shares were held directly or indirectly by Chelsey Direct, LLC and
Stuart Feldman, 38,728,350 shares were held by Basil P. Regan or Regan Partners
L.P., and 55,479 shares were held by other directors and officers of the
Company. As a result, 69,924,183 shares of Common Stock were held by other
public shareholders. There were approximately 3,635 holders of record of Common
Stock.
HIGH LOW
----- -----
FISCAL 2003
First Quarter (Dec. 29, 2002 to March 29, 2003)........... $0.27 $0.19
Second Quarter (March 30, 2003 to June 28, 2003).......... $0.28 $0.18
Third Quarter (June 29, 2003 to Sept. 27, 2003)........... $0.29 $0.22
Fourth Quarter (Sept. 28, 2003 to Dec. 27, 2003).......... $0.30 $0.20
FISCAL 2002
First Quarter (Dec. 30, 2001 to March 30, 2002)........... $0.52 $0.36
Second Quarter (March 31, 2002 to June 29, 2002).......... $0.44 $0.23
Third Quarter (June 30, 2002 to Sept. 28, 2002)........... $0.34 $0.19
Fourth Quarter (Sept. 29, 2002 to Dec. 28, 2002).......... $0.28 $0.18
The Company is restricted from paying dividends on its Common Stock or from
acquiring its capital stock by certain debt covenants contained in agreements to
which the Company is a party.
Recent Sales of Unregistered Securities. On November 30, 2003, the Company
consummated a transaction with Chelsey in which the Company exchanged 564,819
shares of a newly issued Series C Participating Preferred Stock and 81,857,833
shares of newly issued Common Stock for 1,622,111 shares of Series B
Participating Preferred Stock then held by Chelsey. The transaction involved no
cash consideration. The Company relied upon the exemption from registration of
the Series C Participating Preferred Stock and the additional Common Stock
provided by Rule 506 of Regulation D promulgated under the Securities Act of
1933, as amended, based upon the following facts: (i) Chelsey's representation
to the Company that is was an "accredited investor" as that term is defined by
Regulation D; (ii) the Company did not engage in a general solicitation or any
advertising with respect to the transaction; and (iii) the transaction did not
involve any "unaccredited investors" as that term is defined by Regulation D.
24
ITEM 6. SELECTED FINANCIAL DATA
The following table presents selected financial data for each of the fiscal
years indicated:
2003 2002 2001 2000 1999
-------- -------- -------- -------- --------
(IN THOUSANDS OF DOLLARS, EXCEPT PER SHARE DATA)
INCOME STATEMENT DATA:
Net revenues............................ $414,874 $457,644 $532,165 $603,014 $549,852
Special charges......................... 1,308 4,398 11,277 19,126 144
Income (loss) from operations........... 6,106 (432) (23,965) (70,552) (13,756)
Gain on sale of Improvements............ (1,911) (570) (23,240) -- --
Gain on sale of Kindig Lane Property.... -- -- (1,529) -- --
Gain on sale of The Shopper's Edge...... -- -- -- -- (4,343)
Gain on sale of Austad's................ -- -- -- -- (967)
Income (loss) before interest and income
taxes................................. 8,017 138 804 (70,552) (8,446)
Interest expense, net................... 12,088 5,477 6,529 10,083 7,338
Provision for deferred Federal income
taxes................................. 11,300 3,700 -- -- --
Net loss................................ (15,399) (9,130) (5,845) (80,800) (16,314)
Preferred stock dividends and
accretion............................. 7,922 15,556 10,745 4,015 634
-------- -------- -------- -------- --------
Net loss applicable to common
stockholders.......................... $(23,321) $(24,686) $(16,590) $(84,815) $(16,948)
-------- -------- -------- -------- --------
PER SHARE:
Net loss per common share -- basic and
diluted............................... $ (.16) $ (.18) $ (.08) $ (.40) $ (.08)
-------- -------- -------- -------- --------
WEIGHTED AVERAGE NUMBER OF SHARES
OUTSTANDING (IN THOUSANDS):
Basic................................... 144,388 138,280 210,536 213,252 210,719
-------- -------- -------- -------- --------
Diluted................................. 144,388 138,280 210,536 213,252 210,719
-------- -------- -------- -------- --------
AS RESTATED AS RESTATED AS RESTATED AS RESTATED
2003 2002 2001 2000 1999
-------- ----------- ----------- ----------- -----------
(IN THOUSANDS OF DOLLARS)
BALANCE SHEET DATA (END OF PERIOD):
Working (deficiency) capital......... $ (2,012) $ 620 $ 7,412 $ 1,123 $ 12,788
Total assets......................... 114,796 140,100 157,661 203,019 191,419
Total debt excluding Preferred
Stock.............................. 22,510 25,129 29,710 39,036 42,835
Series A Participating Preferred
Stock.............................. -- -- -- 71,628 --
Series B Participating Preferred
Stock.............................. -- 92,379 76,823 -- --
Series C Participating Preferred
Stock.............................. 72,689 -- -- -- --
Shareholders' (deficiency) equity.... (47,508) (58,841) (35,728) (24,452) 53,865
There were no cash dividends declared on the Common Stock in any of the periods
presented.
See Note 18 of Notes to Consolidated Financial Statements for more
information regarding prior year restatements.
See notes to Consolidated Financial Statements.
25
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following table sets forth, for the fiscal years indicated, the
percentage relationship to revenues of certain items in the Company's
Consolidated Statements of Income (Loss):
FISCAL YEAR
-----------------------
2003 2002 2001
----- ----- -----
Net revenues................................................ 100.0% 100.0% 100.0%
Cost of sales and operating expenses........................ 63.0 63.5 63.8
Special charges............................................. 0.3 0.9 2.1
Selling expenses............................................ 24.0 23.0 26.5
General and administrative expenses......................... 10.2 11.4 10.7
Depreciation and amortization............................... 1.1 1.2 1.4
Gain on sale of Improvements................................ (0.5) (0.1) (4.4)
Gain on sale of Kindig Lane Property........................ -- -- (0.3)
Income (loss)before interest and income taxes............... 1.9 0.1 0.2
Interest expense, net....................................... 2.9 1.2 1.2
Provision for deferred Federal income taxes................. 2.7 0.8 --
Net loss.................................................... (3.7)% (2.0)% (1.1)%
EXECUTIVE SUMMARY
Company Overview. The Company is a specialty direct marketer that markets
a diverse portfolio of branded home fashions, men's and women's apparel, and
gift products, through mail-order catalogs, retail stores and connected Internet
Web sites directly to the consumer. The Company recognizes revenue for catalog
and Internet sales upon shipment of the merchandise to customers and at the time
of sale for retail sales, net of estimated returns. Postage and handling charges
billed to customers are also recognized as revenue upon shipment of the related
merchandise. Shipping terms for catalog and Internet sales are FOB shipping
point, and title passes to the customer at the time and place of shipment.
Prices for all merchandise are listed in the Company's catalogs and on its Web
sites and are confirmed with the customer upon order. In addition, the Company
continues to service existing third party clients with business-to-business
(B-to-B) e-commerce transaction services. These services include a full range of
order processing, customer care, customer information, and shipping and
distribution services. Revenues from the Company's e-commerce transaction
services are recognized as the related services are provided. Customers are
charged on an activity unit basis, which applies a contractually specified rate
according to the type of transaction service performed. The Company utilizes a
fully integrated system and operations support platform initially developed to
manage the Company's wide variety of catalog/Internet product offerings. This
infrastructure is being utilized by the aforementioned B-to-B e-commerce
transaction services on behalf of third party clients.
Financial Overview. During fiscal 2003, the Company's major focus was on
the following issues:
- Recapitalization of the Series B Cumulative Participating Preferred Stock
- Continued refinement of the strategic business realignment program
- Analysis of Internet customers' origination
- Ongoing implementation of the strategic decision to eliminate
unprofitable circulation across all Brand categories
Management's primary objective since the third quarter of 2002 has been the
recapitalization of the Series B Participating Preferred Stock. The successful
completion of the Chelsey transaction on November 30, 2003, which replaced the
Series B Participating Preferred Stock with Series C Participating Preferred
Stock and Common Stock, reduces the total amount of the repayment and extends
the repayment date to
26
January 1, 2009. This removes the concern associated with the Company's ability
to repay the Series B Participating Preferred Stock by August 31, 2005. The
Recapitalization also reduced interest expense beginning in fiscal December 2003
since effective June 29, 2003, SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity" ("SFAS 150"),
required the Company to reclassify its Series B Participating Preferred Stock as
a liability and reflect the accretion of the preferred stock balance as interest
expense. From the period June 29, 2003 through the Recapitalization on November
30, 2003, the Company recorded $7.2 million of additional interest expense
incurred on the Series B Participating Preferred Stock as a result of the
implementation of SFAS 150. Due to concessions made by Chelsey and the resulting
application of SFAS No. 15, interest expense will no longer prospectively be
impacted by the Series B Participating Preferred Stock or Series C Participating
Preferred Stock.
The Company continues to refine and implement the strategic business
realignment program, which began in December 2000. As part of this process the
Company has eliminated additional director level and above management positions
in a further consolidation of operations to continue the reduction of the
overhead cost structure. The costs eliminated by these actions total $0.9
million annually. General and administrative expenses continued to decline in
fiscal 2003 from the prior year in both dollars and as a percentage of net
revenues. The Company continues to search for avenues to alleviate the long-term
lease obligations related to various exited facilities. Due to the loss of
sub-tenants and declining real estate values in certain areas of the country,
the Company continues to increase the required reserves held for these
liabilities. The negative impact of these exited properties for the fiscal year
ended December 27, 2003 was $1.0 million.
The Company has experienced tremendous growth in Internet sales. Internet
sales have now reached 27.9% of combined Internet and catalog revenues for the
Company's four categories for the fiscal period ended December 27, 2003 and have
improved by $21.2 million or 24.2% to $108.6 million from $87.4 million in 2002.
The Company is currently analyzing the extent of cannibalization of catalog
sales by Internet sales. Two examples of topics being researched are (1) what is
the percentage of Internet customers who received a catalog and selected the
Internet as a vehicle for order placement and (2) what drew the Internet
customer to the Internet Web site for non-recipients of catalogs. Acquiring
customers through the Internet as opposed to mailing them a catalog results in
lower overall costs and increased profitability for the Company.
During 2002, the Company recognized the impact that unprofitable
circulation was having on net income and developed a strategic plan to reduce
and eliminate unprofitable circulation throughout all brands. In fiscal 2003,
circulation decreased by 5.9% from the prior year. This decrease in circulation
contributed to a decrease in net revenues of $42.8 million or 9.4% for the
fiscal year ended December 27, 2003 from $457.6 million for the comparable
period in 2002. The remaining decline was attributable to softness in demand for
the Company's products, which resulted from a general deterioration in economic
conditions in the United States leading to reduced consumer confidence during
part of fiscal 2003.
RESULTS OF OPERATIONS
2003 COMPARED WITH 2002
Net Loss. The Company reported a net loss of $15.4 million or $.16 per
share for the year ended December 27, 2003 compared with a net loss of $9.1
million or $.18 per share for the comparable period in the 2002 fiscal year. The
per share amounts were calculated after deducting preferred dividends and
accretion of $7.9 million and $15.6 million in fiscal years 2003 and 2002,
respectively. The weighted average number of shares of common stock outstanding
was 144,387,672 and 138,280,196 for the fiscal years ended December 27, 2003 and
December 28, 2002, respectively. This increase in weighted average shares was a
result of the Chelsey Recapitalization consummated on November 30, 2003 (see
Notes 7 and 8 to the Company's Consolidated Financial Statements).
The $6.3 million increase in net loss was primarily due to:
- $7.6 million deferred Federal income tax provision incurred to increase
the valuation allowance and fully reserve the remaining net deferred tax
asset. Due to a number of factors, including the continued softness in
the demand for the Company's products, management lowered its projections
of future
27
taxable income for fiscal years 2003 and 2004. As a result of lower
projections of future taxable income, the future utilization of the
Company's net operating losses were no longer "more-likely-than-not" to
be achieved;
- $7.2 million of additional interest expense incurred on the Series B
Participating Preferred Stock as a result of the implementation of SFAS
150. Effective June 29, 2003, SFAS 150 required the Company to reclassify
its Series B Participating Preferred Stock as a liability and reflect the
accretion of the preferred stock balance as interest expense;
- $3.6 million unfavorable due to reduction in variable contribution
associated with decline in net revenues;
- $3.3 million favorable summary judgment ruling in the Kaul litigation
causing a reversal of a substantial portion of the loss reserve related
to this litigation;
- $3.1 million favorable due to the reduction of special charges recorded;
- $2.8 million favorable comprising continued reductions in cost of sales
and operating expenses, general and administrative expenses and a
decrease in depreciation and amortization;
- $1.3 million favorable due to recognition of the deferred gain related to
the June 29, 2001 sale of the Company's Improvements business; and
- $1.6 million favorable due to the implementation of the revised vacation
and sick benefit policy.
Net Revenues. Net revenues decreased $42.8 million or 9.4% for the year
ended December 27, 2003 to $414.8 million from $457.6 million for the comparable
period in 2002. The decreases were due to a number of factors including softness
in the economy and demand for the Company's products during the first six months
of the year. In addition, the Company's strategy of reducing unprofitable
circulation contributed to the decline throughout the year. Management believes
that these trends will not continue in 2004. Circulation decreased by 5.9% from
the prior year with continued implementation of the strategic plan of reducing
unprofitable circulation. Internet sales have now reached 27.9% of combined
Internet and catalog revenues for the Company's four categories and have
improved by $21.2 million or 24.2% to $108.6 million from $87.4 million in 2002.
Catalog sales have declined by $61.8 million or 18.1% for the year ended
December 27, 2003 to $280.1 million from $341.9 million for the comparable
period in 2002.
Cost of Sales and Operating Expenses. Cost of sales and operating expenses
decreased to 63.0% of net revenues for the year ended December 27, 2003 as
compared with 63.5% of net revenues for the comparable period in 2002. The
decrease from the prior year was caused by a reduction of total merchandise cost
of 0.9% due to a more cost-efficient merchandise sourcing strategy and a
decrease of 0.1% in variable order processing costs. These declines were
partially offset by increased product shipping costs of 0.5% related to an
increase in rates charged by third party shipping companies. Fixed distribution
and telemarketing costs as a percentage of net revenues were constant between
the fiscal periods 2003 and 2002.
Special Charges. In December 2000, the Company began a strategic business
realignment program that resulted in the recording of special charges for
severance, facility exit costs and asset write-offs. Special charges recorded in
fiscal years 2003, 2002 and 2001 relating to the strategic business realignment
program were $1.3 million, $4.4 million and $11.3 million, respectively. The
actions related to the strategic business realignment program were taken in an
effort to direct the Company's resources primarily towards a loss reduction
strategy and a return to profitability.
In the first quarter of 2003, special charges were recorded in the amount
of $0.3 million. These charges consisted primarily of additional severance costs
associated with the Company's strategic business realignment program. During the
second, third and fourth quarters of 2003, the Company recorded special charges
of $0.2 million, $0.2 million and $0.6 million, respectively. These charges were
incurred primarily to revise estimated losses related to sublease arrangements
for 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.
28
Selling Expenses. Selling expenses decreased $5.7 million to $99.5 million
for the year ended December 27, 2003 from $105.2 million for the comparable
fiscal period in 2002. As a percentage relationship to net revenues, selling
expenses increased to 24.0% of net revenues for the year ended December 27, 2003
from 23.0% for the comparable period in 2002. This increase was due primarily to
a combined increase of 1.2% in postage, catalog preparation and printing costs,
which was partially offset by a 0.2% decline in paper prices.
General and Administrative Expenses. General and administrative expenses
decreased by $10.2 million for the year ended December 27, 2003 over the prior
year. This decrease was primarily due to reductions in incentive compensation
programs of $3.5 million, a favorable summary judgment ruling in the Kaul
litigation resulting in a reduction to the reserve of $3.3 million, a reduction
of legal costs of $2.2 million related to the Kaul and Schupak litigation,
benefits recognized from the implementation of the Company's new vacation and
sick policy of $0.8 million, and payroll and other cost reductions of $0.4
million.
Depreciation and Amortization. Depreciation and amortization decreased to
1.1% of net revenues for the year ended December 27, 2003 from 1.2% for the
comparable period in 2002. The decrease was primarily due to capital
expenditures that have become fully amortized.
Income from Operations. The Company's income from operations increased
$6.5 million to $6.1 million for the year ended December 27, 2003 from a loss of
$0.4 million for the comparable period in 2002. The increase is principally due
to reductions in special charges, general and administrative expenses, and
depreciation and amortization, which were partially offset by increased costs in
selling expenses.
Gain on Sale of the Improvements Business. During fiscal 2003, the Company
recognized the remaining approximately $1.9 million of deferred gain consistent
with the terms of the escrow agreement relating to the Improvements sale.
Effective March 28, 2003, the remaining $2.0 million escrow balance was received
by the Company, thus terminating the agreement (see Note 2 to the Company's
Consolidated Financial Statements).
Interest Expense, Net. Interest expense, net increased $6.6 million to
$12.1 million for the year ended December 27, 2003 from $5.5 million for the
comparable period in the year 2002. The increase in interest expense is due to
the recording of $7.2 million of Series B Participating Preferred Stock
dividends and accretion as interest expense based upon the implementation of
SFAS 150. Effective June 29, 2003, SFAS 150 required the Company to reclassify
its Series B Participating Preferred Stock as a liability and reflect the
accretion of the Participating Preferred stock balance as interest expense. This
increase was partially offset by a $0.3 million expected refund of the March
2003 payment made on behalf of Richemont to the Internal Revenue Service
relating to the increases in the liquidation preference of the Series B
Participating Preferred Stock. Because SFAS 150 required the reclassification of
the Series B Participating Preferred Stock to liabilities and the recording of
increases in the liquidation preference as interest expense, the expected refund
on Federal taxes previously paid has been treated as a decrease to interest
expense. In addition to this refund, the increase in interest expense was also
partially offset by a decrease in amortization of deferred financing costs
relating to the Company's amendments to the Congress Credit Facility.
Income Taxes. During the fiscal year ended December 27, 2003, the Company
made a decision to fully reserve the remaining net deferred tax asset by
increasing the valuation allowance via an $11.3 million deferred Federal income
tax provision. During the quarter ended September 27, 2003, management lowered
its projections of future taxable income for fiscal years 2003 and 2004 due to a
number of factors, including the continued softness in the demand for the
Company's products and the impact of the May 19, 2003 change in control (see
Note 13 to the Company's Consolidated Financial Statements).
2002 COMPARED WITH 2001
Net Loss. The Company reported a net loss of $9.1 million or $.18 per
share for the year ended December 28, 2002 compared with a net loss of $5.8
million or $.08 per share for the comparable period in the fiscal year 2001. The
per share amounts were calculated after deducting preferred dividends and
accretion of $15.6 million and $10.7 million in fiscal years 2002 and 2001,
respectively. The weighted average number of shares of common stock outstanding
was 138,280,196 and 210,535,959 for the fiscal years ended December 28,
29
2002 and December 29, 2001, respectively. This decrease in weighted average
shares was pursuant to the terms of the Richemont Transaction consummated on
December 19, 2001 (see Notes 7 and 8 to the Company's Consolidated Financial
Statements). The increased loss of $3.3 million resulted from the recording of
$24.8 million in gains during fiscal year 2001 related to the sale of the
Company's Improvements business and the Kindig Lane Property and a $3.7 million
reduction to the carrying value of the deferred tax asset in fiscal year 2002.
This deferred tax asset adjustment was based on a reassessment of the Company's
ability to utilize certain net operating losses prior to their expiration. The
impact of the deferred tax asset adjustment was mitigated by cost reductions,
primarily in selling expenses.
Net Revenues. Net revenues decreased $74.6 million or 14.0% for the year
ended December 28, 2002 to $457.6 million from $532.2 million for the comparable
period in 2001. This decrease was due in part to the sale of the Improvements
business on June 29, 2001, which accounted for $34.1 million of the reduction.
The discontinuance of the Domestications Kitchen & Garden, Kitchen & Home,
Encore and Turiya catalogs contributed an additional $6.4 million to the
reduction. Revenues for continuing businesses in fiscal year 2002 decreased by
$34.1 million or 6.9%. Overall circulation for the continuing businesses
decreased by 9.0% from the prior year with almost all of the decrease in the
continuing revenues stemming from efforts to reduce unprofitable circulation.
Internet sales have now reached 20.3% of combined internet and catalog revenues
for the Company's four categories and have improved by $20.4 million or 30.4% to
$87.3 million from $66.9 million in 2001, excluding sales from the Improvements
business that was sold during 2001.
Cost of Sales and Operating Expenses. Cost of sales and operating expenses
decreased to 63.5% of net revenues for the year ended December 28, 2002 as
compared with 63.8% of net revenues for the comparable period in 2001. The
slight decrease over the prior year was due to the reduction of fixed costs
incurred primarily by the Company's fulfillment operations. While substantial
reductions were realized during 2001, costs as a percentage of net revenues held
constant in most areas except for fulfillment, which continued to decline as the
on-going implementation of the Company's strategic business realignment program
continued. Total merchandise cost, as a percent of net revenues, held constant
with the prior year.
Special Charges. In December 2000, the Company began a strategic business
realignment program that resulted in the recording of special charges for
severance, facility exit costs and fixed asset write-offs. Special charges
recorded in fiscal years 2002, 2001, and 2000 relating to the strategic business
realignment program were $4.4 million, $11.3 million, and $19.1 million,
respectively. The actions related to the strategic business realignment program
were taken in an effort to direct the Company's resources primarily towards a
return to profitability.
In the first quarter of 2002, special charges relating to the strategic
business realignment program were recorded in the amount of $0.2 million. These
charges consisted primarily of severance costs related to the elimination of an
additional 10 FTE positions and costs associated with the Company's decision to
close a product storage facility located in San Diego, California. In September
2002, the Company continued to execute this plan through the integration of The
Company Store and Domestications divisions. As a result of the continued actions
needed to execute these plans, during the third quarter of 2002, an additional
$1.5 million of special charges was recorded. Of this amount, $1.3 million
consisted of additional facility exit costs resulting primarily from the
integration of The Company Store and Domestications divisions, causing
management to reassess its plan to consolidate its office space at the corporate
offices in New Jersey. The additional $0.2 million consisted of further
severance costs for an individual relating to the Company's strategic business
realignment program.
In the fourth quarter of 2002, special charges totaling $2.7 million were
recorded. Of this amount, $1.5 million was related to severance costs, including
$1.2 million for two of the Company's senior management members, $0.2 million
associated with the consolidation of a portion of the Company's Hanover,
Pennsylvania fulfillment operations into its Roanoke, Virginia facility, and
$0.1 million of additional severance costs and adjustments pertaining to the
Company's previous strategic business realignment initiatives. The remaining
$1.2 million consisted primarily of a $0.4 million credit reflecting the
reduction of the deferred rental liabilities applicable to the portions of the
facilities previously included in the Company's strategic
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business realignment program and a $1.6 million charge in order to properly
reflect the current marketability of such facilities in the rental markets.
Selling Expenses. Selling expenses decreased to 23.0% of net revenues for
the year ended December 28, 2002 from 26.5% for the comparable period in 2001,
primarily due to a shift in focus resulting in the elimination of mailing to
unprofitable circulation lists. In addition to lower circulation, favorable
paper prices were obtained, which have also contributed to the decline in
selling expenses over the prior year.
General and Administrative Expenses. General and administrative expenses
decreased by $4.5 million in 2002 over the prior year. The reductions reflect
the elimination of a significant number of FTE positions across all departments,
which began late in 2000 as part of the Company's strategic business realignment
program and have continued through December 28, 2002. This reduction was
achieved even after absorbing in excess of $3.5 million in costs associated with
the Company's litigation defense against Rakesh Kaul and the Company's
litigation defense and settlement against Donald Schupak during 2002. As a
percentage of net revenues, general and administrative expenses rose to 11.4% in
2002 from 10.7% for the comparable period in 2001. The total increase was
attributable to the expense incurred by the Company to defend and settle
litigation brought by Donald Schupak, and the expense incurred by the Company to
defend itself against litigation brought by Rakesh Kaul.
Depreciation and Amortization. Depreciation and amortization decreased to
1.2% of net revenues for the year ended December 28, 2002 from 1.4% for the
comparable period in 2001. The decrease was primarily due to capital
expenditures that have become fully amortized and the elimination of goodwill
amortization resulting from the implementation of SFAS 142 at the beginning of
fiscal 2002.
Loss from Operations. The Company's loss from operations decreased $23.6
million to $0.4 million for the year ended December 28, 2002 from a loss of
$24.0 million for the comparable period in 2001.
Gain on Sale of the Improvements Business. During fiscal 2002, the Company
recognized approximately $0.6 million of deferred gain consistent with the terms
of the escrow agreement relating to the Improvements sale. The recognition of
additional gain of up to approximately $2.0 million has been deferred until the
contingencies described in the escrow agreement expire, which will occur no
later than the middle of the 2003 fiscal year. As of December 28, 2002, no
claims had been made against the escrow.
Interest Expense, Net. Interest expense, net for the year ended December
28, 2002 decreased $1.1 million to $5.5 million and is attributable to lower
average borrowings over the last nine months of 2002 coupled with a reduction in
interest rates. This reduction is partially offset by an increase in the
amortization of deferred financing costs relating to the Company's amendments to
the Congress Credit Facility.
Income Taxes. For year ended December 28, 2002, the Company reduced the
carrying value of its deferred tax asset. This deferred tax asset adjustment was
based on a reassessment of the Company's ability to utilize certain net
operating losses prior to their expiration.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities. For the year ended December 27,
2003, net cash provided by operating activities was $8.1 million. Net losses,
when adjusted for depreciation, amortization and other non-cash items, resulted
in $8.5 million of operating cash provided for the period. In addition,
decreases, primarily in accounts receivable, prepaid catalog costs, and
inventory, contributed to positive cash flow from operating activities. This
positive cash flow was partially offset by funds being used to reduce accrued
liabilities, accounts payable, and other long-term liabilities. The payment of
compensation, severance benefits and the release of a non-cash reserve accrued
as of December 28, 2002 was the primary factor causing the reduction in accrued
liabilities.
Net cash provided by investing activities. For the year ended December 27,
2003, net cash provided by investing activities was $0.1 million. This was due
to proceeds received relating to the deferred gain of $2.0 million associated
with the sale of the Improvements business and $0.1 million of proceeds received
from the disposal of property and equipment. These receipts were offset by
approximately $1.9 million of capital
31
expenditures, consisting of upgrades to the Company's distribution and
fulfillment equipment located at its Roanoke, Virginia fulfillment facility,
acquisitions of telemarketing hardware and various computer hardware and
software. In addition, $0.1 million of costs relating to the early release of
escrow funds associated with the sale of the Improvements business also
contributed to the offset of net cash provided by investing activities.
Net cash used by financing activities. For the year ended December 27,
2003, net cash used by financing activities was $6.7 million. Payments to reduce
both Congress Tranche A and Tranche B Term Loan facilities were $3.8 million.
The Company also paid $0.9 million in fees to amend the Congress Credit Facility
(see Note 5 to the Company's Consolidated Financial Statements) and $1.3 million
in fees to enter into the Recapitalization Agreement with Chelsey (see Note 8 to
the Company's Consolidated Financial Statements), as well as a payment of $0.3
million for the Company's obligation to remit withholding taxes on behalf of
Richemont for estimated taxes due from the scheduled increases in Liquidation
Preference on the Series B Participating Preferred Stock (see Note 7 of the
Company's Consolidated Financial Statements). In addition, the Company paid $0.5
million relating to capital lease obligations. These payments were partially
offset by net borrowings under the Congress revolving loan facility.
Congress Credit Facility -- On December 27, 2003, the Company's credit
facility, as amended, with Congress contained a maximum credit line, subject to
certain limitations, of up to $56.5 million. In October 2003, the Company
amended the Congress Credit Facility to extend the expiration thereof from
January 31, 2004 to January 31, 2007. The Congress Credit Facility, as amended,
comprises a revolving loan facility, a $17.5 million Tranche A Term Loan, and a
$6.3 million Tranche B Term Loan. Total cumulative borrowings under the Congress
Credit Facility are subject to limitations based upon specified percentages of
eligible receivables and eligible inventory, and the Company is required to
maintain $3.0 million of excess credit availability at all times. The Congress
Credit Facility is secured by assets of the Company and places restrictions on
the incurrence of additional indebtedness and on the payment of common stock
dividends. As of December 27, 2003, the revolving loan facility of $9.0 million
was recognized as a current liability on the Company's Consolidated Balance
Sheet. On or before April 30, 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.
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. As of December 27, 2003, the Company was not in compliance with
the working capital covenant; however, it has subsequently received a waiver
from Congress addressing the deficiency. The Company was in compliance with all
other covenants as of December 27, 2003. There can be no assurance that Congress
will waive any future non-compliance by the Company with the financial and other
covenants contained in the Congress Credit Facility which could result in a
default by the Company, allowing Congress to accelerate the amounts due under
the facility.
A summary of the amendments implemented during 2003 is as follows:
In February 2003, the Company amended the Congress Credit Facility to amend
the existing change in control Event of Default. The existing change in control
Event of Default under the Congress Credit Facility was based upon NAR Group
Limited, a former shareholder of the Company, ceasing to be the direct or
indirect beneficial owner of a sufficient number of issued and outstanding
shares of capital stock of the Company on a fully diluted basis to elect a
majority of the members of the Company's Board of Directors. This was replaced
during February 2003 with a new change in control Event of Default, which is
patterned on the Change In Control concepts in the Company's various Key
Executive Compensation Continuation Plans. The new Event of Default would be
triggered by certain transfers of assets, certain liquidations or dissolutions,
the acquisition by a person or group (other than a Permitted Holder, as defined)
of a majority of the total outstanding voting stock of the Company, and certain
changes in the composition of the Company's Board of Directors.
In April 2003, the Company amended the Congress Credit Facility to allow
the Company's chief financial officer or its corporate controller to certify the
financial statements required to be delivered to Congress under the Congress
Credit Facility, rather than the chief financial officer of each subsidiary
borrower or guarantor.
32
In August 2003, the Company amended the Congress Credit Facility to make
certain technical amendments thereto, including the amendment of the definition
of Consolidated Net Worth and the temporary release of a $3.0 million
availability reserve established thereunder. The temporary release of the $3.0
million availability reserve was removed by the end of fiscal year 2003. The
amendment required the payment of fees in the amount of $165,000.
In October 2003, the Company amended the Congress Credit Facility to extend
the expiration thereof from January 31, 2004 to January 31, 2007, to reduce the
amount of revolving loans available thereunder to $43.0 million, to make
adjustments to the sublimits available to the various borrowers thereunder, to
amend the EBITDA covenant to specify minimum levels of EBITDA that must be
achieved during the Company's fiscal years ending 2004, 2005 and 2006, to permit
the borrowing under certain circumstances of up to $1.0 million against certain
inventory in transit to locations in the United States, and to make certain
other technical amendments. The amendment required the payment of fees in the
amount of $650,000.
On November 4, 2003, the Company amended the Congress Credit Facility to
change the definition of Consolidated Net Worth so as to provide that for the
purposes of calculating such amount for the Company's fiscal year ending
December 27, 2003, the Company's net deferred tax assets in the amount of $11.3
million that are required to be fully reserved pursuant to SFAS No. 109,
"Accounting for Income Taxes" ("SFAS 109"), shall be added back for the purposes
of determining the Company's assets.
On November 25, 2003, the Company amended the Congress Credit Facility to
receive consent from Congress in regards to the Recapitalization Agreement with
Chelsey so that the Company could exchange 1,622,111 shares of Series B
Participating Preferred Stock held by Chelsey in consideration of the issuance
by the Company of 564,819 shares of newly issued Series C Participating
Preferred Stock and 81,857,833 shares of newly issued Common Stock to Chelsey.
In addition, the Company may repurchase, redeem or retire shares of its Series C
Participating Preferred Stock owned by Chelsey using a portion of the net
proceeds from any asset sales consummated after the implementation of all asset
sale lending adjustments. The Company also amended the Congress Credit Facility
to make certain technical amendments thereto, including the amendment of the
amounts of Consolidated Working Capital and Consolidated Net Worth. The
amendment required the payment of fees in the amount of $150,000.
The Company re-examined the provisions of the Congress Credit Facility and,
based on EITF 95-22 and certain provisions in the credit agreement, the Company
is required to reclassify its revolving loan facility from long-term to
short-term debt, though the existing revolving loan facility does not mature
until January 31, 2007. As a result, the Company reclassified $8.8 million as of
December 28, 2002 from Long-term debt to Short-term debt and capital lease
obligations that is classified as Current liabilities. See Note 18 of Notes to
Consolidated Financial Statements for further discussion regarding the
restatement of prior year borrowings outstanding under the Congress Credit
Facility.
As of December 27, 2003, the Company had $21.5 million of cumulative
borrowings outstanding under the Congress Credit Facility, comprising $9.0
million 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, $12.8 million is classified as short-term
with $8.7 million classified as long-term on the Company's Consolidated Balance
Sheet. As of December 28, 2002, the Company had $25.1 million of borrowings
outstanding under the Congress Credit Facility comprising $8.8 million under the
revolving loan facility, bearing an interest rate of 4.75%, $8.5 million under
the Tranche A Term Loan, bearing an interest rate of 5.0%, and $7.8 million
under the Tranche B Term Loan, bearing an interest rate of 13.0%.
The revolving loan facility bears interest at prime plus 0.5% or Eurodollar
plus 2.5%, the Tranche A Term Loans bear interest at prime plus 0.75% or
Eurodollar plus 3.5%, and the Tranche B Term Loans bear interest at prime plus
4.25%, but in no event less than 13.0%.
On March 25, 2004, the Company amended the Congress Credit Facility to
change the definition of Consolidated Net Worth, to amend the Consolidated
Working Capital and Consolidated Net Worth covenants to specify minimum levels
of Consolidated Working Capital and Consolidated Net Worth that must
33
be maintained during each month commencing January 2004, and to amend the EBITDA
covenant to specify minimum levels of EBITDA that must be achieved during the
Company's fiscal years ending 2004, 2005 and 2006. The Company expects to
maintain the minimum levels of these covenants in future periods. In addition,
the definition of "Event of Default" was amended by replacing the Event of
Default which would have occurred on the occurrence of a material adverse change
in the business, assets, liabilities or condition of the Company and its
subsidiaries, with an Event of Default which would occur if certain specific
events, such as a decrease in consolidated revenues beyond certain specified
levels or aging of inventory or accounts payable beyond certain specified
levels, were to occur.
Based on the provisions of EITF 95-22 and certain provisions in the credit
agreement, the Company is required to classify its revolving loan facility as
short-term debt. See Note 18 for further discussion regarding the restatement of
prior year borrowings outstanding under the Congress Credit Facility.
The Company is considering replacing the Congress Credit Facility with a
new senior loan facility from a major financial institution with more favorable
terms. However, there can be no assurance that such a facility will be found.
The Company is also considering a sale-lease back of its principal warehouse and
distribution center, the funds from which would be used to reduce the Company's
debt, although no definitive agreements have been reached. There can be no
assurance that the Company will engage in such a transaction.
Achievement of the Company's strategic business realignment program is
critical to the maintenance of adequate liquidity, as is compliance with the
terms and provisions of the Congress Credit Facility and the Company's ability
to operate effectively during the 2004 fiscal year. In the event of a softer
than expected economic climate, management has available several courses of
action to maintain liquidity and help maintain compliance with financial
covenants, including selective reductions in catalog circulation, additional
expense reductions and sales of non-core assets.
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 such 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,
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.
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 anniversary of
the dividend commencement date 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 Company's credit
agreement with Congress currently prohibits 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 will be redeemed by the
34
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, 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 Financial Corporation 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.
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.
Because its Series B Participating Preferred Stock was mandatorily
redeemable and thus accounted for as a liability, the Company accounted for the
exchange of 1,622,111 outstanding shares of its Series B Participating Preferred
Stock held by Chelsey for the issuance of 564,819 shares of newly-created Series
C Participating Preferred Stock and 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 Restructuring." 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 in equity.
Sale of the Improvements Business. On June 29, 2001, the Company sold
certain assets and liabilities of its Improvements business to HSN, a division
of USA Networks, Inc.'s Interactive Group, for approximately $33.0 million. In
conjunction with the sale, the Company's Keystone Internet Services, Inc.
subsidiary agreed to provide telemarketing and fulfillment services for the
Improvements business under a service agreement with the buyer for a period of
three years.
The asset purchase agreement between the Company and HSN provided that if
Keystone Internet Services failed to perform its obligations during the first
two years of the services contract, the purchaser 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 of
approximately $33.0 million, had been established for a period of two years
under the terms of an escrow agreement between LWI Holdings, Inc., HSN and The
Chase Manhattan Bank as a result of these contingencies.
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 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 Internet Services failed to
perform its obligations during the first two years of the services contract. In
consideration for the release, Keystone Internet Services issued a credit to HSN
for $100,000, which could be applied by HSN against any invoices of Keystone
Internet Services 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 fiscal year 2001,
which represented the excess of the net proceeds from the sale over the net
assets acquired by HSN, the goodwill associated with the Improvements business
and expenses related to the transaction. During fiscal year 2002, the Company
recognized approximately
35
$0.6 million of the deferred gain consistent with the terms of the escrow
agreement. During the 13- weeks ended March 29, 2003, the Company recognized the
remaining net deferred gain of $1.9 million from 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. By letter dated May 2, 2001, the
American Stock Exchange (the "Exchange") notified the Company that it was below
certain of the Exchange's continued listing guidelines set forth in the
Exchange's Company Guide. The Exchange instituted a review of the Company's
eligibility for continuing listing of the Company's common stock on the
Exchange. On January 17, 2002, the Company received a letter dated January 9,
2002 from the Exchange confirming that the American Stock Exchange determined to
continue the Company's listing on the Exchange pending quarterly reviews of the
Company's compliance with the steps of its strategic business realignment
program. This determination was made subject to the Company's favorable progress
in satisfying the Exchange's guidelines for continued listing and to the
Exchange's periodic review of the Company's Securities and Exchange Commission
and other filings.
On November 11, 2002, the Company received a letter dated November 8, 2002
from the Exchange updating its position regarding the Company's compliance with
certain of the Exchange's continued listing standards as set forth in Part 10 of
the Exchange's Company Guide. Although the Company had been making favorable
progress in satisfying the Exchange's guidelines for continued listing based on
its compliance with the steps of its strategic business realignment program
shared with the Exchange in 2001 and updated in 2002, the Exchange informed the
Company that it had now become strictly subject to the procedures and
requirements of Part 10 of the Company Guide. Specifically, the Company must not
fall below the requirements of: (i) Section 1003(a)(i) 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; (ii) Section 1003(a)(ii) 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 (iii) Section 1003(a)(iii) 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 submit a plan to the
Exchange by December 11, 2002, advising the Exchange of action it has taken, or
will take, that would bring it into compliance with the continued listing
standards by December 28, 2003. The Company submitted a plan to the Exchange on
December 11, 2002, in an effort to maintain the listing of the Company's common
stock on the Exchange.
On January 28, 2003, the Company received a letter from the Exchange
confirming that, as of the date of the letter, the Company had evidenced
compliance with the requirements necessary for continued listing on the
Exchange. Such compliance resulted from a recent rule change by the Exchange
approved by the Securities and Exchange Commission related to continued listing
on the basis of compliance with total market capitalization or total assets and
revenues standards as alternatives to shareholders' equity standards including
the requirement that each listed company maintain $ 15$15 million of public float.
The letter is subject to changes in the American Stock Exchange Rules that might
supersede the letter or require the Exchange to re-evaluate its position.
19. REGULATIONGeneral. At December 27, 2003, the Company had $2.3 million in cash and
cash equivalents, compared with $0.8 million at December 28, 2002. Working
capital and current ratio at December 27, 2003 were $(2.0) million and 0.97 to
1. Total cumulative borrowings, including financing under capital lease
obligations and excluding the Series C Participating Preferred Stock, as of
December 27, 2003, aggregated $22.5 million, $9.0 million of which is classified
as long-term. Remaining availability under the Congress Revolving Loan Facility
as of December 27, 2003 was $9.9 million. There were nominal capital commitments
(less than $0.2 million) at December 27, 2003.
Management believes that the Company has sufficient liquidity and
availability under its credit agreement to fund its planned operations through
at least December 25, 2004. Achievement of the cost savings and other objectives
of the Company's strategic business realignment program is critical to the
maintenance of
36
adequate liquidity as is compliance with the terms and provisions of the
Congress Credit Facility as mentioned in Note 5 to the Consolidated Financial
Statements.
USE OF ESTIMATES AND OTHER CRITICAL ACCOUNTING POLICIES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities at the date of the financial statements and revenues and expenses
during the period. Significant accounting policies employed by the Company,
including the use of estimates, are presented in the Notes to Consolidated
Financial Statements.
On April 30, 2002, the Securities and Exchange Commission issued a proposed
rule to improve the financial statement disclosure of accounting estimates and
critical accounting policies used by companies in the presentation of their
financial condition, changes in financial condition or results of operations.
Critical accounting policies are those that are most important to the portrayal
of the Company's financial condition and results of operations, and require
management's most difficult, subjective or complex judgments, as a result of the
need to make estimates about the effect of matters that are inherently
uncertain. The Company's most critical accounting policies, discussed below,
pertain to revenue recognition, inventory valuation, catalog costs, reserves
related to the Company's strategic business realignment program, reserves
related to the Company's employee health, welfare and benefit plans, and the
Company's net deferred tax asset.
Revenue Recognition -- The Company recognizes revenue for catalog and
Internet sales upon shipment of the merchandise to customers and at the time of
sale for retail sales, each net of estimated returns. Postage and handling
charges billed to customers are also recognized as revenue upon shipment of the
related merchandise. Shipping terms for catalog and Internet sales are FOB
shipping point, and title passes to the customer at the time and place of
shipment. Prices for all merchandise are listed in the Company's catalogs and on
Internet Web sites and are confirmed with the customer upon order. The customer
has no cancellation privileges after shipment other than customary rights of
return that are accounted for in accordance with SFAS No. 48, "Revenue
Recognition When Right of Return Exists." The Company's revenue recognition
policy includes the use of estimates of the future amount of returns to be
received on the current period's sales. These estimates of future returns are
determined using historical measures including the amount of time between the
shipment of a product and its return (return lag -- rounded up to the nearest
whole week), the overall rate of return, and the average product margin
associated with the returned products. Returns estimates are calculated for each
catalog brand and are used to determine each individual brand's returns reserve.
The Company's total returns reserve at the end of the fiscal years 2003, 2002
and 2001 was $2.2 million, $1.9 million and $2.8 million, respectively. During
October 2003, the Company modified its return policy, which previously allowed
unlimited returns, to limit returns to a maximum of 90 days after the sale of
the merchandise. Because this policy change was recently adopted, it did not
impact the Company's total returns reserve for the fiscal year ended December
27, 2003, however, it could potentially impact the Company's future financial
results through a change in the Company's actual and estimated return rates. Net
revenues, Cost of sales and operating expenses on the Company's Consolidated
Statements of Income (Loss), as well as Accrued liabilities on the Consolidated
Balance Sheets, are impacted by the returns reserve calculations.
Inventory Valuation -- The Company's inventory valuation policy includes
the use of estimates regarding the future loss on inventory that will be sold at
a price less than the cost of the inventory (inventory write-downs), and the
amount of freight-in expense associated with the inventory on-hand (capitalized
freight). These amounts are included in Inventories, as recorded on the
Company's Consolidated Balance Sheets. The Company's inventory write-downs are
determined for each individual catalog brand using the estimated amount of
overstock inventory that will need to be sold below cost and an estimate of the
method of liquidating this inventory (each method generates a different level of
cost recovery). The estimated amount of overstock inventory is determined using
current and historical sales trends for each category of inventory as well as
the content of future merchandise offers that will be produced by the Company.
An estimate of the percentage of freight-in expense associated with each dollar
of inventory received is used in calculating the amount of freight-in expense to
include in the Company's inventory value. Different percentage estimates are
37
developed for each catalog brand and for inventory purchased from foreign and
domestic sources. The estimates used to determine the Company's inventory
valuation affect the balance of Inventories on the Company's Consolidated
Balance Sheets and Cost of sales and operating expenses on the Company's
Consolidated Statements of Income (Loss).
Catalog Costs -- An estimate of the future sales dollars to be generated
from each individual catalog drop is used in the Company's catalog costs policy.
The estimate of future sales is calculated for each catalog drop using
historical trends for similar catalog drops mailed in prior periods as well as
the overall current sales trend for the catalog brand. This estimate is compared
with the actual sales generated to-date for the catalog drop to determine the
percentage of total catalog costs to be classified as prepaid on the Company's
Consolidated Balance Sheets. The Company's total Prepaid catalog costs at the
end of fiscal years 2003, 2002 and 2001 were $11.8 million, $13.5 million and
$14.6 million, respectively. Prepaid catalog costs on the Consolidated Balance
Sheets and Selling expenses on the Consolidated Statements of Income (Loss) are
affected by these estimates.
Reserves related to the Company's strategic business realignment program
and other Accrued Liabilities -- The reserves established by the Company related
to its strategic business realignment program include estimates primarily
associated with the potential subleasing of leased properties which have been
vacated by the Company. The properties that have available space for subleasing
as of December 27, 2003 include the corporate headquarters and administrative
offices located in Weehawken, New Jersey and Edgewater, New Jersey; and the
retail and office facility that includes the Gump's retail store in San
Francisco, California. The overall reserves for leased properties that have been
vacated by the Company are developed using estimates that include the potential
ability to sublet leased but unoccupied properties, the length of time needed to
obtain suitable tenants and the amount of rent to be received for the sublet.
Real estate broker representations regarding current and future market
conditions are sometimes used in estimating these items. Current Accrued
liabilities and Other Non-current liabilities on the Company's Consolidated
Balance Sheets and Special charges on the Company's Consolidated Statements of
Income (Loss) are impacted by these estimates. See Note 3 and Note 4 to the
Company's Consolidated Financial Statements.
The most significant estimates involved in evaluating the Company's accrued
liabilities are used in the determination of the accrual for legal liabilities.
The Company accrues for loss litigation when management determines that it is
probable that an unfavorable outcome will result. The Company's policy is to
accrue an amount equal to the estimated potential loss and associated legal
fees. For the fiscal year ended December 28, 2002, the Company used estimates to
determine the accrued liability for the Rakesh Kaul case. In calculating this
accrual, the Company used estimates including the likelihood that this case
would reach the trial stage, the legal expenses associated with continuing this
legal action, the ultimate outcome of the case, and the amounts to be awarded if
the outcome was not in the Company's favor. These estimates were developed and
approved by the Company's Senior Management. For the fiscal year ended December
27, 2003, the Company modified the assumptions used to calculate the estimates
due to a favorable outcome at summary judgment on January 7, 2004 (see Note 16
of Notes to the Consolidated Financial Statements). An accrued liability in the
amount of $0.2 million was maintained for the fiscal year ended December 27,
2003 pending the resolution of the two outstanding claims and any appeals.
Accrued Liabilities on the Consolidated Balance Sheets and General and
administrative expenses on the Consolidated Statements of Income (Loss) are
affected by these estimates.
Reserves related to employee health, welfare and benefit plans -- The
Company maintains a self-insurance program related to losses and liabilities
associated with employee health and welfare claims. Stop-loss coverage is held
on both an aggregate and individual claim basis; thereby, limiting the amount of
losses the Company will experience. Losses are accrued based upon estimates of
the aggregate liability for claims incurred using the Company's experience
patterns. General and administrative expenses on the Consolidated Statement of
Income (Loss) and Accrued liabilities on the Consolidated Balance Sheet are
affected by these estimates.
Net Deferred Tax Asset -- In determining the Company's net deferred tax
asset (gross deferred tax asset net of a valuation allowance and the deferred
tax liability), projections concerning the future utilization of the
38
Company's net operating loss carryforwards are employed. These projections
involve evaluations of the Company's future operating plans and ability to
generate taxable income, as well as future economic conditions and the Company's
future competitive environment. For the year ended December 27, 2003, the
carrying value of the deferred tax asset was adjusted based on a reassessment of
the Company's ability to utilize certain net operating losses prior to their
expiration, the Company's history of losses and continued softness in demand for
the Company's products. The Deferred tax asset and Deferred tax liability on the
Company's Consolidated Balance Sheets and the Provision for deferred Federal
income taxes on the Company's Consolidated Statements of Income (Loss) are
impacted by these projections.
NEW ACCOUNTING PRONOUNCEMENTS
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" ("SFAS 146"). SFAS 146 nullifies
Emerging Issues Task Force Issue No. 94-3 ("EITF 94-3"). SFAS 146 requires that
a liability for a cost associated with an exit or disposal activity be
recognized when the liability is incurred whereas, under EITF 94-3, the
liability was recognized at the commitment date to an exit plan. The Company has
adopted the provisions of SFAS 146 for exit or disposal activities initiated
after December 31, 2002.
In January 2003, the Securities and Exchange Commission issued a new
disclosure regulation, "Conditions for Use of Non-GAAP Financial Measures"
("Regulation G"), which is effective for all public disclosures and filings made
after March 28, 2003. Regulation G requires public companies that disclose or
release information containing financial measures that are not in accordance
with generally accepted accounting principles ("GAAP") to include in the
disclosure or release a presentation of the most directly comparable GAAP
financial measure and a reconciliation of the disclosed non-GAAP financial
measure to the most directly comparable GAAP financial measure. The Company
became subject to Regulation G in fiscal 2003 and believes that it is in
compliance with the new disclosure requirements.
In May 2003, the FASB issued SFAS 150. SFAS 150 establishes standards for
how an issuer classifies and measures certain financial instruments with
characteristics of both liabilities and equity. It requires that an issuer
classify a financial instrument that is within its scope as a liability, many of
which had been previously classified as equity or between the liabilities and
equity sections of the consolidated balance sheet. The provisions of SFAS 150
are effective for financial instruments entered into or modified after May 31,
2003, and otherwise is effective at the beginning of the first interim period
beginning after June 15, 2003. It 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 has adopted the provisions of SFAS
150 and has been impacted by the requirement to reclassify its Series B
Participating Preferred Stock as a liability as opposed to between the
liabilities and equity sections of the consolidated balance sheet. Based upon
the requirements set forth by SFAS 150, this reclassification was subject to
implementation beginning on June 29, 2003. Upon implementation of SFAS 150, the
Company has reflected the accretion of the preferred stock balance as an
increase in Total Liabilities with a corresponding reduction in capital in
excess of par value, because the Company has an accumulated deficit. Such
accretion has been recorded as interest expense, resulting in a decrease in Net
Income (Loss) and Comprehensive Income (Loss) of $7.6 million for the 52- weeks
ended December 27, 2003. In addition, based upon the Company's current
projections for 2003, it is estimated the Company has not incurred a tax
reimbursement obligation for 2003 relating to the increases in the Liquidation
Preference of the Series B Participating Preferred Stock and has filed for a
refund of the $0.3 million Federal tax payment made in March 2003. Due to the
SFAS 150 requirements to reclassify the Series B Participating Preferred Stock
to liabilities and to record the accretion of the preferred stock balance as
interest expense, the refund has been treated as a decrease to interest expense
on the Consolidated Statements of Income (Loss) and an increase of Capital in
excess of par value on the Consolidated Balance Sheets. Net Income (Loss)
Applicable to Common Shareholders and Net Income (Loss) Per Common Share remains
unchanged in comparison with the Company's classification of the instrument
prior to June 29, 2003. In addition, there is no cumulative effect of a change
in accounting principle as a result of the implementation of SFAS 150. As of
December 27, 2003, the implementation of SFAS 150 has increased Total
Liabilities by approximately $72.7 million.
39
Shareholders' Deficiency remained unchanged since the balance had previously
been classified between Total Liabilities and Shareholders' Deficiency on the
Consolidated Balance Sheet. The classification of the Series C Participating
Preferred Stock as a liability under SFAS 150 should not change its
classification as equity under state law.
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
December 27, 2003 (in thousands), as required by Item 303(a)(5) of SEC
Regulation S-K. In addition to obligations recorded on the Company's
Consolidated Balance Sheets as of December 27, 2003, the schedule includes
purchase obligations, which are defined as legally binding and enforceable
agreements to purchase goods or services that specify all significant terms
(quantity, price, and timing of transaction).
PAYMENT DUE BY PERIOD
LESS THAN MORE THAN
CONTRACTUAL OBLIGATIONS TOTAL 1 YEAR 1-3 YEARS 3-5 YEARS 5 YEARS
- ----------------------- -------- --------- --------- --------- ---------
Debt Obligations(a)....................... $ 21,478 $12,789 $ 8,689 $ -- $ --
Total Minimum Lease Payments Under Capital
Lease Obligations(b).................... 1,104 734 366 4 --
Operating Lease Obligations(b)............ 16,219 5,397 4,956 3,724 2,142
Operating Lease
Obligations -- Restructuring/
Discontinued Operations(b).............. 9,682 3,424 3,083 2,005 1,170
Purchase Obligations(c)................... 3,386 1,882 1,504 -- --
Other Long-Term Liabilities Reflected on
the Registrant's Balance Sheet under
GAAP(d)................................. 72,689 -- -- -- 72,689
-------- ------- ------- ------ -------
Total..................................... $124,558 $16,522 $26,302 $5,733 $76,001
======== ======= ======= ====== =======
- ---------------
(a) As disclosed in Note 5 to the Company's Consolidated Financial Statements.
(b) As disclosed in Note 14 to the Company's Consolidated Financial Statements.
(c) The Company's purchase obligations consist primarily of a total commitment
of approximately $960,000 to purchase telecommunication services during the
period from October 1, 2003 through March 31, 2004, of which approximately
$460,000 had been fulfilled as of December 27, 2003; a total commitment of
$2,000,000 to purchase telecommunication services during the period from
May 1, 2004 through 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
$39,000 had been fulfilled as of December 27, 2003, and of which
approximately $277,000 should be fulfilled during fiscal 2004 and the
remaining $171,000 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; and several commitments totaling
approximately $151,000 for various consulting services to be provided
during the period April 2003 through July 2004, of which approximately
$88,000 had been fulfilled as of December 27, 2003.
(d) Represents Series C Participating Preferred Stock as disclosed in Note 8 to
the Company's Consolidated Financial Statements.
40
FORWARD-LOOKING STATEMENTS
The following statements constitute forward-looking statements within the
meaning of the Private Securities Litigation Reform Act of 1995:
"Management believes that these trends will not continue in 2004."
"Management believes that the Company has sufficient liquidity and
availability under its credit agreement to fund its planned operations through
at least December 25, 2004."
"The Company expects to maintain the minimum levels of these covenants in
future periods."
"Achievement of the Company's strategic business realignment program is
critical to the maintenance of adequate liquidity, as is compliance with the
terms and provisions of the Congress Credit Facility and the Company's ability
to operate effectively during the 2004 fiscal year. In the event of a softer
than expected economic climate, management has available several courses of
action to maintain liquidity and help maintain compliance with financial
covenants, including selective reductions in catalog circulation, additional
expense reductions and sales of non-core assets."
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 success of the Amazon.com
venture. 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
41
ability of the Company to find alternative vendors and suppliers on
competitive terms if vendors or suppliers who exist cease doing business
with the Company.
- The inability of the Company to timely obtain and distribute merchandise,
leading to an increase in backorders and cancellations.
- Defaults under the Congress Credit Facility, or inadequacy of available
borrowings thereunder, reducing or impairing the Company's ability to
obtain letters of credit or other credit to support its purchase of
inventory and support normal operations, impacting the Company's ability
to obtain, market and sell merchandise in a timely manner.
- Continued compliance by the Company with and the enforcement by Congress
of financial and other covenants and limitations contained in the
Congress Credit Facility, including net worth, net working capital,
capital expenditure and EBITDA covenants, and limitations based upon
specified percentages of eligible receivables and eligible inventory, and
the requirement that the Company maintain $3.0 million of excess credit
availability at all times, affecting the ability of the Company to
continue to make borrowings under the Congress Credit Facility.
- Continuation of the Company's history of operating losses, and the
incidence of costs associated with the Company's strategic business
realignment program, resulting in the Company failing to comply with
certain financial and other covenants contained in the Congress Credit
Facility, including net worth, net working capital, capital expenditure
and EBITDA covenants and the ability of the Company to obtain waivers
from Congress in the event that future internal and/or external events
result in performance that results in noncompliance by the Company with
the terms of the Congress Credit 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 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.
42
- The ability of the Company to maintain the listing of its Common Stock on
the American Stock Exchange.
- The continued willingness of customers to place and receive mail orders
in light of worries about bio-terrorism.
- The ability of the Company to sublease, terminate or renegotiate the
leases of its vacant facilities in Weehawken, New Jersey and other
locations.
- 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 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.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
INTEREST RATES: The Company's exposure to market risk relates to interest
rate fluctuations for borrowings under the Congress revolving credit facility
and its term financing facility, which bear interest at variable rates. At
December 27, 2003, outstanding principal balances under these facilities subject
to variable rates of interest were approximately $15.5 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 December 27,
2003, would be approximately $0.15 million on an annual basis.
43
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA -- REPORT OF INDEPENDENT
AUDITORS
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders Hanover Direct, Inc.:
We have audited the accompanying consolidated balance sheets of Hanover
Direct, Inc. and subsidiaries as of December 27, 2003 and December 28, 2002 and
the related consolidated statements of income (loss), shareholders' deficiency,
and cash flows for the years then ended. In connection with our audits of the
2003 and 2002 consolidated financial statements, we also have audited the 2003
and 2002 consolidated financial statement schedule as listed in the accompanying
index. These consolidated financial statements and financial statement schedule
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these consolidated financial statements and financial
statement schedule based on our audits. The 2001 financial statements and
financial statement schedule of Hanover Direct, Inc. as listed in the
accompanying index were audited by other auditors who have ceased operations.
Those auditors expressed an unqualified opinion on those financial statements
and financial statement schedule in their report dated March 16, 2002.
We conducted our audit in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Hanover
Direct, Inc. and subsidiaries as of December 27, 2003 and December 28, 2002 and
the results of their operations and their cash flows for the years then ended,
in conformity with accounting principles generally accepted in the United States
of America. Also in our opinion, the related 2003 and 2002 consolidated
financial statement schedule, when considered in relation to the basic
consolidated financial statements taken as a whole, presents fairly, in all
material respects, the information set forth therein.
As described in Note 18, the Company's consolidated balance sheet as of
December 28, 2002 has been restated to classify certain debt as current.
As discussed in Note 1 to the financial statements, the Company adopted the
provisions of Financial Accounting Standards Board's Statement of Financial
Accounting Standards No. 150, "Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity" in 2003 and of Statement of
Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets"
in 2002.
KPMG LLP
New York, NY
April 2, 2004
44
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 27, 2003 AND DECEMBER 28, 2002
AS RESTATED
DECEMBER 27, DECEMBER 28,
2003 2002
------------ ------------
(IN THOUSANDS OF DOLLARS,
EXCEPT SHARE AMOUNTS)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents................................. $ 2,282 $ 785
Accounts receivable, net of allowance for doubtful
accounts of $1,105 in 2003 and $1,560 in 2002........... 14,335 16,945
Inventories............................................... 41,576 53,131
Prepaid catalog costs..................................... 11,808 13,459
Other current assets...................................... 3,951 3,967
--------- ---------
Total Current Assets.................................... 73,952 88,287
--------- ---------
PROPERTY AND EQUIPMENT, AT COST:
Land...................................................... 4,361 4,395
Buildings and building improvements....................... 18,210 18,205
Leasehold improvements.................................... 10,108 9,915
Furniture, fixtures and equipment......................... 53,212 56,094
--------- ---------
85,891 88,609
Accumulated depreciation and amortization................. (58,113) (59,376)
--------- ---------
Property and equipment, net............................... 27,778 29,233
--------- ---------
Goodwill, net............................................. 9,278 9,278
Deferred tax asset........................................ 2,213 12,400
Other non-current assets.................................. 1,575 902
--------- ---------
Total Assets............................................ $ 114,796 $ 140,100
========= =========
LIABILITIES AND SHAREHOLDERS' DEFICIENCY
CURRENT LIABILITIES:
Short-term debt and capital lease obligations............. $ 13,468 $ 12,621
Accounts payable.......................................... 41,880 42,873
Accrued liabilities....................................... 12,918 26,351
Customer prepayments and credits.......................... 5,485 4,722
Deferred tax liability.................................... 2,213 1,100
--------- ---------
Total Current Liabilities............................... 75,964 87,667
--------- ---------
NON-CURRENT LIABILITIES:
Long-term debt............................................ 9,042 12,508
Series C Participating Preferred Stock, authorized, issued
and outstanding 564,819 shares at December 27, 2003;
liquidation preference was $56,482 at December 27,
2003.................................................... 72,689 --
Other..................................................... 4,609 6,387
--------- ---------
Total Non-current Liabilities........................... 86,340 18,895
--------- ---------
Total Liabilities....................................... 162,304 106,562
--------- ---------
SERIES B PARTICIPATING PREFERRED STOCK, authorized, issued
and outstanding 1,622,111 shares at December 28, 2002..... -- 92,379
--------- ---------
SHAREHOLDERS' DEFICIENCY:
Common Stock, $.66 2/3 par value, authorized 300,000,000
shares; 222,294,562 shares issued and outstanding at
December 27, 2003 and 140,336,729 shares issued and
outstanding at December 28, 2002........................ 148,197 93,625
Capital in excess of par value............................ 302,432 337,507
Accumulated deficit....................................... (494,791) (486,627)
--------- ---------
(44,162) (55,495)
Less:
Treasury stock, at cost (2,120,929 shares at December 27,
2003 and December 28, 2002)............................... (2,996) (2,996)
Notes receivable from sale of Common Stock.................. (350) (350)
--------- ---------
Total Shareholders' Deficiency.......................... (47,508) (58,841)
--------- ---------
Total Liabilities and Shareholders' Deficiency.......... $ 114,796 $ 140,100
========= =========
See notes to Consolidated Financial Statements.
45
CONSOLIDATED STATEMENTS OF INCOME (LOSS)
FOR THE YEARS ENDED DECEMBER 27, 2003, DECEMBER 28, 2002 AND DECEMBER 29, 2001
2003 2002 2001
--------- --------- ---------
(IN THOUSANDS OF DOLLARS, EXCEPT
PER SHARE AMOUNTS)
NET REVENUES................................................ $414,874 $457,644 $532,165
-------- -------- --------
OPERATING COSTS AND EXPENSES:
Cost of sales and operating expenses...................... 261,118 290,531 339,556
Special charges........................................... 1,308 4,398 11,277
Selling expenses.......................................... 99,543 105,239 141,140
General and administrative expenses....................... 42,080 52,258 56,727
Depreciation and amortization............................. 4,719 5,650 7,430
-------- -------- --------
408,768 458,076 556,130
-------- -------- --------
INCOME (LOSS) FROM OPERATIONS............................... 6,106 (432) (23,965)
Gain on sale of Improvements.............................. (1,911) (570) (23,240)
Gain on sale of Kindig Lane Property...................... -- -- (1,529)
-------- -------- --------
INCOME (LOSS) BEFORE INTEREST AND INCOME TAXES.............. 8,017 138 804
Interest expense, net..................................... 12,088 5,477 6,529
-------- -------- --------
LOSS BEFORE INCOME TAXES.................................... (4,071) (5,339) (5,725)
Provision for deferred Federal income taxes............... 11,300 3,700 --
Provision for state income taxes.......................... 28 91 120
-------- -------- --------
NET LOSS AND COMPREHENSIVE LOSS............................. (15,399) (9,130) (5,845)
Preferred stock dividends................................. 7,922 15,556 10,745
-------- -------- --------
NET LOSS APPLICABLE TO COMMON SHAREHOLDERS.................. $(23,321) $(24,686) $(16,590)
======== ======== ========
NET LOSS PER COMMON SHARE:
Net loss per common share -- basic and diluted............ $ (.16) $ (.18) $ (.08)
======== ======== ========
Weighted average common shares outstanding -- basic and
diluted (thousands).................................... 144,388 138,280 210,536
======== ======== ========
See notes to Consolidated Financial Statements.
46
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 27, 2003, DECEMBER 28, 2002 AND DECEMBER 29, 2001
2003 2002 2001
-------- ------- --------
(IN THOUSANDS OF DOLLARS)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss.................................................. $(15,399) $(9,130) $ (5,845)
Adjustments to reconcile net loss to net cash provided
(used) by operating activities:
Depreciation and amortization, including deferred
fees................................................... 5,715 7,203 8,112
Provision for doubtful accounts......................... 378 304 91
Special charges......................................... 16 18 3,254
Provision for deferred tax.............................. 11,300 3,700 --
Gain on the sale of Improvements........................ (1,911) (570) (23,240)
Gain on the sale of Kindig Lane Property................ -- -- (1,529)
Loss (Gain) on the sale of property and equipment....... (4) (167) --
Interest expense related to Series B Participating
Preferred Stock redemption price increase.............. 7,235 -- --
Compensation expense related to stock options........... 1,141 1,332 1,841
Changes in assets and liabilities
Accounts receivable..................................... 2,232 2,207 7,398
Inventories............................................. 11,555 6,092 7,077
Prepaid catalog costs................................... 1,651 1,161 4,456
Accounts payable........................................ (993) (3,475) (12,818)
Accrued liabilities..................................... (13,433) 1,219 (11,117)
Customer prepayments and credits........................ 763 (421) (300)
Other, net.............................................. (2,173) (4,814) 1,400
-------- ------- --------
Net cash provided (used) by operating activities.......... 8,073 4,659 (21,220)
-------- ------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisitions of property and equipment.................. (1,895) (639) (1,627)
Proceeds from sale of Improvements...................... 2,000 570 30,036
Costs related to early release of escrow funds.......... (89) -- --
Proceeds from sale of Kindig Lane Property.............. -- -- 4,671
Proceeds from disposal of property and equipment........ 78 169 --
-------- ------- --------
Net cash provided by investing activities................. 94 100 33,080
-------- ------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings (payments) under Congress revolving loan
facility............................................... 179 (4,704) (2,189)
Borrowings under Congress Tranche B term loan
facility............................................... -- 3,500 --
Payments under Congress Tranche A term loan facility.... (1,991) (1,991) (5,208)
Payments under Congress Tranche B term loan facility.... (1,800) (1,314) (1,069)
Payments of 7.5% convertible debentures................. -- -- (751)
Payments of capital lease obligations................... (466) (104) (90)
Payments of Series C Participating Preferred Stock
financing costs........................................ (1,334) -- --
Payments of debt issuance costs......................... (910) (722) (3,095)
Payment of estimated Richemont tax obligation on Series
B Participating Preferred Stock accretion.............. (347) -- --
Proceeds from issuance of common stock.................. -- 25 --
Series B Participating Preferred Stock transaction cost
adjustment............................................. -- 215 --
Other, net.............................................. (1) -- (28)
-------- ------- --------
Net cash used by financing activities..................... (6,670) (5,095) (12,430)
-------- ------- --------
Net increase (decrease) in cash and cash equivalents...... 1,497 (336) (570)
Cash and cash equivalents at the beginning of the year.... 785 1,121 1,691
-------- ------- --------
Cash and cash equivalents at the end of the year.......... $ 2,282 $ 785 $ 1,121
======== ======= ========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the year for:
Interest................................................ $ 3,325 $ 3,405 $ 5,286
Income taxes............................................ $ 705 $ 193 $ 150
Non-cash investing and financing activities:
Series B Participating Preferred Stock redemption price
increase............................................... $ 7,575 $15,556 $ --
Redemption of Series B Participating Preferred Stock.... $107,536 $ -- $ --
Stock dividend and accretion of Series A Cumulative
Participating Preferred Stock.......................... $ -- $ -- $ 10,745
Redemption of Series A Cumulative Participating
Preferred Stock and Accrued Stock Dividends............ $ -- $ -- $ 82,390
Issuance of Series B Participating Preferred Stock...... $ -- $ -- $ 76,823
Issuance of Series C Participating Preferred Stock...... $ 72,689 $ -- $ --
Gain on issuance of Series C Participating Preferred
Stock.................................................. $ 13,867 $ -- $ --
Tandem share expirations................................ $ -- $ 55 $ 719
Capital lease obligations............................... $ 1,459 $ 32 $ 9
See notes to Consolidated Financial Statements.
47
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' DEFICIENCY
FOR THE YEARS ENDED DECEMBER 27, 2003, DECEMBER 28, 2002 AND DECEMBER 29, 2001
NOTES
COMMON STOCK RECEIVABLE
$.66 2/3 PAR VALUE CAPITAL TREASURY STOCK FROM SALE
------------------ IN EXCESS OF ACCUM. ---------------- OF COMMON
SHARES AMOUNT PAR VALUE (DEFICIT) SHARES AMOUNT STOCK TOTAL
------- -------- ------------ --------- ------ ------- ---------- --------
(IN THOUSANDS OF DOLLARS AND SHARES)
BALANCE AT DECEMBER 30, 2000........... 214,425 $142,951 $307,595 $(471,651) (729) $(2,223) $(1,124) $(24,452)
======= ======== ======== ========= ====== ======= ======= ========
Net loss applicable to common
shareholders......................... (16,590) (16,590)
Preferred Stock accretion.............. (2,129) 2,129 --
Preferred Stock dividend............... (8,615) 8,615 --
Stock options expensed................. 1,841 1,841
Issuance of Common Stock for employee
stock plan........................... 10 7 (5) 2
Tandem share expirations............... (1,530) (719) 719 --
Retirement of Treasury Shares.......... 158 -- --
Series B Participating Preferred Stock
issuance costs....................... (2,095) (2,095)
Conversion to Preferred Stock.......... (74,098) (49,400) 54,966 5,566
------- -------- -------- --------- ------ ------- ------- --------
BALANCE AT DECEMBER 29, 2001........... 140,337 $ 93,558 $351,558 $(477,497) (2,101) $(2,942) $ (405) $(35,728)
======= ======== ======== ========= ====== ======= ======= ========
Net loss applicable to common
shareholders......................... (24,686) (24,686)
Series B Participating Preferred stock
liquidation preference accrual....... (15,556) 15,556 --
Stock options expensed................. 1,332 1,332
Issuance of Common Stock for employee
stock plan........................... 100 67 (42) 25
Tandem share expirations............... (20) (54) 54 --
Series B Preferred Stock issuance cost
adjustment........................... 215 1 216
------- -------- -------- --------- ------ ------- ------- --------
BALANCE AT DECEMBER 28, 2002........... 140,437 $ 93,625 $337,507 $(486,627) (2,121) $(2,996) $ (350) $(58,841)
======= ======== ======== ========= ====== ======= ======= ========
Net loss applicable to common
shareholders......................... (23,321) (23,321)
Series B Participating Preferred Stock
liquidation preference accrual....... (15,157) 15,157 --
Stock options expensed................. 1,141 1,141
Gain on Recapitalization, net of
issuance costs of $1,334............. 13,867 13,867
Issuance of Common Stock in conjunction
with Recapitalization................ 81,858 54,572 (34,926) 19,646
------- -------- -------- --------- ------ ------- ------- --------
BALANCE AT DECEMBER 27, 2003........... 222,295 $148,197 $302,432 $(494,791) (2,121) $(2,996) $ (350) $(47,508)
======= ======== ======== ========= ====== ======= ======= ========
See notes to Consolidated Financial Statements.
48
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 27, 2003, DECEMBER 28, 2002 AND DECEMBER 29, 2001
1. BACKGROUND OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations -- Hanover Direct, Inc., a Delaware corporation (the
"Company"), is a specialty direct marketer, that markets a diverse portfolio of
branded home fashions, men's and women's apparel, and gift products, through
mail-order catalogs, retail stores and connected Internet Web sites directly to
the consumer ("direct commerce"). In addition, the Company continues to service
existing third party clients with business-to-business (B-to-B) e-commerce
transaction services. These services include a full range of order processing,
customer care, customer information, and shipping and distribution services.
The Company utilizes a fully integrated system and operations support
platform initially developed to manage the Company's wide variety of
catalog/Internet product offerings. This infrastructure is being utilized by the
aforementioned B-to-B e-commerce transaction services on behalf of third party
clients. Pursuant to Statement of Financial Accounting Standards ("SFAS") No.
131, "Disclosures about Segments of an Enterprise and Related Information"
("SFAS 131"), the Company began to report results for the consolidated
operations of Hanover Direct, Inc. as one segment commencing with the fiscal
year 2001 (See Note 10).
Basis of Presentation -- The consolidated financial statements include all
subsidiaries of the Company, and all intercompany transactions and balances have
been eliminated. The preparation of financial statements, in conformity with
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.
Fiscal Year -- The Company operates on a 52 or 53-week fiscal year, ending
on the last Saturday in December. The years ended December 27, 2003, December
28, 2002 and December 29, 2001 were reported as 52-week years.
Cash and Cash Equivalents -- Cash includes cash equivalents consisting of
highly liquid investments with an original maturity of ninety days or less.
Allowance for Doubtful Accounts -- An allowance for doubtful accounts is
calculated for the Company's accounts receivable. A combination of historical
and rolling bad debt rates are applied to the various receivables maintained by
the Company to determine the amount of the allowance to be recorded. The Company
also records additional specific allowances deemed necessary by management,
based on known circumstances related to the overall receivable portfolio.
Inventories -- Inventories consist principally of merchandise held for
resale and are stated at the lower of cost or market. Cost, which is determined
using the first-in, first-out (FIFO) method, includes the cost of the product as
well as freight-in charges. The Company considers slow moving inventory to be
surplus and calculates a loss on the impairment as the difference between an
individual item's cost and the net proceeds anticipated to be received upon
disposal. The Company utilizes various liquidation vehicles to dispose of aged
catalog inventory including special sale catalogs, sale sections within main
catalogs, sale sections on the Company's Internet Web sites, and liquidations
through off-price merchants. Such inventory is written down to its net
realizable value, if the expected proceeds of disposal are less than the cost of
the merchandise.
Prepaid Catalog Costs -- Prepaid catalog costs consist of direct response
advertising costs related to catalog production and mailing. In accordance with
Statement of Position 93-7, "Reporting on Advertising Costs," these costs are
deferred and amortized as selling expenses over the estimated period in which
the sales related to such advertising are generated. Total catalog expense was
$98.5 million, $104.1 million and $139.4 million for fiscal years 2003, 2002 and
2001, respectively.
49
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Merchandise Postage Expense -- Merchandise postage expense consists of the
cost to mail packages to the customer utilizing a variety of shipping services,
as well as the cost of packaging the merchandise for shipment. Total merchandise
postage expense for fiscal years 2003, 2002 and 2001 was $40.2 million, $42.0
million and $47.6 million, respectively. These costs are included in Cost of
sales and operating expenses in the Company's Consolidated Statements of Income
(Loss).
Depreciation and Amortization -- Depreciation and amortization of property
and equipment is computed on the straight-line method over the following lives:
buildings and building improvements, 30-40 years; furniture, fixtures and
equipment, 3-10 years; and leasehold improvements, over the estimated useful
lives or the terms of the related leases, whichever is shorter. Repairs and
maintenance are expensed as incurred.
Assets Held under Capital Leases -- Assets held under capital leases are
recorded at the lower of the net present value of the minimum lease payments or
the fair value of the leased asset at the inception of the lease. Amortization
expense is computed using the straight-line method over the shorter of the
estimated useful lives of the assets or the period of the related lease.
Goodwill, Net -- In July 2001, the Financial Accounting Standards Board
("FASB") issued SFAS No. 141, "Business Combinations" ("SFAS 141") and No. 142,
"Goodwill and Other Intangible Assets" ("SFAS 142"). SFAS 141 requires all
business combinations initiated after June 30, 2001 to be accounted for using
the purchase method. Under SFAS 142, goodwill and intangible assets with
indefinite lives are no longer amortized but are reviewed annually (or more
frequently if impairment indicators arise) for impairment. Separable intangible
assets that are not deemed to have indefinite lives will continue to be
amortized over their useful lives (but with no maximum life). Prior to the
adoption of SFAS 142, the excess of cost over the net assets of acquired
businesses was amortized on a straight-line basis over periods of up to forty
years.
Goodwill relates to the International Male and the Gump's brands and the
net balance at December 27, 2003 is $9.3 million. The Company adopted SFAS 142
effective January 1, 2002 and, as a result, has not recorded an amortization
charge for goodwill since that time. The Company obtained the services of an
independent appraisal firm during the second quarter ended June 28, 2003 to
assist in the assessment of its annual goodwill impairment. The results of the
appraisal indicated that goodwill was not impaired based upon the requirements
set forth in SFAS 142.
If the provisions under SFAS 142 had been implemented for the year ended
December 29, 2001 and the Company had not included an amortization charge for
goodwill, the Company's net loss would have decreased as follows (in thousands
of dollars, except per share amounts):
DECEMBER 29,
2001
------------
Net loss.................................................... $(5,845)
Exclusion of goodwill amortization per SFAS 142............. 430
-------
Net loss under provisions of SFAS 142....................... $(5,415)
-------
Net loss per share under provisions of SFAS 142 -- basic and
diluted................................................... $ (.08)
=======
Impairment of Long-lived Assets -- In accordance with SFAS No.144,
"Accounting for the Impairment or Disposal of Long-lived Assets" ("SFAS 144"),
the Company reviews long-lived assets, other than goodwill, for impairment
whenever events indicate that the carrying amount of such assets may not be
fully recoverable. The Company performs non-discounted cash flow analyses to
determine if impairment exists. If impairment is determined to exist, any
related impairment loss is calculated based on fair value, which is generally
based on discounted future cash flows.
Long-lived assets to be disposed of would be separately presented in the
balance sheet and reported at the lower of the carrying amount or fair value
less cost to sell, and are not depreciated while they are classified as
50
U.S.C. APP. 1-44 ISSUE
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
held for disposal. The assets and liabilities of a disposal group classified as
held for sale would be presented separately in the appropriate asset and
liability sections of the balance sheet. Impairment losses on assets to be
disposed, if any, are based on the estimated proceeds to be received, less costs
of disposal.
Prior to the adoption of SFAS 144, during fiscal 2002, the Company
accounted for long-lived assets and long-lived assets to be disposed of in
accordance with SFAS No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of."
Reserves related to loss contingencies and legal expenses -- The Company
accrues for loss litigation when management determines that it is probable that
an unfavorable outcome will result from the legal action and the loss is
reasonably estimable. The Company's policy is to accrue an amount equal to the
estimated potential loss, including associated legal fees.
Reserves related to the Company's strategic business realignment
program -- Reserves have been established for leased properties vacated by the
Company and currently subleased or available for sublease. For leases with
remaining terms of greater than one year, the Company records charges on a
discounted basis to reflect the present value of such costs to be incurred.
Properties for which reserves have been recorded include portions of the
corporate headquarters and administrative offices located in Weehawken, New
Jersey and in Edgewater, New Jersey; and the Gump's retail store located in San
Francisco, California.
Reserves related to employee health and welfare claims -- The Company
maintains a self-insurance program related to losses and liabilities associated
with employee health and welfare claims. Stop-loss coverage is held on both an
aggregate and individual claim basis; thereby, limiting the amount of losses the
Company will experience. Losses are accrued based upon estimates of the
aggregate liability for claims incurred using the Company's experience patterns.
Employee Benefits -- Vacation and Sick Compensation -- During June 2003,
the Company established and issued a new Company-wide vacation and sick policy
to better administer vacation and sick benefits. For purposes of the policy,
employees were converted to a fiscal year for earning vacation benefits. Under
the new policy, vacation benefits are deemed earned and thus accrued ratably
throughout the fiscal year and employees must utilize all vacation earned by the
end of the same year. Generally, any unused vacation benefits not utilized by
the end of a fiscal year will be forfeited. In prior periods, employees earned
vacation in the twelve months prior to the year that it would be utilized. The
policy has been modified in certain locations to comply with state and local
laws or written agreements. As a result of the transition to this new policy,
the Company has recognized a benefit of approximately $1.6 million for fiscal
year 2003. Approximately $0.8 million of general and administrative expenses was
reduced as a result of the recognition of this benefit for fiscal year 2003.
Approximately $0.8 million of operating expenses was reduced as a result of the
recognition of this benefit for fiscal year 2003.
Stock-Based Compensation -- The Company accounts for its stock-based
compensation to employees using the fair value-based methodology under SFAS No.
123, "Accounting for Stock-Based Compensation."
Income Taxes -- The Company accounts for income taxes in accordance with
SFAS No. 109, "Accounting for Income Taxes." SFAS No. 109 requires an asset and
liability approach for financial accounting and reporting of income taxes. The
provision for income taxes is based on income after adjustment for those
temporary and permanent items that are not considered in the determination of
taxable income. The gross deferred tax asset is the total tax benefit available
from net operating loss carryovers and reversals of temporary differences. A
valuation allowance is calculated, based on the Company's projections of its
future taxable income, to establish the amount of deferred tax asset that the
Company is expected to utilize on a "more-likely-than-not" basis. A deferred tax
liability represents future taxes that may be due arising from the reversal of
temporary differences. Due to a number of factors, including the annual
limitation on utilization of net operating losses caused by the Chelsey Direct,
LLC purchase of Richemont Finance, S.A.'s stockholdings in the Company during
the year (Note 8), and continued softness in the market for the Company's
products, management has lowered its projections of taxable income for fiscal
year 2004. As a result of this lower projection of future taxable income and the
annual limitation on the utilization of net operating losses, the Company made a
decision, during the quarter ended September 27, 2003, to fully reserve the
remaining net
51
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
deferred tax asset (the gross deferred tax asset net of the valuation allowance
and deferred tax liability) by increasing the valuation allowance via an $11.3
million deferred Federal income tax provision.
Net Loss Per Share -- Net loss per share is computed using the weighted
average number of common shares outstanding in accordance with the provisions of
SFAS No. 128, "Earnings Per Share." The weighted average number of shares used
in the calculation for both basic and diluted net loss per share for fiscal
years 2003, 2002 and 2001 was 144,387,672, 138,280,196 and 210,535,959 shares,
respectively. Diluted earnings per share equals basic earnings per share as the
dilutive calculation for preferred stock and stock options would have an
anti-dilutive impact as a result of the net losses incurred during fiscal years
2003, 2002 and 2001. The number of potentially dilutive securities excluded from
the calculation of diluted earnings per share were 31,146, 2,541,843 and 978,253
common share equivalents that represent options to purchase common stock in each
of the three fiscal years 2003, 2002 and 2001, respectively.
Revenue Recognition --
-- Direct Commerce: The Company recognizes revenue for catalog and
Internet sales upon shipment of the merchandise to customers and at the time of
sale for retail sales, each net of estimated returns. Postage and handling
charges billed to customers are also recognized as revenue upon shipment of the
related merchandise. Shipping terms for catalog and Internet sales are FOB
shipping point, and title passes to the customer at the time and place of
shipment. Prices for all merchandise are listed in the Company's catalogs and on
Internet Web sites and are confirmed with the customer upon order. The customer
has no cancellation privileges after shipment other than customary rights of
return that are accounted for in accordance with SFAS No. 48, "Revenue
Recognition When Right of Return Exists." The Company accrues for expected
future returns that relate to sales prior to the balance sheet date utilizing a
combination of historical and current trends. During October 2003, the Company
modified its returns policy, which previously allowed unlimited returns, by
adopting a policy that limits returns to a maximum of 90 days after the sale of
the merchandise. Because this policy change was recently adopted, it did not
impact the Company's total returns reserve for the fiscal year ended December
27, 2003, however, it could potentially impact the Company's future financial
results through a change in the Company's actual and estimated return rates.
-- Membership Services: Customers may purchase memberships in a number of
the Company's Buyers' Club programs for an annual fee. The Company defers
revenue recognition for membership fees received in its Buyers' Club programs
until the cancellation period ends. Thereafter, revenue net of actual
cancellations is recognized on a monthly basis over the remaining membership
period. The Company also receives commission revenue related to its solicitation
of the MemberWorks membership programs and Magazine Direct magazine subscription
programs. For the MemberWorks program, the Company is guaranteed a revenue
stream dependent upon the actual number of offers made. To the extent that the
program performs better than a pre-designated level, the Company will receive a
higher level of revenue than its guaranteed minimum. Revenue is recognized
monthly based on the number of acceptances received using a formula that has
been contractually agreed upon by the Company and MemberWorks. The commission
revenue recognized by the Company for the Magazine Direct magazine program is on
a per-solicitation basis according to the number of solicitations made, with
additional revenue recognized if the customer accepts the solicitation.
Collectively, the amount of revenues the Company recorded from these sources was
$5.7 million or 1.4% of net revenues, $5.1 million or 1.1% of net revenues, and
$4.8 million or 0.9% of net revenues for fiscal years 2003, 2002 and 2001,
respectively. As of May 2003, the Company discontinued its solicitation of the
Magazine Direct program. The Company will continue to consider opportunities to
offer new and different goods and services to its customers on inbound order
calls and the Company's Internet Web sites from time to time, with the Company
receiving commission revenue related to its solicitations.
-- B-to-B Services: Revenues from the Company's e-commerce transaction
services are recognized as the related services are provided. Customers are
charged on an activity unit basis, which applies a contractually specified rate
according to the type of transaction service performed. Revenues recorded from
52
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
the Company's B-to-B services were $20.0 million or 4.8% of net revenues, $20.1
million or 4.4% of net revenues, and $22.2 million or 4.2% of net revenues, for
fiscal years 2003, 2002 and 2001, respectively.
Fair Value of Financial Instruments -- The carrying amounts for cash and
cash equivalents, accounts receivable, accounts payable and the short-term debt
and capital lease obligations approximate fair value due to the short maturities
of these instruments. Additionally, the current value of long-term debt also
approximates fair value, as this debt bears interest at prevailing market rates.
NEW ACCOUNTING PRONOUNCEMENTS
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" ("SFAS 146"). SFAS 146 nullifies
Emerging Issues Task Force Issue No. 94-3 ("EITF 94-3"). SFAS 146 requires that
a liability for a cost associated with an exit or disposal activity be
recognized when the liability is incurred whereas, under EITF 94-3, the
liability was recognized at the commitment date to an exit plan. The Company has
adopted the provisions of SFAS 146 for exit or disposal activities initiated
after December 31, 2002.
In January 2003, the Securities and Exchange Commission issued a new
disclosure regulation, "Conditions for Use of Non-GAAP Financial Measures"
("Regulation G"), which is effective for all public disclosures and filings made
after March 28, 2003. Regulation G requires public companies that disclose or
release information containing financial measures that are not in accordance
with generally accepted accounting principles ("GAAP") to include in the
disclosure or release a presentation of the most directly comparable GAAP
financial measure and a reconciliation of the disclosed non-GAAP financial
measure to the most directly comparable GAAP financial measure. The Company
became subject to Regulation G in fiscal 2003 and believes that it is in
compliance with the new disclosure requirements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity"
("SFAS 150"). SFAS 150 establishes standards for how an issuer classifies and
measures certain financial instruments with characteristics of both liabilities
and equity. It requires that an issuer classify a financial instrument that is
within its scope as a liability, many of which had been previously classified as
equity or between the liabilities and equity sections of the consolidated
balance sheet. The provisions of SFAS 150 are effective for financial
instruments entered into or modified after May 31, 2003, and otherwise is
effective at the beginning of the first interim period beginning after June 15,
2003. It 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 has adopted the provisions of SFAS 150 and has been impacted by the
requirement to reclassify its Series B Participating Preferred Stock as a
liability as opposed to between the liabilities and equity sections of the
consolidated balance sheet. Based upon the requirements set forth by SFAS 150,
this reclassification was subject to implementation beginning on June 29, 2003.
Upon implementation of SFAS 150, the Company has reflected the accretion of the
preferred stock balance as an increase in Total Liabilities with a corresponding
reduction in capital in excess of par value, because the Company has an
accumulated deficit. Such accretion has been recorded as interest expense,
resulting in a decrease in Net Income (Loss) and Comprehensive Income (Loss) of
$7.6 million for the 52- weeks ended December 27, 2003. In addition, based upon
the Company's current projections for 2003, it is estimated the Company has not
incurred a tax reimbursement obligation for 2003 relating to the increases in
the Liquidation Preference of the Series B Participating Preferred Stock and has
filed for a refund of the $0.3 million Federal tax payment made in March 2003.
Due to the SFAS 150 requirements to reclassify the Series B Participating
Preferred Stock to liabilities and to record the accretion of the preferred
stock balance as interest expense, the refund has been treated as a decrease to
interest expense on the Consolidated Statements of Income (Loss) and an increase
of Capital in excess of par value on the Consolidated Balance Sheets. If SFAS
150 were applicable for fiscal year 2002, Net Loss and Comprehensive Loss would
have been $24.7 million. Net Income (Loss) Applicable to Common
53
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Shareholders and Net Income (Loss) Per Common Share remains unchanged in
comparison with the Company's classification of the instrument prior to June 29,
2003. In addition, there is no cumulative effect of a change in accounting
principle as a result of the implementation of SFAS 150. As of December 27,
2003, the implementation of SFAS 150 has increased Total Liabilities by
approximately $72.7 million. Shareholders' Deficiency remained unchanged since
the balance had previously been classified between Total Liabilities and
Shareholders' Deficiency on the Consolidated Balance Sheet. The classification
of the Series C Participating Preferred Stock as a liability under SFAS 150
should not change its classification as equity under state law.
2. DIVESTITURES
During 2001, the Company sold the following businesses and assets:
Sale of the 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) agreed to provide telemarketing
and fulfillment services for the Improvements business under a services
agreement with the buyer for a period of three years.
The asset purchase agreement between the Company and HSN provided that if
Keystone Internet Services, Inc. failed to perform its obligations during the
first two years of the services contract, the purchaser 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., HSN and The Chase Manhattan Bank as a
result of these contingencies. The balance in the escrow fund as of December 29,
2001, December 28, 2002 and December 27, 2003 were $2.6 million, $2.0 million
and $0.0 million, respectively.
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 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 Internet Services failed to
perform its obligations during the first two years of the services contract. In
consideration for the release, Keystone Internet Services issued a credit to HSN
for $100,000, which could be applied by HSN against any invoices of Keystone
Internet Services 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, which represented the excess of the net proceeds from the sale
over the net assets acquired by HSN, the goodwill associated with the
Improvements business and expenses related to the transaction. During fiscal
2002, the Company recognized approximately $0.6 million of the deferred gain
consistent with the terms of the escrow agreement. Proceeds related to the
deferred gain were received on July 2, 2002 and December 30, 2002 for $0.3
million and $0.3 million, respectively. The Company recognized the remaining net
deferred gain of $1.9 million upon the receipt of the escrow balance on March
28, 2003. This gain was reported net of the costs incurred to provide the credit
to HSN of approximately $0.1 million.
Sale of Kindig Lane Property. On May 3, 2001, as part of the Company's
strategic business realignment program, the Company sold its fulfillment
warehouse in Hanover, Pennsylvania (the "Kindig Lane Property") and certain
equipment located therein for $4.7 million to an unrelated third party.
Substantially all of the net proceeds of the sale were paid to Congress,
pursuant to the terms of the Congress Credit Facility, and applied to a partial
repayment of the Tranche A Term Loan made to Hanover Direct Pennsylvania, Inc.,
an affiliate of the Company, and to a partial repayment of the indebtedness
under the Congress Credit Facility. The Company realized a net gain on the sale
of approximately $1.5 million, which included the sale price net of
54
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
selling expenses in excess of the net book value of assets sold. The Company
continued to use the Kindig Lane Property under a lease agreement with the third
party, and leased a portion of the Kindig Lane Property through March 2003, at
which time, the Company moved its remaining operations to the Company's facility
in Roanoke, Virginia.
During 1999, the Company sold The Shopper's Edge. Transactions related to
this sale impact the fiscal years 2002 and 2001, which are presented below.
The Shopper's Edge. In March 1999, the Company, through a newly formed
subsidiary, established and promoted a discount buyers' club to consumers known
as "The Shopper's Edge." In exchange for an up-front membership fee, The
Shopper's Edge program enabled members to purchase a wide assortment of
merchandise at discounts that were not available through traditional retail
channels. Initially, prospective members participated in a 45-day trial period
that, unless canceled, was automatically converted into a full membership term,
which was one year in duration. Memberships were automatically renewed at the
end of each term unless canceled by the member. Effective December 1999, the
Company sold its interest in The Shopper's Edge subsidiary to an unaffiliated
third party for a nominal fair value based upon an independent appraisal. In
January 2000, the Company entered into a solicitation services agreement,
effectively amending and restating the original agreement to re-define the
parties and their roles under that agreement. The Company received $0.0 million
for fiscal year 2003 and $0.4 million and $2.5 million of fee revenue for fiscal
years 2002 and 2001, respectively, for solicitation services provided.
3. SPECIAL CHARGES
In December 2000, the Company began a strategic business realignment
program that resulted in the recording of special charges for severance,
facility exit costs and fixed asset write-offs. Special charges recorded in
fiscal years 2003, 2002 and 2001 relating to the strategic business realignment
program were $1.3 million, $4.4 million and $11.3 million, respectively. The
actions related to the strategic business realignment program were taken in an
effort to direct the Company's resources primarily towards a loss reduction
strategy and return to profitability.
For fiscal year 2001, the $11.3 million of special charges were related to
the strategic business realignment program that was initiated at the end of 2000
and consisted of severance ($4.2 million), facility exit costs ($3.8 million)
and asset write-offs ($3.3 million, all of which is non-cash).
In December 2001, the Company made a decision, as part of the continuing
implementation of the strategic business realignment program, to close its San
Diego telemarketing center in the first quarter of 2002. Accordingly, severance
costs include $0.3 million for associates of the telemarketing center whose jobs
were eliminated as a result. In addition severance costs recorded for the year
include $0.4 million for associates of the Kindig Lane Property whose jobs were
eliminated as a result of the sale of the facility in May 2001. The remainder of
the severance charges recorded in 2001, which amounted to $3.5 million,
represents the elimination of 442 FTE positions across all divisions of the
Company's business as part of the strategic business realignment program. In
October 2001, the Company determined it was more cost effective to relocate
certain of its operating and administrative functions from the first floor of
its facility in Weehawken, New Jersey to a previously closed space in Edgewater,
New Jersey and attempted to sublet the space vacated in Weehawken, New Jersey.
This amendment of the original plan resulted in an additional charge of $0.8
million for facility exit costs and a charge of $0.6 million for the write-off
of fixed assets related to the Weehawken location. In addition, special charges
totaling $0.2 million were recorded, primarily related to loan forgiveness of
certain of the severed associates.
In addition, the exit of the Maumelle and Kindig Lane buildings, as well as
the closing of the San Diego telemarketing center, resulted in special charges
of $3.7 million in addition to the aforementioned severance costs. The charges
related to the exit of the Maumelle facility included a $1.1 million addition to
the estimated loss on the lease provision and a $1.9 million fixed asset
write-down. The exit charges for the Kindig Lane Property building consisted of
a $0.5 million write-off for the impairment in value of the fixed assets located
in
55
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
that facility. Finally, the costs associated with closing the San Diego
telemarketing center included a write-down for the fixed assets of $0.1 million,
and a lease provision for the facility of $0.1 million.
The special charges recorded in 2001 also included $1.8 million to revise
estimated losses provided for sublease arrangements in connection with a retail
outlet store in San Diego that was previously closed and office facilities
located in San Francisco, California. The Company reduced its estimated loss on
the San Diego store lease by $0.4 million reflecting the locating of a subtenant
quicker than originally expected. This was more than offset by the charge
required for anticipated losses on sublease arrangements for the San Francisco
office space resulting from declining market values in that area of the country.
In May 2002, the Company entered into an agreement with the landlord and
the sublandlord to terminate its sublease of the Company's closed 497,200 square
foot warehouse and telemarketing facility located in Maumelle, Arkansas. The
agreement provided for the payment by the Company to the sublandlord of $1.6
million plus taxes through April 30, 2002 in the amount of $0.2 million. The
Company made all of the payments in four weekly installments between May 2, 2002
and May 24, 2002. Upon the satisfaction by the Company of all of its obligations
under the agreement, the sublease terminated and the Company was released from
all further obligations under the sublease. The Company's previously established
reserves for Maumelle, Arkansas were adequate based upon the terms of the final
settlement agreement.
In the first quarter of 2002, special charges relating to the strategic
business realignment program were recorded in the amount of $0.2 million. These
charges consisted primarily of severance costs related to the elimination of an
additional 10 FTE positions and costs associated with the Company's decision to
close a product storage facility located in San Diego, California. In September
2002, the Company continued to execute this program through the integration of
its The Company Store and Domestications divisions. As a result of the continued
actions needed to execute these plans, during the third quarter of 2002, an
additional $1.5 million of special charges were recorded. Of this amount, $1.3
million consisted of additional facility exit costs resulting primarily from the
integration of The Company Store and Domestications divisions, causing
management to reassess its plan to consolidate its office space utilization at
the corporate offices in New Jersey. The additional $0.2 million consisted of
further severance costs for an individual relating to the Company's strategic
business realignment program.
In the fourth quarter of 2002, special charges totaling $2.7 million were
recorded. Of this amount, $1.5 million was for severance costs, including $1.2
million for two of the Company's senior management members, $0.2 million was
associated with the elimination of 32 FTE positions in the Company's Hanover,
Pennsylvania fulfillment operation as a result of its consolidation into the
Company's Roanoke, Virginia facility in March 2003, and $0.1 million was for
additional severance costs and adjustments pertaining to the Company's previous
strategic business realignment initiatives. The remaining $1.2 million consisted
primarily of a $0.4 million credit reflecting the reduction of the deferred
rental liabilities applicable to the portions of the facilities previously
included in the Company's strategic business realignment program, and a $1.6
million charge in order to properly reflect the current marketability of such
facilities in the rental markets.
In the first quarter of 2003, special charges were recorded in the amount
of $0.3 million. These charges consisted primarily of additional severance costs
associated with the Company's strategic business realignment program. During the
second, third, and fourth quarters of 2003, special charges were recorded in the
amount of $0.2 million, $0.2 million and $0.6 million, respectively. These
charges were incurred primarily to revise estimated losses related to sublease
arrangements for 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.
56
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
At December 27, 2003 and December 28, 2002, liabilities of $2.4 million and
$3.3 million, respectively, were included within Accrued Liabilities, and
liabilities of $3.4 million and $4.7 million, respectively, were included within
Other Non-Current Liabilities. These liabilities relate to future payments in
connection with the Company's strategic business realignment program and consist
of the following (in thousands):
SEVERANCE & REAL ESTATE INFORMATION
PERSONNEL LEASE & TECHNOLOGY
COSTS EXIT COSTS LEASES TOTAL
----------- ----------- ----------- -------
Balance at December 30, 2000.............. $ 4,422 $ 7,558 $1,043 $13,023
2001 Expenses............................. 4,135 3,828 -- 7,963
Paid in 2001.............................. (6,011) (3,249) (670) (9,930)
------- ------- ------ -------
Balance at December 29, 2001.............. 2,546 8,137 373 11,056
2002 Expenses............................. 1,817 2,952 -- 4,769
Paid in 2002.............................. (2,911) (4,672) (210) (7,793)
------- ------- ------ -------
Balance at December 28, 2002.............. 1,452 6,417 163 8,032
2003 Expenses............................. 291 1,013 -- 1,304
Paid in 2003.............................. (1,538) (1,841) (163) (3,542)
------- ------- ------ -------
Balance at December 27, 2003.............. $ 205 $ 5,589 $ -- $ 5,794
======= ======= ====== =======
A summary of the liability related to Real Estate Lease and Exit Costs, by
location, as of the end of 2003 and 2002, is as follows (in thousands):
DECEMBER 27, DECEMBER 28,
2003 2002
------------ ------------
Gump's facility, San Francisco, CA.......................... $3,788 $3,349
Corporate facility, Weehawken, NJ........................... 1,447 2,325
Corporate facility, Edgewater, NJ........................... 261 439
Administrative and telemarketing facility, San Diego, CA.... 90 179
Retail store facilities, Los Angeles and San Diego, CA...... 3 125
------ ------
Total Lease and Exit Cost Liability......................... $5,589 $6,417
====== ======
4. ACCRUED LIABILITIES
Accrued liabilities consist of the following (in thousands):
DECEMBER 27, DECEMBER 28,
2003 2002
------------ ------------
Special charges............................................. $ 2,362 $ 3,327
Reserve for future sales returns............................ 2,165 1,888
Compensation and benefits................................... 4,341 11,614
Income and other taxes...................................... 258 1,003
Litigation and other........................................ 3,792 8,519
------- -------
Total.................................................. $12,918 $26,351
======= =======
57
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
5. DEBT
Debt consists of the following (in thousands):
AS RESTATED
DECEMBER 27, DECEMBER 28,
2003 2002
------------ ------------
Congress facility:
Term loans............................................... $ 8,689 $12,479
Capital lease obligations................................... 353 29
------- -------
Long-term debt $ 9,042 $12,508
Congress facility:
Term loans - Current portion............................. $ 3,792 $ 3,792
Revolver................................................. 8,997 8,819
Capital lease obligations - Current portion................. 679 10
------- -------
Short-term debt...................................... $13,468 $12,621
------- -------
Total debt........................................... $22,510 $25,129
======= =======
Changes to Congress Credit Facility -- On December 27, 2003, the Congress
Credit Facility contained a maximum credit line, subject to certain limitations,
of up to $56.5 million. In October 2003, the Company amended the Congress Credit
Facility to extend the expiration thereof from January 31, 2004 to January 31,
2007. The Congress Credit Facility, as amended, comprises a revolving loan
facility, a $17.5 million Tranche A Term Loan, and a $6.3 million Tranche B Term
Loan. Total cumulative borrowings under the Congress Credit Facility are subject
to limitations based upon specified percentages of eligible receivables and
eligible inventory, and the Company is required to maintain $3.0 million of
excess credit availability at all times. The Congress Credit Facility is secured
by assets of the Company and places restrictions on the incurrence of additional
indebtedness and on the payment of common stock dividends. As of December 27,
2003, the revolving loan facility of $9.0 million was recognized as a current
liability on the Company's Consolidated Balance Sheet. On or before April 30,
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.
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. As of December 27, 2003, the Company was not in compliance with
the working capital covenant; however, it has subsequently received a waiver
from Congress addressing the deficiency. The Company was in compliance with all
other covenants as of December 27, 2003. There can be no assurance that Congress
will waive any future non-compliance by the Company with the financial and other
covenants contained in the Congress Credit Facility which could result in a
default by the Company, allowing Congress to accelerate the amounts due under
the facility.
A summary of the amendments implemented during 2003 is as follows:
In February 2003, the Company amended the Congress Credit Facility to amend
the existing change in control Event of Default. The existing change in control
Event of Default under the Congress Credit Facility was based upon NAR Group
Limited, a former shareholder of the Company, ceasing to be the direct or
indirect beneficial owner of a sufficient number of issued and outstanding
shares of capital stock of the Company on a fully diluted basis to elect a
majority of the members of the Company's Board of Directors. This was replaced
during February 2003 with a new change in control Event of Default, which is
patterned on the Change In Control concepts in the Company's various Key
Executive Compensation Continuation Plans. The new Event of Default would be
triggered by certain transfers of assets, certain liquidations or dissolutions,
the acquisition by a person or group (other than a Permitted Holder, as defined)
of a majority of the total outstanding voting stock of the Company, and certain
changes in the composition of the Company's Board of Directors.
58
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In April 2003, the Company amended the Congress Credit Facility to allow
the Company's chief financial officer or its corporate controller to certify the
financial statements required to be delivered to Congress under the Congress
Credit Facility, rather than the chief financial officer of each subsidiary
borrower or guarantor.
In August 2003, the Company amended the Congress Credit Facility to make
certain technical amendments thereto, including the amendment of the definition
of Consolidated Net Worth and the temporary release of a $3.0 million
availability reserve established thereunder. The temporary release of the $3.0
million availability reserve was removed by the end of fiscal year 2003. The
amendment required the payment of fees in the amount of $165,000.
In October 2003, the Company amended the Congress Credit Facility to extend
the expiration thereof from January 31, 2004 to January 31, 2007, to reduce the
amount of revolving loans available thereunder to $43.0 million, to make
adjustments to the sublimits available to the various borrowers thereunder, to
amend the EBITDA covenant to specify minimum levels of EBITDA that must be
achieved during the Company's fiscal years ending 2004, 2005 and 2006, to permit
the borrowing under certain circumstances of up to $1.0 million against certain
inventory in transit to locations in the United States, and to make certain
other technical amendments. The amendment required the payment of fees in the
amount of $650,000.
On November 4, 2003, the Company amended the Congress Credit Facility to
change the definition of Consolidated Net Worth so as to provide that for the
purposes of calculating such amount for the Company's fiscal year ending
December 27, 2003, the Company's net deferred tax assets in the amount of $11.3
million that are required to be fully reserved pursuant to SFAS 109, shall be
added back for the purposes of determining the Company's assets.
On November 25, 2003, the Company amended the Congress Credit Facility to
receive consent from Congress in regards to the Recapitalization Agreement with
Chelsey (See Note 8) so that the Company could exchange 1,622,111 shares of
Series B Participating Preferred Stock held by Chelsey in consideration of the
issuance by the Company of 564,819 shares of newly issued Series C Participating
Preferred Stock and 81,857,833 shares of newly issued Common Stock to Chelsey.
In addition, the Company may repurchase, redeem or retire shares of its Series C
Participating Preferred Stock owned by Chelsey using a portion of the net
proceeds from any asset sales consummated after the implementation of all asset
sale lending adjustments. The Company also amended the Congress Credit Facility
to make certain technical amendments thereto, including the amendment of the
amounts of Consolidated Working Capital and Consolidated Net Worth. The
amendment required the payment of fees in the amount of $150,000.
The revolving loan facility bears interest at prime plus 0.5% or Eurodollar
plus 2.5%, the Tranche A Term Loans bear interest at prime plus 0.75% or
Eurodollar plus 3.5%, and the Tranche B Term Loans bear interest at prime plus
4.25%, but in no event less than 13.0%.
The Company has 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 is required to reclassify its
revolving loan facility from long-term to short-term debt, though the existing
revolving loan facility does not mature until January 31, 2007. As a result, the
Company has reclassified $8.8 million as of December 28, 2002 from Long-term
debt to Short-term debt and capital lease obligations that is classified as
Current liabilities. See Note 18 for further discussion regarding the
restatement of prior year borrowings outstanding under the Congress Credit
Facility.
As of December 27, 2003, the Company had $21.5 million of cumulative
borrowings outstanding under the Congress Credit Facility, comprising $9.0
million 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, $12.8 million is classified as short-term
with $8.7 million classified as long-term on the Company's
59
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Consolidated Balance Sheet. As of December 28, 2002, the Company had $25.1
million of borrowings outstanding under the Congress Credit Facility comprising
$8.8 million under the revolving loan facility, bearing an interest rate of
4.75%, $8.5 million under the Tranche A Term Loan, bearing an interest rate of
5.0%, and $7.8 million under the Tranche B Term Loan, bearing an interest rate
of 13.0%.
On March 25, 2004, the Company amended the Congress Credit Facility to
change the definition of Consolidated Net Worth, to amend the Consolidated
Working Capital and Consolidated Net Worth covenants to specify minimum levels
of Consolidated Working Capital and Consolidated Net Worth that must be
maintained during each month commencing January 2004, and to amend the EBITDA
covenant to specify minimum levels of EBITDA that must be achieved during the
Company's fiscal years ending 2004, 2005 and 2006. The Company expects to
maintain the minimum levels of these covenants in future periods. In addition,
the definition of "Event of Default" was amended by replacing the Event of
Default which would have occurred on the occurrence of a material adverse change
in the business, assets, liabilities or condition of the Company and its
subsidiaries, with an Event of Default which would occur if certain specific
events, such as a decrease in consolidated revenues beyond certain specified
levels or aging of inventory or accounts payable beyond certain specified
levels, were to occur.
Based on the provisions of EITF 95-22 and certain provisions in the credit
agreement, the Company is required to classify its revolving loan facility as
short-term debt.
Achievement of the Company's strategic business realignment program is
critical to the maintenance of adequate liquidity, as is compliance with the
terms and provisions of the Congress Credit Facility and the Company's ability
to operate effectively during the 2004 fiscal year. In the event of a softer
than expected economic climate, management has available several courses of
action to maintain liquidity and help maintain compliance with financial
covenants, including selective reductions in catalog circulation, additional
expense reductions and sales of non-core assets.
General -- At December 27, 2003, the aggregate annual principal payments
required on debt instruments (including capital lease obligations) are as
follows (in thousands): 2004 -- $13,468; 2005 -- $4,092; 2006 -- $3,840; and
thereafter -- $1,110.
6. SERIES A CUMULATIVE PARTICIPATING PREFERRED STOCK
On August 24, 2000, the Company issued 1.4 million shares of preferred
stock designated as Series A Cumulative Participating Preferred Stock to
Richemont, the then holder of approximately 47.9% of the Company's Common Stock,
for $70 million. The Series A Participating Preferred Stock had a par value of
$0.01 per share and a liquidation preference of $50.00 per share and was
recorded net of issuance costs of $2.3 million. The issuance costs were being
accreted as an additional dividend over a five-year period ending on the
mandatory redemption date. Dividends were cumulative and accrued at an annual
rate of 15%, or $7.50 per share, and were payable quarterly either in cash or
in-kind through the issuance of additional Series A Participating Preferred
Stock. Cash dividend payments were required for dividend payment dates occurring
after February 1, 2004. As of September 30, 2001, the Company had accrued
dividends of $12,389,700, and reserved 247,794 additional shares of Series A
Participating Preferred Stock for the payment of such dividends. In-kind
dividends and issuance cost accretion were charged against additional paid-in
capital, with a corresponding increase in the carrying amount of the Series A
Participating Preferred Stock. Cash dividends were also reflected as a charge to
additional paid-in capital, however, no adjustment to the carrying amount of the
Series A Participating Preferred Stock was made. The Series A Participating
Preferred Stock was generally non-voting, except if dividends had been in
arrears and unpaid for four quarterly periods, whether or not consecutive. The
holder of the Series A Participating Preferred Stock was entitled to receive
additional participating dividends in the event any dividends were declared or
paid, or any other distribution was made, with respect to the Common Stock of
the Company. The additional dividends would be equal to the applicable
percentage of the amount of the dividends or distributions payable in respect of
one share of Common Stock. In the event of a liquidation or dissolution of the
Company, the holder of the Series A
60
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Participating Preferred Stock would be paid an amount equal to $50.00 per share
of Series A Participating Preferred Stock plus the amount of any accrued and
unpaid dividends, before any payments to other shareholders.
The Company could redeem the Series A Participating Preferred Stock in
whole at any time and the holder of the Series A Participating Preferred Stock
could elect to cause the Company to redeem all or any of such holder's Series A
Participating Preferred Stock under certain circumstances involving a change of
control, asset disposition or equity sale. Mandatory redemption of the Series A
Participating Preferred Stock by the Company was required on August 23, 2005 at
a redemption price of $50.00 per share of Series A Participating Preferred Stock
plus the amount of any accrued and unpaid dividends.
On December 19, 2001, the Company consummated a transaction with Richemont.
In the Richemont Transaction, the Company repurchased from Richemont all of the
outstanding shares of the Series A Participating Preferred Stock and 74,098,769
shares of the Common Stock of the Company held by Richemont in return for the
issuance to Richemont of 1,622,111 shares of newly-created Series B
Participating Preferred Stock and the reimbursement of expenses of $1 million to
Richemont. Richemont agreed, as part of the transaction, to forego any claim it
had to the accrued but unpaid dividends on the Series A Participating Preferred
Stock. The Richemont Transaction was made pursuant to an Agreement, dated as of
December 19, 2001, between the Company and Richemont. As part of the Richemont
Transaction, the Company (i) released Richemont, the individuals appointed by
Richemont to the Board of Directors of the Company and certain of their
respective affiliates and representatives from any claims by or in the right of
the Company against any member of the Richemont Group which arise out of
Richemont's acts or omissions as a stockholder of or lender to the Company or
the acts or omissions of any Richemont board designee in his capacity as such
and (ii) entered into an Indemnification Agreement with Richemont pursuant to
which the Company agreed to indemnify each member of the Richemont Group from
any losses suffered as a result of any third party claim which is based upon
Richemont's acts as a stockholder of or lender to the Company or the acts or
omissions of any Richemont board designee in his capacity as such. The
Indemnification Agreement is not limited as to term and does not include any
limitations on maximum future payments thereunder. The impact of the Richemont
Transaction was to reflect the reduction of the Series A Participating Preferred
Stock for the then carrying amount of $82.4 million and the issuance of Series B
Participating Preferred Stock in the amount of $76.8 million which was equal to
the aggregate liquidation preference of the Series B Participating Preferred
Stock on December 19, 2001. In addition, the par value of $49.4 million of the
Common Stock repurchased by the Company and subsequently retired was reflected
as a reduction of Common Stock, with an offsetting increase to capital in excess
of par value. The Company recorded a net decrease in shareholders' deficiency of
$5.6 million as a result of the Richemont Transaction.
The shares of the Series A Participating Preferred Stock that were
repurchased from Richemont represented all of the outstanding shares of such
series. The Company filed a certificate in Delaware eliminating the Series A
Participating Preferred Stock from its Certificate of Incorporation.
7. SERIES B CUMULATIVE PARTICIPATING PREFERRED STOCK
On December 19, 2001, as part of the Richemont Transaction, 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.
The holders of the Series B Participating Preferred Stock were entitled to ten
votes per share on any matter on which the Common Stock voted. In addition, in
the event that the Company defaulted on its obligations arising in connection
with the Richemont Transaction, the Certificate of Designations of the Series B
Participating Preferred Stock or its agreements with Congress, or in the event
that the Company failed to redeem at least 811,056 shares of Series B
Participating Preferred Stock by August 31, 2003, then the holders of the Series
B Participating Preferred Stock, voting as a class, were entitled to elect two
members to the Board of Directors of the Company.
61
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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. During each period
set forth in the table below, the liquidation preference was equal to the amount
set forth opposite such period:
LIQUIDATION
PREFERENCE
PERIOD PER SHARE TOTAL VALUE
- ------ ----------- ---------------
March 1, 2002 -- May 31, 2002............................ $49.15 $ 79,726,755.65
June 1, 2002 -- August 31, 2002.......................... $51.31 $ 83,230,515.41
September 1, 2002 -- November 30, 2002................... $53.89 $ 87,415,561.79
December 1, 2002 -- February 28, 2003.................... $56.95 $ 92,379,221.45
March 1, 2003 -- May 31, 2003............................ $60.54 $ 98,202,599.94
June 1, 2003 -- August 31, 2003.......................... $64.74 $105,015,466.14
September 1, 2003 -- November 30, 2003................... $69.64 $112,963,810.04
December 1, 2003 -- February 29, 2004.................... $72.25 $117,197,519.75
March 1, 2004 -- May 31, 2004............................ $74.96 $121,593,440.56
June 1, 2004 -- August 31, 2004.......................... $77.77 $126,151,572.47
September 1, 2004 -- November 30, 2004................... $80.69 $130,888,136.59
December 1, 2004 -- February 28, 2005.................... $83.72 $135,803,132.92
March 1, 2005 -- May 31, 2005............................ $86.85 $140,880,340.35
As a result, beginning November 30, 2003, the aggregate liquidation
preference of the Series B Participating Preferred Stock would be effectively
equal to the aggregate liquidation preference of the Class A Participating
Preferred Stock previously held by Richemont (See Note 6).
For Federal income tax purposes, the increases in the liquidation
preference of the Series B Participating Preferred Stock were considered
distributions, by the Company to Richemont, deemed made on the commencement
dates of the quarterly increases, as discussed above. These distributions may
have been taxable dividends to Richemont, provided the Company had accumulated
or current earnings and profits ("E&P") for each year in which the distributions
were deemed to be made. Under the terms of the Richemont Transaction, the
Company was obligated to reimburse Richemont for any U.S. income tax incurred
pursuant to the Richemont Transaction. Based on the Company's past income tax
filings and its current income tax position, the Company had an E&P deficit as
of December 28, 2002 and December 27, 2003. Accordingly, the Company has not
incurred a tax reimbursement obligation for the years 2002 and 2003.
Dividends on the Series B Participating Preferred Stock were required to be
paid whenever a dividend was declared on the Common Stock. The amount of any
dividend on the Series B Participating Preferred Stock was determined by
multiplying (i) the amount obtained by dividing the amount of the dividend on
the Common Stock by the then current fair market value of a share of Common
Stock and (ii) the liquidation preference of the Series B Participating
Preferred Stock.
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. At the
option of the holders thereof, the Company was required to redeem the Series B
Participating Preferred Stock upon a Change of Control or upon the consummation
of an Asset Disposition or Equity Sale (all as defined in the Certificate of
Designations of the Series B Participating Preferred Stock). The redemption
price for the Series B Participating Preferred Stock upon a Change of Control or
upon the consummation of an Asset Disposition or Equity Sale was the then
applicable liquidation preference of the Series B Participating Preferred Stock
plus the amount of any declared but unpaid dividends on the Series B
Participating Preferred Stock. The Company's obligation to redeem the Series B
Participating Preferred Stock upon an Asset
62
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Disposition or an Equity Sale was subject to the satisfaction of certain
conditions set forth in the Certificate of Designations of the Series B
Participating Preferred Stock.
The Certificate of Designations of the Series B Participating Preferred
Stock provided that, for so long as Richemont was the holder of at least 25% of
the then outstanding shares of Series B Participating Preferred Stock, it would
be entitled to appoint a non-voting observer to attend all meetings of the Board
of Directors and any committees thereof.
Pursuant to the terms of the Certificate of Designations of the Series B
Participating Preferred Stock, the Company's obligation to pay dividends on or
redeem the Series B Participating Preferred Stock was subject to its compliance
with its agreements with Congress.
As a result of filings made by Richemont and certain related parties with
the SEC 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 Series B Participating
Preferred Stock for a purchase price equal to $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 purportedly succeeded to Richemont's rights in the Common
Shares 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 July 17, 2003, the Company filed an action in the Supreme Court of the
State of New York, County of New York (Index No. 03/602269) against Richemont
and Chelsey seeking a declaratory judgment as to whether Richemont improperly
transferred all of Richemont's securities in the Company consisting of the
Shares to Chelsey on or about May 19, 2003 and whether the Company could
properly recognize the transfer of those Shares from Richemont to Chelsey under
federal and/or state law. On October 27, 2003, the Court granted Chelsey's
motion for summary judgment and Richemont's motion to dismiss and ordered that
judgment be entered dismissing the case in its entirety. The Court also denied
Chelsey's and Richemont's motions for sanctions and Chelsey's motion to compel
production of certain documents.
On Thursday, August 7, 2003 representatives of Chelsey delivered to the
Company a document entitled "Recapitalization of Hanover Direct, Inc. Summary of
Terms" (the "Chelsey Proposal") and made a presentation to the Board of
Directors regarding the Chelsey Proposal. The Company's Board of Directors
referred the Chelsey Proposal to its Transactions Committee for consideration
with a view towards making a recommendation to the Board of Directors. The
Transactions Committee engaged financial advisors and counsel to assist it in
its deliberations with respect to the Chelsey Proposal. Negotiations between the
parties ensued in the weeks thereafter.
On November 10, 2003, the Company signed a Memorandum of Understanding with
Chelsey and Regan Partners, L.P. setting forth the agreement in principle to
recapitalize the Company, reconstitute the Board of Directors and settle
outstanding litigation between the Company and Chelsey. The Memorandum of
Understanding had been approved by the Transactions Committee of the Board of
Directors of the Company. The parties agreed to effect within ten days or as
soon thereafter as possible a binding Recapitalization Agreement that would,
upon the closing of the transactions set forth in the Recapitalization
Agreement, exchange 564,819 shares of a newly issued Series C Participating
Preferred Stock and 81,857,833 shares of newly issued Common Stock for the
1,622,111 shares of Series B Participating Preferred Stock then held by Chelsey,
subject to adjustment if the transaction was not consummated by December 17,
2003.
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
63
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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, and Mr. Donald Hecht was elected to the Company's Board of
Directors and the Audit Committee thereof. 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 (who
initially were Martin Edelman, William Wachtel, Stuart Feldman, Wayne Garten and
Donald Hecht) 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 (who initially
was Basil Regan). The right of Regan Partners to designate a nominee to the
Board of Directors shall terminate if Regan Partners ceases to own at least 75%
of the outstanding shares of Common Stock (as adjusted for stock splits, reverse
stock splits and the like) owned by Regan Partners as of November 10, 2003. All
shares for which the Company's management or Board of Directors hold proxies
(including undesignated proxies) will be voted in favor of the election of such
designees of Chelsey and Regan Partners, except as may otherwise be provided by
stockholders submitting such proxies. In the event that any Chelsey or Regan
Partners designee shall cease to serve as a director of the Company for any
reason, the Company will cause the vacancy resulting thereby to be filled by a
designee of Chelsey or Regan Partners, as the case may be, reasonably acceptable
to the Board of Directors as promptly as practicable. Chelsey may nominate or
propose for nomination or elect any persons to the Board of Directors, without
regard to the foregoing limitations, after the Series C Participating Preferred
Stock is redeemed in full.
The shares of Series B Participating Preferred Stock that were exchanged
with Chelsey for shares of Series C Participating Preferred Stock and additional
shares of Common Stock of the Company represented all of the outstanding shares
of Series B Participating Preferred Stock. The Company filed a certificate in
Delaware eliminating such series from its Certificate of Incorporation.
The transaction with Chelsey, including the issuance of the Series C
Participating Preferred Stock and the newly issued Common Stock to Chelsey, was
unanimously approved by the members of the Board of Directors of the Company and
the members of the Transactions Committee of the Board of Directors. In
addition, Congress executed an amendment to its Loan and Security Agreement with
the Company and its subsidiaries in which it consented to the transactions
between the Company and Chelsey and received a fee of $150,000. See Note 5.
Because its Series B Participating Preferred Stock was mandatorily
redeemable and thus accounted for as a liability, the Company accounted for the
exchange of 1,622,111 outstanding shares of its Series B Participating Preferred
Stock held by Chelsey for the issuance of 564,819 shares of newly-created Series
C Participating Preferred Stock and 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 Restructuring." 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 in equity.
64
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
8. 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 such
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.
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 anniversary of
the dividend commencement date 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 Company's credit
agreement with Congress currently prohibits 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, 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 Financial Corporation 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.
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.
9. CAPITAL STOCK
Richemont Transaction -- On December 19, 2001, as part of the Richemont
Transaction, the Company repurchased from Richemont 74,098,759 shares of the
Common Stock of the Company held by Richemont. As part of the transaction,
Richemont revoked the proxy that it then held to vote 4,289,000 shares of Common
Stock, which were owned by a third party.
65
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Recapitalization -- On November 30, 2003, as part of the Recapitalization
with Chelsey, the Company issued 81,857,833 shares of Common Stock to Chelsey.
General -- At December 27, 2003 and December 28, 2002, there were
222,294,562 and 140,436,729 shares of Common Stock issued and outstanding
(including treasury shares), respectively. Additionally, an aggregate of
14,251,446 shares of Common Stock were reserved for issuance pursuant to the
exercise of outstanding options at December 27, 2003.
Treasury stock consisted of 2,120,929 shares of Common Stock at both
December 27, 2003 and December 28, 2002, respectively. During fiscal year 2002,
the Company retained 20,000 shares of outstanding Common Stock held in escrow on
behalf of certain participants in the Company's Executive Equity Incentive Plan
whose rights, under the terms of the plan, have expired.
Dividend Restrictions -- The Company is restricted from paying dividends on
its Common Stock or from acquiring its capital stock by certain debt covenants
contained in agreements to which the Company is a party.
10. SEGMENT REPORTING
In prior years the Company reported two separate operating and reporting
segments: direct commerce and B-to-B e-commerce transaction services. In
conjunction with the Company's previously announced strategic business
realignment program, the Company has (1) terminated an intercompany services
agreement effective December 30, 2000, (2) ceased the Desius LLC business
operations and (3) closed the leased fulfillment and telemarketing facility in
Maumelle, Arkansas. As a result of these actions, the Company's B-to-B revenues
from fiscal 2001 and beyond are expected to be reduced and for the foreseeable
future will be limited to third party clients serviced by Keystone Internet
Services, LLC. Taken in conjunction with the Company's announced intention to
direct resources primarily towards growth in core brands, these actions have
caused the Company, pursuant to SFAS 131, to report results for the consolidated
operations of Hanover Direct, Inc. as one segment commencing in fiscal year
2001.
11. CHANGES IN MANAGEMENT AND EMPLOYMENT
Shull Employment Agreement. Effective December 5, 2000, Thomas C. Shull,
Meridian Ventures, LLC, a limited liability company controlled by Mr. Shull
("Meridian"), and the Company entered into a Services Agreement (the "December
2000 Services Agreement"). The December 2000 Services Agreement was replaced by
a subsequent services agreement, dated as of August 1, 2001 (the "August 2001
Services Agreement"), among Mr. Shull, Meridian and the Company, and a Services
Agreement, dated as of December 14, 2001 (the "2001 Services Agreement"), among
Mr. Shull, Meridian, and the Company. The 2001 Services Agreement was replaced
effective September 1, 2002 by an Employment Agreement between Mr. Shull and the
Company, dated as of September 1, 2002, as amended by Amendment No. 1 thereto,
dated as of September 1, 2002, Amendment No. 2 thereto, dated as of June 23,
2003, and Amendment No. 3 thereto, dated as of August 3, 2003 (as amended, the
"2002 Employment Agreement"), pursuant to which Mr. Shull is employed by the
Company as its President and Chief Executive Officer, as described below. The
term of the 2002 Employment Agreement began on September 1, 2002 and will
terminate on March 31, 2006 (the "2002 Employment Agreement Term").
Under the 2002 Employment Agreement, Mr. Shull is to receive from the
Company base compensation equal to $855,000 per annum, payable at the rate of
$71,250 per month, subject to certain exceptions described in the 2002
Employment Agreement ("Base Compensation"). Mr. Shull is to be provided with
participation in the Company's employee benefit plans, including but not limited
to the Company's Key Executive Eighteen Month Compensation Continuation Plan
(the "Change of Control Plan") and its transaction bonus program. The Company is
also to reimburse Mr. Shull for his reasonable out-of-pocket expenses incurred
in connection with his employment by the Company.
66
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Under the 2002 Employment Agreement, the Company paid the remaining unpaid
$300,000 of Mr. Shull's fiscal 2001 bonus under the Company's 2001 Management
Incentive Plan in December 2002. Mr. Shull also received the same bonus amount
for fiscal 2002 under the Company's 2002 Management Incentive Plan as all other
Level 8 participants (as defined in such plan) received under such plan for such
period, subject to all of the terms and conditions applicable generally to Level
8 participants thereunder. Mr. Shull earned an annual bonus for fiscal 2003
under the Company's 2003 Management Incentive Plan consistent with bonuses
awarded to other senior executives under such plan. Mr. Shull shall earn an
annual bonus for fiscal 2004 under such plan as the Company's Compensation
Committee may approve in a manner consistent with bonuses awarded to other
senior executives under such plan.
Under the 2002 Employment Agreement, the Company made two installment
payments in September and November 2002 to satisfy the obligation of $450,000 to
Mr. Shull previously due to be paid to Meridian on June 30, 2002. In addition,
the Company agreed to make two equal lump sum cash payments of $225,000 each to
Mr. Shull on March 31, 2003 and September 30, 2004, provided the 2002 Employment
Agreement has not terminated due to Willful Misconduct (as defined in the 2002
Employment Agreement) or material breach thereof by Mr. Shull, or Mr. Shull's
death or permanent disability. Such payments were to be made notwithstanding any
other termination of the Employment Agreement on or prior to such date or as a
result of another event constituting a Change of Control. The March 31, 2003
payment was made on or prior to such date. The Recapitalization constituted a
"change of control" under the 2002 Employment Agreement and Mr. Shull received a
payment in the amount of $225,000 in December 2003 under the terms of the 2002
Employment Agreement, representing an acceleration of the cash payment due in
September 2004.
Under the 2002 Employment Agreement, upon the closing of any transaction
which constitutes a "change of control" thereunder, provided that Mr. Shull is
then employed by the Company, the Company will be required to make a lump sum
cash payment to Mr. Shull on the date of such closing pursuant to the Change of
Control Plan, the Company's transaction bonus program and the Company's
Management Incentive Plan for the applicable fiscal year. Any such lump sum
payment would be in lieu of (i) any cash payment under the 2002 Employment
Agreement as a result of a termination thereof upon the first day after the
acquisition of the Company (whether by merger or the acquisition of all of its
outstanding capital stock) or the tenth day after the sale or any series of
sales since April 27, 2001 involving an aggregate of 50% or more of the market
value of the Company's assets (for this purpose under the 2002 Employment
Agreement, such 50% amount shall be deemed to be $107.6 million), and (ii) the
aggregate amount of Base Compensation to which Mr. Shull would have otherwise
been entitled through the end of the 2002 Employment Agreement Term. The
Recapitalization constituted a "change of control" under the 2002 Employment
Agreement and Mr. Shull received payments on December 5, 2003 and December 12,
2003 in the aggregate amount of $1,575,000 under the terms of the 2002
Employment Agreement, representing a $1,350,000 change of control payment and
the acceleration of a $225,000 cash payment due in September 2004. These amounts
were recorded as compensation to Mr. Shull. Mr. Shull will not be entitled to
any additional change of control payments under the 2002 Employment Agreement
relating to the Recapitalization transaction.
Under the 2002 Employment Agreement, additional amounts are payable to Mr.
Shull by the Company under certain circumstances upon the termination of the
2002 Employment Agreement. If the termination is on account of the expiration of
the 2002 Employment Agreement Term, Mr. Shull shall be entitled to receive such
amount of bonus as may be payable pursuant to the Company's applicable bonus
plan as well as employee benefits such as accrued vacation and insurance in
accordance with the Company's customary practice. If the termination is on
account of the Company's material breach of the 2002 Employment Agreement or the
Company's termination of the 2002 Employment Agreement where there has been no
Willful Misconduct (as defined in the 2002 Employment Agreement) or material
breach thereof by Mr. Shull, Mr. Shull shall be entitled to receive (i) a lump
sum payment equal to the aggregate amount of Base Compensation to which he would
have otherwise been entitled through the end of the 2002 Employment Agreement
Term (not to exceed 18 months of such Base Compensation), plus (ii) such
additional amount, if any, in severance pay which, when combined with the amount
payable pursuant to clause (i) equals
67
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
18 months of Base Compensation and such amount of bonus as may be payable
pursuant to the Company's 2002 Management Incentive Plan or other bonus plan, as
applicable (based upon the termination date and the terms and conditions of the
applicable bonus plan), as described in paragraph 4(b), as well as employee
benefits such as accrued vacation and insurance in accordance with the Company's
customary practice. If the termination is on account of the acquisition of the
Company (whether by merger or the acquisition of all of its outstanding capital
stock) or the sale or any series of sales since April 27, 2001 involving an
aggregate of 50% or more of the market value of the Company's assets (for this
purpose under the 2002 Employment Agreement, such 50% amount shall be deemed to
be $107.6 million) and the amount realized in the transaction is less than $0.50
per common share (or the equivalent of $0.50 per common share), and if and only
if the Change of Control Plan shall not then be in effect, Mr. Shull shall be
entitled to receive a lump sum payment equal to the aggregate amount of Base
Compensation to which he would have otherwise been entitled through the end of
the 2002 Employment Agreement Term. If the termination is on account of the
acquisition of the Company (whether by merger or the acquisition of all of its
outstanding capital stock) or the sale or any series of sales since April 27,
2001 involving an aggregate of 50% or more of the market value of the Company's
assets (for this purpose under the 2002 Employment Agreement, such 50% amount
shall be deemed to be $107.6 million) and the amount realized in the transaction
equals or exceeds $0.50 per common share (or the equivalent of $0.50 per common
share), and if and only if the Change of Control Plan shall not then be in
effect, Mr. Shull shall be entitled to receive a lump sum payment equal to the
greater of the Base Compensation to which he would have otherwise been entitled
through the end of the 2002 Employment Agreement Term or $1,000,000. If the
termination is on account of an acquisition or sale of the Company (whether by
merger or the acquisition of all of its outstanding capital stock) or the sale
or any series of sales since April 27, 2001 involving an aggregate of 50% or
more of the market value of the Company's assets (for this purpose under the
2002 Employment Agreement, such 50% amount shall be deemed to be $107.6 million)
and the Change of Control Plan shall then be in effect, Mr. Shull shall only be
entitled to receive his benefit under the Change of Control Plan. The
Recapitalization transaction was deemed a "change of control" for purposes of
the 2002 Employment Agreement and the Change of Control Plan. The Company was
permitted to make any payments thereunder on the closing of the
Recapitalization. Mr. Shull received payments on December 5, 2003 and December
12, 2003 in the aggregate amount of $1,575,000 under the terms of the 2002
Employment Agreement, representing a $1,350,000 change of control payment and
the acceleration of a $225,000 cash payment due in September 2004. These amounts
were recorded as compensation to Mr. Shull. Mr. Shull will not be entitled to
any additional change of control payments under the 2002 Employment Agreement
relating to the Recapitalization transaction.
Under the 2002 Employment Agreement, the Company is required to maintain
directors' and officers' liability insurance for Mr. Shull during the 2002
Employment Agreement Term. The Company is also required to indemnify Mr. Shull
in certain circumstances.
Amended Thomas C. Shull Stock Option Award Agreements. During December
2000, the Company entered into a stock option agreement with Thomas C. Shull to
evidence the grant to Mr. Shull of an option to purchase 2.7 million shares of
the Company's common stock (the "Shull 2000 Stock Option Agreement"). Effective
as of September 1, 2002, the Company amended the Shull 2000 Stock Option
Agreement to (i) extend the final expiration date for the stock option under the
Shull 2000 Stock Option Agreement to June 30, 2005, and (ii) replace all
references therein to the December 2000 Services Agreement with references to
the 2002 Employment Agreement. Effective as of August 3, 2003, the 2002
Employment Agreement was amended to extend the final expiration date for the
stock option under the Shull 2000 Stock Option Agreement to March 31, 2006.
During December 2001, the Company entered into a stock option agreement
with Mr. Shull to evidence the grant to Mr. Shull of an option to purchase
500,000 shares of the Company's Common Stock under the Company's 2000 Management
Stock Option Plan (the "Shull 2001 Stock Option Agreement"). Effective as of
September 1, 2002, the Company has amended the Shull 2001 Stock Option Agreement
to (i) provide that any shares purchased by Mr. Shull under the Shull 2001 Stock
Option Agreement would not be saleable until
68
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
September 30, 2004, and (ii) replace all references therein to the 2001 Services
Agreement with references to the 2002 Employment Agreement.
Amended Thomas C. Shull Transaction Bonus Letter. During May 2001, Thomas
C. Shull entered into a letter agreement with the Company (the "Shull
Transaction Bonus Letter") under which he would be paid a bonus on the
occurrence of certain transactions involving the sale of certain of the
Company's businesses. Effective as of September 1, 2002, the Company has amended
the Shull Transaction Bonus Letter to (i) increase the amount of Mr. Shull's
agreed to base salary for purposes of the transaction bonus payable thereunder
from $600,000 to $900,000, and (ii) replace all references therein to the
December 2000 Services Agreement with references to the 2002 Employment
Agreement.
The Recapitalization transaction was deemed a "change of control" for
purposes of the Shull Transaction Bonus Letter. The Company was permitted to
make any payments thereunder on or after the closing of the Recapitalization.
Mr. Shull received an additional $450,000 payment on December 5, 2003 under the
terms of the Shull Transaction Bonus Letter.
Issuance of Stock Options. On August 8, 2002, the Company issued options
to purchase 3,750,000 shares of the Company's Common Stock to certain Management
Incentive Plan ("MIP") Level 7 and 8 employees, including various executive
officers, at a price of $0.24 per share and services rendered under the
Company's 2000 Management Stock Option Plan. In addition, on August 8, 2002, the
Company authorized the President to grant options to purchase up to an aggregate
of 1,045,000 and 1,366,000 shares of the Company's Common Stock to certain MIP
Level 4 and MIP Level 5 and 6 employees, respectively, at a price of $0.24 per
share and services rendered under the Company's 2000 Management Stock Option
Plan.
On October 2, 2002, the Company issued options to purchase 600,000 shares
of the Company's Common Stock to an Executive Vice President at a price of $0.27
per share and services rendered under the Company's 2000 Management Stock Option
Plan.
On September 29, 2003, the Company issued options to purchase an aggregate
of 100,000 shares of the Company's Common Stock to two newly-elected Board
members at a price of $0.27 per share and services rendered.
On August 1, 2003, the Company issued options to purchase an aggregate of
210,000 shares of the Company's Common Stock to the then existing six board
members at a price of $0.25 per share and services rendered and options to
purchase 35,000 shares at a price of $0.25 per share and services rendered to a
consultant to the Company per their agreement.
On July 29, 2003, the Company issued options to purchase an aggregate of
100,000 shares of the Company's Common Stock to two newly-elected Board members
at a price of $0.25 per share and services rendered.
Charles F. Messina. During September 2002, Charles F. Messina resigned as
Executive Vice President, Chief Administrative Officer and Secretary of the
Company. In connection with such resignation, the Company and Mr. Messina
entered into a severance agreement dated September 30, 2002 providing for cash
payments of $884,500 and other benefits which were accrued in the fourth quarter
of 2002.
Brian C. Harriss. Brian C. Harriss was appointed as Executive Vice
President, Human Resources and Legal and Secretary of the Company effective
December 2, 2002 and as Executive Vice President, Finance and Administration
effective November 11, 2003. Prior to January 2002, Mr. Harriss had served the
Company as Executive Vice President and Chief Financial Officer. In connection
with the December 2002 appointment, Mr. Harriss and the Company terminated a
severance agreement entered into during January 2002 at the time of Mr. Harriss'
resignation from the Company during January 2002, and Mr. Harriss waived his
rights to certain payments under such severance agreement. Effective February
15, 2004, the position of Executive Vice President, Finance and Administration
was eliminated in connection with the Company's ongoing strategic business
realignment program. In connection with such change, Mr. Harriss and the Company
69
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
entered into a severance agreement dated February 15, 2004 providing for
$545,000 of cash payments, as well as other benefits that were accrued and paid
in the first quarter of 2004. Mr. Harriss is also entitled to receive a payment
under the Company's 2003 Management Incentive Plan.
Chief Financial Officer. On November 3, 2003, Charles E. Blue was
appointed Chief Financial Officer of the Company effective November 11, 2003,
replacing Edward M. Lambert as Chief Financial Officer effective on such date in
connection with the Company's ongoing strategic business realignment program.
Mr. Blue joined the Company in 1999 and had most recently served as Senior Vice
President, Finance, a position eliminated by the strategic business realignment
program. Mr. Lambert continued to serve as Executive Vice President of the
Company until January 2, 2004. In connection with such change, Mr. Lambert and
the Company entered into a severance agreement dated November 4, 2003 providing
for $640,000 of cash payments, as well as other benefits that were accrued and
paid in the fourth quarter of 2003. Mr. Lambert is also entitled to receive a
payment under the Company's 2003 Management Incentive Plan.
Other Executives. In October 2002, the Company entered into arrangements
with Edward M. Lambert, Brian C. Harriss and Michael D. Contino (the
"Compensation Continuation Agreements") pursuant to which it agreed to provide
eighteen months of severance pay, COBRA reimbursement and Exec-U-Care plan
coverage in the event their employment with the Company was terminated either by
the Company other than "For Cause" or by them "For Good Reason" (as such terms
are defined). On November 6, 2002, the Company also entered into a Compensation
Continuation Agreement with Frank Lengers pursuant to which it agreed to provide
twelve months of severance pay, COBRA reimbursement and Exec-U-Care plan
coverage in the event his employment with the Company was terminated either by
the Company "For Cause" or by Mr. Lengers "For Good Reason" (as such terms are
defined).
Hanover Direct, Inc. Key Executive Eighteen-Month Compensation Continuation
Plan. Effective April 27, 2001, the Company terminated the Hanover Direct, Inc.
Key Executive Thirty-Six Month Compensation Continuation Plan and the Hanover
Direct, Inc. Key Executive Twenty-Four Month Compensation Plan. Effective April
27, 2001, the Company established the Hanover Direct, Inc. Key Executive
Eighteen Month Compensation Continuation Plan (the "Executive Plan") for its
Chief Executive Officer, corporate executive vice presidents, corporate senior
vice presidents, strategic unit presidents, and other employees selected by its
Chief Executive Officer. The purpose of the Executive Plan is to attract and
retain key management personnel by reducing uncertainty and providing greater
personal security in the event of a Change of Control. For purposes of the
Executive Plan, a "Change of Control" will occur: (i) when any person becomes,
through an acquisition, the beneficial owner of shares of the Company having at
least 50% of the total number of votes that may be cast for the election of
directors of the Company (the "Voting Shares"); provided, however, that the
following acquisitions shall not constitute a Change of Control: (a) if a person
owns less than 50% of the voting power of the Company and that person's
ownership increases above 50% solely by virtue of an acquisition of stock by the
Company, then no Change of Control will 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 date of
the establishment of the Executive Plan owned at least 33% of the Voting Shares;
(ii)(a) notwithstanding the foregoing, a Change of Control will occur when the
stockholders of the Company approve any of the following (each, a
"Transaction"): (I) any reorganization, merger, consolidation or other business
combination of the Company; (II) any sale of 50% or more of the market value of
the Company's assets (for this purpose, 50% is deemed to be $107.6 million); or
(III) a complete liquidation or dissolution of the Company; (b) notwithstanding
(ii)(a), stockholder approval of either of the following types of Transactions
will not give rise to a Change of Control: (I) a Transaction involving only the
Company and one or more of its subsidiaries; or (II) a Transaction immediately
following which the stockholders of the Company immediately prior to the
Transaction continue to have a majority of the voting power in the resulting
entity; (iii) when, within any 24-month period, persons who were directors of
the Company (each, a "Director") immediately before the beginning of such period
(the "Incumbent Directors") 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 (iii), any
Director who
70
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
was not a Director as of the effective date of the Executive Plan will be deemed
to be an Incumbent Director if such Director was elected to the Board of
Directors by, or on the recommendation of, or with the approval of, at least a
majority of the members of the Board of Directors or the nominating committee
who, at the time of the vote, qualified as Incumbent Directors either actually
or by prior operation of (iii), and any persons (and their successors from time
to time) who are designated by a holder of 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 effective date of the Executive Plan shall be
considered Incumbent Directors. Notwithstanding the foregoing, any director
elected to the Board of Directors to avoid or settle a threatened or actual
proxy contest shall not, under any circumstances, be deemed to be an Incumbent
Director); or (iv) when the Company sells, assigns or transfers more than 50% of
its interest in, or the assets of, one or more of its subsidiaries (each, a
"Sold Subsidiary" and, collectively, the "Sold Subsidiaries"); provided,
however, that such a sale, assignment or transfer will constitute a Change of
Control only for: (a) the Executive Plan participants who are employees of that
Sold Subsidiary; and (b) the Executive Plan participants who are employees of a
direct or indirect parent company of one or more Sold Subsidiaries, and then
only if: (I) the gross assets of such parent company's Sold Subsidiaries
constitute more than 50% of the gross assets of such parent company (calculated
on a consolidated basis with the direct and indirect subsidiaries of such parent
company and with reference to the most recent balance sheets of the Sold
Subsidiaries and the parent company); (II) the property, plant and equipment of
such parent company's Sold Subsidiaries constitute more than 50% of the
property, plant and equipment of such parent company (calculated on a
consolidated basis with the direct and indirect subsidiaries of such parent
company and with reference to the most recent balance sheets of the Sold
Subsidiaries and the parent company); or (III) in the case of a publicly-traded
parent company, the ratio (as of the date a binding agreement for the sale is
entered) of (x) the capitalization (based on the sale price) of such parent
company's Sold Subsidiaries, to (y) the market capitalization of such parent
company, is greater than 0.50. (For purposes of (iv), a Transaction shall be
deemed to involve the sale of more than 50% of a company's assets if: (a) the
gross assets being sold constitute more than 50% of the gross assets of the
Company as stated on the most recent balance sheet of the Company; (b) the
property, plant and equipment being sold constitute more than 50% of the
property, plant and equipment of the Company as stated on the most recent
balance sheet of the Company; or (c) in the case of a publicly-traded company,
the ratio (as of the date a binding agreement for the sale is entered) of (x)
the capitalization (based on the sale price) of the division, subsidiary or
business unit being sold, to (y) the market capitalization of the Company, is
greater than 0.50. For purposes of this (iv), no Change of Control will be
deemed to have occurred if, immediately following a sale, assignment or transfer
by the Company of more than 50% of its interest in, or the assets of, a Sold
Subsidiary, any stockholder of the Company owning 33% or more of the voting
power of the Company immediately prior to such transactions, owns no less than
the equivalent percentage of the voting power of the Sold Subsidiary.)
Under the Executive Plan, an Executive Plan participant shall be entitled
to Change of Control Benefits under the Executive Plan solely if there occurs a
Change of Control (which occurred on the closing of the Recapitalization) and
thereafter the Company terminates his/her employment other than For Cause (as
defined in the Executive Plan) or the participant voluntarily terminates his/her
employment with the Company For Good Reason (as defined in the Executive Plan),
in either case, solely during the 2-year period immediately following the Change
of Control. A participant will not be entitled to Change of Control Benefits
under the Executive Plan if: (i) he/she voluntarily terminates his/her
employment with the Company or has his/her employment with the Company
terminated by the Company, in either case, prior to a Change of Control, (ii)
he/she voluntarily terminates employment with the Company following a Change of
Control but other than For Good Reason, (iii) he/she is terminated by the
Company following a Change of Control For Cause, (iv) has his/her employment
with the Company terminated solely on account of his/her death, (v) he/she
voluntarily or involuntarily terminates his/her employment with the Company
following a Change of Control as a result of his/her Disability (as defined in
the Executive Plan), or (vi) his/her employment with the Company is terminated
by the Company upon or following a Change of Control but where he/she
71
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
receives an offer of comparable employment, regardless of whether the
participant accepts the offer of comparable employment.
The Change of Control Benefits under the Executive Plan are as follows: (i)
an amount equal to 18 months of the participant's annualized base salary; (ii)
an amount equal to the product of 18 multiplied by the applicable monthly
premium that would be charged by the Company for COBRA continuation coverage for
the participant, the participant's spouse and the dependents of the participant
under the Company's group health plan in which the participant was participating
and with the coverage elected by the participant, in each case immediately prior
to the time of the participant's termination of employment with the Company;
(iii) an amount equal to 18 months of the participant's car allowance then in
effect as of the date of the termination of the participant's employment with
the Company; and (iv) an amount equal to the cost of 12 months of
executive-level outplacement services at a major outplacement services firm.
The Recapitalization transaction was a "Change of Control" for purposes of
the Executive Plan.
Hanover Direct, Inc. Directors Change of Control Plan. Effective May 3,
2001, the Company's Board of Directors established the Hanover Direct, Inc.
Directors Change of Control Plan (the "Directors Plan") for all Directors of the
Company except for (i) any Director who is also an employee of the Company for
purposes of the Federal Insurance Contributions Act; or (ii) any persons (and
their successors from time to time) who are designated by a holder of
thirty-three percent (33%) or more of the Voting Shares to stand for election
and serve as a Director. For purposes of the Directors Plan, a "Change of
Control" will occur upon the occurrence of the first of any of the events
specified in item (i), (ii) or (iii) of the definition of "Change in Control"
under the Executive Plan, as discussed above.
A participant in the Directors Plan shall be entitled to receive a Change
of Control Payment under the Directors Plan if there occurs a Change of Control
and he/she is a Director on the effective date of such Change of Control. A
Change of Control Payment under the Directors Plan shall be an amount equal to
the greater of (i) $40,000 or (ii) 150% of the sum of the annual retainer fee,
meeting fees and per diem fees paid to a Director for his/her service on the
Board of Directors of the Company during the 12-month period immediately
preceding the effective date of the Change of Control.
The Recapitalization transaction was a "Change of Control" for purposes of
the Directors Plan. The Company was permitted to make all payments thereunder on
or after the closing of the Recapitalization. On December 18, 2003, each of the
eight non-employee directors (Messrs. Brown, James, Krushel, Sonnenfeld, Masson,
Regan, Garten and Edelman) received a payment in the amount of $87,000 under the
terms of the Directors Plan.
Change in Control Payments. Pursuant to the Recapitalization Agreement,
upon completion of the Recapitalization, there was a "change in control" of the
Company for purposes of all of the Company's existing Compensation Continuation
(Change of Control) Plans, including the Directors Change of Control Plan, the
Employment Agreement, dated as of September 1, 2002, as amended, between the
Company and Mr. Shull and the Transaction Bonus Letters between the Company and
the following executive officers: Mr. Shull, Mr. Contino and Mr. Harriss. Mr.
Shull received payments on December 5, 2003 and December 12, 2003 in the
aggregate amount of $1,575,000 under the terms of the 2002 Employment Agreement.
See "Employment Contracts, Termination of Employment and Change-in-Control
Arrangements -- 2002 Employment Agreement." In December 2003, Messrs. Shull,
Harriss and Contino received payments in the amount of $450,000, $168,500 and
$193,500, respectively, under the terms of the Transaction Bonus Letters to
which they are a party. See "Employment Contracts, Termination of Employment and
Change-in-Control Arrangements -- Transaction Bonus Letters." On December 18,
2003, each of the eight non-employee directors (Messrs. Brown, James, Krushel,
Sonnenfeld, Masson, Regan, Garten and Edelman) received a payment in the amount
of $87,000 under the terms of the Hanover Direct, Inc. Directors Change of
Control Plan. See "Employment Contracts, Termination of Employment and
Change-in-Control Arrangements -- Hanover Direct, Inc. Directors Change of
Control Plan." All of such amounts were treated as compensation to the
recipients.
72
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Transaction Bonus Letters. During May 2001, each of Thomas C. Shull,
Jeffrey Potts, Brian C. Harriss and Michael D. Contino, and during November
2002, each of Edward M. Lambert and Brian C. Harriss (each, a "Participant")
entered into a letter agreement with the Company (a "Transaction Bonus Letter")
under which the Participant would be paid a bonus on the occurrence of certain
transactions involving the sale of certain of the Company's businesses. In
addition, Mr. Shull is a party to a "Letter Agreement" with the Company, dated
April 30, 2001, pursuant to which, following the termination of the December
2000 Services Agreement, in the event he is terminated without cause during any
period of his continued employment as the Chief Executive Officer of the
Company, he shall be paid one year of his annual base salary (the "Shull
Termination Payment"). Effective June 1, 2001, the Company amended the Executive
Plan to provide that, notwithstanding anything to the contrary contained in the
Executive Plan, Section 10.2 of the Executive Plan shall not be effective with
respect to the payment of (i) a Participant's "Transaction Bonuses," and/or (ii)
the Shull Termination Payment. The payment of any such "Transaction Bonus" to
any of the Participants, and/or the payment of the Shull Termination Payment,
shall be paid in addition to, and not in lieu of, any Change of Control Benefit
payable to any Participant or Mr. Shull pursuant to the terms of the Executive
Plan. In conjunction with his resignation as Executive Vice President and Chief
Financial Officer, Mr. Harriss released any claims that he may have against the
Company under his May 2001 Transaction Bonus Letter, although he entered into a
new Transaction Bonus Letter in November 2002. The remaining Transaction Bonus
Letters (with Messrs. Shull, Harriss and Contino), other than the Transaction
Bonus Letter with Messrs. Potts, Messina and Lambert, remain in effect.
The Recapitalization transaction was deemed a "change of control" for
purposes of the Transaction Bonus Letters. The Company was permitted to make all
payments thereunder on the closing of the Recapitalization. On December 5 and
12, 2003, Messrs. Shull, Harriss and Contino received payments in the aggregate
amount of $450,000, $168,500 and $193,500, respectively, under the terms of the
Transaction Bonus Letters to which they are a party. Mr. Lambert did not receive
any bonus payment in connection with the Recapitalization under the terms of the
Transaction Bonus Letter to which he is a party because he waived his rights
thereunder pursuant to his severance agreement with the Company.
Letter Agreement with Mr. Shull and Meridian. On April 30, 2001, Mr.
Shull, Meridian and the Company entered into a letter agreement (the "Letter
Agreement") specifying Mr. Shull's rights under the Executive Plan, which is
discussed above. Under the Letter Agreement, Mr. Shull and Meridian agreed that,
so long as the Executive Plan is in effect and Mr. Shull is a Participant
thereunder, Meridian and Mr. Shull will accept the Change in Control Benefits
provided for in the Executive Plan in lieu of the compensation contemplated by
the December 2000 Services Agreement between them (which benefits amounts will
not be offset against the December 2000 flat fee provided for in the December
2000 Services Agreement and shall be payable at such times and in such amounts
as provided in the Executive Plan rather than in a lump sum payable within five
business days after the termination date of the December 2000 Services Agreement
as contemplated by the December 2000 Services Agreement). For purposes of the
change in control benefits under the Executive Plan and the Letter Agreement,
Mr. Shull's annualized base salary is $600,000. In addition to the benefits
provided by the December 2000 Services Agreement, Mr. Shull and those persons
named in the December 2000 Services Agreement shall also be entitled to the
optional cash out of stock options as provided in the Executive Plan. Under the
Letter Agreement, Mr. Shull is also entitled to payment of one year annual base
salary in the event he is terminated without cause during any period of his
continued employment as the Chief Executive Officer of the Company following the
termination of the December 2000 Services Agreement. The participation and
benefits to which Mr. Shull is entitled under the Executive Plan shall also
survive the termination of the December 2000 Services Agreement pursuant to the
terms thereof in the event that Mr. Shull is still employed as the Chief
Executive Officer of the Company and is a Participant under the Executive Plan.
Should the Executive Plan no longer be in effect or Mr. Shull no longer be a
Participant thereunder, Meridian and Mr. Shull shall continue to be entitled to
the compensation contemplated by the December 2000 Services Agreement. The
Letter Agreement was superseded by the 2002 Employment Agreement.
73
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
2002 Directors' Option Plan. Effective January 1, 2003, the 2002 Stock
Option Plan for Directors was amended to increase the annual service award for
Directors who are not employees of the Company from 25,000 to 35,000 options to
purchase shares of Common Stock. In November 2003, the 2002 Stock Option Plan
for Directors was amended to increase the maximum number of shares of Common
Stock that may be delivered or purchased under the plan from 500,000 to 900,000.
Stock Option Plans. Pursuant to the Company's Compensation Continuation
(Change of Control) Plans, upon the closing of the Recapitalization, all stock
options previously granted pursuant to the Company's stock option plans to the
Participants under such Change of Control Plans by the Company became fully
exercisable as of November 30, 2003 (the closing date of the Recapitalization),
whether or not otherwise exercisable and vested as of that date.
Salary Reduction. The Company effected salary reductions of 5% of base pay
for participants in its 2003 Management Incentive Plan, including Executive
Officers, effective with the pay period starting August 3, 2003. These salary
reductions are being restored to those participants at or below the
Vice-President level effective March 28, 2004.
Vacation and Sick Policies. During June 2003, the Company established and
implemented a new Company-wide vacation and sick policy applicable to all
employees, including Executive Officers, to better administer vacation and sick
benefits (see Note 1 of the Consolidated Financial Statements).
Michael D. Contino. In January 1998, the Company made a $75,000
non-interest bearing loan to Michael D. Contino, currently the Company's
Executive Vice President and Chief Operating Officer, for the purchase by Mr.
Contino of a new principal residence in the state of New Jersey. The terms of
the loan agreement, as amended, included a provision for the Company to forgive
the original amount of the principal on the fifth anniversary of the loan. The
loan was secured by the residence that the proceeds were used to purchase. The
loan was forgiven in full in accordance with its terms during January 2003. In
addition to the loan forgiveness, the Company paid all applicable withholding
taxes totaling $64,063.
Martin L. Edelman. Mr. Edelman resigned as a member of the Board of
Directors and the Committees thereof on which he served effective February 15,
2004.
12. EMPLOYEE BENEFIT PLANS
The Company maintains several defined contribution (401-k) plans that are
available to all employees of the Company and provide employees with the option
of investing in the Company's Common Stock. The Company matches a percentage of
employee contributions to the plans up to $10,000. Matching contributions for
all plans were $0.5 million, $0.5 million and $0.6 million for fiscal years
2003, 2002 and 2001, respectively.
13. INCOME TAXES
At December 27, 2003, the Company had net operating loss carryforwards
("NOLs") totaling $356.9 million, which expire between 2004 and 2023. On May 19,
2003 the Company had a change in control, as defined by Internal Revenue Code
Section 382. The Company's available NOLs consist of $355.6 million of NOLs
subject to a $3.0 million annual limitation under Section 382 and $1.3 million
of NOLs not subject to a limitation. The unused portion of the $3.0 million
annual limitation for any year may be carried forward to succeeding years to
increase the annual limitation for those succeeding years. At December 27, 2003,
$59.5 million of NOLs are utilizable prior to expiration and the remaining
$297.4 million of NOLs may expire unused.
SFAS 109 requires management to assess the realizability of the Company's
deferred tax assets. Realization of the future tax benefits is dependent, in
part, on the Company's ability to generate taxable income within the carry
forward period and the periods in which net temporary differences reverse.
Future levels of operating income and taxable income are dependent upon general
economic conditions, competitive pressures on sales and margins, postal and
other delivery rates, and other factors beyond the Company's
74
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
control. Accordingly, no assurance can be given that sufficient taxable income
will be generated for utilization of NOLs and reversals of temporary
differences. Based upon the Company's assessment of these factors, including its
history of past losses and future operating plans, management has reduced its
estimate of the NOLs that it believes the Company will be able to utilize.
Management believes that the $3.7 million deferred tax asset (excluding the $3.7
million deferred tax liability), as of December 27, 2003, represents a "more-
likely-than-not" estimate of the future utilization of the NOLs and the reversal
of temporary differences. The valuation allowance increased by $4.5 million in
2003 and $6.4 million in 2002. Management will continue to routinely evaluate
the likelihood of future profits and the necessity of future adjustments to the
valuation allowance.
The Company's Federal income tax provision consists of $11.3 million of
deferred income tax for 2003, $3.7 million of deferred income tax for 2002 and
zero for fiscal 2001. The Company's current state income tax provision was
$28,000 in 2003, $91,000 in 2002 and $120,000 in 2001.
The components of the net deferred tax asset at December 27, 2003 are as
follows (in millions):
2003 2002
-------------------------- --------------------------
NON- NON-
CURRENT CURRENT TOTAL CURRENT CURRENT TOTAL
------- ------- ------ ------- ------- ------
DEFERRED TAX ASSETS
Federal tax NOL and business tax credit
carry forwards........................... $ 1.9 $123.1 $125.0 $ 1.7 $127.5 $129.2
Allowance for doubtful accounts............ 0.4 -- 0.4 0.5 -- 0.5
Inventories................................ 0.2 -- 0.2 0.2 -- 0.2
Property and equipment..................... -- 5.1 5.1 -- 4.1 4.1
Mailing lists and trademarks............... -- 0.3 0.3 -- 0.3 0.3
Accrued liabilities........................ 1.2 -- 1.2 4.3 0.7 5.0
Customer prepayments and credits........... 1.5 -- 1.5 1.6 -- 1.6
Deferred gain on sale of Improvements
catalog.................................. -- -- -- 0.7 -- 0.7
Deferred rent credits...................... 1.0 1.5 2.5 -- 1.5 1.5
Other...................................... -- -- -- 0.4 -- 0.4
----- ------ ------ ----- ------ ------
Total...................................... 6.2 130.0 136.2 9.4 134.1 143.5
Valuation allowance........................ 6.0 126.5 132.5 7.6 120.4 128.0
----- ------ ------ ----- ------ ------
Deferred tax asset, net of valuation
allowance................................ 0.2 3.5 3.7 1.8 13.7 15.5
----- ------ ------ ----- ------ ------
DEFERRED TAX LIABILITIES
Prepaid catalog costs...................... (2.4) -- (2.4) (2.9) -- (2.9)
Excess of net assets of acquired
business................................. -- (1.3) (1.3) -- (1.3) (1.3)
----- ------ ------ ----- ------ ------
Deferred tax liability..................... (2.4) (1.3) (3.7) (2.9) (1.3) (4.2)
----- ------ ------ ----- ------ ------
Net deferred tax (liability) asset......... $(2.2) $ 2.2 $ 0.0 $(1.1) $ 12.4 $ 11.3
===== ====== ====== ===== ====== ======
75
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company's effective tax rate for the three fiscal years presented
differs from the Federal statutory income tax rate due to the following:
2003 2002 2001
PERCENT OF PERCENT OF PERCENT OF
PRE-TAX PRE-TAX PRE-TAX
LOSS LOSS LOSS
---------- ---------- ----------
Tax benefit at Federal statutory rate....................... (35.0)% (35.0)% (35.0)%
State and local taxes, net of Federal benefit............... 0.4 1.1 0.5
Permanent differences:
$1 million salary limit and stock option compensation..... 29.6 23.9 3.4
Non-deductible interest expense on Series B Preferred
Stock.................................................. 62.2 -- --
Other permanent differences............................... (3.6) 4.0 0.8
Change in valuation allowance............................... 224.7 77.0 31.1
----- ----- -----
Tax expense at effective tax rate........................... 278.3% 71.0% 0.8%
===== ===== =====
14. LEASES
Certain leases to which the Company is a party provide for payment of real
estate taxes and common area maintenance by the Company. Most leases are
accounted for as operating leases and include various renewal options with
specified minimum rentals. Rental expense for operating leases related to
ongoing operations, net of sublease income, was as follows (in thousands):
YEAR ENDED
-------------------------
2003 2002 2001
------ ------ -------
Minimum rentals by lease type:
Land and building......................................... $4,798 $4,682 $ 6,030
Computer equipment........................................ 1,359 3,516 4,510
Plant, office and other................................... 548 446 500
------ ------ -------
Minimum rentals............................................. $6,705 $8,644 $11,040
Sublease income............................................. -- (53) (22)
------ ------ -------
Net minimum rentals......................................... $6,705 $8,591 $11,018
====== ====== =======
Future minimum lease payments under non-cancelable operating leases
relating to ongoing operations, by lease type, that have initial or remaining
terms in excess of one year, together with the present value of the net minimum
lease payments as of December 27, 2003, are as follows and which extend to 2010
(in thousands):
LAND
AND COMPUTER PLANT OFFICE
YEAR ENDING BUILDINGS EQUIPMENT AND OTHER TOTAL
- ----------- --------- --------- ------------ -------
2004.............................................. $ 4,571 $374 $452 $ 5,397
2005.............................................. 2,665 130 169 2,964
2006.............................................. 1,937 9 46 1,992
2007.............................................. 1,868 -- 12 1,880
2008.............................................. 1,844 -- -- 1,844
Thereafter (extending to 2010).................... 2,142 -- -- 2,142
------- ---- ---- -------
Total minimum lease payments.............. $15,027 $513 $679 $16,219
======= ==== ==== =======
76
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company leases certain machinery and equipment under agreements that
are classified as capital leases. The cost of equipment under capital leases is
included in the Balance Sheet as Furniture, fixtures and equipment and was
$1,505,312 and $46,162 at December 27, 2003 and December 28, 2002, respectively.
Accumulated amortization of the leased equipment at December 27, 2003 and
December 28, 2002 was $434,661 and $4,098, respectively. The future minimum
lease payments as of December 27, 2003 are as follows (in thousands):
YEAR ENDING TOTAL
- ----------- ------
2004...................................................... $ 734
2005...................................................... 317
2006...................................................... 49
2007...................................................... 4
------
Total minimum lease payments...................... $1,104
Less:
Amount representing interest........................... (72)
------
Present value of net minimum lease payments............... 1,032
Less:
Current maturities of capital lease obligations........ (679)
------
Long-term capital lease obligations....................... $ 353
======
The Company has established reserves for certain future minimum lease
payments under noncancelable operating leases due to restructuring of business
operations related to such leases. The future commitments under such leases, net
of related sublease income under noncancelable subleases, as of December 27,
2003 are as follows (in thousands):
MINIMUM
LEASE SUBLEASE NET LEASE
YEAR ENDING COMMITMENTS INCOME COMMITMENTS
- ----------- ----------- -------- -----------
2004.................................................... $2,943 $ (987) $1,956
2005.................................................... 1,624 (423) 1,201
2006.................................................... 1,002 (196) 806
2007.................................................... 1,002 (119) 883
2008.................................................... 1,003 (120) 883
Thereafter (extending to 2010).......................... 1,170 (140) 1,030
------ ------- ------
Total minimum lease payments.................... $8,744 $(1,985) $6,759
====== ======= ======
The future minimum lease payments under non-cancelable leases that remain
from the Company's discontinued restaurant operations as of December 27, 2003 as
follows (in thousands):
MINIMUM
LEASE SUBLEASE
YEAR ENDING PAYMENTS INCOME
- ----------- -------- --------
2004...................................................... $481 $(434)
2005...................................................... 385 (359)
2006...................................................... 72 (100)
---- -----
Total minimum lease payments...................... $938 $(893)
==== =====
77
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
15. STOCK-BASED COMPENSATION PLANS
The Company has established several stock-based compensation plans for the
benefit of its officers and employees. As discussed in the Summary of
Significant Accounting Policies (Note 1), the Company applies the
fair-value-based methodology of SFAS No. 123 and, accordingly, has recorded
stock compensation expense of $1.1 million, $1.3 million and $1.8 million for
fiscal 2003, 2002 and 2001, respectively. The information below details each of
the Company's stock compensation plans, including any changes during the years
presented.
1999 Stock Option Plan for Directors -- During August 1999, the Board of
Directors adopted the 1999 Stock Option Plan for Directors providing stock
options to purchase shares of Common Stock of the Company to certain eligible
directors who were neither employees of the Company nor non-resident aliens (the
"Directors' Option Plan"). The Directors' Option Plan was ratified by the
Company's shareholders at the 2000 Annual Meeting of Shareholders. The Company
may issue stock options to purchase up to 700,000 shares of Common Stock to
eligible directors at an exercise price equal to the fair market value as of the
date of grant. An eligible director shall receive a stock option grant to
purchase 50,000 shares of Common Stock as of the effective date of his/her
initial appointment or election to the Board of Directors. Furthermore, on each
Award Date, defined as August 4, 2000 or August 3, 2001, eligible directors were
granted stock options to purchase an additional 10,000 shares of Common Stock.
Stock options granted have terms of 10 years and shall vest and become
exercisable over three (3) years from the date of grant. Payment for shares
purchased upon exercise of options shall be in cash or stock of the Company.
Options outstanding, granted and the weighted average exercise prices under
the Directors' Option Plan are as follows:
1999 STOCK OPTION PLAN FOR DIRECTORS
2003 2002 2001
------------------- ------------------- --------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
-------- -------- -------- -------- --------- --------
Options outstanding, beginning
of period..................... 420,000 $1.62 370,000 $1.78 420,000 $2.13
Granted.................... -- -- 50,000 .38 80,000 .30
Exercised.................. -- -- -- -- -- --
Forfeited.................. -- -- -- -- (130,000) 1.98
-------- -------- ---------
Options outstanding, end of
period........................ 420,000 $1.62 420,000 $1.62 370,000 $1.78
======== ===== ======== ===== ========= =====
Options exercisable, end of
period........................ 366,667 $1.80 316,667 $2.02 253,332 $2.15
======== ===== ======== ===== ========= =====
Weighted average fair value of
options granted............... $ -- $ .29 $ .22
======== ======== =========
The fair value of each option granted is estimated on the date of grant
using the Black-Scholes option-pricing model. The weighted average assumptions
for grants in fiscal 2002 and 2001 under the Directors' Option Plan were as
follows: risk-free interest rate of 4.70% and 4.88%, expected volatility of
89.28% and 83.93%, expected life of six years, and no expected dividends.
78
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following table summarizes information about stock options outstanding
at December 27, 2003 under the Directors' Option Plan:
1999 STOCK OPTION PLAN FOR DIRECTORS
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------ ----------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
EXERCISE PRICES OUTSTANDING LIFE PRICE EXERCISABLE PRICE
- --------------- ----------- ----------- -------- ----------- --------
$0.20............................... 20,000 7.6 $ .20 16,667 $ .20
$0.36............................... 50,000 7.6 $ .36 33,333 $ .36
$0.38............................... 50,000 8.0 $ .38 16,667 $ .38
$1.00............................... 50,000 2.9 $1.00 50,000 $1.00
$2.35............................... 250,000 2.5 $2.35 250,000 $2.35
------- -------
420,000 4.0 $1.62 366,667 $1.80
======= === ===== ======= =====
2002 Stock Option Plan for Directors -- During 2002, the Board of Directors
adopted the 2002 Stock Option Plan for Directors providing stock options to
purchase shares of Common Stock of the Company to certain non-employee directors
(the "2002 Directors' Option Plan"). The 2002 Directors' Option Plan was
ratified by the Company's shareholders at the 2002 Annual Meeting of
Shareholders and was amended during November 2002 and again in November 2003.
The Company may issue stock options to purchase up to 900,000 shares of Common
Stock to eligible directors at an exercise price equal to the fair market value
as of the date of grant. An eligible director shall receive a stock option grant
to purchase 50,000 shares of Common Stock as of the effective date of his/her
initial appointment or election to the Board of Directors. On each Award Date,
defined as August 2, 2002, August 1, 2003, or August 3, 2004, eligible directors
are to be granted stock options to purchase additional shares of Common Stock.
On August 2, 2002, each eligible director was granted stock options to purchase
an additional 25,000 shares of Common Stock. For the August 1, 2003 and August
3, 2004 Award Dates, each eligible director is to be granted stock options to
purchase an additional 35,000 shares of Common Stock. Stock options granted have
terms of 10 years and shall vest and become exercisable over three (3) years
from the date of grant; however, due to the change in control effective November
18, 2003, certain options fully vested and became exercisable immediately.
Payment for shares purchased upon exercise of options shall be in cash or stock
of the Company.
79
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Options outstanding, granted and the weighted average exercise prices under
the 2002 Directors' Option Plan are as follows:
2002 STOCK OPTION PLAN FOR DIRECTORS
2003 2002
------------------- -------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
EXERCISE EXERCISE
SHARES PRICE SHARES PRICE
-------- -------- -------- --------
Options outstanding, beginning of period............. 100,000 $.23 -- $ --
Granted......................................... 610,000 .24 100,000 .23
Exercised....................................... -- -- -- --
Forfeited....................................... -- -- -- --
-------- --------
Options outstanding, end of period................... 710,000 $.24 100,000 $.23
======== ==== ======== ====
Options exercisable, end of period................... 471,666 $.24 -- $ --
======== ==== ======== ====
Weighted average fair value of options granted....... $ .18 $ .16
======== ========
The fair value of each option granted is estimated on the date of grant
using the Black-Scholes option-pricing model. The weighted average assumptions
for grants in fiscal 2003 and 2002 under the 2002 Directors' Option Plan were as
follows: risk-free interest rate of 3.64% and 3.76%, respectively, expected
volatility of 90.74% and 89.36%, respectively, expected life of six years, and
no expected dividends.
The following table summarizes information about stock options outstanding
at December 27, 2003 under the 2002 Directors' Option Plan:
2002 STOCK OPTION PLAN FOR DIRECTORS
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------ ----------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
EXERCISE PRICE OUTSTANDING LIFE PRICE EXERCISABLE PRICE
- -------------- ----------- ----------- -------- ----------- --------
$.20................................ 50,000 9.0 $.20 50,000 $.20
$.22................................ 150,000 9.9 $.22 100,000 $.22
$.23................................ 100,000 8.6 $.23 66,666 $.23
$.25................................ 310,000 9.6 $.25 155,000 $.25
$.27................................ 100,000 9.8 $.27 100,000 $.27
------- -------
710,000 9.5 $.24 471,666 $.24
======= === ==== ======= ====
1993 Executive Equity Incentive Plan -- In December 1992, the Board of
Directors adopted the 1993 Executive Equity Incentive Plan (the "Incentive
Plan"). The Incentive Plan was approved by the Company's shareholders at the
1993 Annual Meeting of Shareholders. The Incentive Plan encouraged executives to
acquire and retain a significant ownership stake in the Company. Under the
Incentive Plan, executives were given an opportunity to purchase shares of
Common Stock with up to 80% of the purchase price financed with a six-year full
recourse Company loan, which bore interest at the mid-term applicable federal
rate as determined by the Internal Revenue Service. The Incentive Plan
participants purchased shares of Common Stock at prices ranging from $0.69 to
$4.94, with the Company accepting notes bearing interest at rates ranging from
5.00% to 7.75%. For each share of stock an employee purchased, he/she received
stock options to acquire two additional shares of Common Stock, up to a maximum
of 250,000 shares in the aggregate. The
80
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
stock options, which were granted by the Compensation Committee of the Board of
Directors, vested after three years and expired after six years. On December 31,
1996, the Incentive Plan was terminated in accordance with its terms, and no
additional Common Stock was purchased or stock options granted. As of December
27, 2003 and December 28, 2002, no stock options remained outstanding or
exercisable related to the Incentive Plan.
Changes to the notes receivable principal balances related to the Incentive
Plan are as follows:
1993 EXECUTIVE EQUITY INCENTIVE PLAN
2003 2002 2001
-------- -------- --------
Notes Receivable balance, beginning of period............... $269,400 $313,400 $324,400
Payments.................................................... -- -- --
Forfeitures................................................. -- (44,000) (11,000)
-------- -------- --------
Notes Receivable balance, end of period..................... $269,400 $269,400 $313,400
======== ======== ========
Common Stock is being held in escrow as collateral on behalf of each
remaining participant of the Incentive Plan and may be transferred to and
retained by the Company in satisfaction of the aforementioned promissory notes,
which are no longer required to be settled. Furthermore, the related
participants have forfeited their initial 20% cash down payment, which was
required for entry into the Incentive Plan.
Management Stock Option Plans -- The Company approved for issuance to
employees 20,000,000 shares of the Company's Common Stock pursuant to the
Company's 2000 Management Stock Option Plan and 7,000,000 shares of the
Company's Common Stock pursuant the Company's 1996 Stock Option Plan. Under both
plans, the option exercise price is equal to the fair market value as of the
date of grant. However, for stock options granted to an employee owning more
than 10% of the total combined voting power of all classes of Company stock, the
exercise price is equal to 110% of the fair market value of the Company's Common
Stock as of the grant date. Stock options granted to an individual employee
under the 2000 Management Stock Option Plan may not exceed 1,000,000 shares of
the Company's Common Stock. Stock options granted to an individual employee
under the 1996 Stock Option Plan may not exceed 500,000 shares of the Company's
Common Stock and may be performance-based. All options granted must be
specifically identified as incentive stock options or non-qualified stock
options, as defined in the Internal Revenue Code. Furthermore, the aggregate
fair market value of Common Stock for which an employee is granted incentive
stock options that first became exercisable during any given calendar year shall
be limited to $100,000. To the extent such limitation is exceeded, the option
shall be treated as a non-qualified stock option. Stock options may be granted
for terms not to exceed 10 years and shall be exercisable in accordance with the
terms and conditions specified in each option agreement. In the case of an
employee who owns stock possessing more than 10% of the total combined voting
power of all classes of stock, the options must become exercisable within 5
years. Due to the change in control transaction effective November 18, 2003,
certain options fully vested and became exercisable immediately. Payment for
shares purchased upon exercise of options shall be in cash or stock of the
Company.
81
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
For the 1996 and 2000 management Stock Option Plans, options outstanding,
granted and the weighted average exercise prices are as follows:
1996 AND 2000 MANAGEMENT STOCK OPTION PLANS
2003 2002 2001
----------------------- ----------------------- -----------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
----------- -------- ----------- -------- ----------- --------
Options outstanding,
beginning of
period............. 9,230,270 $.81 3,962,778 $2.46 9,240,947 $2.41
Granted......... 65,000 .23 6,761,000 .24 30,000 .20
Exercised....... -- -- -- -- (10,000) .20
Forfeited....... (1,073,824) .81 (1,493,508) 2.60 (5,298,169) 2.36
----------- ----------- -----------
Options outstanding,
end of period...... 8,221,446 $.81 9,230,270 $ .81 3,962,778 $2.46
=========== ==== =========== ===== =========== =====
Options exercisable,
end of period...... 8,029,196 $.82 1,913,270 $2.18 2,406,362 $2.12
=========== ==== =========== ===== =========== =====
Weighted average fair
value of options
granted............ $ .16 $ .18 $ .15
=========== =========== ===========
The fair value of each option granted is estimated on the date of grant
using the Black-Scholes option-pricing model. The weighted average assumptions
for grants in fiscal 2003, 2002 and 2001 are as follows: risk-free interest rate
of 3.58%, 3.81% and 4.96%, respectively, expected volatility of 90.96%, 89.58%
and 83.93%, respectively, expected lives of six years for fiscal years 2003,
2002 and 2001, and no expected dividends.
The following table summarizes information about stock options outstanding
at December 27, 2003 under both the 1996 and 2000 Management Stock Option Plans:
1996 AND 2000 MANAGEMENT STOCK OPTION PLANS
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------------- -----------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
RANGE OF EXERCISE PRICES OUTSTANDING LIFE PRICE EXERCISABLE PRICE
- ------------------------ ----------- ----------- -------- ----------- --------
$ .20 to $1.01...................... 6,499,283 8.5 $ .26 6,309,533 $ .26
$1.43 to $1.75...................... 198,332 1.3 $1.47 198,332 $1.47
$2.37 to $2.94...................... 219,000 3.2 $2.47 219,000 $2.47
$3.00 to $3.50...................... 1,304,831 4.7 $3.17 1,302,331 $3.17
--------- ---------
8,221,446 7.5 $ .81 8,029,196 $ .82
========= === ===== ========= =====
The Chief Executive Officer Stock Option Plans -- Stock-based plans were
granted in 1996 for the benefit of Rakesh K. Kaul, the former Chief Executive
Officer of the Company (the "CEO"). In each of the plans, the option price
represents the average of the low and high fair market values of the Common
Stock on August 23, 1996, the date of the closing of the Company's 1996 Rights
Offering.
82
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
On December 5, 2000, the CEO resigned, resulting in the right to exercise
the outstanding options for 12 months thereafter. No options were exercised by
the CEO on or before December 5, 2001. There were no options outstanding and
exercisable under these plans as of December 27, 2003.
The details of the plans are as follows:
The CEO Tandem Plan -- Pursuant to the Company's Tandem Plan (the "Tandem
Plan"), the right to purchase an aggregate of 1,000,000 shares of Common Stock
and an option to purchase 2,000,000 shares of Common Stock was approved for
issuance to the CEO. The option was subject to anti-dilution provisions and due
to the Company's 1996 Rights Offering was adjusted to 1,510,000 shares of Common
Stock and 3,020,000 options. Due to the resignation of the CEO in December 2000,
1,510,000 Tandem Plan shares of Common Stock were transferred and, to date, the
Company has treated the transfers as satisfying a promissory note of
approximately $0.7 million owed by the CEO to the Company. The Company recorded
these shares as treasury stock. There were no options outstanding and
exercisable under the Tandem Plan at December 27, 2003.
The CEO Performance Year Plan -- Pursuant to the Company's Performance Year
Plan (the "Performance Plan"), an option to purchase an aggregate of 1,000,000
shares of Common Stock was approved for issuance to the CEO in 1996. The options
were based upon performance as defined by the Compensation Committee of the
Board of Directors. Should a performance target not be attained, the option is
carried over to the succeeding year in conjunction with that year's option until
the expiration date. The options expire 10 years from the date of grant and vest
over four years. Payment for shares purchased upon the exercise of the options
shall be in cash or stock of the Company. Due to the resignation of the CEO on
December 5, 2000 and the absence of an exercise of the outstanding options for
12 months thereafter, the options were forfeited on December 5, 2001. No options
were outstanding and exercisable under the Performance Plan at December 27,
2003.
The CEO Closing Price Option Plan -- Pursuant to the Company's Closing
Price Option Plan (the "Closing Price Plan"), an option to purchase an aggregate
of 2,000,000 shares of Common Stock was approved for issuance to the CEO in
1996. The options expire 10 years from the date of grant and will become vested
upon the Company's stock price reaching a specific target over a consecutive
91-calendar day period as defined by the Compensation Committee of the Board of
Directors. In May 1998, the Compensation Committee of the Board of Directors
reduced the target per share market price at which the Company's Common Stock
had to trade in consideration of the dilutive effect of the increase in
outstanding shares from the date of the grant. The performance period has a
range of six years beginning August 23, 1996, the date of the closing of the
1996 Rights Offering. Due to the resignation of the CEO on December 5, 2000 and
the absence of an exercise of the outstanding options for 12 months thereafter,
the options were forfeited on December 5, 2001. No options were outstanding and
exercisable under the Closing Price Plan at December 27, 2003.
The CEO Six Year Stock Option Plan -- Pursuant to NAR's Six Year Stock
Option Plan (the "Six Year Plan"), an option to purchase an aggregate of 250,000
shares of Common Stock was granted to the CEO by NAR Group Limited ("NAR") in
1996. The option was subject to anti-dilution provisions and due to the
Company's 1996 Rights Offering was adjusted to 377,500 option shares. The
options expire six years from the date of grant and vest after one year. Due to
the resignation of the CEO on December 5, 2000 and the absence of an exercise of
the outstanding options for 12 months thereafter, the options were forfeited on
December 5, 2001. No options were outstanding and exercisable under the Six Year
Plan at December 27, 2003.
The CEO Seven Year Stock Option Plan -- Pursuant to NAR's Seven Year Stock
Option Plan (the "Seven Year Plan"), an option to purchase an aggregate of
250,000 shares of Common Stock was granted to the CEO by NAR in 1996. The option
was subject to anti-dilution provisions and due to the Company's 1996 Rights
Offering was adjusted to 377,500 option shares. The options expire seven years
from the date of grant and vest after two years. Due to the resignation of the
CEO on December 5, 2000 and the absence of an
83
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
exercise of the outstanding options for 12 months thereafter, the options were
forfeited on December 5, 2001. No options were outstanding and exercisable under
the Seven Year Plan at December 27, 2003.
The CEO Eight Year Stock Option Plan -- Pursuant to NAR's Eight Year Stock
Option Plan (the "Eight Year Plan"), an option to purchase an aggregate of
250,000 shares of Common Stock was granted to the CEO by NAR in 1996. The option
was subject to anti-dilution provisions and due to the Company's 1996 Rights
Offering was adjusted to 377,500 option shares. The options expire eight years
from the date of grant and vest after three years. Due to the resignation of the
CEO on December 5, 2000 and the absence of an exercise of the outstanding
options for 12 months thereafter, the options were forfeited on December 5,
2001. No options were outstanding and exercisable under the Eight Year Plan at
December 27, 2003.
The CEO Nine Year Stock Option Plan -- Pursuant to NAR's Nine Year Stock
Option Plan (the "Nine Year Plan"), an option to purchase an aggregate of
250,000 shares of Common Stock was granted to the CEO by NAR in 1996. The option
was subject to anti-dilution provisions and due to the Company's 1996 Rights
Offering was adjusted to 377,500 option shares. The options expire nine years
from the date of grant and vest after four years. Due to the resignation of the
CEO on December 5, 2000 and the absence of an exercise of the outstanding
options for 12 months thereafter, the options were forfeited on December 5,
2001. No options were outstanding and exercisable under the Nine Year Plan at
December 27, 2003.
For the combined CEO Stock Option Plans, options outstanding, granted and
the weighted average exercise prices are as follows:
CEO STOCK OPTION PLANS
2003 2002 2001
----------------- ----------------- ---------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
------ -------- ------ -------- ---------- --------
Options outstanding, beginning of
period............................. -- -- -- -- 7,530,000 $1.16
Forfeited............................ -- -- -- -- (7,530,000) --
---- ---- ----------
Options outstanding, end of period... -- -- -- -- -- --
==== ==== ==== ==== ========== =====
Options exercisable, end of period... -- -- -- -- -- --
==== ==== ==== ==== ========== =====
As described more fully in Note 16, the Company has been involved in
litigation with the CEO, regarding, among other issues, the amount of cash and
benefits to which the CEO may have been entitled, if any, as a result of his
resignation on December 5, 2000. On January 7, 2004, the case was decided in
favor of the Company on all but two of the CEO's claims in the summary judgment
phase, although the judgment may be appealed. The option plans described above
have expired and will have no further impact on the Company.
OTHER STOCK AWARDS
During 1997, the Company granted, and the Compensation Committee of the
Board of Directors approved, non-qualified options to certain employees for the
purchase of an aggregate of 1,000,000 shares of the Company's Common Stock. The
options vested over three years, had an exercise price of $0.75 and expired
during 2003. The fair value of the options at the date of grant was estimated to
be $0.52 based on the following weighted average assumptions: risk-free interest
rate of 6.48%, expected life of four years, expected volatility of 59.40%, and
no expected dividends. In June 2001, 809,000 options that had not been exercised
were forfeited by certain employees. As of December 27, 2003, all options had
expired.
Meridian Options -- During December 2000, the Company granted, and the
Company's Board of Directors approved, options ("2000 Meridian Options") for the
purchase of an aggregate of 4,000,000 shares of Common Stock with an exercise
price of $0.25 per share. These options have been allocated as follows:
84
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Thomas C. Shull, 2,700,000 shares; Paul Jen, 500,000 shares; John F. Shull,
500,000 shares; Evan M. Dudik, 200,000 shares; and Peter Schweinfurth, 100,000
shares. In December 2001, an additional Services Agreement (the "2001 Services
Agreement") was entered into by the Company by and among Meridian, Mr. Shull,
and the Company. Under the 2001 Services Agreement, the 2000 Meridian Options
terminate in the event that the Services Agreement is terminated (i) the tenth
day after written notice by the Company to Meridian and Mr. Shull of material
breach of the Services Agreement by Meridian or Mr. Shull or willful misconduct
by Meridian or Mr. Shull, or (ii) upon the death or permanent disability of Mr.
Shull. The 2000 Meridian Options vested and became exercisable on December 4,
2001 for all 2000 Meridian Options, except one-half of Mr. Shull's 2000 Meridian
Options, which vested and became exercisable on June 30, 2002. All 2000 Meridian
Options, except for Mr. Shull's 2000 Meridian Options, expire December 14, 2004.
Effective as of September 1, 2002, the Company amended the stock option
agreement with Mr. Shull for his 2,700,000 2000 Meridian Stock Options to (i)
extend the final expiration date for such stock options to June 30, 2005, and
(ii) replace all references therein to the December 2000 Services Agreement with
references to the employment agreement between Mr. Shull and the Company, which
became effective on September 1, 2002.
The fair value of the 2000 Meridian Options was estimated to be $0.07 cents
per share at the date of grant based on the following assumptions: risk-free
interest rate of 6.0%, expected life of 1.5 years, expected volatility of 54.0%,
and no expected dividends.
During December 2001, the Company granted to Meridian, and the Company's
Board of Directors approved, options to Meridian ("2001 Meridian Options") for
the purchase of an additional 1,000,000 shares of Common Stock with an exercise
price of $0.30. These options have been allocated as follows: Thomas C. Shull,
500,000 shares; Edward M. Lambert, 300,000 shares; Paul Jen, 100,000 shares; and
John F. Shull, 100,000 shares. Under the 2001 Services Agreement, the 2001
Meridian Options granted terminate in the event that the 2001 Services Agreement
is terminated (i) the tenth day after written notice by the Company to Meridian
and Mr. Shull of material breach of the 2001 Services Agreement by Meridian or
Mr. Shull or willful misconduct by Meridian or Mr. Shull, or (ii) upon the death
or permanent disability of Mr. Shull. The 2001 Meridian Options vested and
became exercisable on March 31, 2003. Effective as of August 3, 2003, the
Company amended the stock option agreement with Mr. Shull for his 500,000 2001
Meridian Options to (i) adjust the final expiration date for such stock options
to March 31, 2006, and (ii) replace all references therein to the 2001 Services
Agreement with references to the 2002 Employment Agreement.
The fair value of the 2001 Meridian Options was estimated to be $0.16 cents
per share at the date of grant based on the following assumptions: risk-free
interest rate of 2.82%, expected life of 1.25 years, expected volatility of
129.73%, and no expected dividends.
85
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Options outstanding, granted and the weighted average exercise price under
the combined 2000 Meridian Options and the 2001 Meridian Options are as follows:
MERIDIAN OPTION PLANS
2003 2002 2001
-------------------- --------------------- ---------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
--------- -------- ---------- -------- ---------- --------
Options outstanding,
beginning of period........ 4,900,000 $.26 5,000,000 $.26 4,000,000 $.25
Granted................. -- -- -- -- 1,000,000 .30
Exercised............... -- -- (100,000) .25 -- --
Forfeited............... -- -- -- -- -- --
--------- ---------- ----------
Options outstanding, end of
period..................... 4,900,000 $.26 4,900,000 $.26 5,000,000 $.26
========= ==== ========== ==== ========== ====
Options exercisable, end of
period..................... 4,900,000 $.26 3,900,000 $.25 2,650,000 $.25
========= ==== ========== ==== ========== ====
Weighted average fair value
of Options granted......... -- -- $ .16
========= ========== ==========
The following table summarizes information about stock options outstanding
and exercisable at December 27, 2003 under the combined 2000 Meridian Options
and the 2001 Meridian Options:
MERIDIAN OPTION PLANS
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------ ----------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
RANGE OF EXERCISE PRICES OUTSTANDING LIFE PRICE EXERCISABLE PRICE
- ------------------------ ----------- ----------- -------- ----------- --------
$0.25.............................. 3,900,000 1.3 $.25 3,900,000 $.25
$0.30.............................. 1,000,000 2.2 $.30 1,000,000 $.30
--------- ---------
4,900,000 1.5 $.26 4,900,000 $.26
========= === ==== ========= ====
16. COMMITMENTS AND CONTINGENCIES
A class action lawsuit was commenced on March 3, 2000 entitled Edwin L.
Martin v. Hanover Direct, Inc. and John Does 1 through 10, bearing case no.
CJ2000-177 in the State Court of Oklahoma (District Court in and for Sequoyah
County). Plaintiff commenced the action on behalf of himself and a class of
persons who have at any time purchased a product from the Company and paid for
an "insurance charge." The complaint sets forth claims for breach of contract,
unjust enrichment, recovery of money paid absent consideration, fraud and a
claim under the New Jersey Consumer Fraud Act. The complaint alleges that the
Company charges its customers for delivery insurance even though, among other
things, the Company's common carriers already provide insurance and the
insurance charge provides no benefit to the Company's customers. Plaintiff also
seeks a declaratory judgment as to the validity of the delivery insurance. The
damages sought are (i) an order directing the Company to return to the plaintiff
and class members the "unlawful revenue" derived from the insurance charges,
(ii) declaring the rights of the parties, (iii) permanently enjoining the
Company from imposing the insurance charge, (iv) awarding threefold damages of
less than
86
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
$75,000 per plaintiff and per class member, and (v) attorneys' fees and costs.
On April 12, 2001, the Court held a hearing on plaintiff's class certification
motion. Subsequent to the April 12, 2001 hearing on plaintiff's class
certification motion, plaintiff filed a motion to amend the definition of the
class. On July 23, 2001, plaintiff's class certification motion was granted,
defining the class as "All persons in the United States who are customers of any
catalog or catalog company owned by Hanover Direct, Inc. and who have at any
time purchased a product from such company and paid money that was designated to
be an "insurance" charge. On August 21, 2001, the Company filed an appeal of the
order with the Oklahoma Supreme Court and subsequently moved to stay proceedings
in the district court pending resolution of the appeal. The appeal has been
fully briefed. At a subsequent status hearing, the parties agreed that issues
pertaining to notice to the class would be stayed pending resolution of the
appeal, that certain other issues would be subject to limited discovery, and
that the issue of a stay for any remaining issues would be resolved if and when
such issues arise. On January 20, 2004, the plaintiff filed a motion for oral
argument with the Court. The Company believes it has defenses against the claims
and plans to conduct a vigorous defense of this action.
On August 15, 2001, the Company was served with a summons and four-count
complaint filed in Superior Court for the City and County of San Francisco,
California, entitled Teichman v. Hanover Direct, Inc., Hanover Brands, Inc.,
Hanover Direct Virginia, Inc., and Does 1-100. The complaint was filed by a
California resident, seeking damages and other relief for herself and a class of
all others similarly situated, arising out of the insurance fee charged by
catalogs and Internet sites operated by subsidiaries of the Company. Defendants,
including the Company, have filed motions to dismiss based on a lack of personal
jurisdiction over them. In January 2002, plaintiff sought leave to name six
additional entities: International Male, Domestications Kitchen & Garden,
Silhouettes, Hanover Company Store, Kitchen & Home, and Domestications as
co-defendants. On March 12, 2002, the Company was served with the First Amended
Complaint in which plaintiff named as defendants the Company, Hanover Brands,
Hanover Direct Virginia, LWI Holdings, Hanover Company Store, Kitchen and Home,
and Silhouettes. On April 15, 2002, the Company filed a Motion to Stay the
Teichman action in favor of the previously filed Martin action and also filed a
Motion to quash service of summons for lack of personal jurisdiction on behalf
of defendants Hanover Direct, Inc., Hanover Brands, Inc. and Hanover Direct
Virginia, Inc. On May 14, 2002, the Court (1) granted the Company's Motion to
quash service on behalf of Hanover Direct, Hanover Brands, and Hanover Direct
Virginia, leaving only LWI Holdings, Hanover Company Store, Kitchen & Home, and
Silhouettes, as defendants, and (2) granted the Company's Motion to Stay the
action in favor of the previously filed Oklahoma action, so nothing will proceed
on this case against the remaining entities until the Oklahoma case is decided.
The Company believes it has defenses against the claims. The Company plans to
conduct a vigorous defense of this action.
A class action lawsuit was commenced on February 13, 2002 entitled Jacq
Wilson, suing on behalf of himself, all others similarly situated, and the
general public v. Brawn of California, Inc. dba International Male and
Undergear, and Does 1-100 ("Brawn") in the Superior Court of the State of
California, City and County of San Francisco. Does 1-100 are internet and
catalog direct marketers offering a selection of men's clothing, sundries, and
shoes who advertise within California and nationwide. The complaint alleges that
for at least four years, members of the class have been charged an unlawful,
unfair, and fraudulent insurance fee and tax on orders sent to them by Brawn;
that Brawn was engaged in untrue, deceptive and misleading advertising in that
it was not lawfully required or permitted to collect insurance, tax and sales
tax from customers in California; and that Brawn has engaged in acts of unfair
competition under the state's Business and Professions Code. Plaintiff and the
class seek (i) restitution and disgorgement of all monies wrongfully collected
and earned by Brawn, including interest and other gains made on account of these
practices, including reimbursement in the amount of the insurance, tax and sales
tax collected unlawfully, together with interest, (ii) an order enjoining Brawn
from charging customers insurance and tax on its order forms and/or from
charging tax on the delivery, shipping and insurance charges, (iii) an order
directing Brawn to notify the California State Board of Equalization of the
failure to pay the correct amount of tax to the state and to take appropriate
steps to provide the state with the information needed for audit, and (iv)
compensatory damages, attorneys' fees, pre-judgment interest, and costs of the
suit. The claims of the individually named plaintiff and
87
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
for each member of the class amount to less than $75,000. On April 15, 2002, the
Company filed a Motion to Stay the Wilson action in favor of the previously
filed Martin action. On May 14, 2002, the Court denied the Motion to Stay. The
Wilson case proceeded to trial before the Honorable Diane Elan Wick of the
Superior Court of California for the County of San Francisco, and the Judge,
sitting without a jury, heard evidence from April 15-17, 2003. On November 25,
2003, the Court, after hearing evidence and considering post-trial submissions
from the parties, entered judgment in plaintiff's favor, requiring Brawn 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.
Plaintiff did not prevail on the tax issues. The trial court reserved the issue
of whether plaintiff's counsel was entitled to attorney's fees and, if so, in
what amount. On January 12, 2004, plaintiff filed a motion requesting
approximately $740,000 in attorneys' fees and costs. On February 27, 2004, the
Company filed its response to that motion. Plaintiff filed a reply brief on
March 13, 2004. A hearing was held on plaintiff's motion on March 18, 2004. The
Company expects that the judge may rule on that motion before the end of May,
2004. The Company has appealed the trial court's decision on the merits of the
insurance fees issue and plans to conduct a vigorous defense of this action
including contesting plaintiff's counsel's entitlement to the fees and costs
requested. The Company's opening brief in the Court of Appeals will be due on
May 17, 2004. 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 due to management
determining that it is not probable that an unfavorable outcome will result. See
Item 7. Management's Discussion and Analysis of Consolidated Financial Condition
and Results of Operations for more information regarding the Company's accrued
liabilities policy.
A class action lawsuit was commenced on February 20, 2002 entitled Argonaut
Consumer Rights Advocates Inc., suing on behalf of the General Public v. Gump's
By Mail, Inc. ("Gump's"), and Does 1-100 in the Superior Court of the State of
California, City and County of San Francisco. The plaintiff is a non-profit
public benefit corporation suing under the California Business and Profession
Code. Does 1-100 would include persons whose activities include the direct sale
of tangible personal property to California consumers including the type of
merchandise that Gump's -- the store and the catalog -- sell, by telephone, mail
order, and sales through the web sites www.gumpsbymail.com and www.gumps.com.
The complaint alleges that for at least four years members of the class have
been charged an unlawful, unfair, and fraudulent tax and "sales tax" on their
orders in violation of California law and court decisions, including the state
Revenue and Taxation Code, Civil Code, and the California Board of Equalization;
that Gump's engages in unfair business practices; that Gump's engaged in untrue
and misleading advertising in that it was not lawfully required to collect tax
and sales tax from customers in California; is not lawfully required or
permitted to add tax and sales tax on separately stated shipping or delivery
charges to California consumers; and that it does not add the appropriate or
applicable or specific correct tax or sales tax to its orders. Plaintiff and the
class seek (i) restitution of all tax and sales tax charged by Gump's on each
transaction and/or restitution of tax and sales tax charged on the shipping
charges; (ii) an order enjoining Gump's from charging customers for tax on
orders or from charging tax on the shipping charges; and (iii) attorneys' fees,
pre-judgment interest on the sums refunded, and costs of the suit. On April 15,
2002, the Company filed an Answer and Separate Affirmative Defenses to the
complaint, generally denying the allegations of the complaint and each and every
cause of action alleged, and denying that plaintiff has been damaged or is
entitled to any relief whatsoever. On September 19, 2002, the Company filed a
motion for leave to file an amended answer, containing several additional
affirmative defenses based on the proposition that the proper defendant in this
litigation (if any) is the California State Board of Equalization, not the
Company, and that plaintiff failed to exhaust its administrative remedies prior
to filing suit. That motion was granted. At the request of the plaintiff, this
case was dismissed with prejudice by the court on March 17, 2003.
A class action lawsuit was commenced on March 5, 2002 entitled Argonaut
Consumer Rights Advocates Inc., suing on behalf of the General Public v.
Domestications LLC, and Does 1-100 ("Domestications") in the Superior Court of
the State of California, City and County of San Francisco. The plaintiff is a
non-profit public benefit corporation suing under the California Business and
Profession Code. Does 1-100 would include persons responsible for the conduct
alleged in the complaint, including the direct sale of tangible personal
88
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
property to California consumers including the type of merchandise that
Domestications sells, by telephone, mail order, and sales through the web site
www.domestications.com. The plaintiff claims that for at least four years
members of the class have been charged an unlawful, unfair, and fraudulent tax
and sales tax for different rates and amounts on the catalog and internet orders
on the total amount of goods, tax and sales tax on shipping charges, which are
not subject to tax or sales tax under California law, in violation of California
law and court decisions, including the state Revenue and Taxation Code, Civil
Code, and the California Board of Equalization; that Domestications engages in
unfair business practices; and that Domestications engaged in untrue and
misleading advertising in that it was not lawfully required to collect tax and
sales tax from customers in California. Plaintiff and the class seek (i)
restitution of all sums, interest and other gains made on account of these
practices; (ii) prejudgment interest on all sums wrongfully collected; (iii) an
order enjoining Domestications from charging customers for tax on their orders
and/or from charging tax on the shipping charges; and (iv) attorneys' fees and
costs of the suit. The Company filed an Answer and Separate Affirmative Defenses
to the Complaint, generally denying the allegations of the Complaint and each
and every cause of action alleged, and denying that plaintiff has been damaged
or is entitled to any relief whatsoever. Discovery is now proceeding. On
September 19, 2002, the Company filed a motion for leave to file an amended
answer, containing several additional affirmative defenses based on the
proposition that the proper defendant in this litigation (if any) is the
California State Board of Equalization, not the Company, and that plaintiff
failed to exhaust its administrative remedies prior to filing suit. That motion
was granted. On February 28, 2003, the Company filed a notice of motion and
memorandum of points and authorities in support of its motion for summary
judgment setting forth that Plaintiff's claims are without merit and incorrect
as a matter of law. At the request of the plaintiff, this case was dismissed
with prejudice by the court on March 17, 2003.
A class action lawsuit was commenced on October 28, 2002 entitled John
Morris, individually and on behalf of all other persons & entities similarly
situated v. Hanover Direct, Inc., and Hanover Brands, Inc. (referred to here as
"Hanover"), No. L 8830-02 in the Superior Court of New Jersey, Bergen
County -- Law Division. The plaintiff brings 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 certain clothing from Hanover (which was from a men's
division catalog, the only ones which retained the insurance line item in 2002),
Plaintiff claims that for at least six years, Hanover maintained a policy and
practice of adding a charge for "insurance" to the orders it received and
concealed and failed to disclose its policy with respect to all class members.
Plaintiff claims that Hanover's conduct was (i) in violation of the New Jersey
Consumer Fraud Act, as otherwise deceptive, misleading and unconscionable; (ii)
such as to constitute Unjust Enrichment of Hanover at the expense and to the
detriment of plaintiff and the class; and (iii) 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 Morris
action in favor of the previously filed Martin action. Plaintiff then filed an
Amended Complaint adding International Male as a defendant. Hearing on the
motion to stay took place on June 5, 2003. The Court granted the Company's
Motions to Stay the action and the case was stayed first until December 31, 2003
and subsequently until March 31, 2004. The Company plans to conduct a vigorous
defense of this action.
On June 28, 2001, Rakesh K. Kaul, the former President and Chief Executive
Officer of Hanover Direct, Inc., a Delaware corporation (the "Company"), filed a
five-count complaint (the "Complaint") in New York State Court against the
Company, seeking damages and other relief arising out of his separation of
employment from the Company, including severance payments of $2,531,352 plus the
cost of employee benefits, attorneys' fees and costs incurred in connection with
the enforcement of his rights under his employment agreement with the Company,
payment of $298,650 for 13 weeks of accrued and unused vacation, damages in the
amount of $3,583,800, or, in the alternative, a declaratory judgment from the
court that he is entitled to all change of control benefits under the "Hanover
Direct, Inc. Thirty-Six Month Salary
89
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Continuation Plan," and damages in the amount of $1,396,066 or $850,000 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 within the 30 days following his resignation. The Company removed
the case to the U.S. District Court for the Southern District of New York on
July 25, 2001. Mr. Kaul filed an Amended Complaint ("Amended Complaint") in the
U.S. District Court for the Southern District of New York on September 18, 2001.
The Amended Complaint repeats many of the claims made in the original Complaint
and adds ERISA claims.
On October 11, 2001, the Company filed its Answer, Defenses and
Counterclaims to the Amended Complaint, denying liability under each and every
of Mr. Kaul's causes of action, challenging all substantive assertions, raising
several defenses and stating nine counterclaims against Mr. Kaul. The
counterclaims include (1) breach of contract; (2) breach of the Non-Competition
and Confidentiality Agreement with the Company; (3) breach of fiduciary duty;
(4) unfair competition; and (5) unjust enrichment. The Company seeks damages,
including, without limitation, the $341,803 in severance pay and car allowance
Mr. Kaul received following his resignation, $412,336 for amounts paid to Mr.
Kaul for car allowance and related benefits, the cost of a long-term disability
policy, and certain payments made to personal attorneys and consultants retained
by Mr. Kaul during his employment, $43,847 for certain services the Company
provided and certain expenses the Company incurred, relating to the renovation
and leasing of office space occupied by Mr. Kaul's spouse at 115 River Road,
Edgewater, New Jersey, the Company's current headquarters, $211,729 on a tax
loan to Mr. Kaul outstanding since 1997 and interest, compensatory and punitive
damages and attorneys' fees. The Company moved to amend its counterclaims, and
the parties each moved for summary judgment.
The Company sought summary judgment: 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 of, among other things, claims for change of
control benefits; dismissing Mr. Kaul's claim for attorneys' fees on the grounds
that they are not authorized under his employment agreement; dismissing Mr.
Kaul's claims related to change in control benefits based on an administrative
decision that he is not entitled to continued participation in the plan or to
future benefits thereunder; dismissing Mr. Kaul's claim for a tandem bonus
payment on the ground that no payment is owing; dismissing Mr. Kaul's claim for
vacation payments based on Company policy regarding carry over vacation; and
seeking judgment on the Company's counterclaim for unjust enrichment based on
Mr. Kaul's failure to pay under a tax note. Mr. Kaul seeks summary judgment:
dismissing the Company's defenses and counterclaims relating to a release on the
grounds that he tendered a release or that the Company is estopped from
requiring him to do so; dismissing the Company's defenses and counterclaims
relating to his alleged violations of his non-compete and confidentiality
obligations on the grounds that he did not breach the obligations as defined in
the agreement; and dismissing the Company's claims based on his alleged breach
of fiduciary duty, including those based on his monthly car allowance payments
and the leased space to his wife, on the grounds that he was entitled to the car
payments and did not involve himself in or make misrepresentations in connection
with the leased space. The Company has concurrently moved to amend its Answer
and Counterclaims to state a claim that it had cause for terminating Mr. Kaul's
employment based on, among other things, after acquired evidence that Mr. Kaul
received a monthly car allowance and other benefits totaling $412,336 that had
not been authorized by the Company's Board of Directors and that his wife's
lease and related expense was not properly authorized by the Company's Board of
Directors, and to clarify or amend the scope of the Company's counterclaims for
reimbursement.
On January 7, 2004, the parties received the decision of the Court. 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
90
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 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 the Company's
counterclaims relating to his non-compete and confidentiality obligations on the
ground that there is no evidence of actual damage to the Company resulting from
Mr. Kaul's alleged violations of those obligations; granted summary judgment in
favor of Mr. Kaul on the Company's breach of contract and breach of fiduciary
duty claims, including those based on his monthly car allowance payments and the
leased space to his wife, on the grounds that he did not breach his fiduciary
duties in accepting the car payments and would not be unjustly enriched if he
kept them, and on the ground that the Company would not be able to prove fraud
in connection with the leased space based on the circumstances, including Mr.
Kaul's disclosures.
The Court denied in part and granted in part the Company's motion to amend
its Answer and Counterclaims. The Court denied the Company's motion for leave to
state a claim that it had acquired evidence of cause for terminating Mr. Kaul's
employment based on certain reimbursements on the ground that the payments were
authorized, but 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 remain 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. As a result of the favorable outcome of the summary
judgment decision by the District Court dismissing several of Mr. Kaul's claims,
the Company reduced its legal accrual related to this case by $3.3 million in
the fourth quarter. This reduction is reflected in the General and
administrative expenses on the Company's Consolidated Statements of Income
(Loss) as well as Accrued liabilities and Other non-current liabilities on the
Consolidated Balance Sheets. Unless a settlement can be reached, the claim for
attorneys' fees will be tried to the Court without a jury while the remaining
two claims will be tried to a jury. After final judgment issues, each party will
have the right to appeal any aspect of the judgment.
In June 1994, a complaint was filed in the Supreme Court of the State of
New York, County of New York, by Donald Schupak, the former President, CEO and
Chairman of the Board of Directors of The Horn & Hardart Company, the corporate
predecessor to the Company, against the Company and Alan Grant Quasha. The
complaint asserted claims for alleged breaches of an agreement dated February
25, 1992 between Mr. Schupak and the Company (the "Agreement"), and for alleged
tortious interference with the Agreement by Mr. Quasha. Mr. Schupak sought
compensatory damages in an amount, which was estimated to be not more than
$400,000, and punitive damages in the amount of $10 million; applicable
interest, incidental and consequential damages, plus costs and disbursements,
the expenses of the litigation and reasonable attorneys' fees. In addition,
based on the alleged breaches of the Agreement by the Company, Mr. Schupak
sought a "parachute" payment of approximately $3 million under an earlier
agreement with the Company that he allegedly had waived in consideration of the
Company's performance of its obligations under the Agreement. The Company filed
an answer to the complaint on September 7, 1994. Discovery then commenced and
documents were exchanged. Each of the parties filed a motion for summary
judgment at the end of 1995, and both motions were denied in the spring of 1996.
In April 1996, due to health problems then being experienced by Mr. Schupak, the
Court ordered that the case be marked "off calendar" until plaintiff recovered
and was able to proceed with the litigation. In September 2002, more than six
years later, Mr. Schupak filed a motion
91
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
to restore the case to the Court's calendar. The Company filed papers in
opposition to the motion on October 10, 2002, asserting that the motion should
be denied on the ground that plaintiff failed to timely comply with the terms of
the Court's order concerning restoration and, alternatively, on the ground of
laches. The plaintiff filed reply papers on November 4, 2002. On November 20,
2002, the court denied Mr. Schupak's motion to restore the case to the calendar
as "unnecessary and moot" on the ground that the case had been improperly marked
off calendar in the first instance, ruled that the case therefore remained
"active," and fixed a trial date of March 4, 2003. On January 27, 2003, the
parties reached agreement fully and finally settling all of Mr. Schupak's claims
in consideration of a payment by the Company and the exchange of mutual general
releases.
The Company was named as one of 88 defendants in a patent infringement
complaint filed on November 23, 2001 by the Lemelson Medical, Education &
Research Foundation, Limited Partnership (the "Lemelson Foundation"). The
complaint, filed in the U.S. District Court in Arizona, was not served on the
Company until March 2002. In the complaint, the Lemelson Foundation accuses the
named defendants of infringing seven U.S. patents, which allegedly cover
"automatic identification" technology through the defendants' use of methods for
scanning production markings such as bar codes. The Company received a letter
dated November 27, 2001 from attorneys for the Lemelson Foundation notifying the
Company of the complaint and offering a license. The Court entered a stay of the
case on March 20, 2002, requested by the Lemelson Foundation, pending the
outcome of a related case in Nevada being fought by bar code manufacturers. The
order for the stay in the case involving the Company provides that the Company
need not answer the complaint, although it has the option to do so. The Company
was invited to join a common interest/joint-defense group consisting of
defendants named in the complaint as well as in other actions brought by the
Lemelson Foundation. The trial in the Nevada case began on November 18, 2002 and
ended on January 17, 2003. On January 23, 2004, following extensive briefing by
the parties, 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. Subject to the results of any appeal that may be filed
by the parties to the Nevada litigation, the judgment of the Nevada court should
preclude assertion of each of the affected patents against all parties,
including the Company in the Arizona case. Counsel is now monitoring the Nevada
and Arizona cases in order to determine a suitable moment for moving for
dismissal of the Lemelson Foundation's claims. 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 the joint-defense
group, and had discussions with attorneys for the Lemelson Foundation regarding
the license offer. A preliminary estimate of the royalties and attorneys' fees
which the Company may pay if it decides to accept the license offer from the
Lemelson Foundation range from about $125,000 to $400,000. The Company will not
agree to a settlement at this time and thus has not established a reserve.
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
82
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 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 voluntarily disclosed, it does not currently believe
that any such penalties will have a material effect on its business or financial
condition.
20.On July 17, 2003, the Company filed an action in the Supreme Court of the
State of New York, County of New York (Index No. 03/602269) against Richemont
and Chelsey seeking a declaratory judgment as to
92
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
whether Richemont improperly transferred all of Richemont's securities in the
Company consisting of the Shares to Chelsey on or about May 19, 2003 and whether
the Company could properly recognize the transfer of those Shares from Richemont
to Chelsey under federal and/or state law. On July 29, 2003, Chelsey answered
the Company's complaint, alleged certain affirmative defenses and raised three
counterclaims against the Company, including Delaware law requiring the
registration of the Shares, damages, including attorney's fees, for the failure
to register the Shares, and tortious interference with contract. Chelsey also
moved for a preliminary injunction directing the Company to register the
ownership of the Shares in Chelsey's name. Chelsey later moved for summary
judgment dismissing the Company's complaint. Subsequently, Chelsey moved to
compel production of certain documents and for sanctions and/or costs. On August
28, 2003, Richemont moved to dismiss the Company's complaint. It subsequently
filed a motion seeking sanctions and/or costs against the Company. On October
27, 2003, the Court granted Chelsey's motion for summary judgment and
Richemont's motion to dismiss and ordered that judgment be entered dismissing
the case in its entirety. The Court also denied Chelsey's and Richemont's
motions for sanctions and Chelsey's motion to compel production of certain
documents.
On November 10, 2003, the Company signed a Memorandum of Understanding with
Chelsey and Regan Partners, L.P. setting forth the agreement in principle to
recapitalize the Company, reconstitute the Board of Directors and settle
outstanding litigation between the Company and Chelsey. The Memorandum of
Understanding had been approved by the Transactions Committee of the Board of
Directors of the Company. 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 transaction with Chelsey was
unanimously approved by the members of the Board of Directors of the Company and
the members of the Transactions Committee of the Board of Directors.
In addition, the Company is involved in various routine lawsuits of a
nature which are deemed customary and incidental to its businesses. In the
opinion of management, the ultimate disposition of these actions will not have a
material adverse effect on the Company's financial position or results of
operations.
17. AMERICAN STOCK EXCHANGE NOTIFICATION
By letter dated May 2, 2001, the American Stock Exchange (the "Exchange")
notified the Company that it was below certain of the Exchange's continued
listing guidelines set forth in the Exchange's Company Guide. The Exchange
instituted a review of the Company's eligibility for continuing listing of the
Company's common stock on the Exchange. On January 17, 2002, the Company
received a letter dated January 9, 2002 from the Exchange confirming that the
American Stock Exchange determined to continue the Company's listing on the
Exchange pending quarterly reviews of the Company's compliance with the steps of
its strategic business realignment program. This determination was made subject
to the Company's favorable progress in satisfying the Exchange's guidelines for
continued listing and to the Exchange's periodic review of the Company's
Securities and Exchange Commission and other filings.
On November 11, 2002, the Company received a letter dated November 8, 2002
from the Exchange updating its position regarding the Company's compliance with
certain of the Exchange's continued listing standards as set forth in Part 10 of
the Exchange's Company Guide. Although the Company had been making favorable
progress in satisfying the Exchange's guidelines for continued listing based on
its compliance with the steps of its strategic business realignment program
shared with the Exchange in 2001 and updated in 2002, the Exchange informed the
Company that it had now become strictly subject to the procedures and
requirements of Part 10 of the Company Guide. Specifically, the Company must not
fall below the requirements of: (i) Section 1003(a)(i) 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; (ii) Section 1003(a)(ii) 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 (iii) Section 1003(a)(iii) with shareholders' equity of less than $6,000,000
and losses from continuing operations and/or net losses in its
93
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
five most recent fiscal years. The Exchange requested that the Company submit a
plan to the Exchange by December 11, 2002, advising the Exchange of action it
has taken, or will take, that would bring it into compliance with the continued
listing standards by December 28, 2003. The Company submitted a plan to the
Exchange on December 11, 2002, in an effort to maintain the listing of the
Company's common stock on the Exchange.
On January 28, 2003, the Company received a letter from the Exchange
confirming that, as of the date of the letter, the Company had evidenced
compliance with the requirements necessary for continued listing on the
Exchange. Such compliance resulted from a recent rule change by the Exchange
approved by the Securities and Exchange Commission related to continued listing
on the basis of compliance with total market capitalization or total assets and
revenues standards as alternatives to shareholders' equity standards including
the requirement that each listed company maintain $15.0 million of public float.
The letter is subject to changes in the American Stock Exchange Rules that might
supersede the letter or require the Exchange to re-evaluate its position.
18. RESTATEMENT OF PRIOR YEAR DEBT CLASSIFICATION
The Company has re-examined the provisions of the Congress Credit Facility
and, based on EITF 95-22 and certain provisions in the credit agreement, the
Company was required to reclassify its revolving loan facility from long-term to
short-term debt, though the existing revolving loan facility does not mature
until January 31, 2007. As a result, the Company reclassified $8.8 million as of
December 28, 2002 from Long-term debt to Short-term debt and capital lease
obligations that is classified as Current liabilities.
A summary of the effects of the restatement on the Company's Consolidated
Balance Sheet as of December 28, 2002 is as follows:
DECEMBER 28, 2002
------------------------
AS
PREVIOUSLY
REPORTED AS RESTATED
---------- -----------
(IN THOUSANDS)
Short-term debt and capital lease obligations............... $ 3,802 $12,621
Total Current liabilities................................... $78,848 $87,667
Long-term debt.............................................. $21,327 $12,508
Total Non-current liabilities............................... $27,714 $18,895
94
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
19. SELECTED QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
-------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
20022003
Net revenues....................................... $109,511 $113,852 $106,030 $128,251
(Loss) income$102,474 $105,765 $ 96,633 $110,002
Income (loss) before interest and income taxes..... (427) 3,232 (2,905) 2381,655 1,805 (64) 4,621
Net income (loss) income and comprehensive income
(loss)
income........................................... (1,810) 1,816 (4,212) (4,924)........................................... 192 690 (16,645) 364
Preferred stock dividends and accretion............ 2,904 3,503 4,185 4,964
Net loss applicable to common shareholders......... $ (4,714) $ (1,687) $ (8,397) $ (9,888)
======== ======== ======== ========
Net loss per share3,632 4,290 -- basic and diluted............ $ (0.04) $ (0.01) $ (0.06) $ (0.07)
======== ======== ======== ========
2001
Net revenues....................................... $144,294 $133,507 $117,431 $136,933
(Loss) income before interest and income taxes..... (5,806) 14,607 (5,325) (2,672)
Net (loss) income and comprehensive (loss)
income........................................... (7,642) 12,732 (6,806) (4,129)
Preferred stock dividends and accretion............ 2,880 2,984 3,092 1,789--
Net (loss) income applicable to common
shareholders..................................... $(10,522) $ 9,748(3,440) $ (9,898)(3,600) $(16,645) $ (5,918)364
======== ======== ======== ========
Net (loss) income per share -- basic and diluted... $ (0.05)(0.02) $ 0.05(0.02) $ (0.05)(0.12) $ (0.03)0.00
======== ======== ======== ========
2002
Net revenues....................................... $109,511 $113,852 $106,030 $128,251
(Loss) income before interest and income taxes..... (427) 3,232 (2,905) 238
Net (loss) income and comprehensive (loss)
income........................................... (1,810) 1,816 (4,212) (4,924)
Preferred stock dividends and accretion............ 2,904 3,503 4,185 4,964
Net loss applicable to common shareholders......... $ (4,714) $ (1,687) $ (8,397) $ (9,888)
======== ======== ======== ========
Net loss per share -- basic and diluted............ $ (0.04) $ (0.01) $ (0.06) $ (0.07)
======== ======== ======== ========
21. RESTATEMENT
The Company has 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," and certain provisions in the
credit agreement, the Company is required to reclassify its revolving loan
facility from long-term to short-term debt, though the existing credit facility
does not mature until January 31, 2007. As a result, the Company reclassified
$8.8 million and $13.5 million as of December 28, 2002 and December 29, 2001,
respectively, from long-term debt to short-term debt and capital lease
obligations.
A summary of the effects of the restatement on our Consolidated Balance
Sheets as of December 28, 2002 and December 29, 2001 follows:
83
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 28, 2002 DECEMBER 29, 2001
--------------------- ---------------------
AS AS
PREVIOUSLY AS PREVIOUSLY AS
REPORTED REPORTED REPORTED REPORTED
---------- -------- ---------- --------
(IN THOUSANDS)
Short-term debt and capital lease
obligations.................................. $ 3,802 $ 12,621 $ 3,162 $ 16,685
Total current liabilities...................... $78,848 $ 87,667 $79,785 $ 93,308
Long-term debt................................. $21,327 $ 12,508 $26,548 $ 13,025
Total non-current liabilities.................. $27,714 $ 18,895 $36,781 $ 23,258
8495
SCHEDULE II
HANOVER DIRECT, INC.
VALUATION AND QUALIFYING ACCOUNTS
YEARS ENDED DECEMBER 27, 2003, DECEMBER 28, 2002
AND DECEMBER 29, 2001
AND DECEMBER 30, 2000
(IN THOUSANDS OF DOLLARS)
COLUMN C
--------
COLUMN A COLUMN B ADDITIONSCOLUMN C COLUMN D COLUMN E
- ----------------------------------------- ---------- ------------------------------------ ---------- ----------
ADDITIONS
---------------------------
BALANCE AT CHARGED TO CHARGED TO BALANCE AT
BEGINNING COSTS AND OTHER ACCOUNTS DEDUCTIONS END OF
DESCRIPTION OF PERIOD EXPENSES (DESCRIBE) (DESCRIBE) PERIOD
- ----------- ---------- ---------- -------------- ---------- ----------
2003:
Allowance for Doubtful Accounts
Receivable, Current............... $ 1,560 $ 378 $ 833(1) $ 1,105
Reserves for Discontinued
Operations........................ 322 40 293(2) 69
Special Charges Reserve............. 8,032 1,304 3,542(3) 5,794
Reserves for Sales Returns.......... 1,888 2,557 2,280(3) 2,165
Deferred Tax Asset Valuation
Allowance......................... 128,000 $11,300(4) 6,844(5) 132,456
2002:
Allowance for Doubtful Accounts
Receivable, Current............ $Current............... 2,117 $ 304 $ 861(1) $ 1,560
Reserves for Discontinued
Operations.....................Operations........................ 737 40 455(2) 322
Special Charges Reserve..........Reserve............. 11,056 4,769 7,793(3) 8,032
Reserves for Sales Returns.......Returns.......... 2,764 306 1,182(3) 1,888
Deferred Tax Asset Valuation
Allowance......................Allowance......................... 121,600 $ 6,400(4)3,700(4) (2,700)(5) 128,000
2001:
Allowance for Doubtful Accounts
Receivable, Current............Current............... 5,668 91 3,642(1) 2,117
Reserves for Discontinued
Operations.....................Operations........................ 588 275 126(3) 737
Special Charges Reserve..........Reserve............. 13,023 7,963 9,930(3) 11,056
Reserves for Sales Returns.......Returns.......... 3,371 2,692 3,299(3) 2,764
Deferred Tax Asset Valuation
Allowance......................Allowance......................... 123,900 (2,300)(5)2,300(5) 121,600
2000:
Allowance for Doubtful Accounts
Receivable, Current............ 3,912 4,947 3,191(1) 5,668
Reserves for Discontinued
Operations..................... 849 261(3) 588
Special Charges Reserve.......... 2,299 11,978 1,254(3) 13,023
Reserves for Sales Returns....... 4,680 6,101 7,410(3) 3,371
Deferred Tax Asset Valuation
Allowance...................... 97,500 26,400(5) 123,900
- ---------------
(1) Written-off.
(2) Utilization of reserves $(130) and reversal of reserves $(325).reserves.
(3) Utilization of reserves.
(4) $3,700 represents an increaseIncrease in the valuation allowance charged to the
deferred income tax
provision and the balance represents the net change in
the valuation allowance offset by the change in the gross deferred tax
asset.provision.
(5) Represents the change in the valuation allowance offset by the change in the
gross deferred tax asset.
8596
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
There were no disagreements with accountants on accounting and financial
disclosure.
The Board of Directors of the Company, upon recommendation of its Audit
Committee, ended the engagement of Arthur Andersen LLP ("Arthur Andersen") as
the Company's independent public accountants, effective after Arthur Andersen's
review of the Company's financial results for the fiscal quarter ended March 30,
2002 and the filing of this Quarterly Report on Form 10-Q for such quarter, and
authorized the engagement of KPMG LLP ("KPMG") to serve as the Company's
independent public accountants for the fiscal year ending December 28, 2002.
Arthur Andersen's report on the Company's 2001 financial statements was issued
on March 16, 2002, in conjunction with the filing of the Company's Annual Report
on Form 10-K for the fiscal year ended December 29, 2001.
86
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
(a) Identification of Directors
Directors hold office until the next annual meeting or until their
successors have been elected or until their earlier death, resignation,
retirement, disqualification or removal as provided in the Company's Certificate
of Incorporation and Bylaws. On January 10, 2002, the Board of Directors
announced the reduction of the number of Directors of the Company from six to
five. On January 10, 2002, the Board of Directors announced the appointment of
Thomas C. Shull as Chairman of the Company's Board of Directors and the election
of E. Pendleton James as a member of the Company's Board of Directors, each
filling the vacancies created by the resignation of Eloy Michotte and Alan
Grieve and each to serve until the Company's next Annual Shareholders Meeting.
On December 20, 2002, the Board of Directors announced the election of Robert H.
Masson as a member of the Company's Board of Directors effective January 1,
2003, filling the vacancy created by the resignation of J. David Hakman,
effective December 31, 2002.
DIRECTOR
NAME AGE TITLE AND OTHER INFORMATION SINCE
- ---- --- --------------------------- --------
Thomas C. Shull 51 Thomas C. Shull has been Chairman of the Company's 2000
Board of Directors since January 10, 2002 and a
member of the Board of Directors of the Company and
President and Chief Executive Officer of the Company
since December 5, 2000. In 1990, Mr. Shull co-founded
Meridian Ventures, a venture management and
turnaround firm presently based in Connecticut, and
has served as chief executive officer since its
inception. From 1997 to 1999, he served as President
and CEO of Barneys New York, a leading luxury
retailer, where he led them out of bankruptcy. From
1992 to 1994, Mr. Shull was Executive Vice President
of the R.H. Macy Company, Inc., where he was
responsible for human resources, information
technology, business development, strategic planning
and merchandise distribution and led the merger
negotiations with Federated Department Stores. Prior
to that, he served as a consultant with McKinsey &
Company and in the early 1980s as a member of the
National Security Council Staff in the Reagan White
House.
E. Pendleton James 73 E. Pendleton James has been a director of the Company 2002
since January 2002. Mr. James has over thirty years
experience in executive search and recently merged
his firm, Pendleton James Associates, with Whitehead
Mann. He currently serves on the Board of the
Citizens for Democracy Corps and is a Trustee for the
Center for the Study of the Presidency. Mr. James
served as an assistant to Presidents Nixon and
Reagan. He is a former member of the Board of
Directors of Comsat Corporation, the Metropolitan
Life Series Fund, the White House Fellows Commission,
the Ronald Reagan Foundation and the USO World Board
of Governors.
87
DIRECTOR
NAME AGE TITLE AND OTHER INFORMATION SINCE
- ---- --- --------------------------- --------
Kenneth J. Krushel 50 Kenneth J. Krushel has been the Executive Vice 1999
President of Strategic and Business Development of
Blackboard Inc., a provider of e-education software
and commerce and access systems, since December 2000.
From October 1999 to December 2000, Mr. Krushel was
the Chairman and Chief Executive Officer of College
Enterprises, Inc. From 1996 to 1999, Mr. Krushel was
the Senior Vice President of Strategic Development
for NBC Corp. and from 1994 to 1996 was Senior Vice
President, Business Development, for King World
Productions. Formerly, Mr. Krushel was President and
Chief Operating Officer of Think Entertainment and
Vice-President of Programming and Marketing for
American Cablesystems. Mr. Krushel was elected a
director of the Company in May 1999.
Robert H. Masson 67 Robert H. Masson served as Senior Vice President, 2003
Finance and Administration and Vice President and
Chief Financial Officer of Parsons & Whittemore,
Inc., a global pulp and paper manufacturer, from May
1990 until his retirement June 30, 2002. Prior
thereto, Mr. Masson held various executive, financial
and treasury roles with The Ford Motor Company,
Knutson Construction Company, Ellerbe, PepsiCo, Inc.
and Combustion Engineering (now part of the ABB
Group). Mr. Masson was elected a director of the
Company effective January 1, 2003.
Basil P. Regan 62 Basil P. Regan has been the General Partner of Regan 2001
Partners, L.P., a limited partnership that invests
primarily in turnaround companies and special
situations, since December 1989. He has been
President of Regan Fund Management Ltd. since October
1995, which manages Regan Partners, L.P., Regan Fund
International, L.P. and Super Hedge Fund, L.P. From
1986 to 1989, Mr. Regan was Vice President and
Director of Equity Research of Reliance Group
Holdings. Mr. Regan was elected a director of the
Company in August 2001.
(b) Identification of Executive Officers
Pursuant to the Company's Bylaws, its officers are chosen annually by the
Board of Directors and hold office until their respective successors are chosen
and qualified.
Effective January 28, 2002, Edward M. Lambert was appointed to succeed
Brian C. Harriss as Executive Vice President and Chief Financial Officer of the
Company and Mr. Harriss was appointed as Executive Advisor to the Chairman of
the Company coincident with his resignation as Executive Vice President and
Chief Financial Officer of the Company.
During September 2002, Charles F. Messina resigned as Executive Vice
President, Chief Administrative Officer and Secretary of the Company.
Effective December 2, 2002, Brian C. Harriss was appointed Executive Vice
President -- Human Resources and Legal and Secretary of the Company.
88
OFFICE HELD
NAME AGE TITLE AND OTHER INFORMATION SINCE
- ---- --- --------------------------- -----------
Thomas C. Shull 51 President and Chief Executive Officer and a member 2000
of the Board of Directors since December 5, 2000.
Chairman of the Board since January 10, 2002. In
1990, Mr. Shull co-founded Meridian Ventures, a
venture management and turnaround firm presently
based in Connecticut, and has served as chief
executive officer since its inception. From 1997 to
1999, he served as President and Chief Executive
Officer of Barneys New York, a leading luxury
retailer, where he led them out of bankruptcy. From
1992 to 1994, Mr. Shull was Executive Vice
President of the R.H. Macy Company, Inc., where he
was responsible for human resources, information
technology, business development, strategic
planning and merchandise distribution and led the
merger negotiations with Federated Department
Stores. Prior to that, he served as a consultant
with McKinsey & Company and in the early 1980s as a
member of the National Security Council Staff in
the Reagan White House.
Edward M. Lambert 42 Executive Vice President and Chief Financial 2002
Officer since January 28, 2002. From July 2001
until January 28, 2002, Mr. Lambert served as an
advisor to the Company. In 1990, Mr. Lambert
co-founded Meridian Ventures, a venture management
and turnaround firm presently based in Connecticut,
and served as a Managing Director until December
2000. From 1998 to 1999, he served as Chief
Financial Officer of Barneys New York, a leading
luxury retailer, and from 1993 to 1994, he served
as Executive Vice President of Applied Solar Energy
Corporation, a space systems manufacturer.
Michael D. Contino 42 Executive Vice President and Chief Operating 2001
Officer since April 25, 2001. Senior Vice President
and Chief Information Officer from December 1996 to
April 25, 2001 and President of Keystone Internet
Services, Inc. (now Keystone Internet Services,
LLC) since November 2000. Mr. Contino joined the
Company in 1995 as Director of Computer Operations
and Telecommunications. Prior to 1995, Mr. Contino
was the Senior Manager of IS Operations at New
Hampton, Inc., a subsidiary of Spiegel, Inc.
89
OFFICE HELD
NAME AGE TITLE AND OTHER INFORMATION SINCE
- ---- --- --------------------------- -----------
Brian C. Harriss 54 Executive Vice President -- Human Resources and 2002
Legal and Secretary since December 2002. Executive
Advisor to the Chairman of the Company from January
28, 2002 to December 2002, and Executive Vice
President and Chief Financial Officer from June
1999 to January 28, 2002. From 1998 to 1999, Mr.
Harriss was a Managing Director of Dailey Capital
Management, LP, a venture capital fund, and Chief
Operating Officer of E-Bidding Inc., an Internet
e-commerce freight Web site. From 1997 to 1998, Mr.
Harriss served as the Vice President of Corporate
Development at the Reader's Digest Association,
Inc. From 1994 to 1996, Mr. Harriss was the Chief
Financial Officer of the Thompson Minwax Company.
Prior thereto, Mr. Harriss held various financial
positions with Cadbury Schweppes PLC, Tambrands,
Inc. and PepsiCo, Inc.
William C. Kingsford 56 Vice President and Corporate Controller since May 1997
1997. Prior to May 1997, Mr. Kingsford was Vice
President and Chief Internal Auditor at Melville
Corporation.
Frank J. Lengers 46 Vice President, Treasurer since October 2000. Mr. 2000
Lengers joined the Company in November 1988 as an
Internal Audit Manager. From 1990 to 1994, Mr.
Lengers served as Manager of Corporate Treasury
Operations. In 1994, he was promoted to Director of
Treasury Operations and in 1997 to Assistant
Treasurer, a position he held until October 2000.
Prior to joining the Company, Mr. Lengers held
various audit positions with R.H. Macy & Co. and
The Metropolitan Museum of Art.
Steven Lipner 54 Vice President, Taxation since October 2000. Mr. 2000
Lipner served as Director of Taxes from February
1984 to October 2000. Prior thereto, he served as
Director of Taxes at Avnet, Inc. and held various
positions in public accounting. He holds a license
as a Certified Public Accountant in New York.
(c) Audit Committee Financial Expert
The Company's Board of Directors has determined that the Company has at
least one "audit committee financial expert" serving on the Audit Committee of
the Board of Directors who is "independent" of management within the definition
of such term in the Securities Exchange Act of 1934, as amended, and the listing
requirements of the American Stock Exchange. Robert H. Masson, a member of the
Board of Directors and the Chairman of its Audit Committee, is the "audit
committee financial expert" serving on the Company's Audit Committee.
(d) Code of Ethics
The Company has adopted a code of ethics that applies to the Company's
principal executive officer, principal financial officer and principal
accounting officer and other persons performing similar functions. A copy of the
code of ethics has been filed as an Exhibit to this Annual Report on Form 10-K.
(e) Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934 requires officers,
directors and beneficial owners of more than 10% of the Company's shares to file
reports with the Securities and Exchange Commission and the American Stock
Exchange. Based solely on a review of the reports and representations furnished
to the
90
Company during the last fiscal year by such persons, the Company believes that
each of these persons is in compliance with all applicable filing requirements
except for Messrs. Kingsford, Lengers and Lipner, who each failed to file one
report in a timely fashion.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference from the
Company's definitive proxy statement to be filed by the Company pursuant to
Regulation 14A.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The information required by this item is incorporated by reference from the
Company's definitive proxy statement to be filed by the Company pursuant to
Regulation 14A.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated by reference from the
Company's definitive proxy statement to be filed by the Company pursuant to
Regulation 14A.
ITEM 14.9A. CONTROLS AND PROCEDURES
An evaluation was performed under the supervision and with the
participation of the Company's management, including its Chief Executive Officer
and Chief Financial Officer, of the effectiveness of the Company's disclosure
controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934, as amended) as of the end of the period covered
by this report. Based on that evaluation, the Chief Executive Officer and Chief
Financial Officer concluded that these disclosure controls and procedures were
effective. There has been no change in the Company's internal control over
financial reporting during the Company's recent fiscal quarter that has
materially affected, or is reasonably likely to materially affect, the Company's
internal control over financial reporting.
9197
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
(a) Identification of Directors
Directors hold office until the next annual meeting or until their
successors have been elected or until their earlier death, resignation,
retirement, disqualification or removal as provided in the Company's Certificate
of Incorporation and Bylaws.
On July 17, 2003, the size of the Company's Board of Directors was
increased from five to seven members and Jeffrey A. Sonnenfeld and A. David
Brown were elected as members of the newly-expanded Board of Directors, subject
to the fulfillment of certain conditions precedent which were fulfilled on July
29, 2003. On September 29, 2003, Martin L. Edelman and Wayne P. Garten were
elected to the Company's Board of Directors by Chelsey, as the holder of the
Series B Participating Preferred Stock, as a result of the Company's failure to
redeem any shares of the Series B Participating Preferred Stock on or prior to
August 31, 2003, and the Board expanded from seven to nine members. On November
18, 2003, the date of signing of the Recapitalization Agreement with Chelsey,
Jeffrey A. Sonnefeld, Kenneth J. Krushel and E. Pendleton James resigned as
members of the Company's Board of Directors, the size of the Board of Directors
changed from nine to eight members and Stuart Feldman and William Wachtel were
elected as members of the Board of Directors. Pursuant to the Recapitalization
Agreement with Chelsey, upon the closing of the Recapitalization on November 30,
2003, the size of the Board of Directors was increased from eight to nine
members and Donald Hecht was elected as a member of the Company's Board of
Directors. Martin L. Edelman resigned as a member of the Company's Board of
Directors effective February 15, 2004. Paul S. Goodman was designated by Chelsey
to fill this vacancy effective April 12, 2004.
Pursuant to the Corporate Governance Agreement, dated as of November 30,
2003, by and among the Company, Chelsey, Stuart Feldman, Regan Partners, L.P.,
Regan International Fund Limited and Basil P. Regan, the parties agreed that for
a period of two years from the closing of the Recapitalization, five of the nine
directors of the Company will at all times be directors of the Company
designated by Chelsey (who initially were Martin L. Edelman, William Wachtel,
Stuart Feldman, Wayne Garten and Donald Hecht) and one of the nine directors of
the Company will at all times be a director of the Company designated by Regan
Partners (who initially was Basil Regan). The right of Regan Partners to
designate a nominee to the Board of Directors shall terminate if Regan Partners
ceases to own at least 75% of the outstanding shares of Common Stock (as
adjusted for stock splits, reverse stock splits and the like) owned by Regan
Partners as of November 10, 2003. In connection with the closing of the
transactions contemplated by the Recapitalization Agreement, Chelsey, Stuart
Feldman, Regan Partners and Basil Regan entered into a Voting Agreement dated as
of November 30, 2003, providing that each of them will vote any shares of the
Company beneficially owned by them or any entity affiliated with them, to elect
the nominees to the Board of Directors of Chelsey and Regan Partners designated
pursuant to the Recapitalization Agreement, for a period of two years unless
sooner terminated. All shares for which the Company's management or Board of
Directors hold proxies (including undesignated proxies) will be voted in favor
of the addition of such designees of Chelsey and Regan Partners, except as may
otherwise be provided by stockholders submitting such proxies. In the event that
any Chelsey or Regan Partners designee shall cease to serve as a director of the
Company for any reason, the Company will cause the vacancy resulting thereby to
be filled by a designee of Chelsey or Regan Partners, as the case may be,
reasonably acceptable to the Board of Directors as promptly as practicable.
Chelsey may nominate or propose for nomination or elect any persons to the Board
of Directors, without regard to the foregoing limitations, after the Series C
Participating Preferred Stock is redeemed in full.
98
Set forth below is certain information regarding the current directors of
the Company as of the date hereof:
DIRECTOR
NAME AGE TITLE AND OTHER INFORMATION SINCE
- ---- --- --------------------------- --------
Thomas C. Shull 52 Thomas C. Shull has been Chairman of the Company's 2000
Board of Directors since January 10, 2002 and a
member of the Board of Directors of the Company and
President and Chief Executive Officer of the Company
since December 5, 2000. In 1990, Mr. Shull
co-founded Meridian Ventures, a venture management
and turnaround firm presently based in Connecticut,
and has served as Chief Executive Officer since its
inception. From 1997 to 1999, he served as President
and Chief Executive Officer of Barneys New York, a
leading luxury retailer, where he led them out of
bankruptcy. From 1992 to 1994, Mr. Shull was
Executive Vice President of R.H. Macy Company, Inc.,
where he was responsible for human resources,
information technology, business development,
strategic planning and merchandise distribution and
led the merger negotiations with Federated
Department Stores. Prior to that, he served as a
consultant with McKinsey & Company and in the early
1980s as a member of the National Security Council
Staff in the Reagan White House.
Robert H. Masson 68 Robert H. Masson served as Senior Vice President, 2003
Finance and Administration and Vice President and
Chief Financial Officer of Parsons & Whittemore,
Inc., a global pulp and paper manufacturer, from May
1990 until his retirement June 30, 2002. Prior
thereto, Mr. Masson held various executive,
financial and treasury roles with The Ford Motor
Company, Knutson Construction Company, Ellerbe,
PepsiCo, Inc. and Combustion Engineering (now part
of the ABB Group). Mr. Masson currently serves as a
Trustee and as the Chairman of the Finance Committee
of The Naval Aviation Museum Foundation, Inc. in
Pensacola, Florida. Mr. Masson was elected a
director of the Company effective January 1, 2003.
Basil P. Regan 63 Basil P. Regan has been the General Partner of Regan 2001
Partners, L.P., a limited partnership that invests
primarily in turnaround companies and special
situations, since December 1989. He has been
President of Regan Fund Management Ltd. since
October 1995, which manages Regan Partners, L.P.,
Regan Fund International, L.P. and Super Hedge Fund,
L.P. From 1986 to 1989, Mr. Regan was Vice President
and Director of Equity Research of Reliance Group
Holdings. Mr. Regan was elected a director of the
Company in August 2001.
99
DIRECTOR
NAME AGE TITLE AND OTHER INFORMATION SINCE
- ---- --- --------------------------- --------
A. David Brown 61 Mr. Brown is the co-founder of Bridge Partners LLC, 2003
a consumer financial services and diversity
headhunting firm. Prior to co-founding Bridge
Partners, Mr. Brown served as a Managing Director of
Whitehead Mann after having served as Vice President
of the Worldwide Retail/Fashion Specialty Practice
at Korn/Ferry International. Previously, Mr. Brown
served for 12 years as Senior Vice President for
Human Resources at R.H. Macy & Co. He was
responsible for human resources and labor relations
for 50,000 employees in five U.S. divisions and 17
foreign buying offices around the world. He serves
on the Boards of Zale Corporation and Selective
Insurance Group, Inc. He is a member of the Board of
Trustees of Morristown Memorial Hospital, Drew
University and the Jackie Robinson Foundation. Mr.
Brown was elected a director of the Company
effective July 29, 2003.
Wayne P. Garten 51 Mr. Garten has served as the President of 2003
Caswell-Massey Ltd., Inc., a retailer and direct
marketer of fragrance and other personal care
products, since January 2004. Prior thereto, Mr.
Garten was a financial consultant specializing in
the direct marketing industry. He was Chief
Executive Officer and President of Popular Club,
Inc., a direct selling, catalog marketer of apparel
and general merchandise products, from 2001 to 2003.
From 1997 to 2000, he was Executive Vice President
and Chief Financial Officer of Micro Warehouse,
Inc., an international catalog reseller of computer
products. From 1983 to 1996, Mr. Garten held various
financial positions at Hanover Direct and its
predecessor, The Horn & Hardart Company, including
Executive Vice President and Chief Financial Officer
from 1989 to 1996. Mr. Garten is a Certified Public
Accountant. Mr. Garten was elected a director of the
Company by Chelsey effective September 29, 2003.
William B. Wachtel 49 Mr. Wachtel has been a managing partner of Wachtel & 2003
Masyr, LLP, or its predecessor law firm (Gold &
Wachtel, LLP), since its founding in August 1984. He
is the co-founder of the Drum Major Institute, a
not-for-profit organization carrying forth the
legacy of Dr. Martin Luther King, Jr. Mr. Wachtel is
the Manager of Chelsey. Mr. Wachtel was elected a
director of the Company effective November 18, 2003,
the date of signing of the Recapitalization
Agreement.
Stuart Feldman 43 Mr. Feldman has been a principal of Chelsey Capital, 2003
LLC, a private hedge fund, for more than the past
five years. Mr. Feldman is the principal beneficiary
of Chelsey Capital Profit Sharing Plan, which is the
sole member of Chelsey. Mr. Feldman was elected a
director of the Company effective November 18, 2003,
the date of signing of the Recapitalization
Agreement.
100
DIRECTOR
NAME AGE TITLE AND OTHER INFORMATION SINCE
- ---- --- --------------------------- --------
Donald Hecht 70 Mr. Hecht has, since 1966, together with his brother 2003
Michael Hecht, managed Hecht & Company, an
accounting firm. Mr. Hecht was elected a director of
the Company effective November 30, 2003, the date of
the closing of the Recapitalization.
Paul S. Goodman 50 Mr. Goodman is the Chief Executive Officer of 2004
Chelsey Broadcasting Company, LLC, which position he
has held since January 2003. Chelsey Broadcasting is
the owner of middle market network-affiliated
television stations. Until October 2002, Mr. Goodman
had served as a director of Benedek Broadcasting
Corporation from November 1994 and as a director of
Benedek Communications Corporation from its
inception. From 1983 until October 2002, Mr. Goodman
was also corporate counsel to Benedek Broadcasting
and Benedek Communications since its formation in
1996 until October 2002. From April 1993 to December
2002, Mr. Goodman was a member of the law firm of
Shack Siegel Katz Flaherty & Goodman, P.C. From
January 1990 to April 1993, Mr. Goodman was a member
of the law firm of Whitman & Ransom. Mr. Goodman
became a director of the Company effective April 12,
2004.
(b) Identification of Executive Officers
Pursuant to the Company's Bylaws, its officers are chosen annually by the
Board of Directors and hold office until their respective successors are chosen
and qualified.
On November 3, 2003, Charles E. Blue was appointed Chief Financial Officer
of the Company effective November 11, 2003, replacing Edward M. Lambert as Chief
Financial Officer effective on such date in connection with the Company's
ongoing strategic business realignment program. Mr. Blue joined the Company in
1999 and had most recently served as Senior Vice President, Finance, a position
eliminated by the strategic business realignment program. Mr. Lambert continued
to serve as Executive Vice President of the Company until January 2, 2004. Also
effective November 11, 2003, Brian C. Harriss was appointed Executive Vice
President, Finance and Administration of the Company. Effective February 13,
2004, the position of Executive Vice President, Finance and Administration held
by Brian C. Harriss was also eliminated in connection with the Company's ongoing
strategic business realignment program. On such date, Mr. Blue was appointed to
succeed Mr. Harriss as Secretary of the Company.
101
Set forth below is certain information regarding the current executive
officers of the Company
OFFICE HELD
NAME AGE TITLE AND OTHER INFORMATION SINCE
- ---- --- --------------------------- -----------
Thomas C. Shull 52 President and Chief Executive Officer and a member of 2000
the Board of Directors since December 5, 2000.
Chairman of the Board since January 10, 2002. In 1990,
Mr. Shull co-founded Meridian Ventures, a venture
management and turnaround firm presently based in
Connecticut, and has served as Chief Executive Officer
since its inception. From 1997 to 1999, he served as
President and Chief Executive Officer of Barneys New
York, a leading luxury retailer, where he led them out
of bankruptcy. From 1992 to 1994, Mr. Shull was
Executive Vice President of R.H. Macy Company, Inc.,
where he was responsible for human resources,
information technology, business development,
strategic planning and merchandise distribution and
led the merger negotiations with Federated Department
Stores. Prior to that, he served as a consultant with
McKinsey & Company and in the early 1980s as a member
of the National Security Council Staff in the Reagan
White House.
Michael D. Contino 43 Executive Vice President and Chief Operating Officer 2001
since April 25, 2001. Senior Vice President and Chief
Information Officer from December 1996 to April 25,
2001 and President of Keystone Internet Services, Inc.
(now Keystone Internet Services, LLC) since November
2000. Mr. Contino joined the Company in 1995 as
Director of Computer Operations and
Telecommunications. Prior to 1995, Mr. Contino was the
Senior Manager of IS Operations at New Hampton, Inc.,
a subsidiary of Spiegel, Inc.
William C. Kingsford 57 Senior Vice President, Treasury and Control (Corporate 2003
Controller) since May 2003. Vice President and
Corporate Controller from May 1997 to May 2003. Prior
to May 1997, Mr. Kingsford was Vice President and
Chief Internal Auditor at Melville Corporation. Mr.
Kingsford filed a petition under Chapter 13 of the
United States Bankruptcy Code during March 2001.
Charles E. Blue 43 Senior Vice President and Chief Financial Officer 2003
effective November 11, 2003 and Secretary effective
February 13, 2004. Mr. Blue joined the Company in 1999
and had most recently served as the Company's Senior
Vice President, Finance. Before joining the Company,
he held the positions of Director of Planning and
Treasury for Genesis Direct, Inc. and Director of
Strategic Planning for The Copeland Companies.
Steven Lipner 55 Vice President, Taxation since October 2000. Mr. 2000
Lipner served as Director of Taxes from February 1984
to October 2000. Prior thereto, he served as Director
of Taxes at Avnet, Inc. and held various positions in
public accounting. He holds a license as a Certified
Public Accountant in New York.
102
(c) Audit Committee Financial Expert
The Company's Board of Directors has determined that the Company has at
least one "audit committee financial expert" serving on the Audit Committee of
the Board of Directors who is "independent" of management within the definition
of such term in the Securities Exchange Act of 1934, as amended, and the listing
requirements of the American Stock Exchange. Robert H. Masson, a member of the
Board of Directors and the Chairman of its Audit Committee, is the "audit
committee financial expert" serving on the Company's Audit Committee. Mr. Masson
meets the AMEX requirements that at least one member of the Audit Committee be
financially sophisticated.
At various times during 2003, Messrs. Robert H. Masson (Chairman), Kenneth
J. Krushel and E. Pendleton James were members of the Audit Committee. Upon
execution of the Recapitalization Agreement, the members of the Audit Committee
became Robert Masson (Chairman), Wayne P. Garten and A. David Brown. Donald
Hecht was added to the Audit Committee at the same time he was added to the
Board of Directors. The current members of the Audit Committee are Messrs.
Masson (Chairman), Garten, Brown and Hecht. Each of the members of the Audit
Committee is independent, as defined in Rule Section 121(A) of the American
Stock Exchange's listing standards.
(d) Code of Ethics
The Company has adopted a code of ethics that applies to the Company's
principal executive officer, principal financial officer and principal
accounting officer and other persons performing similar functions. A copy of the
code of ethics has been filed as an Exhibit to the Company's 2002 Annual Report
on Form 10-K. The Company has also adopted a code of conduct that applies to the
Company's directors, officers and employees. A copy of the code of conduct was
filed as an Exhibit to this Annual Report on Form 10-K.
(e) Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934 requires officers,
directors and beneficial owners of more than 10% of the Company's shares to file
reports with the Securities and Exchange Commission and the American Stock
Exchange. Based solely on a review of the reports and representations furnished
to the Company during the last fiscal year by such persons, the Company believes
that each of these persons is in compliance with all applicable filing
requirements.
ITEM 11. EXECUTIVE COMPENSATION
The following table shows salaries, bonuses, and long-term compensation
paid during the last three years for the Chief Executive Officer and the
Company's four (4) next most highly compensated executive officers who were
serving as executive officers at the end of the Company's 2003 fiscal year.
LONG TERM COMPENSATION
-----------------------------------
AWARDS PAYOUTS
----------------------- -------
SECURITIES
ANNUAL COMPENSATION RESTRICTED UNDERLYING
NAME AND ------------------------ OTHER ANNUAL STOCK OPTIONS/ LTIP ALL OTHER
PRINCIPAL POSITION YEAR SALARY BONUS COMPENSATION AWARDS(S) SARS PAYOUTS COMPENSATION
------------------ ---- ---------- ---------- ------------ ---------- ---------- ------- ------------
Thomas C. Shull(1)......... 2003 $ 915,588(2) $2,250,000(2) -- -- -- None $ 12,369(18)
President and Chief 2002 $ 905,923(3) $1,327,500(3) $165,000(10) -- -- None $ 2,116(19)
Executive Officer 2001 $ 900,000(4) $ 600,000(4) $180,000(10) -- 500,000(14) None --
Edward M. Lambert(1)....... 2003 $1,046,923(5) $ -- -- -- -- None $101,486(20)
Executive Vice President 2002 $ 361,539 $ 685,000(6) -- -- 1,000,000(15) None $142,570(21)
2001 -- $ -- -- -- 300,000(17) None --
Brian C. Harriss(1)........ 2003 $ 357,902 $ 168,500(7) -- -- -- None $ 12,164(22)
Executive Vice President, 2002 $ 459,226 $ 287,503(7) $ 12,000(11) -- 600,000(15) None $ 10,001(23)
Finance and Administration 2001 $ 335,192 $ 375,000(7) $ 12,000(11) -- -- None $ 4,089(24)
and Secretary
Michael D. Contino(1)...... 2003 $ 393,698 $ 193,500(8) -- -- -- None $151,282(25)
Executive Vice President 2002 $ 382,270 $ 565,988(8) $ 4,000(12) -- 1,000,000(15) None $ 9,873(26)
and Chief Operating Officer 2001 $ 317,115 $ 350,000(8) $ 12,000(12) -- -- None $ 3,876(27)
Charles E. Blue(1)......... 2003 $ 231,096 $ -- -- -- -- None $ 12,219(28)
Senior Vice President 2002 $ 197,000 $ 206,938(9) $ 4,000(13) -- 250,000(16) None $ 9,873(29)
and Chief Financial Officer 2001 $ 175,858 $ 92,500(9) $ 8,733(13) -- -- None $ 3,992(30)
- ---------------
(1) Thomas C. Shull was named President and Chief Executive Officer and was
elected to the Company's Board of Directors on December 5, 2000. On April
25, 2001, Brian C. Harriss became Executive Vice
103
President and Chief Financial Officer of the Company and Michael D. Contino
became Executive Vice President and Chief Operating Officer of the Company.
Effective January 28, 2002, Mr. Harriss resigned as Executive Vice President and
Chief Financial Officer of the Company. Effective January 28, 2002, Edward
M. Lambert was appointed to succeed Brian C. Harriss as Executive Vice
President and Chief Financial Officer of the Company and Mr. Harriss was
appointed as Executive Advisor to the Chairman of the Company coincident
with his resignation as Executive Vice President and Chief Financial
Officer of the Company. Effective December 2, 2002, Mr. Harriss was
appointed Executive Vice President, Human Resources and Legal and Secretary
of the Company. Effective November 11, 2003, Charles E. Blue was appointed
Senior Vice President and Chief Financial Officer of the Company replacing
Edward M. Lambert as Chief Financial Officer effective on such date in
connection with the Company's strategic business realignment program. Mr.
Lambert continued to serve as an Executive Vice President of the Company
until January 2, 2004. Also effective November 11, 2003, Brian C. Harriss
was appointed Executive Vice President, Finance and Administration.
Effective February 13, 2004, Mr. Harriss resigned from all positions held
with the Company as part of the Company's strategic business realignment
program and Mr. Blue was appointed to succeed Mr. Harriss as Secretary of
the Company.
(2) $915,588 of salary, a $450,000 stay bonus and a $1,350,000 change of
control payment was paid to Mr. Shull under an Employment Agreement between
Mr. Shull and the Company, dated as of September 1, 2002, as amended by
Amendment No. 1 thereto dated as of September 1, 2002, Amendment No. 2
thereto dated as of June 23, 2003, and Amendment No. 3 thereto dated as of
August 3, 2003 (as amended, the "2002 Employment Agreement"), pursuant to
which Mr. Shull is employed by the Company as its President and Chief
Executive Officer. An additional $450,000 transaction bonus was paid to Mr.
Shull under the Shull Transaction Bonus Letter (as defined below).
(3) $276,923 of salary and a $450,000 stay bonus was paid to Mr. Shull under
the 2002 Employment Agreement between Mr. Shull and the Company. Includes a
$877,500 performance bonus for 2002 paid in 2003 under the 2002 Employment
Agreement. The remaining $629,000 of salary and bonus was paid to Meridian
Ventures, LLC, a limited liability company controlled by Mr. Shull
("Meridian"), in consideration for providing the services of Mr. Shull
pursuant to the provisions of a Services Agreement, dated as of December 5,
2000 (the "December 2000 Services Agreement"), a Services Agreement, dated
as of August 1, 2001 (the "August 2001 Services Agreement"), or a Services
Agreement, dated as of December 14, 2001, as amended effective April 2,
2002 (the "December 2001 Services Agreement" and, together with the
December 2000 Services Agreement and the August 2001 Services Agreement,
the "Services Agreements"), each among Meridian, the Company and Mr. Shull.
See "Employment Contracts, Termination of Employment and Change-in-Control
Arrangements."
(4) Paid to Meridian Ventures, LLC under the Services Agreements.
(5) $406,923 of salary and $640,000 of severance was paid to Mr. Lambert in
connection with a severance agreement with the Company dated November 4,
2003.
(6) Includes the following payments made by the Company to Mr. Lambert: for
fiscal 2002, a $200,000 performance bonus and a $100,000 stay bonus paid in
2002 and a $385,000 performance bonus paid in 2003.
(7) Includes the following payments made by the Company to Mr. Harriss: for
fiscal 2003, a $168,500 transaction bonus, for fiscal 2002, a $287,503 2002
performance bonus paid in 2003; and for fiscal 2001, a $375,000 2001
performance bonus paid in 2002.
(8) Includes the following payments made by the Company to Mr. Contino: for
fiscal 2003, a $193,500 transaction bonus, for fiscal 2002, a $565,988 2002
performance bonus paid in 2003; and for fiscal year 2001, a $350,000 2001
performance bonus paid in 2002.
(9) Includes the following payments made by the Company to Mr. Blue: for fiscal
2002, a $206,938 performance bonus for 2002 paid in 2003; and for fiscal
2001, a $92,500 performance bonus for 2001 paid in 2002.
104
(10) Paid to Meridian pursuant to the Services Agreements, and is deemed to
cover Meridian's over-head (including legal and accounting), health care
costs, payroll costs, and other expenses relating to Mr. Shull. See
"Employment Contracts, Termination of Employment and Change in Control
Arrangements."
(11) Includes the following payments made by the Company on behalf of Mr.
Harriss: $12,000 in car allowance and related benefits in 2002; and $12,000
in car allowance and related benefits in 2001.
(12) Includes the following payments made by the Company on behalf of Mr.
Contino: $4,000 in car allowance and related benefits in 2002; and $12,000
in car allowance and related benefits in 2001.
(13) Includes the following payments made by the Company on behalf of Mr. Blue:
$4,000 in car allowance and related benefits in 2002; and $8,733 in car
allowance and related benefits in 2001.
(14) Granted pursuant to the December 2001 Services Agreement and allocated to
Mr. Shull. See "Employment Contracts, Termination of Employment and
Change-in-Control Arrangements."
(15) Issued by the Company pursuant to the Company's 2000 Management Stock
Option Plan. See "Report of the Stock Option and Executive Compensation
Committee on Executive Compensation -- 2000 Management Stock Option Plan."
Options to purchase 100,000 shares issued to Mr. Harriss during 2000 were
forfeited during 2002 following his resignation as Executive Vice President
and Chief Financial Officer of the Company effective January 28, 2002.
(16) Issued by the Company pursuant to the Company's 2000 Management Stock
Option Plan.
(17) Granted pursuant to the December 2001 Services Agreement under the
Company's 2000 Management Stock Option Plan and allocated to Mr. Lambert.
See "Report of the Stock Option and Executive Compensation Committee on
Executive Compensation -- 2000 Management Stock Option Plan."
(18) Includes the following payments made by the Company on behalf of Mr. Shull
in 2003: $276 in group term life insurance premiums; $40 in accidental
death and disability insurance premiums; $162 in core life insurance
premiums; $205 in dental insurance premiums; $158 in long-term disability
premiums; $8,195 in health care insurance premiums; and $3,333 in matching
contributions under the Company's 401(k) Savings Plan.
(19) Includes the following payments made by the Company on behalf of Mr. Shull
in 2002: $85 in group term life insurance premiums; $12 in accidental death
and disability insurance premiums; $50 in core life insurance premiums; $44
in dental insurance premiums; $49 in long-term disability premiums; and
$1,876 in health care insurance premiums.
(20) Includes the following payments made by the Company on behalf of Mr.
Lambert in 2003: $125 in group term life insurance premiums; $40 in
accidental death and disability insurance premiums; $162 in core life
insurance premiums; $205 in dental insurance premiums; $158 in long-term
disability premiums; $8,195 in health care insurance premiums; $3,333 in
matching contributions under the Company's 401(k) Savings Plan; and $89,268
in a gross-up for income tax purposes of travel expenses.
(21) Includes the following payments made by the Company on behalf of Mr.
Lambert in 2002: $79 in group term life insurance premiums; $26 in
accidental death and disability insurance premiums; $106 in core life
insurance premiums; $44 in dental insurance premiums; $191 in long-term
disability premiums; $1,876 in health care insurance premiums; $3,333 in
matching contributions under the Company's 401(k) Savings Plan; and
$136,915 in a gross-up for income tax purposes of travel expenses.
(22) Includes the following payments made by the Company on behalf of Mr.
Harriss in 2003: $287 in group term life insurance premiums; $40 in
accidental death and disability insurance premiums; $162 in core life
insurance premiums; $159 in long-term disability premiums; $8,195 in health
care insurance premiums; and $3,321 in matching contributions under the
Company's 401(k) Savings Plan.
(23) Includes the following payments made by the Company on behalf of Mr.
Harriss in 2002: $276 in group term life insurance premiums; $40 in
accidental death and disability insurance premiums; $162 in core life
insurance premiums; $38 in dental insurance premiums; $561 in long-term
disability premiums; $5,589 in health care insurance premiums; $3,333 in
matching contributions under the Company's 401(k) Savings Plan; and $2 in
vision plan premiums.
105
(24) Includes the following payments made by the Company on behalf of Mr.
Harriss in 2001: $2,833 in matching contributions under the Company's
401(k) Savings Plan; $770 in long-term disability premiums; $439 in term
life insurance premiums; and $40 of accidental death insurance premiums.
(25) Includes the following payments made by the Company on behalf of Mr.
Contino in 2003: $125 in group term life insurance premiums; $40 in
accidental death and disability insurance premiums; $162 in core life
insurance premiums; $205 in dental insurance premiums; $159 in long-term
disability premiums; $8,195 in health care insurance premiums; and $3,333
in matching contributions under the Company's 401(k) Savings Plan. Also
includes forgiveness of a $75,000 non-interest-bearing loan made by the
Company to Mr. Contino in January 1998. The loan was forgiven in full in
accordance with its terms during January 2003. In addition to the loan
forgiveness, the Company paid all applicable withholding taxes totaling
$64,063.
(26) Includes the following payments made by the Company on behalf of Mr.
Contino in 2002: $120 in group term life insurance premiums; $40 in
accidental death and disability insurance premiums; $162 in core life
insurance premiums; $143 in dental insurance premiums; $484 in long-term
disability premiums; $5,589 in health care insurance premiums; $3,333 in
matching contributions under the Company's 401(k) Savings Plan; and $2 in
vision plan premiums.
(27) Includes the following payments made by the Company on behalf of Mr.
Contino in 2001: $2,833 in matching contributions under the Company's
401(k) Savings Plan; $722 in long-term disability premiums; $281 in term
life insurance premiums; and $40 of accidental death insurance premiums.
(28) Includes the following payments made by the Company on behalf of Mr. Blue
in 2003: $125 in group term life insurance premiums; $40 in accidental
death and disability insurance premiums; $162 in core life insurance
premiums; $205 in dental insurance premiums; $159 in long-term disability
premiums; $8,195 in health care insurance premiums; and $3,333 in matching
contributions under the Company's 401(k) Savings Plan.
(29) Includes the following payments made by the Company on behalf of Mr. Blue
in 2002: $120 in group term life insurance premiums; $40 in accidental
death and disability insurance premiums; $162 in core life insurance
premiums; $143 in dental insurance premiums; $285 in long-term disability
premiums; $6,195 in health care insurance premiums; $3,265 in matching
contributions under the Company's 401(k) Savings Plan; and $2 in vision
plan premiums.
(30) Includes the following payments made by the Company on behalf of Mr. Blue
in 2001: $116 in group term life insurance premiums; $2,345 in matching
contributions under the Company's 401(k) Savings Plan; $403 in long-term
disability premiums; $162 in term life insurance premiums; and $40 of
accidental death insurance premiums.
106
STOCK OPTIONS AND STOCK APPRECIATION RIGHTS
The following table contains information concerning options and stock
appreciation rights ("SARs") granted to the Chief Executive Officer and the
Company's four (4) next most highly compensated executive officers who were
serving as executive officers at the end of the Company's 2003 fiscal year.
There were no SARs granted during fiscal 2003 to the Chief Executive Officer or
the Company's four (4) next most highly compensated executive officers who were
serving as executive officers at the end of the Company's 2003 fiscal year.
OPTION/SAR GRANTS IN FISCAL 2003
INDIVIDUAL GRANTS
----------------------------------------------------------------------------
NUMBER OF GRANT DATE
SECURITIES PERCENTAGE OF VALUE
UNDERLYING TOTAL OPTIONS/ ----------
OPTIONS/ SARS GRANTED EXERCISE MARKET PRICE GRANT DATE
SARS TO EMPLOYEES IN OR BASE ON DATE OF PRESENT
NAME GRANTED FISCAL YEAR 2003 PRICE GRANT EXPIRATION DATE VALUE($)
---- ---------- ---------------- -------- ------------ --------------- ----------
Thomas C. Shull........ -- -- -- -- -- --
Edward M. Lambert...... -- -- -- -- -- --
Brian C. Harriss....... -- -- -- -- -- --
Michael D. Contino..... -- -- -- -- -- --
Charles E Blue......... -- -- -- -- -- --
107
The following table contains information concerning the fiscal 2003
year-end values of all options and SARs granted to the Chief Executive Officer
and the Company's four (4) next most highly compensated executive officers who
were serving as executive officers at the end of the Company's 2003 fiscal year.
No SARs have been granted to the Chief Executive Officer or the Company's four
(4) next most highly compensated executive officers who were serving as
executive officers at the end of the Company's 2003 fiscal year.
AGGREGATED OPTION/SAR EXERCISES IN 2003 FISCAL YEAR
AND DECEMBER 27, 2003 OPTION/SAR VALUES
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY
OPTIONS/SARS AT OPTIONS/SARS AT
DECEMBER 27, 2003 DECEMBER 27, 2003
----------------------- --------------------
SHARES ACQUIRED VALUE EXERCISABLE/ EXERCISABLE/
NAME ON EXERCISE(#) REALIZED($) UNEXERCISABLE UNEXERCISABLE
---- --------------- ----------- ----------------------- --------------------
Thomas C. Shull.......... None None 3,200,000 options(1) $0/$0
100% exercisable
Edward M. Lambert........ None None 1,300,000 options(1)(2) $0/$0
100% exercisable
Brian C. Harriss......... None None 600,000 options(2) none $0/$0
100% exercisable
Michael D. Contino....... None None 1,450,000 options(2) $0/$0
100% exercisable
Charles E. Blue.......... None None 294,000 options $0/$0
100% exercisable
- ---------------
(1) 2,700,000 options were awarded to Mr. Shull under the December 2000 Services
Agreement. All of such options were exercisable on December 28, 2002 and
expire on March 31, 2006. 500,000 options were awarded to Mr. Shull, and
300,000 options were awarded to Mr. Lambert, under the December 2001
Services Agreement. Mr. Lambert's options were exercisable on March 31, 2003
and expire on March 31, 2006, while Mr. Shull's options were exercisable on
March 31, 2003, are not saleable until September 30, 2004 and expire on
March 31, 2006.
(2) 200,000 options for Mr. Contino represent options granted pursuant to the
1996 Stock Option Plan. Under this plan, these options become exercisable
after three years and expire after six years from the date of grant.
Additionally, 600,000 options for Mr. Harriss, 1,150,000 options for Mr.
Contino, 1,000,000 options for Mr. Lambert, and 235,117 options for Mr. Blue
represent options granted pursuant to the 2000 Management Stock Option Plan.
Under this plan, Mr. Harriss' and Mr. Contino's options become exercisable
after four years and expire after ten years from the date of grant; Mr.
Lambert's options became fully vested on January 2, 2004. An additional
100,000 options for Mr. Contino represent options granted effective November
3, 1999. These options became fully exercisable after four years.
108
EQUITY COMPENSATION PLAN INFORMATION TABLE
The following table provides information about the securities authorized
for issuance under the Company's equity compensation plans as of December 27,
2003:
(A) (B) (C)
-------------------- -------------------- ----------------------------
NUMBER OF NUMBER OF SECURITIES
SECURITIES TO BE REMAINING AVAILABLE FOR
ISSUED UPON WEIGHTED-AVERAGE FUTURE ISSUANCE UNDER EQUITY
EXERCISE OF EXERCISE PRICE OF COMPENSATION PLANS
OUTSTANDING OPTIONS, OUTSTANDING OPTIONS, (EXCLUDING SECURITIES
PLAN CATEGORY WARRANTS AND RIGHTS WARRANTS AND RIGHTS REFLECTED IN COLUMN(A))
------------- -------------------- -------------------- ----------------------------
Equity compensation plans approved
by security holders............... 11,551,446 $0.70 16,648,554
Equity compensation plans not
approved by security holders...... 2,700,000 0.25 2,700,000
---------- ----------
Total............................... 14,251,446 $0.62 19,348,554
========== ===== ==========
LONG-TERM INCENTIVE PLANS
No awards under long-term incentive plans were granted in fiscal 2003 to
the Chief Executive Officer or the Company's four (4) next most highly
compensated executive officers who were serving as executive officers at the end
of the Company's 2003 fiscal year.
DEFINED BENEFIT OR ACTUARIAL PLANS
The Company has no defined benefit or actuarial plans under which benefits
are determined primarily by final compensation (or average final compensation)
and years of service.
EMPLOYMENT CONTRACTS, TERMINATION OF EMPLOYMENT AND CHANGE-IN-CONTROL
ARRANGEMENTS
Shull Employment Agreement. Effective December 5, 2000, Thomas C. Shull,
Meridian Ventures, LLC, a limited liability company controlled by Mr. Shull
("Meridian"), and the Company entered into a Services Agreement (the "December
2000 Services Agreement"). The December 2000 Services Agreement was replaced by
a subsequent services agreement, dated as of August 1, 2001 (the "August 2001
Services Agreement"), among Mr. Shull, Meridian and the Company, and a Services
Agreement, dated as of December 14, 2001 (the "2001 Services Agreement"), among
Mr. Shull, Meridian, and the Company. The 2001 Services Agreement was replaced
effective September 1, 2002 by an Employment Agreement between Mr. Shull and the
Company, dated as of September 1, 2002, as amended by Amendment No. 1 thereto,
dated as of September 1, 2002, Amendment No. 2 thereto, dated as of June 23,
2003, and Amendment No. 3 thereto, dated as of August 3, 2003 (as amended, the
"2002 Employment Agreement"), pursuant to which Mr. Shull is employed by the
Company as its President and Chief Executive Officer, as described below. The
term of the 2002 Employment Agreement began on September 1, 2002 and will
terminate on March 31, 2006 (the "2002 Employment Agreement Term").
Under the 2002 Employment Agreement, Mr. Shull is to receive from the
Company base compensation equal to $855,000 per annum, payable at the rate of
$71,250 per month, subject to certain exceptions described in the 2002
Employment Agreement ("Base Compensation"). Mr. Shull is to be provided with
participation in the Company's employee benefit plans, including but not limited
to the Company's Key Executive Eighteen Month Compensation Continuation Plan
(the "Change of Control Plan") and its transaction bonus program. The Company is
also to reimburse Mr. Shull for his reasonable out-of-pocket expenses incurred
in connection with his employment by the Company.
Under the 2002 Employment Agreement, the Company paid the remaining unpaid
$300,000 of Mr. Shull's fiscal 2001 bonus under the Company's 2001 Management
Incentive Plan in December 2002. Mr. Shull also received the same bonus amount
for fiscal 2002 under the Company's 2002 Management Incentive Plan as all other
Level 8 participants (as defined in such plan) received under such plan for such
109
period, subject to all of the terms and conditions applicable generally to Level
8 participants thereunder. Mr. Shull earned an annual bonus for fiscal 2003
under the Company's 2003 Management Incentive Plan consistent with bonuses
awarded to other senior executives under such plan. Mr. Shull shall earn an
annual bonus for fiscal 2004 under such plan as the Company's Compensation
Committee may approve in a manner consistent with bonuses awarded to other
senior executives under such plan.
Under the 2002 Employment Agreement, the Company made two installment
payments in September and November 2002 to satisfy the obligation of $450,000 to
Mr. Shull previously due to be paid to Meridian on June 30, 2002. In addition,
the Company agreed to make two equal lump sum cash payments of $225,000 each to
Mr. Shull on March 31, 2003 and September 30, 2004, provided the 2002 Employment
Agreement has not terminated due to Willful Misconduct (as defined in the 2002
Employment Agreement) or material breach thereof by Mr. Shull, or Mr. Shull's
death or permanent disability. Such payments were to be made notwithstanding any
other termination of the Employment Agreement on or prior to such date or as a
result of another event constituting a Change of Control. The March 31, 2003
payment was made on or prior to such date. The Recapitalization constituted a
"change of control" under the 2002 Employment Agreement and Mr. Shull received a
payment in the amount of $225,000 in December 2003 under the terms of the 2002
Employment Agreement, representing an acceleration of the cash payment due in
September 2004.
Under the 2002 Employment Agreement, upon the closing of any transaction
which constitutes a "change of control" thereunder, provided that Mr. Shull is
then employed by the Company, the Company will be required to make a lump sum
cash payment to Mr. Shull on the date of such closing pursuant to the Change of
Control Plan, the Company's transaction bonus program and the Company's
Management Incentive Plan for the applicable fiscal year. Any such lump sum
payment would be in lieu of (i) any cash payment under the 2002 Employment
Agreement as a result of a termination thereof upon the first day after the
acquisition of the Company (whether by merger or the acquisition of all of its
outstanding capital stock) or the tenth day after the sale or any series of
sales since April 27, 2001 involving an aggregate of 50% or more of the market
value of the Company's assets (for this purpose under the 2002 Employment
Agreement, such 50% amount shall be deemed to be $107.6 million), and (ii) the
aggregate amount of Base Compensation to which Mr. Shull would have otherwise
been entitled through the end of the 2002 Employment Agreement Term. The
Recapitalization constituted a "change of control" under the 2002 Employment
Agreement and Mr. Shull received payments on December 5, 2003 and December 12,
2003 in the aggregate amount of $1,575,000 under the terms of the 2002
Employment Agreement, representing a $1,350,000 change of control payment and
the acceleration of a $225,000 cash payment due in September 2004. These amounts
were recorded as compensation to Mr. Shull. Mr. Shull will not be entitled to
any additional change of control payments under the 2002 Employment Agreement
relating to the Recapitalization transaction.
Under the 2002 Employment Agreement, additional amounts are payable to Mr.
Shull by the Company under certain circumstances upon the termination of the
2002 Employment Agreement. If the termination is on account of the expiration of
the 2002 Employment Agreement Term, Mr. Shull shall be entitled to receive such
amount of bonus as may be payable pursuant to the Company's applicable bonus
plan as well as employee benefits such as accrued vacation and insurance in
accordance with the Company's customary practice. If the termination is on
account of the Company's material breach of the 2002 Employment Agreement or the
Company's termination of the 2002 Employment Agreement where there has been no
Willful Misconduct (as defined in the 2002 Employment Agreement) or material
breach thereof by Mr. Shull, Mr. Shull shall be entitled to receive (i) a lump
sum payment equal to the aggregate amount of Base Compensation to which he would
have otherwise been entitled through the end of the 2002 Employment Agreement
Term (not to exceed 18 months of such Base Compensation), plus (ii) such
additional amount, if any, in severance pay which, when combined with the amount
payable pursuant to clause (i) equals 18 months of Base Compensation and such
amount of bonus as may be payable pursuant to the Company's 2002 Management
Incentive Plan or other bonus plan, as applicable (based upon the termination
date and the terms and conditions of the applicable bonus plan), as described in
paragraph 4(b), as well as employee benefits such as accrued vacation and
insurance in accordance with the Company's customary practice. If the
termination is on account of the acquisition of the Company (whether by merger
or the acquisition of all of its outstanding capital stock) or the sale or any
series of sales since April 27, 2001 involving an aggregate of 50%
110
or more of the market value of the Company's assets (for this purpose under the
2002 Employment Agreement, such 50% amount shall be deemed to be $107.6 million)
and the amount realized in the transaction is less than $0.50 per common share
(or the equivalent of $0.50 per common share), and if and only if the Change of
Control Plan shall not then be in effect, Mr. Shull shall be entitled to receive
a lump sum payment equal to the aggregate amount of Base Compensation to which
he would have otherwise been entitled through the end of the 2002 Employment
Agreement Term. If the termination is on account of the acquisition of the
Company (whether by merger or the acquisition of all of its outstanding capital
stock) or the sale or any series of sales since April 27, 2001 involving an
aggregate of 50% or more of the market value of the Company's assets (for this
purpose under the 2002 Employment Agreement, such 50% amount shall be deemed to
be $107.6 million) and the amount realized in the transaction equals or exceeds
$0.50 per common share (or the equivalent of $0.50 per common share), and if and
only if the Change of Control Plan shall not then be in effect, Mr. Shull shall
be entitled to receive a lump sum payment equal to the greater of the Base
Compensation to which he would have otherwise been entitled through the end of
the 2002 Employment Agreement Term or $1,000,000. If the termination is on
account of an acquisition or sale of the Company (whether by merger or the
acquisition of all of its outstanding capital stock) or the sale or any series
of sales since April 27, 2001 involving an aggregate of 50% or more of the
market value of the Company's assets (for this purpose under the 2002 Employment
Agreement, such 50% amount shall be deemed to be $107.6 million) and the Change
of Control Plan shall then be in effect, Mr. Shull shall only be entitled to
receive his benefit under the Change of Control Plan. The Recapitalization
transaction was deemed a "change of control" for purposes of the 2002 Employment
Agreement and the Change of Control Plan. The Company was permitted to make any
payments thereunder on the closing of the Recapitalization. Mr. Shull received
payments on December 5, 2003 and December 12, 2003 in the aggregate amount of
$1,575,000 under the terms of the 2002 Employment Agreement, representing a
$1,350,000 change of control payment and the acceleration of a $225,000 cash
payment due in September 2004. Mr. Shull will not be entitled to any additional
change of control payments under the 2002 Employment Agreement relating to the
Recapitalization transaction.
Under the 2002 Employment Agreement, the Company is required to maintain
directors' and officers' liability insurance for Mr. Shull during the 2002
Employment Agreement Term. The Company is also required to indemnify Mr. Shull
in certain circumstances.
Amended Thomas C. Shull Stock Option Award Agreements. During December
2000, the Company entered into a stock option agreement with Thomas C. Shull to
evidence the grant to Mr. Shull of an option to purchase 2.7 million shares of
the Company's common stock (the "Shull 2000 Stock Option Agreement"). Effective
as of September 1, 2002, the Company amended the Shull 2000 Stock Option
Agreement to (i) extend the final expiration date for the stock option under the
Shull 2000 Stock Option Agreement to June 30, 2005, and (ii) replace all
references therein to the December 2000 Services Agreement with references to
the 2002 Employment Agreement. Effective as of August 3, 2003, the 2002
Employment Agreement was amended to extend the final expiration date for the
stock option under the Shull 2000 Stock Option Agreement to March 31, 2006.
During December 2001, the Company entered into a stock option agreement
with Mr. Shull to evidence the grant to Mr. Shull of an option to purchase
500,000 shares of the Company's Common Stock under the Company's 2000 Management
Stock Option Plan (the "Shull 2001 Stock Option Agreement"). Effective as of
September 1, 2002, the Company has amended the Shull 2001 Stock Option Agreement
to (i) provide that any shares purchased by Mr. Shull under the Shull 2001 Stock
Option Agreement would not be saleable until September 30, 2004, and (ii)
replace all references therein to the 2001 Services Agreement with references to
the 2002 Employment Agreement.
Amended Thomas C. Shull Transaction Bonus Letter. During May 2001, Thomas
C. Shull entered into a letter agreement with the Company (the "Shull
Transaction Bonus Letter") under which he would be paid a bonus on the
occurrence of certain transactions involving the sale of certain of the
Company's businesses. Effective as of September 1, 2002, the Company has amended
the Shull Transaction Bonus Letter to (i) increase the amount of Mr. Shull's
agreed to base salary for purposes of the transaction bonus payable
111
thereunder from $600,000 to $900,000, and (ii) replace all references therein to
the December 2000 Services Agreement with references to the 2002 Employment
Agreement.
The Recapitalization transaction was deemed a "change of control" for
purposes of the Shull Transaction Bonus Letter. The Company was permitted to
make any payments thereunder on or after the closing of the Recapitalization.
Mr. Shull received an additional $450,000 payment on December 5, 2003 under the
terms of the Shull Transaction Bonus Letter.
Issuance of Stock Options. On August 8, 2002, the Company issued options
to purchase 3,750,000 shares of the Company's Common Stock to certain Management
Incentive Plan ("MIP") Level 7 and 8 employees, including various executive
officers, at a price of $0.24 per share and services rendered under the
Company's 2000 Management Stock Option Plan. In addition, on August 8, 2002, the
Company authorized the President to grant options to purchase up to an aggregate
of 1,045,000 and 1,366,000 shares of the Company's Common Stock to certain MIP
Level 4 and MIP Level 5 and 6 employees, respectively, at a price of $0.24 per
share and services rendered under the Company's 2000 Management Stock Option
Plan.
On October 2, 2002, the Company issued options to purchase 600,000 shares
of the Company's Common Stock to an Executive Vice President at a price of $0.27
per share and services rendered under the Company's 2000 Management Stock Option
Plan.
On September 29, 2003, the Company issued options to purchase an aggregate
of 100,000 shares of the Company's Common Stock to two newly-elected Board
members at a price of $0.27 per share and services rendered.
On August 1, 2003, the Company issued options to purchase an aggregate of
210,000 shares of the Company's Common Stock to the then existing six board
members at a price of $0.25 per share and services rendered and options to
purchase 35,000 shares at a price of $0.25 per share and services rendered to a
consultant to the Company per their agreement.
On July 29, 2003, the Company issued options to purchase an aggregate of
100,000 shares of the Company's Common Stock to two newly-elected Board members
at a price of $0.25 per share and services rendered.
Charles F. Messina. During September 2002, Charles F. Messina resigned as
Executive Vice President, Chief Administrative Officer and Secretary of the
Company. In connection with such resignation, the Company and Mr. Messina
entered into a severance agreement dated September 30, 2002 providing for cash
payments of $884,500 and other benefits which were accrued in the fourth quarter
of 2002.
Brian C. Harriss. Brian C. Harriss was appointed as Executive Vice
President, Human Resources and Legal and Secretary of the Company effective
December 2, 2002 and as Executive Vice President, Finance and Administration
effective November 11, 2003. Prior to January 2002, Mr. Harriss had served the
Company as Executive Vice President and Chief Financial Officer. In connection
with the December 2002 appointment, Mr. Harriss and the Company terminated a
severance agreement entered into during January 2002 at the time of Mr. Harriss'
resignation from the Company during January 2002, and Mr. Harriss waived his
rights to certain payments under such severance agreement. Effective February
15, 2004, the position of Executive Vice President, Finance and Administration
was eliminated in connection with the Company's ongoing strategic business
realignment program. In connection with such change, Mr. Harriss and the Company
entered into a severance agreement dated February 15, 2004 providing for
$545,000 of cash payments, as well as other benefits that was accrued and paid
in the first quarter of 2004. Mr. Harriss is also entitled to receive a payment
under the Company's 2003 Management Incentive Plan.
Chief Financial Officer. On November 3, 2003, Charles E. Blue was
appointed Chief Financial Officer of the Company effective November 11, 2003,
replacing Edward M. Lambert as Chief Financial Officer effective on such date in
connection with the Company's ongoing strategic business realignment program.
Mr. Blue joined the Company in 1999 and had most recently served as Senior Vice
President, Finance, a position eliminated by the strategic business realignment
program. Mr. Lambert continued to serve as Executive Vice President of the
Company until January 2, 2004. In connection with such change,
112
Mr. Lambert and the Company entered into a severance agreement dated November 4,
2003 providing for $640,000 of cash payments, as well as other benefits that
were accrued and paid in the fourth quarter of 2003. Mr. Lambert is also
entitled to receive a payment under the Company's 2003 Management Incentive
Plan.
Other Executives. In October 2002, the Company entered into arrangements
with Edward M. Lambert, Brian C. Harriss and Michael D. Contino (the
"Compensation Continuation Agreements") pursuant to which it agreed to provide
eighteen months of severance pay, COBRA reimbursement and Exec-U-Care plan
coverage in the event their employment with the Company is terminated either by
the Company other than "For Cause" or by them "For Good Reason" (as such terms
are defined). On November 6, 2002, the Company also entered into a Compensation
Continuation Agreement with Frank Lengers pursuant to which it agreed to provide
twelve months of severance pay, COBRA reimbursement and Exec-U-Care plan
coverage in the event his employment with the Company is terminated either by
the Company "For Cause" or by Mr. Lengers "For Good Reason" (as such terms are
defined).
Hanover Direct, Inc. Key Executive Eighteen-Month Compensation Continuation
Plan. Effective April 27, 2001, the Company terminated the Hanover Direct, Inc.
Key Executive Thirty-Six Month Compensation Continuation Plan and the Hanover
Direct, Inc. Key Executive Twenty-Four Month Compensation Plan. Effective April
27, 2001, the Company established the Hanover Direct, Inc. Key Executive
Eighteen Month Compensation Continuation Plan (the "Executive Plan") for its
Chief Executive Officer, corporate executive vice presidents, corporate senior
vice presidents, strategic unit presidents, and other employees selected by its
Chief Executive Officer. The purpose of the Executive Plan is to attract and
retain key management personnel by reducing uncertainty and providing greater
personal security in the event of a Change of Control. For purposes of the
Executive Plan, a "Change of Control" will occur: (i) when any person becomes,
through an acquisition, the beneficial owner of shares of the Company having at
least 50% of the total number of votes that may be cast for the election of
directors of the Company (the "Voting Shares"); provided, however, that the
following acquisitions shall not constitute a Change of Control: (a) if a person
owns less than 50% of the voting power of the Company and that person's
ownership increases above 50% solely by virtue of an acquisition of stock by the
Company, then no Change of Control will 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 date of
the establishment of the Executive Plan owned at least 33% of the Voting Shares;
(ii)(a) notwithstanding the foregoing, a Change of Control will occur when the
stockholders of the Company approve any of the following (each, a
"Transaction"): (I) any reorganization, merger, consolidation or other business
combination of the Company; (II) any sale of 50% or more of the market value of
the Company's assets (for this purpose, 50% is deemed to be $107.6 million); or
(III) a complete liquidation or dissolution of the Company; (b) notwithstanding
(ii)(a), stockholder approval of either of the following types of Transactions
will not give rise to a Change of Control: (I) a Transaction involving only the
Company and one or more of its subsidiaries; or (II) a Transaction immediately
following which the stockholders of the Company immediately prior to the
Transaction continue to have a majority of the voting power in the resulting
entity; (iii) when, within any 24 month period, persons who were directors of
the Company (each, a "Director") immediately before the beginning of such period
(the "Incumbent Directors") 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 (iii), any
Director who was not a Director as of the effective date of the Executive Plan
will be deemed to be an Incumbent Director if such Director was elected to the
Board of Directors by, or on the recommendation of, or with the approval of, at
least a majority of the members of the Board of Directors or the nominating
committee who, at the time of the vote, qualified as Incumbent Directors either
actually or by prior operation of (iii), and any persons (and their successors
from time to time) who are designated by a holder of 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 effective date of the Executive Plan shall
be considered Incumbent Directors. Notwithstanding the foregoing, any director
elected to the Board of Directors to avoid or settle a threatened or actual
proxy contest shall not, under any circumstances, be deemed to be an Incumbent
Director); or (iv) when the Company sells, assigns or transfers more than 50% of
its interest in, or the assets of, one or more of its subsidiaries (each, a
"Sold Subsidiary" and, collectively, the "Sold Subsidiaries"); provided,
however, that such a sale, assignment or transfer will constitute a Change of
Control only for: (a) the Executive Plan participants who are employees of
113
that Sold Subsidiary; and (b) the Executive Plan participants who are employees
of a direct or indirect parent company of one or more Sold Subsidiaries, and
then only if: (I) the gross assets of such parent company's Sold Subsidiaries
constitute more than 50% of the gross assets of such parent company (calculated
on a consolidated basis with the direct and indirect subsidiaries of such parent
company and with reference to the most recent balance sheets of the Sold
Subsidiaries and the parent company); (II) the property, plant and equipment of
such parent company's Sold Subsidiaries constitute more than 50% of the
property, plant and equipment of such parent company (calculated on a
consolidated basis with the direct and indirect subsidiaries of such parent
company and with reference to the most recent balance sheets of the Sold
Subsidiaries and the parent company); or (III) in the case of a publicly-traded
parent company, the ratio (as of the date a binding agreement for the sale is
entered) of (x) the capitalization (based on the sale price) of such parent
company's Sold Subsidiaries, to (y) the market capitalization of such parent
company, is greater than 0.50. (For purposes of (iv), a Transaction shall be
deemed to involve the sale of more than 50% of a company's assets if: (a) the
gross assets being sold constitute more than 50% of the gross assets of the
Company as stated on the most recent balance sheet of the Company; (b) the
property, plant and equipment being sold constitute more than 50% of the
property, plant and equipment of the Company as stated on the most recent
balance sheet of the Company; or (c) in the case of a publicly-traded company,
the ratio (as of the date a binding agreement for the sale is entered) of (x)
the capitalization (based on the sale price) of the division, subsidiary or
business unit being sold, to (y) the market capitalization of the Company, is
greater than 0.50. For purposes of this (iv), no Change of Control will be
deemed to have occurred if, immediately following a sale, assignment or transfer
by the Company of more than 50% of its interest in, or the assets of, a Sold
Subsidiary, any stockholder of the Company owning 33% or more of the voting
power of the Company immediately prior to such transactions, owns no less than
the equivalent percentage of the voting power of the Sold Subsidiary.)
Under the Executive Plan, an Executive Plan participant shall be entitled
to Change of Control Benefits under the Executive Plan solely if there occurs a
Change of Control (which occurred on the closing of the Recapitalization) and
thereafter the Company terminates his/her employment other than For Cause (as
defined in the Executive Plan) or the participant voluntarily terminates his/her
employment with the Company For Good Reason (as defined in the Executive Plan),
in either case, solely during the 2-year period immediately following the Change
of Control. A participant will not be entitled to Change of Control Benefits
under the Executive Plan if: (i) he/she voluntarily terminates his/her
employment with the Company or has his/her employment with the Company
terminated by the Company, in either case, prior to a Change of Control, (ii)
he/she voluntarily terminates employment with the Company following a Change of
Control but other than For Good Reason, (iii) he/she is terminated by the
Company following a Change of Control For Cause, (iv) has his/her employment
with the Company terminated solely on account of his/her death, (v) he/she
voluntarily or involuntarily terminates his/her employment with the Company
following a Change of Control as a result of his/her Disability (as defined in
the Executive Plan), or (vi) his/her employment with the Company is terminated
by the Company upon or following a Change of Control but where he/she receives
an offer of comparable employment, regardless of whether the participant accepts
the offer of comparable employment.
The Change of Control Benefits under the Executive Plan are as follows: (i)
an amount equal to 18 months of the participant's annualized base salary; (ii)
an amount equal to the product of 18 multiplied by the applicable monthly
premium that would be charged by the Company for COBRA continuation coverage for
the participant, the participant's spouse and the dependents of the participant
under the Company's group health plan in which the participant was participating
and with the coverage elected by the participant, in each case immediately prior
to the time of the participant's termination of employment with the Company;
(iii) an amount equal to 18 months of the participant's car allowance then in
effect as of the date of the termination of the participant's employment with
the Company; and (iv) an amount equal to the cost of 12 months of
executive-level outplacement services at a major outplacement services firm.
The Recapitalization transaction was a "Change of Control" for purposes of
the Executive Plan.
Hanover Direct, Inc. Directors Change of Control Plan. Effective May 3,
2001, the Company's Board of Directors established the Hanover Direct, Inc.
Directors Change of Control Plan (the "Directors Plan") for
114
all Directors of the Company except for (i) any Director who is also an employee
of the Company for purposes of the Federal Insurance Contributions Act; or (ii)
any persons (and their successors from time to time) who are designated by a
holder of thirty-three percent (33%) or more of the Voting Shares to stand for
election and serve as a Director. For purposes of the Directors Plan, a "Change
of Control" will occur upon the occurrence of the first of any of the events
specified in item (i), (ii) or (iii) of the definition of "Change in Control"
under the Executive Plan, as discussed above.
A participant in the Directors Plan shall be entitled to receive a Change
of Control Payment under the Directors Plan if there occurs a Change of Control
and he/she is a Director on the effective date of such Change of Control. A
Change of Control Payment under the Directors Plan shall be an amount equal to
the greater of (i) $40,000 or (ii) 150% of the sum of the annual retainer fee,
meeting fees and per diem fees paid to a Director for his/her service on the
Board of Directors of the Company during the 12-month period immediately
preceding the effective date of the Change of Control.
The Recapitalization transaction was a "Change of Control" for purposes of
the Directors Plan. The Company was permitted to make all payments thereunder on
or after the closing of the Recapitalization. On December 18, 2003, each of the
eight non-employee directors (Messrs. Brown, James, Krushel, Sonnenfeld, Masson,
Regan, Garten and Edelman) received a payment in the amount of $87,000 under the
terms of the Directors Plan.
Change in Control Payments. Pursuant to the Recapitalization Agreement,
upon completion of the Recapitalization, there was a "change in control" of the
Company for purposes of all of the Company's existing Compensation Continuation
(Change of Control) Plans, including the Directors Change of Control Plan, the
Employment Agreement, dated as of September 1, 2002, as amended, between the
Company and Mr. Shull and the Transaction Bonus Letters between the Company and
the following executive officers: Mr. Shull, Mr. Contino and Mr. Harriss. Mr.
Shull received payments on December 5, 2003 and December 12, 2003 in the
aggregate amount of $1,575,000 under the terms of the 2002 Employment Agreement.
See "Employment Contracts, Termination of Employment and Change-in-Control
Arrangements -- 2002 Employment Agreement." In December 2003, Messrs. Shull,
Harriss and Contino received payments in the amount of $450,000, $168,500 and
$193,500, respectively, under the terms of the Transaction Bonus Letters to
which they are a party. See "Employment Contracts, Termination of Employment and
Change-in-Control Arrangements -- Transaction Bonus Letters." On December 18,
2003, each of the eight non-employee directors (Messrs. Brown, James, Krushel,
Sonnenfeld, Masson, Regan, Garten and Edelman) received a payment in the amount
of $87,000 under the terms of the Hanover Direct, Inc. Directors Change of
Control Plan. See "Employment Contracts, Termination of Employment and
Change-in-Control Arrangements -- Hanover Direct, Inc. Directors Change of
Control Plan." All of such amounts were treated as compensation to the
recipients.
Transaction Bonus Letters. During May 2001, each of Thomas C. Shull,
Jeffrey Potts, Brian C. Harriss and Michael D. Contino and, during November
2002, each of Edward M. Lambert and Brian C. Harriss (each, a "Participant")
entered into a letter agreement with the Company (a "Transaction Bonus Letter")
under which the Participant would be paid a bonus on the occurrence of certain
transactions involving the sale of certain of the Company's businesses. In
addition, Mr. Shull is a party to a "Letter Agreement" with the Company, dated
April 30, 2001, pursuant to which, following the termination of the December
2000 Services Agreement, in the event he is terminated without cause during any
period of his continued employment as the Chief Executive Officer of the
Company, he shall be paid one year of his annual base salary (the "Shull
Termination Payment"). Effective June 1, 2001, the Company amended the Executive
Plan to provide that, notwithstanding anything to the contrary contained in the
Executive Plan, Section 10.2 of the Executive Plan shall not be effective with
respect to the payment of (i) a Participant's "Transaction Bonuses," and/or (ii)
the Shull Termination Payment. The payment of any such "Transaction Bonus" to
any of the Participants, and/or the payment of the Shull Termination Payment,
shall be paid in addition to, and not in lieu of, any Change of Control Benefit
payable to any Participant or Mr. Shull pursuant to the terms of the Executive
Plan. In conjunction with his resignation as Executive Vice President and Chief
Financial Officer, Mr. Harriss released any claims that he may have against the
Company under his May 2001 Transaction Bonus Letter, although he entered into a
new Transaction Bonus Letter in November 2002. The remaining Transaction Bonus
Letters
115
(with Messrs. Shull, Harriss and Contino), other than the Transaction Bonus
Letter with Messrs. Potts, Messina and Lambert, remain in effect.
The Recapitalization transaction was deemed a "change of control" for
purposes of the Transaction Bonus Letters. The Company was permitted to make all
payments thereunder on the closing of the Recapitalization. On December 5 and
12, 2003, Messrs. Shull, Harriss and Contino received payments in the aggregate
amount of $450,000, $168,500 and $193,500, respectively, under the terms of the
Transaction Bonus Letters to which they are a party. Mr. Lambert did not receive
any bonus payment in connection with the Recapitalization under the terms of the
Transaction Bonus Letter to which he is a party because he waived his rights
thereunder pursuant to his severance agreement with the Company.
Letter Agreement with Mr. Shull and Meridian. On April 30, 2001, Mr.
Shull, Meridian and the Company entered into a letter agreement (the "Letter
Agreement") specifying Mr. Shull's rights under the Executive Plan, which is
discussed above. Under the Letter Agreement, Mr. Shull and Meridian agreed that,
so long as the Executive Plan is in effect and Mr. Shull is a Participant
thereunder, Meridian and Mr. Shull will accept the Change in Control Benefits
provided for in the Executive Plan in lieu of the compensation contemplated by
the December 2000 Services Agreement between them (which benefits amounts will
not be offset against the December 2000 flat fee provided for in the December
2000 Services Agreement and shall be payable at such times and in such amounts
as provided in the Executive Plan rather than in a lump sum payable within five
business days after the termination date of the December 2000 Services Agreement
as contemplated by the December 2000 Services Agreement). For purposes of the
change in control benefits under the Executive Plan and the Letter Agreement,
Mr. Shull's annualized base salary is $600,000. In addition to the benefits
provided by the December 2000 Services Agreement, Mr. Shull and those persons
named in the December 2000 Services Agreement shall also be entitled to the
optional cash out of stock options as provided in the Executive Plan. Under the
Letter Agreement, Mr. Shull is also entitled to payment of one year annual base
salary in the event he is terminated without cause during any period of his
continued employment as the Chief Executive Officer of the Company following the
termination of the December 2000 Services Agreement. The participation and
benefits to which Mr. Shull is entitled under the Executive Plan shall also
survive the termination of the December 2000 Services Agreement pursuant to the
terms thereof in the event that Mr. Shull is still employed as the Chief
Executive Officer of the Company and is a Participant under the Executive Plan.
Should the Executive Plan no longer be in effect or Mr. Shull no longer be a
Participant thereunder, Meridian and Mr. Shull shall continue to be entitled to
the compensation contemplated by the December 2000 Services Agreement. The
Letter Agreement was superseded by the 2002 Employment Agreement.
2002 Directors' Option Plan. Effective January 1, 2003, the 2002 Stock
Option Plan for Directors was amended to increase the annual service award for
Directors who are not employees of the Company from 25,000 to 35,000 options to
purchase shares of Common Stock. In November 2003, the 2002 Stock Option Plan
for Directors was amended to increase the maximum number of shares of Common
Stock that may be delivered or purchased under the plan from 500,000 to 900,000.
Stock Option Plans. Pursuant to the Company's Compensation Continuation
(Change of Control) Plans, upon the closing of the Recapitalization, all stock
options previously granted pursuant to the Company's stock option plans to the
Participants under such Change of Control Plans by the Company became fully
exercisable as of November 30, 2003 (the closing date of the Recapitalization),
whether or not otherwise exercisable and vested as of that date.
Salary Reduction. The Company effected salary reductions of 5% of base pay
for participants in its 2003 Management Incentive Plan, including Executive
Officers, effective with the pay period starting August 3, 2003. These salary
reductions are being restored to those participants at or below the
Vice-President level effective March 28, 2004.
Vacation and Sick Policies. During June 2003, the Company established and
implemented a new Company-wide vacation and sick policy applicable to all
employees, including Executive Officers, to better administer vacation and sick
benefits.
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Michael D. Contino. In January 1998, the Company made a $75,000
non-interest bearing loan to Michael D. Contino, currently the Company's
Executive Vice President and Chief Operating Officer, for the purchase by Mr.
Contino of a new principal residence in the state of New Jersey. The terms of
the loan agreement, as amended, included a provision for the Company to forgive
the original amount of the principal on the fifth anniversary of the loan. The
loan was secured by the residence that the proceeds were used to purchase. The
loan was forgiven in full in accordance with its terms during January 2003. In
addition to the loan forgiveness, the Company paid all applicable withholding
taxes totaling $64,063.
REPRICING OF OPTIONS/SARS
During fiscal 2003, the Company did not adjust or amend the exercise price
of stock options or SARs previously awarded to the Chief Executive Officer or
the Company's four (4) next most highly compensated executive officers who were
serving as executive officers at the end of the Company's 2003 fiscal year.
STOCK OPTION AND EXECUTIVE COMPENSATION COMMITTEE INTERLOCKS AND INSIDER
PARTICIPATION
At various times during fiscal year ended December 27, 2003, Messrs.
Jeffrey A. Sonnenfeld (Chairman), A. David Brown and Robert H. Masson were
members of the Stock Option and Executive Compensation Committee. Upon execution
of the Recapitalization Agreement, the members of the Stock Option and Executive
Compensation Committee became A. David Brown (Chairman), Wayne Garten and Stuart
Feldman who are also the current members of the Stock Option and Executive
Compensation Committee. None of such persons was, during such fiscal year or
formerly, an officer or employee of the Company or any of its subsidiaries or
had any relationship with the Company other than serving as a Director of the
Company except for Mr. Garten who served in various executive positions at the
Company from 1983 to 1996. During the 2003 fiscal year, no executive officer of
the Company served as a member of the compensation committee (or other board
committee performing equivalent functions or, in the absence of such committee,
the entire board of directors) of another entity, one of whose executive
officers served as a member of the Stock Option and Executive Compensation
Committee. During the 2003 fiscal year, no executive officer of the Company
served as a director of another entity, one of whose executive officers served
as a member of the Stock Option and Executive Compensation Committee. During the
2003 fiscal year, no executive officer of the Company served as a member of the
compensation committee (or other board committee performing equivalent functions
or, in the absence of such committee, the entire board of directors) of another
entity, one of whose executive officers served as a Director of the Company.
REPORT OF THE STOCK OPTION AND EXECUTIVE COMPENSATION COMMITTEE ON EXECUTIVE
COMPENSATION
The report of the Stock Option and Executive Compensation Committee (the
"Compensation Committee") for the fiscal year ended December 27, 2003, is as
follows:
The Compensation Committee, consisting as of the date of this report for
the fiscal year ended December 27, 2003 of A. David Brown (Chairman), Wayne
Garten and Stuart Feldman, has the responsibility, under delegated authority
from the Company's Board of Directors, for developing, administering and
monitoring the executive compensation policies of the Company and making
recommendations to the Company's Board of Directors with respect to these
policies. The Board of Directors has accepted the Compensation Committee's
recommendations for 2003 compensation.
Executive Compensation Philosophy
The Compensation Committee's executive compensation philosophy supports the
Company's overall business strategy and has at its core a strong link between
pay, performance and retention. The philosophy emphasizes recognition of
achievement at both the Company and individual level. A significant portion of
compensation delivered to executives to reflect such achievement is intended to
be in the form of long-term incentives. This long-term focus emphasizes
sustained performance and encourages retention of executive talent. In addition,
executives are encouraged to hold a significant ownership stake in the Company
so that their interests are closely aligned with those of the stockholders in
terms of both risk and reward.
117
The specific executive compensation plans are designed to support the
executive compensation philosophy. Compensation of the Company's executives
consists of three components, which are discussed below: salary, annual
incentive awards and long-term incentive awards. Base salary levels have been
established in order to attract and retain key executives, commensurate with
their level of responsibility within the organization. Annual incentives closely
link executive pay with performance in areas that are critical to the Company's
short-term operating success. Long-term incentives motivate executives to make
decisions that are in the best interests of the Company's owners and reward them
for the creation of stockholder value. It is the intent of both the Company and
the Compensation Committee that the components of the executive compensation
program will support the Company's compensation philosophy, reinforce the
Company's overall business strategy, and ultimately drive stockholder value
creation.
Base Salaries
Individual salaries for executives of the Company, other than Mr. Shull,
are generally influenced by several equally weighted factors: the qualifications
and experience of the executive, the executive's level of responsibility within
the organization, pay levels at firms which compete with the Company for
executive talent, individual performance, and performance-related factors used
by the Company to determine annual incentive awards. Mr. Shull's compensation
and other benefits are specified in the 2002 Employment Agreement. See
"Employment Contracts, Termination of Employment and Change-in-Control
Arrangements."
The base salaries of the Company's executives are subject to periodic
review and adjustment. Annual salary adjustments are made based on the factors
described above.
Annual Incentive Awards
In addition to base salaries, each of the Company's executives and selected
key managers participate in the Company's Management Incentive Plan. As of the
date of this report (April 2004), approximately 207 executives and key managers
are eligible to participate in the annual Management Incentive Plan. Under this
plan, each participant is assigned a target bonus, expressed as a percentage of
his/her base salary, which is paid if all performance targets are fully met. It
is the policy of the Compensation Committee to position target bonuses at
competitive levels. Individual target bonuses are based on the person's
responsibility level in the organization and the bonus award opportunity at the
other organizations included in the performance chart. Target bonus levels range
from 50% to 125% of salary. Target bonus opportunities for Messrs. Contino,
Harriss, Lambert, Blue and Shull for fiscal year 2003 were 75% of salary while
maximum bonuses were 125% of salary. For purposes of the 2003 Management
Incentive Plan, Mr. Shull's base salary was deemed to be $900,000.
Participants are eligible to receive an annual bonus depending upon the
extent to which certain goals are achieved. As in past years, performance goals
for 2003 were based on Earnings Before Interest, Taxes, Depreciation and
Amortization (EBITDA), net sales, variable contribution and other business
objectives. Goals are set at both the corporate and business unit levels,
depending on the participant's scope of responsibility thus encouraging teamwork
amongst the Company's employees. The importance of each goal in determining a
participant's bonus award also depends on his/her scope of responsibility.
Actual bonus levels vary depending upon the degree of achievement in
relationship to the performance goals.
Payouts of awards have been determined based on the Company's performance
during fiscal 2003. Payments related to fiscal year 2003 are scheduled to be
made to the Chief Executive Officer and the four (4) most highly compensated
executive officers in the amount of $153,487 for Mr. Shull, $97,208 for Mr.
Lambert, $81,898 for Mr. Harriss, $98,999 for Mr. Contino and $66,511 for Mr.
Blue under the 2003 Management Incentive Plan in the summer of 2004. Payments to
Messrs. Shull, Lambert, Harriss, Contino and Blue under the 2002 Management
Incentive Plan in the aggregate amount of $2,322,929 for the fiscal year 2002
were paid in fiscal year 2003. One hundred percent of awards made under the
bonus plan are currently paid in cash, in some cases on a deferred basis.
118
Long-Term Incentive Awards
1993 Executive Equity Incentive Plan
The 1993 Executive Equity Incentive Plan terminated in accordance with its
terms on December 31, 1996. Such plan provided executives and other key
employees with incentives to maximize the long-term creation of stockholder
value. The long-term incentive plan encouraged executives to acquire and retain
a significant ownership stake in the Company. Under the plan, executives were
given an opportunity to purchase shares of Common Stock with up to 80% of the
purchase price financed with a full recourse Company loan. For each share of
stock an employee purchased, he/she received an option to acquire two additional
shares of Common Stock, to a maximum of 250,000 shares in the aggregate, which
vest after three (3) years and expire after six (6) years. By creating this
opportunity, the Company encouraged executives to own Common Stock thereby
aligning executives' interests with those of the stockholders. The number of
shares offered for purchase to each executive and the corresponding number of
tandem options increased with the executive's level of responsibility within the
organization.
In December 1999, the rights of certain participants in this plan expired.
These participants had cumulative promissory notes of approximately $1.0 million
payable to the Company, comprised of $0.8 million of principal and $0.2 million
of interest, on the expiration date. Accordingly, collateral encompassing 20,000
shares and 20,000 shares of the Company's Common Stock in fiscal years 2002 and
2001, respectively, held in escrow on behalf of each participant, was
transferred to and retained by the Company in satisfaction of the aforementioned
promissory notes, which were no longer required to be settled. The Company
recorded these shares as treasury stock. Furthermore, these participants
forfeited their initial 20% cash down payment, which was required for entry into
the 1993 Executive Equity Incentive Plan.
At December 27, 2003, current and former officers and executives of the
Company owed the Company approximately $0.3 million, excluding accrued interest,
under the 1993 Executive Equity Incentive Plan. These amounts due to the Company
bear interest at rates ranging from 5.54% to 7.75% and are due or will be due
during 2004.
As of December 27, 2003, no stock options remained outstanding or
exercisable under the 1993 Executive Entity Incentive Plan.
1996 Stock Option Plan
The purpose of the 1996 Stock Option Plan is to provide employees of the
Company and its subsidiaries with a larger personal and financial interest in
the success of the Company through the grant of stock-based incentive
compensation. Under the plan, employees may be granted options to purchase
shares of Common Stock at the fair market value on the date of grant. The total
options granted to an employee is one-half performance-based. The 1996 Stock
Option Plan provides that options may be granted for terms of not more than 10
years.
Employees are no longer eligible to participate in the 1996 Stock Option
Plan. During 2003, no options to purchase shares of Common Stock were granted
pursuant to the 1996 Stock Option Plan. However, as of December 27, 2003,
options to purchase 872,446 shares of Common Stock remained outstanding under
the 1996 Stock Option Plan including options to purchase 110,000 shares held by
the executives named in the executive compensation table.
2000 Management Stock Option Plan
The purpose of the 2000 Management Stock Option Plan is to advance the
interests of the Company and its stockholders by providing employees of the
Company, through the grant of options to purchase shares of Common Stock, with a
larger personal and financial interest in the success of the Company. Under the
terms of the plan, officers, directors, agents, and employees of the Company and
consultants to the Company or of any subsidiary of the Company may be granted
options to purchase shares of Common Stock at their fair market value on the
date of grant. The plan provides that options may be granted for terms of not
more than 10 years and shall vest according to the terms of the grant of the
options. In addition, options may not be exercised more than 30 days after a
participant ceases to be an employee of the Company, except in the case
119
of death, disability or retirement, in which cases options may be exercised
within 90 days after the date of death, disability or retirement.
During 2003, 65,000 options to purchase shares of Common Stock were granted
to employees in accordance with the 2000 Management Stock Option Plan. During
2003, no options were granted to executives named in the executive compensation
table in accordance with the 2000 Management Stock Option Plan.
1999 Stock Option Plan for Directors
The purpose of the 1999 Stock Option Plan for Directors is to advance the
interests of the Company by providing non-employee directors of the Company,
through the grant of options to purchase shares of Common Stock, with a larger
personal and financial interest in the success of the Company. Under the terms
of the plan, directors who are neither employees of the Company nor nonresident
aliens shall be granted an option to purchase 50,000 shares of Common Stock as
of the effective date of his or her initial appointment or election to the Board
of Directors or, if later, the effective date of the plan, and shall be granted
an option to purchase 10,000 shares of Common Stock on August 4, 2000 and August
3, 2001, provided that such directors continue to serve as directors on such
dates. The price at which shares of Common Stock may be purchased upon the
exercise of the options granted under the plan shall be the fair market value of
such shares on the date of grant of the options. The plan provides that options
shall be granted for terms of 10 years and shall vest one-third, one-third and
one-third on the first, second and third anniversaries of the date of grant. In
addition, options may not be exercised more than 3 months after a participant
ceases to be a director of the Company, except in the case of death or
disability, in which cases options may be exercised within 12 months after the
date of such death or disability.
During 2003, no options to purchase shares of Common Stock were granted to
eligible directors in accordance with the 1999 Stock Option Plan for Directors.
During 2003, no options to purchase shares of Common Stock under the 1999 Stock
Option Plan for Directors were exercised. During 2003, no options to purchase
shares of Common Stock granted to eligible directors under the 1999 Stock Option
Plan for Directors expired following the resignation of a director from the
Company's Board of Directors. As of December 27, 2003, 420,000 options to
purchase Common Stock under the 1999 Stock Option Plan for Directors were
outstanding, of which 366,667 options were exercisable.
No additional options to purchase shares of Common Stock will be granted
under the 1999 Stock Option Plan for Directors.
2002 Stock Option Plan for Directors
The purpose of the 2002 Stock Option Plan for Directors is to advance the
interests of the Company by providing non-employee directors of the Company,
through the grant of options to purchase shares of Common Stock, with a larger
personal and financial interest in the success of the Company. Under the terms
of the plan, directors who are neither employees of the Company nor nonresident
aliens shall be granted an option to purchase 50,000 shares of Common Stock as
of the effective date of his or her initial appointment or election to the Board
of Directors or, if later, the effective date of the plan, and shall be granted
an option to purchase 25,000 shares of Common Stock on August 2, 2002, and an
option to purchase 35,000 shares of Common Stock on August 1, 2003 and August 3,
2004, provided that such directors continue to serve as directors on such dates.
The price at which shares of Common Stock may be purchased upon the exercise of
the options granted under the plan shall be the fair market value of such shares
on the date of grant of the options. The plan provides that options shall be
granted for terms of 10 years and shall vest one-third, one-third and one-third
on the first, second and third anniversaries of the date of grant. In addition,
options may not be exercised more than 3 months after a participant ceases to be
a director of the Company, except in the case of death or disability, in which
cases options may be exercised within 12 months after the date of such death or
disability.
Effective January 1, 2003, the 2002 Stock Option Plan for Directors was
amended to increase the annual service award for directors who are not employees
of the Company from 25,000 to 35,000 options to purchase shares of Common Stock.
In November 2003, the 2002 Stock Option Plan for Directors was amended to
increase the maximum number of shares of Common Stock that may be delivered or
purchased under the
120
Plan from 500,000 to 900,000.
During 2003, a total of 610,000 options to purchase shares of Common Stock
were granted to eligible directors all in accordance with the 2002 Stock Option
Plan for Directors. During 2003, no options to purchase shares of Common Stock
under the 2002 Stock Option Plan for Directors were exercised. During 2003, no
options to purchase shares of Common Stock granted to eligible directors under
the 2002 Stock Option Plan for Directors expired following the resignation of a
director from the Company's Board of Directors. As of December 27, 2003, 710,000
options to purchase Common Stock under the 2002 Stock Option Plan for Directors
were outstanding, 471,666 of which were exercisable.
Chief Executive Officer Compensation
On December 5, 2000, Thomas C. Shull was named President and Chief
Executive Officer and was elected to the Board of Directors of the Company.
Effective on that date, Mr. Shull, Meridian and the Company entered into the
December 2000 Services Agreement. Under the December 2000 Services Agreement,
Meridian provided for the benefit of the Company the services of Mr. Shull and
certain persons providing consulting services to the Company thereunder (the
"Consultants"). The term of the December 2000 Services Agreement, and the term
for the services of Mr. Shull, began on December 5, 2000 and would have
terminated on December 4, 2001, while the term for the services of the
Consultants would have terminated on June 4, 2001. The December 2000 Services
Agreement was replaced by the August 2001 Services Agreement, pursuant to which
the term of the services of Mr. Shull and the Consultants began on August 1,
2001 and would have terminated on June 30, 2002. The August 2001 Services
Agreement was replaced by the December 2001 Services Agreement. Effective
September 1, 2002, the Company and Mr. Shull entered into the 2002 Employment
Agreement, which replaced the August 2001 Services Agreement. The 2002
Employment Agreement will expire on March 31, 2006. See "Employment Contracts,
Termination of Employment and Change-in-Control Arrangements."
Change in Control Payments
Pursuant to the Recapitalization Agreement, upon completion of the
Recapitalization, there was a "change in control" of the Company for purposes of
all of the Company's existing Compensation Continuation (Change of Control)
Plans, including the Directors Change of Control Plan, the 2002 Employment
Agreement between the Company and Mr. Shull and the Transaction Bonus Letters
between the Company and Mr. Shull, Mr. Contino and Mr. Harriss. Mr. Shull
received payments on December 5, 2003 and December 12, 2003 in the aggregate
amount of $1,575,000 under the terms of the 2002 Employment Agreement. See
"Employment Contracts, Termination of Employment and Change-in-Control
Arrangements -- 2002 Employment Agreement." In December 2003, Messrs. Shull,
Harriss and Contino received payments in the amount of $450,000, $168,500 and
$193,500, respectively, under the terms of the Transaction Bonus Letters to
which they are a party. See "Employment Contracts, Termination of Employment and
Change-in-Control Arrangements -- Transaction Bonus Letters." On December 18,
2003, each of the eight non-employee directors (Messrs. Brown, James, Krushel,
Sonnenfeld, Masson, Regan, Garten and Edelman) received a payment in the amount
of $87,000 under the terms of the Hanover Direct, Inc. Directors Change of
Control Plan. See "Employment Contracts, Termination of Employment and
Change-in-Control Arrangements -- Hanover Direct, Inc. Directors Change of
Control Plan."
Nondeductible Compensation
Section 162(m) of the Internal Revenue Code, as amended (the "Code"),
generally disallows a tax deduction to public companies for compensation over
$1,000,000 (the "$1 Million Limit") paid to a company's chief executive officer
and four (4) other most highly compensated executive officers, as reported in
its proxy statement. Qualifying performance-based compensation is not subject to
the deduction limit, if certain requirements are met. The Company has not
structured certain aspects of the performance-based portion of the compensation
for its executive officers (which currently includes awards under performance
based annual management incentive plans) in a manner that complies with the
statute. Payments of
121
compensation in 2003 relating to Thomas Shull and Edward Lambert exceeded the $1
Million Limit; consequently, in each case, the excess of such payments over the
$1 Million Limit was not deductible.
Respectfully Submitted,
The Stock Option and Executive
Compensation
Committee (April 2004)
A. David Brown (Chairman)
Stuart Feldman
Wayne P. Garten
122
REPORT OF THE AUDIT COMMITTEE
The Audit Committee has reviewed and discussed with management and KPMG
LLP, the Company's independent auditors, the Company's audited financial
statements as of and for the year ended December 27, 2003.
The Audit Committee has discussed with the independent auditors the matters
required to be discussed by Statement on Auditing Standards ("SAS") No. 61,
Communication with Audit Committees, as amended by SAS 90.
The Audit Committee has received and reviewed the written disclosures and
the letter from the independent auditors required by Independence Standard No.
1, Independence Discussions with Audit Committees, as amended, by the
Independence Standards Board, and has discussed with the auditors the auditors'
independence.
Based on the review and discussions referred to above, we recommend to the
Board of Directors that the financial statements referred to above be included
in the Company's Annual Report on Form 10-K for the year ended December 27,
2003.
Respectfully Submitted,
The Audit Committee (April 2004)
Robert Masson (Chairman)
A. David Brown
Wayne P. Garten
Donald Hecht
123
PERFORMANCE GRAPH
The following graph compares the yearly percentage change in the cumulative
total stockholder return on the Company's Common Stock for each of the Company's
last five fiscal years with the cumulative total return (assuming reinvestment
of dividends) of (i) the Standard & Poor's 500 Stock Index (which includes the
Company) and (ii) peer issuers from the Company's line of business selected by
the Company in good faith.
COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*
AMONG HANOVER DIRECT, INC., THE S&P 500 INDEX AND A PEER GROUP
(LINE GRAPH)
Cumulative Total Return
---------------------------------------------------------
- --------------------------------------------------------------------------------
12/98 12/99 12/00 12/01 12/02 12/03
- --------------------------------------------------------------------------------
HANOVER DIRECT, INC 100.00 105.45 10.91 10.76 5.53 6.40
S & P 500 100.00 121.04 110.02 96.95 75.52 97.18
PEER GROUP 100.00 110.57 53.08 105.94 129.50 164.07
* Direct Marketing Peer Group consists of direct merchandising companies that
market their products through alternative distribution channels, such as mail
or television media; peer companies include Blair, Spiegel and Williams
Sonoma. Land's End was acquired by Sears and was removed from the Direct
Marketing Peer Group in 2002. Lillian Vernon Corp. was acquired in July 2003
by Ripplewood Holdings and Zelnick Media and was removed from the Direct
Marketing Peer Group in 2003.
NOTE: Assumes $100 invested on December 31, 1998 in the Company's Common Stock,
S&P 500 Stock Index and the Direct Marketing Peer Group, and that
dividends of each are reinvested quarterly.
DIRECTOR COMPENSATION
Standard Arrangements. Non-employee directors of the Company currently
receive an annual cash fee of $58,000. During the first half of fiscal year
2003, non-employee directors were to receive an annual cash fee of $40,000 and
an additional $16,000, $8,000, $8,000, $8,000 and $8,000 annual cash fee for
serving as the Chairman of the Audit, Compensation, Transaction, Executive and
Nominating Committees, respectively. Effective July 10, 2003, the Company
amended its director compensation policy to provide that the annual fee for
non-employee directors will be $58,000 and that there will be no supplemental
annual fees for serving as Chairman of a Board committee or for attending board
meetings. Non-employee directors also participate in the Hanover Direct, Inc.
Change of Control Plan for Directors, the 1999 Stock Option Plan for Directors
and the 2002 Stock Option Plan for Directors. See "Employment Contracts,
Termination of Employment and Change-in-Control Arrangements." The Company does
not compensate its employees, or employees of its subsidiaries, who serve as
directors. During fiscal 2003, the Company provided $50,000 of term life
insurance for each director.
124
During 2003, no options to purchase shares of Common Stock were granted to
eligible directors in accordance with the 1999 Stock Option Plan for Directors.
During 2003, no options to purchase shares of Common Stock under the 1999 Stock
Option Plan for Directors were exercised. During 2003, no options to purchase
shares of Common Stock granted to eligible directors under the 1999 Stock Option
Plan for Directors expired following the resignation of a director from the
Company's Board of Directors. As of December 27, 2003, 420,000 options to
purchase Common Stock under the 1999 Stock Option Plan for Directors were
outstanding, of which 366,667 options were exercisable.
During 2003, a total of 610,000 options to purchase shares of Common Stock
were granted to eligible directors all in accordance with the 2002 Stock Option
Plan for Directors. During 2003, no options to purchase shares of Common Stock
under the 2002 Stock Option Plan for Directors were exercised. During 2003, no
options to purchase shares of Common Stock granted to eligible directors under
the 2002 Stock Option Plan for Directors expired following the resignation of a
director from the Company's Board of Directors. As of December 27, 2003, 710,000
options to purchase Common Stock under the 2002 Stock Option Plan for Directors
were outstanding, 471,666 of which were exercisable.
Effective January 1, 2003, the 2002 Stock Option Plan for Directors was
amended to increase the annual service award for directors who are not employees
of the Company from 25,000 to 35,000 options to purchase shares of Common Stock.
In November 2003, the 2002 Stock Option Plan for Directors was amended to
increase the maximum number of shares of Common Stock that may be delivered or
purchased under the plan from 500,000 to 900,000.
Hanover Direct, Inc. Directors Change of Control Plan. Effective May 3,
2001, the Company's Board of Directors established the Hanover Direct, Inc.
Directors Change of Control Plan (the "Directors Plan") for all Directors of the
Company except for (i) any Director who is also an employee of the Company for
purposes of the Federal Insurance Contributions Act; or (ii) any persons (and
their successors from time to time) who are designated by a holder of
thirty-three percent (33%) or more of the Voting Shares to stand for election
and serve as a Director. For purposes of the Directors Plan, a "Change of
Control" will occur upon the occurrence of the first of any of the events
specified in item (i), (ii) or (iii) of the definition of "Change in Control"
under the Executive Plan, as discussed above.
A participant in the Directors Plan shall be entitled to receive a Change
of Control Payment under the Directors Plan if there occurs a Change of Control
and he/she is a director on the effective date of such Change of Control. A
Change of Control Payment under the Directors Plan shall be an amount equal to
the greater of (i) $40,000 or (ii) 150% of the sum of the annual retainer fee,
meeting fees and per diem fees paid to a Director for his/her service on the
Board of Directors of the Company during the 12-month period immediately
preceding the effective date of the Change of Control.
The Recapitalization transaction was a "Change of Control" for purposes of
the Directors Plan. The Company was permitted to make payments thereunder on or
after the closing of the Recapitalization. On December 18, 2003, each of the
eight non-employee directors (Messrs. Brown, James, Krushel, Sonnenfeld, Masson,
Regan, Garten and Edelman) received a payment in the amount of $87,000 under the
terms of the Directors Plan.
125
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
Per the requirements of SEC Item 201(7)(d), the following table provides
information about the securities authorized for issuance under the Company's
equity compensation plans as of December 27, 2003.
(A) (B) (C)
-------------------- ----------------- -------------------------
NUMBER OF WEIGHTED-AVERAGE NUMBER OF SECURITIES
SECURITIES TO BE EXERCISE PRICE OF REMAINING AVAILABLE FOR
ISSUED UPON OUTSTANDING FUTURE ISSUANCE UNDER
EXERCISE OF OPTIONS, EQUITY COMPENSATION PLANS
OUTSTANDING OPTIONS, WARRANTS AND (EXCLUDING SECURITIES
PLAN CATEGORY WARRANTS AND RIGHTS RIGHTS REFLECTED IN COLUMN (A))
- ------------- -------------------- ----------------- -------------------------
Equity compensation plans approved by
security holders................... 11,551,446 $0.70 16,648,554
Equity compensation plans not
approved by security holders....... 2,700,000 0.25 2,700,000
---------- ----------
Total................................ 14,251,446 $0.62 19,348,554
========== ===== ==========
126
PRINCIPAL HOLDERS OF VOTING SECURITIES OF THE COMPANY
CERTAIN BENEFICIAL OWNERS
The following table lists the beneficial owners known by management of at
least 5% of the Company's Common Stock or 5% of the Company's Series C Preferred
Stock as of March 27, 2004. The information is determined in accordance with
Rule 13d-3 promulgated under the Securities Exchange Act of 1934, as amended
(the "Exchange Act"), based upon information furnished by the persons listed or
contained in filings made by them with the Commission. Except as noted below, to
the Company's knowledge, each person named in the table will have sole voting
and investment power with respect to all shares of Common Stock and Series C
Preferred Stock shown as beneficially owned by them.
NAME AND ADDRESS AMOUNT AND NATURE OF PERCENTAGE
TITLE OF CLASS OF BENEFICIAL OWNER BENEFICIAL OWNERSHIP(1) OF CLASS(1)
- -------------- ------------------- ----------------------- -----------
Series C Chelsey Direct, LLC,........................... 564,819(2) 100%
Participating William B. Wachtel and
Preferred Stock Stuart Feldman
c/o Wachtel & Masyr, LLP
110 East 59th Street
New York, New York 10022
Common Stock Chelsey Direct, LLC,........................... 111,465,621(2) 51%
William B. Wachtel and
Stuart Feldman
c/o Wachtel & Masyr, LLP
110 East 59th Street
New York, New York 10022
Common Stock Regan Partners, L.P. and Basil P. Regan........ 38,821,683(3) 18%
32 East 57th Street
New York, New York 10022
- ---------------
(1) In the case of Common Stock, includes shares of Common Stock issued upon
exercise of options or warrants exercisable within 60 days for the subject
individual only. Percentages of Common Stock are computed on the basis of
220,173,633 shares of Common Stock and 564,819 shares of Series C Preferred
Stock outstanding as of March 27, 2004.
(2) Information concerning the number of shares beneficially owned has been
taken from Amendment No. 9 to the Statement on Schedule 13D filed by Chelsey
Direct, LLC on December 4, 2003 with the Commission. Chelsey is the record
holder of 111,304,721 shares of Common Stock and 564,819 shares of Series C
Preferred Stock. Chelsey Capital Profit Sharing Plan (the "Chelsey Plan") is
the sole member of Chelsey and Mr. Wachtel is the Manager of Chelsey. The
sponsor of the Chelsey Plan is DSJ International Resources Ltd. ("DSJI").
Mr. Feldman is the sole officer and director of DSJI and a principal
beneficiary of the Chelsey Plan. Mr. Feldman is also the owner of 160,900
shares of Common Stock. Mr. Wachtel, in his capacity as the Manager of
Chelsey, will have sole voting and dispositive power with respect to
111,304,721 shares of Common Stock and 564,819 shares of Series C Preferred
Stock owned by Chelsey, and Mr. Feldman will have sole voting and
dispositive power with respect to 160,900 shares of Common Stock owned by
him. Each of Messrs. Wachtel and Feldman have options to purchase 50,000
shares of Common Stock exercisable within 60 days. The shares of Common
Stock and Series C Preferred Stock which are owned by Chelsey and Messrs.
Wachtel and Feldman collectively represent approximately 61% of the combined
voting power of the Company's securities.
(3) Information concerning the number of shares beneficially owned has been
taken from Amendment No. 3 to the Statement on Schedule 13D filed by Regan
Partners L.P. on June 5, 2003 with the Commission. Mr. Regan and Regan
Partners L.P. have shared voting and dispositive power with respect to
37,773,450 shares of Common Stock and Mr. Regan has sole voting and
dispositive power with respect to 1,048,233 shares of Common Stock
(including options to purchase 83,333 shares exercisable within 60 days).
127
SECURITY OWNERSHIP OF MANAGEMENT OF THE COMPANY
MANAGEMENT OWNERSHIP
The following table lists share ownership of the Company's Common Stock and
Series C Preferred Stock as of March 27, 2004. The information includes
beneficial ownership by (i) each of the Company's directors and nominees for
director and executive officers and (ii) all directors and executive officers as
a group. The information is determined in accordance with Rule 13d-3 promulgated
under the Exchange Act based upon information furnished by the persons listed or
contained in filings made by them with the Commission. Except as noted below, to
the Company's knowledge, each person named in the table will have sole voting
and investment power with respect to all shares of Common Stock and Series C
Preferred Stock shown as beneficially owned by them.
AMOUNT AND NATURE OF PERCENTAGE OF
NAME OF BENEFICIAL OWNER BENEFICIAL OWNERSHIP(1) CLASS(1)
- ------------------------ ----------------------- -------------
Robert H. Masson.................................... 85,000(2) *
Basil P. Regan...................................... 38,821,683(3) 17.6%
Thomas C. Shull..................................... 3,250,000(4) 1.5%
Wayne P. Garten..................................... 51,905(5) *
A. David Brown...................................... 85,000(6) *
Michael D. Contino.................................. 1,452,400(7) *
Charles E. Blue..................................... 294,000(8) *
Steven Lipner....................................... 71,174(9) *
William B. Wachtel.................................. 111,354,721(10) 51%
564,819(10) 100%
Stuart Feldman...................................... 111,465,621(10) 51%
564,819(10) 100%
Donald Hecht........................................ 0(11) *
Paul S. Goodman..................................... 0 *
William C. Kingsford................................ 235,117(12) *
Directors and Executive Officers as a
Group (13 persons).................................. 155,861,900(13) 71%
564,819(14) 100%
- ---------------
* Less than one percent
(1) Includes in each case shares of Common Stock issuable upon exercise of
options or warrants exercisable within 60 days for the subject individual
only. Percentages are computed on the basis of 220,173,633 shares of Common
Stock and 564,819 shares of Series C Preferred Stock outstanding as of
March 27, 2004.
(2) Represents options to purchase 85,000 shares exercisable within 60 days.
(3) Mr. Regan and Regan Partners L.P. have shared voting and dispositive power
with respect to 37,773,450 shares of Common Stock and Mr. Regan has sole
voting and dispositive power with respect to 1,048,233 shares (including
options to purchase 83,333 shares exercisable within 60 days) of Common
Stock.
(4) Includes options to purchase 3,200,000 shares exercisable within 60 days.
(5) Includes options to purchase 50,000 shares exercisable within 60 days.
(6) Represents options to purchase 85,000 shares exercisable within 60 days.
(7) Includes options to purchase 1,450,000 shares exercisable within 60 days.
(8) Represents options to purchase 294,000 shares exercisable within 60 days.
(9) Includes options to purchase 70,000 shares exercisable within 60 days.
(10) Chelsey is the record holder of 111,304,721 shares of Common Stock and
564,819 shares of Series C Preferred Stock. Chelsey Capital Profit Sharing
Plan (the "Chelsey Plan") is the sole member of
128
Chelsey and Mr. Wachtel is the Manager of Chelsey. The sponsor of the
Chelsey Plan is DSJ International Resources Ltd. ("DSJI"). Mr. Feldman is
the sole officer and director of DSJI and a principal beneficiary of the
Chelsey Plan. Mr. Feldman is also the owner of 160,900 shares of Common
Stock. Mr. Wachtel, in his capacity as the Manager of Chelsey, has sole
voting and dispositive power with respect to 111,304,721 shares of Common
Stock and 564,819 shares of Series C Preferred Stock owned by Chelsey, and
Mr. Feldman has sole voting and dispositive power with respect to 160,900
shares of Common Stock owned by him. Each of Messrs. Wachtel and Feldman
have options to purchase 50,000 shares of Common Stock exercisable within
60 days. The shares of Common Stock and Series C Preferred Stock owned by
Chelsey and Messrs. Wachtel and Feldman collectively represent
approximately 61% of the combined voting power of the Company's securities.
(11) Excludes options to purchase 50,000 shares which are not exercisable within
60 days.
(12) Includes options to purchase 235,117 shares exercisable within 60 days.
(13) Shares of Common Stock; includes options to purchase 5,417,333 shares
exercisable within 60 days.
(14) Shares of Series C Preferred Stock.
129
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
On November 10, 2003, the Company entered into a Memorandum of
Understanding (the "MOU") with Chelsey and Regan Partners. On November 18, 2003,
the Company and Chelsey entered into the Recapitalization Agreement. The
Recapitalization Agreement sets forth the terms and conditions of the
Recapitalization transaction, including the terms of the Series C Preferred
Stock and the reconstituted board of directors. The Recapitalization was a
"Change of Control" for purposes of all of the Company's existing Compensation
Continuation (Change of Control) Plans, the 2002 Employment Agreement, and the
Transaction Bonus Letters between the Company and its executive officers. The
Company was permitted to make any payments required thereunder on or after the
Closing of the Recapitalization. See the disclosure in Item 11 under the caption
"Employment Contracts, Termination of Employment and Change-in-Control
Arrangements." The Closing of the Recapitalization occurred on November 30,
2003. In the MOU and the Recapitalization Agreement, the Company acknowledged
that Chelsey is the lawful and bona fide owner of 29,446,888 shares of Common
Stock and 1,622,111 shares of Series B Preferred Stock. At the Closing of the
Recapitalization, the Company and Chelsey agreed to release each other from all
claims, filed or that could have been filed, as of the date of such release, and
each of the Company and Chelsey discontinued, with prejudice, all pending
litigation between such parties. In the MOU and the Recapitalization Agreement,
the Company agreed that, prior to the expiration of one hundred fifty (150) days
from the execution of the Recapitalization Agreement (or April 16, 2004), it
would not (a) sell, other than in the ordinary course of business, the
inventory, trademarks or customer lists associated with The Company Store
division of the Company or (b) terminate the employment of the Chief Executive
Officer of the Company, unless, in either case, such action has been approved by
the Board of Directors pursuant to an affirmative vote of at least six (6)
members of the Board of Directors. The Company agreed to pay (a) the reasonable
legal fees and disbursements in connection with the preparation and negotiation
of the MOU, the Recapitalization Agreement and all related documentation on
behalf of Chelsey and (b) the reasonable fees of any financial advisors engaged
by Chelsey or Chelsey's legal counsel not to exceed $20,000 in the aggregate
relating to compliance with the Hart-Scott-Rodino Antitrust Improvements Act of
1976, as amended, including, without limitation, a valuation by such financial
advisors of the securities to be received by Chelsey pursuant to the
Recapitalization. Pursuant to the Recapitalization Agreement, the following
additional documents were executed: (i) a certificate of designations setting
forth the terms and conditions of the Series C Preferred Stock which was filed
with the Delaware Secretary of State, (ii) a voting agreement setting forth
certain voting arrangements among Chelsey, Stuart Feldman, Regan Partners and
Basil Regan, (iii) a registration rights agreement providing for registration
rights with respect to resales by Chelsey and Stuart Feldman of all shares of
Common Stock owned by Chelsey and Mr. Feldman, and (iv) a corporate governance
agreement between the Company, Chelsey, Stuart Feldman, Regan Partners, Regan
Fund and Basil Regan setting forth the corporate governance provisions in the
Recapitalization Agreement.
At December 28, 2002, Richemont Finance S.A., a Luxembourg company
("Richemont"), owned approximately 21.3% of the Company's Common Stock
outstanding and 100% of the Company's Series B Preferred Stock through direct
and indirect ownership. Pursuant to the terms and conditions of that certain
Purchase and Sale Agreement, dated as of May 19, 2003, between Richemont and
Chelsey, Chelsey purchased all of Richemont's securities in the Company,
consisting of 29,446,888 shares of Common Stock and 1,622,111 shares of Series B
Preferred Stock, for a purchase price of $40,000,000. The Company was not a
party to such transaction. As a result of this transaction, on such date,
Chelsey became the beneficial owner of 21.3% of the Company's Common Stock and
100% of the Company's Series B Preferred Stock.
On December 19, 2001, the Company consummated a transaction with Richemont
(the "Richemont Transaction"). In the Richemont Transaction, the Company
repurchased from Richemont all of the outstanding shares of the Series A
Preferred Stock and 74,098,769 shares of the Common Stock of the Company held by
Richemont in return for the issuance to Richemont of 1,622,111 shares of newly
created Series B Preferred Stock and the reimbursement of expenses of $1 million
to Richemont. Richemont agreed, as part of the transaction, to forego any claim
it had to the accrued but unpaid dividends on the Series A Preferred Stock. The
Richemont Transaction was made pursuant to an Agreement (the "Agreement"), dated
130
as of December 19, 2001, between the Company and Richemont. As part of the
Richemont Transaction, the Company (i) released Richemont, the individuals
appointed by Richemont to the Board of Directors of the Company and certain of
their respective affiliates and representatives (collectively, the "Richemont
Group") from any claims by or in the right of the Company against any member of
the Richemont Group which arise out of Richemont's acts or omissions as a
stockholder of or lender to the Company or the acts or omissions of any
Richemont board designee in his capacity as such and (ii) entered into an
Indemnification Agreement with Richemont pursuant to which the Company agreed to
indemnify each member of the Richemont Group from any losses suffered as a
result of any third party claim which is based upon Richemont's acts as a
stockholder or lender of the Company or the acts or omissions of any Richemont
board designee in his capacity as such.
John F. Shull, the brother of Thomas C. Shull, the President and Chief
Executive Officer of the Company, acted as a consultant under the December 2001
Services Agreement, and received an option to purchase 100,000 shares of the
Company's Common Stock under the December 2001 Services Agreement and an option
to purchase 500,000 shares of the Company's Common Stock under the December 2000
Services Agreement.
In January 1998, the Company made a $75,000 non-interest bearing loan to
Mr. Contino for the purchase by Mr. Contino of a new principal residence in the
State of New Jersey. The terms of the loan agreement included a provision for
the Company to forgive the original amount of the principal on the fifth
anniversary of the loan. The loan was secured by the residence which the
proceeds were used to purchase. The loan was forgiven in full in accordance with
its terms during January 2003. In addition to the loan forgiveness, the Company
paid all applicable withholding taxes totaling $64,063.
At December 27, 2003, current and former officers and executives of the
Company owed the Company approximately $0.3 million, excluding accrued interest,
under the 1993 Executive Equity Incentive Plan. These amounts due to the Company
bear interest at rates ranging from 5.54% to 7.75% and are due or will be due
during 2004.
See also "Stock Options and Stock Appreciation Rights" and "Employment
Contracts, Termination of Employment and Change-in-Control Arrangements" for
additional information on relationships and related-party transactions.
Either the Company's Board of Directors, a committee of the Company's Board
of Directors, or the stockholders have approved these relationships and
transactions and, to the extent that such arrangements are available from
nonaffiliated parties, all relationships and transactions are on terms no less
favorable to the Company than those available from non affiliated parties.
131
ITEM 14. PRINCIPAL ACCOUNTANTS FEES AND SERVICES
FEES AND INDEPENDENCE
KPMG LLP provided audit services to the Company consisting of the annual
audit of the Company's 2003 and 2002 consolidated financial statements contained
in the Company's Annual Report on Form 10-K for each year and reviews of the
financial statements contained in the Company's Quarterly Reports on Form 10-Q
for the 2003 fiscal year and the final three quarters of the 2002 fiscal year.
Arthur Anderson LLP billed the Company an aggregate of $29,800 for audit and
audit-related fees for its review of the financial statements contained in the
Company's Quarterly Report on Form 10-Q for the first quarter of the 2002 fiscal
year. The following table shows the fees that were billed to the Company by KPMG
LLP for professional services rendered for the fiscal years ended December 27,
2003 and December 28, 2002.
FEE CATEGORY FISCAL YEAR 2003 % OF TOTAL FISCAL YEAR 2002 % OF TOTAL
- ------------ ---------------- ---------- ---------------- ----------
Audit Fees(1).............................. $814,500 84.6% $632,801 77.9%
Audit-Related Fees(2)...................... 133,500 13.9% 49,619 13.2%
Tax Fees(3)................................ 14,500 1.5% 36,975 4.6%
All Other Fees(4).......................... -0- 0% 35,130 4.3%
Total Fees................................. $962,500 100.0% $754,525 100.0%
- ---------------
(1) Audit Fees are fees for professional services performed for the audit of the
Company's annual financial statements and review of financial statements
included in the Company's 10-Q filings, and services that are normally
provided in connection with statutory and regulatory filings or engagements.
(2) Audit-Related Fees are fees for assurance and related services that are
reasonably related to the performance of the audit or review of the
Company's financial statements. This includes: employee benefit and
compensation plan audits; due diligence related to mergers and acquisitions;
auditor attestations that are not required by statute or regulation; and
consulting on financial accounting/ reporting standards.
(3) Tax Fees are fees for professional services performed with respect to tax
compliance, tax advice and tax planning. For fiscal year 2003, tax fees of
$14,500 are related to tax compliance billings. For fiscal year 2002, tax
fees of $6,825 are related to tax compliance billings and $30,150 are
related to tax consultation and planning.
(4) All Other Fees are fees for other permissible work that does not meet the
above category descriptions, including consulting services regarding the
evaluation of stock option grants and employee agreements.
KPMG LLP did not provide any services related to financial information
systems design and implementation during the 2003 and 2002 fiscal years.
The Audit Committee of the Board of Directors has considered whether the
provision of services by KPMG described above are compatible with maintaining
KPMG's independence as the Company's principal accountant.
PRE-APPROVAL POLICY
The Audit Committee has policies and procedures that require the
pre-approval by the Audit Committee of all fees paid to, and all services
performed by, our independent auditors. Each year, the Audit Committee approves
the proposed services, including the nature, type and scope of services
contemplated and the related fees, to be rendered by our accountants during the
year. In addition, Audit Committee pre-approval is also required for those
engagements that may arise during the course of the year that are outside the
scope of the initial services and fees pre-approved by the Audit Committee.
All of the fees and services provided as noted in the table above were
authorized and approved by the Audit Committee in compliance with the
pre-approval policies and procedures described herein.
132
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this report:
PAGE
NO.
----
1. Index to Financial Statements
Report of Independent Public Accountants -- Hanover Direct,
Inc. and
Subsidiaries Financial Statements........................... 3844
Consolidated Balance Sheets as of December 28, 200227, 2003 and
December 29, 2001........................................... 4028, 2002........................................... 45
Consolidated Statements of Income (Loss) for the years ended
December 27, 2003, December 28, 2002 and December 29,
2001 and December 30,
2000........................................................ 412001........................................................ 46
Consolidated Statements of Cash Flows for the years ended
December 28, 2002, December 29, 2001 and December 30,
2000........................................................ 42
Consolidated Statements of Shareholders' Deficiency for the
years ended December 28, 2002, December 29, 2001 and
December 30, 2000........................................... 43
Notes to Consolidated Financial Statements for the years
ended December 28, 2002, December 29, 2001 and December 30,
2000........................................................ 44
Supplementary Data:
Selected quarterly financial information (unaudited) for the
two fiscal years ended27, 2003, December 28, 2002 and December 29,
2001........................................................ 8347
Consolidated Statements of Shareholders Deficiency for the
years ended December 27, 2003, December 28, 2002 and
December 29, 2001........................................... 48
Selected Quarterly Financial Information (unaudited) for the
fiscal year ended December 27, 2003......................... 94
2. Index to Financial Statement Schedule
Schedule II -- Valuation and Qualifying Accounts for the
years ended December 27, 2003, December 28, 2002 and
December 29, 2001 and
December 30, 2000........................................... 852001........................................... 96
Schedules other than that listed above are omitted because
they are not applicable or the required information is shown
in the financial statements or notes thereto.
3. Exhibits
The exhibits required by Item 601 of Regulation S-K filed as
part of, or incorporated by reference in, this report are
listed in the accompanying Exhibit Index found after the
Signature page.Page.
(b) Reports on Form 8-K:
1.1 Form 8-K, filed October 2, 20022003 -- reporting pursuant to Items 5 and
7 of such Form the election of Martin L. Edelman and Wayne P. Garten
to the Company's Board of Directors by Chelsey, as the holder of the
Series B Participating Preferred Stock, as a result of the Company's
failure to redeem any shares of the Series B Participating Preferred
Stock on or prior to August 31, 2003.
1.2 Form 8-K, filed October 28, 2003 -- reporting pursuant to Item 5 of
such Form the dismissal of the action filed by the Company on July
17, 2003 in the Supreme Court of the State of New York, New York
County against Chelsey and Richemont.
1.3 Form 8-K, filed November 4, 2003 -- reporting pursuant to Items 5
and 7 of such Form the execution by the Company and Congress of the
27th Amendment to the Congress Facility and the appointment of
Mr. Brian C. HarrissCharles E. Blue as Executive Vice
President -- Human Resources and Legal and SecretaryChief Financial Officer of the Company effective
December 2, 2002, and the resignation of Charles F.
MessinaNovember 11, 2003, replacing Edward M. Lambert as Executive Vice President, Chief AdministrativeFinancial
Officer and Secretary of the Company, effective September 30, 2002.
1.2 Form 8-K, filed October 2, 2002 -- reporting pursuant to Item 5 ofon such Form the integration of the Company's Domestications and The
Company Store divisions.
1.3 Form 8-K, filed October 30, 2002 -- reporting pursuant to Item 5 of
such Form that pursuant to a previously signed, ordinary course,
multi-year strategic alliance with Amazon.com, Amazon.com had begun
to offer Hanover Direct merchandise to some customers through a
preview site on Amazon.com.date.
1.4 Form 8-K, filed November 6, 20027, 2003 -- reporting pursuant to ItemItems 5
and 7 of such Form scheduling information regardingconcerning its quarterly
conference call with management to review the fiscal year 2002 third quarteroperating results for
the 13 and nine
months operating results.39 weeks ended September 29, 2003.
1.5 Form 8-K, filed November 7, 200210, 2003 -- reporting pursuant to Item 5 of
such Form the issuance of two press releases announcing that,
pursuant to a previously signed, ordinary course, multi-
92
year strategic alliance with Amazon.com, Amazon.com had begun to
offer the Company's merchandise to all its customers through the
formal launch of its Apparel & Accessories Store.
1.6 Form 8-K, filed NovemberItems 7,
2002 -- reporting pursuant to Item 5 of
such Form scheduling information regarding its conference call with
management to review the fiscal year 2002 third quarter9 and year-to-date operating results.
1.7 Form 8-K, filed November 8, 2002 -- reporting pursuant to Item 9 of
such Form a change to previous guidance given by the Company
regarding the anticipated level of its EBITDA and sales for its 2002
fiscal year to $7 million in EBITDA and $450 million in sales.
1.8 Form 8-K, filed November 8, 2002 -- reporting pursuant to Item 912 of such Form the issuance of a press release announcing
operating results for the thirteen13 and thirty-nine39 weeks ended September 28,
2002.
1.929, 2003.
133
1.6 Form 8-K, filed November 12, 200210, 2003 -- reporting pursuant to Items 5
and 7 of such Form the execution of the Memorandum of Understanding
by and among the Company, Chelsey and Regan Partners, L.P. and the
issuance of a press release announcing the parties' execution of the
Memorandum of Understanding.
1.7 Form 8-K, filed November 13, 2003 -- reporting pursuant to Item 9 of
such Form an unofficial transcript of its conference call with
management to review the fiscal year 2002 first half operating
results2003 third quarter results.
1.8 Form 8-K, filed November 19, 2003 -- reporting pursuant to Items 5
and 7 of such Form the Recapitalization Agreement between the
Company and Chelsey and the issuance of a press release announcing
operating results for the thirteenparties' execution of the Recapitalization Agreement.
1.9 Form 8-K, filed December 1, 2003 -- reporting pursuant to Items 1, 5
and twenty-six weeks ended June 29, 2002.7 of such Form the consummation of the transactions contemplated
by the Recapitalization Agreement.
1.10 Form 8-K, filed November 21, 2002January 8, 2004 -- reporting pursuant to Item 5 of
such Form the receipt bygrant of summary judgment in favor of the Company
of a letter from the
American Stock Exchange (the "Exchange") updating its position
regarding the Company's compliance withdismissing certain of those claims made by Rakesh Kaul in an action
filed against the Exchange's
continued listing standards as set forthCompany on June 28, 2001 in Part 10the Supreme Court of
the Amex
Company Guide.State of New York, County of New York.
1.11 Form 8-K, filed November 21, 2002February 13, 2004 -- reporting pursuant to ItemItems 5
and 7 of such Form the conclusion by the Company's management and Board
of Directors that it is unlikely that the Company will be able to
accumulate sufficient capital, surplus, or other assets under
Delaware corporate law or to obtain sufficient debt financing to
either redeem at least 811,056 shareselimination of the Series B Preferred
Stock by August 31, 2003, or redeem allposition of Executive
Vice President, Finance and Administration, the acceptance of the
sharesresignation of Series B
Preferred Stock by August 31, 2005.Brian C. Harriss and the appointment of Charles E.
Blue as Senior Vice President and Chief Financial Officer and
Secretary effective February 13, 2004.
1.12 Form 8-K, filed December 30, 2002February 13, 2004 -- reporting pursuant to ItemItems 5
and 7 of such Form the electionresignation of Mr. Robert H. MassonMartin L. Edelman as a member
of the Board of Directors of the Company effective January 1, 2003,February 15, 2004 and the
resignationissuance of a press release announcing Mr. J. David Hakman as a member of the Board
of Directors of the Company effective December 31, 2002.Edelman's resignation.
1.13 Form 8-K, filed January 29, 2003March 25, 2004 -- reporting pursuant to ItemItems 5 and
7 of such Form the issuance of a press release announcing unaudited
revenue results forthat the fiscal year ended December 28, 2002 and the
expansion of the Company's brand offerings with Amazon.com during
the first quarter of 2003.
1.14 Form 8-K, filed January 30, 2003 -- reporting pursuant to Item 5 of
such Form the receipt of a letter from the American Stock Exchange
(the "Exchange") confirming that, as of the date of the letter, the
Company had evidenced compliance with the requirements necessary
for continued listing on the Exchange.
1.15 Form 8-K, filed March 20, 2003 -- reporting pursuant to Item 5 of
such Form scheduling information regarding its
conference call with management to review the Company's fiscal year
20022003 operating results.
93results had been rescheduled from March 25, 2004 to
March 29, 2004.
1.14 Form 8-K, filed March 29, 2004 -- reporting pursuant to Items 5 and
7 of such Form the issuance of a press release announcing that the
Company had filed a Form 12b-25 Notification of Late Filing with
the Securities and Exchange Commission extending the deadline for
filing its Annual Report for the fiscal year ended December 27,
2003 and that the conference call with management of the Company to
review the fiscal year 2003 operating results scheduled for March
29, 2004 had been cancelled and postponed to a later date following
the filing of the 2003 Annual Report.
1.15 Form 8-K, filed April 2, 2004 -- reporting pursuant to Items 5 and
7 of such Form the Company's sending letters dated March 22, 2004
and April 2, 2004 to Chelsey Direct, LLC.
134
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this amendment no.Amendment No. 1 to the
report to be signed on its behalf by the undersigned, thereunto duly authorized.
Date: April 9,26, 2004 HANOVER DIRECT, INC.
(Registrant)
By: /s/ THOMAS C. SHULL
------------------------------------
Thomas C. Shull,
Chairman of the Board, President
and Chief Executive Officer
(On behalf of the registrant
and as principal executive officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
amendment no.Amendment No. 1 to the report has been signed below by the following persons on
behalf of the registrant and in the capacities indicated and on the date
indicated below.
Principal Officers:
By: /s/ CHARLES E. BLUE
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Charles E. Blue,
Senior Vice President and
Chief Financial Officer
(principal financial officer)
By: /s/ WILLIAM C. KINGSFORD
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William C. Kingsford,
Senior Vice President of Treasury
and Corporate ControllerControl (principal accounting officer)
Board of Directors:
/s/ THOMAS C. SHULLBASIL P. REGAN
- -----------------------------------------------------
Thomas C. Shull,Basil P. Regan, Director
/s/ ROBERT H. MASSON
- -----------------------------------------------------
Robert H. Masson, Director
/s/ BASIL P. REGAN
- -----------------------------------------------------
Basil P. Regan, Director
/s/ WILLIAM WACHTEL
- -----------------------------------------------------
William Wachtel, Director
/s/ A. DAVID BROWN
- -----------------------------------------------------
A. David Brown, Director
/s/ DONALD HECHT- -----------------------------------------------------
Paul S. Goodman, Director
- -----------------------------------------------------
Donald Hecht, Director
/s/ STUART FELDMANTHOMAS C. SHULL
- -----------------------------------------------------
Thomas C. Shull, Director
- -----------------------------------------------------
Stuart Feldman, Director
/s/ WAYNE P. GARTEN
- -----------------------------------------------------
Wayne P. Garten, Director
Date: April 9,26, 2004
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2.1 Letter agreement, dated December 21, 1999, between the Company and FAR
Services, LLC. Incorporated by reference to the Company's Annual Report
on Form 10-K for the year ended December 25, 1999.
2.2 The Shopper's Edge, LLC Purchase Agreement, dated as of December 25,
1999, between Hanover Brands, Inc. and Far Services, LLC. Incorporated
by reference to the Company's Annual Report on Form 10-K for the year
ended December 25, 1999.
2.3 Asset Purchase Agreement, dated as of June 13, 2001, among the Company,
LWI Holdings, Inc., HSN LP, HSN Improvements, LLC and HSN Catalog
Services, Inc. Incorporated by reference to the Company's Current
Report on Form 8-K filed August 9, 2001.
2.42.2 Amendment No. 1, dated as of June 20, 2001, to the Asset Purchase
Agreement, dated as of June 13, 2001, among the Company, LWI Holdings,
Inc., HSN LP, HSN Improvements, LLC and HSN Catalog Services, Inc.
Incorporated by reference to the Company's Current Report on Form 8-K
filed August 9, 2001.
2.52.3 Agreement, dated as of December 19, 2001, between the Company and
Richemont. Incorporated by reference to the Company's Current Report on
Form 8-K filed December 20, 2001.
3.1 Restated Certificate of Incorporation. Incorporated by reference to the
Company's Annual Report on Form 10-K for the year ended December 28,
1996.
3.2 Certificate of Correction filed to correct a certain error in the
Restated Certificate of Incorporation. Incorporated by reference to the
Company's Annual Report on Form 10-K for the year ended December 26,
1998.
3.3 Certificate of Amendment to Certificate of Incorporation dated May 28,
1999. Incorporated by reference to the Company's Annual Report on Form
10-K for the year ended December 25, 1999.
3.4 Certificate of Correction Filed to Correct a Certain Error in the
Restated Certificate of Incorporation dated August 26, 1999.
Incorporated by reference to the Company's Annual Report on Form 10-K
for the year ended December 25, 1999.
3.5 Certificate of Designations, Powers, Preferences and Rights of Series A
Cumulative Participating Preferred Stock. Incorporated by reference to
the Company's Current Report on Form 8-K filed August 30, 2000.
3.6 Certificate of Designations, Powers, Preferences and Rights of Series A
Cumulative Participating Preferred Stock. Incorporated by reference to
the Company's Current Report on Form 8-K filed August 30, 2000.
3.7 Certificate of the Designations, Powers, Preferences and Rights of
Series B Participating Preferred Stock. Incorporated by reference to
the Company's Current Report on Form 8-K filed December 20, 2001.
3.83.7 Certificate of Elimination of the Series A Cumulative Participating
Preferred Stock. Incorporated by reference to the Company's Current
Report on Form 8-K filed December 20, 2001.
3.8 Certificate of the Designations, Powers, Preferences and Rights of
Series C Participating Preferred Stock. Incorporated by reference to
the Company's Current Report on Form 8-K filed November 30, 2003.
3.9 Certificate of Elimination of the Series B Participating Preferred
Stock. Incorporated by reference to the Company's Current Report on
Form 8-K filed November 30, 2003.
3.10 Certificate of Correction filed on November 26, 2003 with the Delaware
Secretary of State to Correct a Certain Error in the Amended and
Restated Certificate of Incorporation of Hanover Direct, Inc. filed
with the Delaware Secretary of State on October 31, 1996. Incorporated
by reference to the Company's Current Report on Form 8-K filed November
30, 2003.
3.11 By-laws. Incorporated by reference to the Company's Quarterly Report on
Form 10-Q for the quarterly period ended September 27, 1997.
4.1 Registration Rights Agreement between the Company and Richemont dated
as of August 23, 2000.3.12 Amendment to By-laws. Incorporated by reference to the Company's
Current Report on Form 8-K filed AugustNovember 30, 2000.2003.
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10.1 Registration Rights Agreement between the Company and Rakesh K. Kaul,
dated as of August 23, 1996. Incorporated by reference to the Company's
Annual Report on Form 10-K for the year ended December 28, 1996.
10.2 Form of Indemnification Agreement among the Company* and each of the
Company's directors and executive officers. Incorporated by reference
to the Company's* Current Report on Form 8-K dated October 25, 1991.
10.3 Hanover Direct, Inc. Savings Plan as amended. Incorporated by reference
to the Company's Annual Report on Form 10-K for the year ended January
1, 1994.
10.410.2 Restricted Stock Award Plan. Incorporated by reference to the Company's*Company's
Registration Statement on Form S-8 filed on February 24, 1993,
Registration No. 33-58760.
10.510.3 All Employee Equity Investment Plan. Incorporated by reference to the
Company's* Registration Statement on Form S-8 filed on February 24,
1993, Registration No. 33-58756.
10.610.4 Executive Equity Incentive Plan, as amended. Incorporated by reference
to the Company's Annual Report on Form 10-K for the year ended December
28, 1996.
10.710.5 Form of Supplemental Retirement Plan. Incorporated by reference to the
Company's Annual Report on Form 10-K for the year ended January 1,
1994.
10.810.6 1996 Stock Option Plan, as amended. Incorporated by reference to the
Company's 1997 Proxy Statement.
10.910.7 1999 Stock Option Plan for Directors. Incorporated by reference to the
Company's Annual Report on Form 10-K for the year ended December 25,
1999.
10.1010.8 2000 Management Stock Option Plan. Incorporated by reference to the
Company's Annual Report on Form 10-K for the year ended December 25,
1999.
10.1110.9 2002 Stock Option Plan for Directors. Incorporated by reference to the
Company's Annual Report on Form 10-K for the year ended December 29,
2001.
10.1210.10 Amendment No. 1 to 2002 Stock Option Plan for Directors. Incorporated
by reference to the Company's Annual Report on Form 10-K for the year
ended December 28, 2002.
10.1310.11 Form of Stock Option Agreement under 2002 Stock Option Plan for
Directors. Incorporated by reference to the Company's Annual Report on
Form 10-K for the year ended December 28, 2002.
10.1410.12 Hanover Direct, Inc. Key Executive Eighteen Month Compensation
Continuation Plan. Incorporated by reference to the Company's Quarterly
Report on Form 10-Q for the quarterly period ended March 31, 2001.
10.1510.13 Amendment No. 1 to the Hanover Direct, Inc. Key Executive Eighteen
Month Compensation Continuation Plan, dated as of June 1, 2001.
Incorporated by reference to the Company's Quarterly Report on Form
10-Q for the quarterly period ended June 30, 2001.
10.1610.14 Amendment No. 2 to the Hanover Direct, Inc. Key Executive Eighteen
Month Compensation Continuation Plan, effective as of August 1, 2001.
Incorporated by reference to the Company's Quarterly Report on Form
10-Q for the quarterly period ended March 30, 2002.
10.1710.15 Amendment No. 3 to Hanover Direct, Inc. Key Executive Eighteen Month
Compensation Continuation Plan, effective October 29, 2003.
Incorporated by reference to the Company's Quarterly Report on Form
10-Q for the quarterly period ended September 27, 2003.
10.16 Hanover Direct, Inc. Key Executive Twelve Month Compensation
Continuation Plan. Incorporated by reference to the Company's Quarterly
Report on Form 10-Q for the quarterly period ended March 31, 2001.
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10.1810.17 Amendment No. 1 to the Hanover Direct, Inc. Key Executive Twelve Month
Compensation Continuation Plan, effective as of August 1, 2001.
Incorporated by reference to the Company's Quarterly Report on Form
10-Q for the quarterly period ended March 30, 2002.
10.18 Amendment No. 2 to the Hanover Direct, Inc. Key Executive Twelve Month
Compensation Continuation Plan, effective as of December 28, 2002.
Incorporated by reference to the Company's Quarterly Report on Form
10-Q for the quarterly period ended September 27, 2003.
10.19 Hanover Direct, Inc. Key Executive Six Month Compensation Continuation
Plan. Incorporated by reference to the Company's Quarterly Report on
Form 10-Q for the quarterly period ended March 31, 2001.
10.20 Amendment No. 1 to the Hanover Direct, Inc. Key Executive Six Month
Compensation Continuation Plan, effective as of August 1, 2001.
Incorporated by reference to the Company's Quarterly Report on Form
10-Q for the quarterly period ended March 30, 2002.
10.21 Amendment No. 2 to the Hanover Direct, Inc. Key Executive Six Month
Compensation Continuation Plan, effective as of December 28, 2002.
Incorporated by reference to the Company's Quarterly Report on Form
10-Q for the quarterly period ended September 27, 2003.
10.22 Hanover Direct, Inc. Directors Change of Control Plan. Incorporated by
reference to the Company's Quarterly Report on Form 10-Q for the
quarterly period ended March 31, 2001.
10.2210.23 Amendment No. 1 to the Hanover Direct, Inc. Directors Change of Control
Plan, effective as of August 1, 2001. Incorporated by reference to the
Company's Quarterly Report on Form 10-Q for the quarterly period ended
March 30, 2002.
10.2310.24 Loan and Security Agreement dated as of November 14, 1995 by and among
Congress Financial Corporation ("Congress"), HDPA, Brawn, Gump's by
Mail, Gump's, The Company Store, Inc. ("The Company Store"), Tweeds,
Inc. ("Tweeds"), LWI Holdings, Inc. ("LWI"), Aegis Catalog Corporation
("Aegis"), Hanover Direct Virginia, Inc. ("HDVA") and Hanover Realty
Inc. ("Hanover Realty"). Incorporated by reference to the Company's
Annual Report on Form 10-K for the year ended December 30, 1995.
10.2410.25 First Amendment to Loan and Security Agreement dated as of February 22,
1996 by and among Congress, HDPA, Brawn, Gump's by Mail, Gump's, The
Company Store, Tweeds, LWI, Aegis, HDVA, Hanover Realty and TAC.
Incorporated by reference to the Company's Annual Report on Form 10-K
for the year ended December 28, 1996.
10.2510.26 Second Amendment to Loan and Security Agreement dated as of April 16,
1996 by and among Congress, HDPA, Brawn, Gump's by Mail, Gump's, The
Company Store, Tweeds, LWI, Aegis, HDVA, Hanover Realty and TAC.
Incorporated by reference to the Company's Annual Report on Form 10-K
for the year ended December 28, 1996.
10.2610.27 Third Amendment to Loan and Security Agreement dated as of May 24, 1996
by and among Congress, HDPA, Brawn, Gump's by Mail, Gump's, The Company
Store, Tweeds, LWI, Aegis, HDVA, Hanover Realty and TAC. Incorporated
by reference to the Company's Annual Report on Form 10-K for the year
ended December 28, 1996.
10.2710.28 Fourth Amendment to Loan and Security Agreement dated as of May 31,
1996 by and among Congress, HDPA, Brawn, Gump's by Mail, Gump's, The
Company Store, Tweeds, LWI, Aegis, HDVA, Hanover Realty and TAC.
Incorporated by reference to the Company's Annual Report on Form 10-K
for the year ended December 28, 1996.
10.28 Fifth Amendment to Loan and Security Agreement dated as of September
11,
1996 by and among Congress, HDPA, Brawn, Gump's by Mail, Gump's, The
Company Store, Tweeds, LWI, Aegis, HDVA, Hanover Realty and TAC.
Incorporated by reference to the Company's Annual Report on Form 10-K
for the year ended December 28, 1996.
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10.29 Fifth Amendment to Loan and Security Agreement dated as of September
11, 1996 by and among Congress, HDPA, Brawn, Gump's by Mail, Gump's,
The Company Store, Tweeds, LWI, Aegis, HDVA, Hanover Realty and TAC.
Incorporated by reference to the Company's Annual Report on Form 10-K
for the year ended December 28, 1996.
10.30 Sixth Amendment to Loan and Security Agreement dated as of December 5,
1996 by and among Congress, HDPA, Brawn, Gump's by Mail, Gump's, The
Company Store, Tweeds, LWI, Aegis, HDVA, Hanover Realty and TAC.
Incorporated by reference to the Company's Annual Report on Form 10-K
for the year ended December 28, 1996.
10.3010.31 Seventh Amendment to Loan and Security Agreement dated as of December
18, 1996 by and among Congress, HDPA, Brawn, Gump's by Mail, Gump's,
The Company Store, Tweeds, LWI, Aegis, HDVA, Hanover Realty and TAC.
Incorporated by reference to the Company's Annual Report on Form 10-K
for the year ended December 28, 1996.
10.3110.32 Eighth Amendment to Loan and Security Agreement dated as of March 26,
1997 by and among Congress, HDPA, Brawn, Gump's by Mail, Gump's, The
Company Store, Tweeds, LWI, Aegis, HDVA, Hanover Realty and TAC.
Incorporated by reference to the Company's Annual Report on Form 10-K
for the year ended December 26, 1998.
10.3210.33 Ninth Amendment to Loan and Security Agreement dated as of April 18,
1997 by and among Congress, HDPA, Brawn, Gump's by Mail, Gump's, The
Company Store, Tweeds, LWI, Aegis, HDVA, Hanover Realty and TAC.
Incorporated by reference to the Company's Annual Report on Form 10-K
for the year ended December 26, 1998.
10.3310.34 Tenth Amendment to Loan and Security Agreement dated as of October 31,
1997 by and among Congress, HDPA, Brawn, Gump's by Mail, Gump's, The
Company Store, Tweeds, LWI, Aegis, HDVA, Hanover Realty and TAC.
Incorporated by reference to the Company's Annual Report on Form 10-K
for the year ended December 26, 1998.
10.3410.35 Eleventh Amendment to Loan and Security Agreement dated as of March 25,
1998 by and among Congress, HDPA, Brawn, Gump's by Mail, Gump's, The
Company Store, Tweeds, LWI, Aegis, HDVA, Hanover Realty and TAC.
Incorporated by reference to the Company's Annual Report on Form 10-K
for the year ended December 26, 1998.
10.3510.36 Twelfth Amendment to Loan and Security Agreement dated as of September
30, 1998 by and among Congress, HDPA, Brawn, Gump's by Mail, Gump's,
The Company Store, Tweeds, LWI, Aegis, HDVA, Hanover Realty and TAC.
Incorporated by reference to the Company's Annual Report on Form 10-K
for the year ended December 25, 1999.
10.3610.37 Thirteenth Amendment to Loan and Security Agreement dated as of
September 30, 1998 by and among Congress, HDPA, Brawn, Gump's by Mail,
Gump's, The Company Store, Tweeds, LWI, Aegis, HDVA, Hanover Realty and
TAC. Incorporated by reference to the Company's Annual Report on Form
10-K for the year ended December 25, 1999.
10.3710.38 Fourteenth Amendment to Loan and Security Agreement dated as of
February 28, 2000 by and among Congress, HDPA, Brawn, Gump's by Mail,
Gump's, The Company Store, Tweeds, LWI, Aegis, HDVA, Hanover Realty and
TAC. Incorporated by reference to the Company's Annual Report on Form
10-K for the year ended December 25, 1999.
10.38 Fifteenth Amendment to Loan and Security Agreement dated as of March
24, 2000 by and among Congress, HDPA, Brawn, Gump's by Mail,
Gump's, The Company Store, Tweeds, LWI, Aegis, HDVA, Hanover Realty The Company Store Factory, Inc., The Company
Office, Inc., Keystone Internet Services, Inc., Tweeds, LLC,
Silhouettes, LLC, Hanover Company Store, LLC and
Domestications, LLC.TAC. Incorporated by reference to the Company's QuarterlyAnnual Report on Form
10-Q10-K for the quarterly periodyear ended MarchDecember 25, 2000.1999.
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10.39 Fifteenth Amendment to Loan and Security Agreement dated as of March
24, 2000 by and among Congress, HDPA, Brawn, Gump's by Mail, Gump's,
LWI, HDVA, Hanover Realty, The Company Store Factory, Inc., The Company
Office, Inc., Keystone Internet Services, Inc., Tweeds, LLC,
Silhouettes, LLC, Hanover Company Store, LLC and Domestications, LLC.
Incorporated by reference to the Company's Quarterly Report on Form
10-Q for the quarterly period ended March 25, 2000.
10.40 Sixteenth Amendment to Loan and Security Agreement dated as of August
8, 2000 by and among Congress, HDPA, Brawn, Gump's by Mail, Gump's,
LWI, HDVA, Hanover Realty, The Company Store Factory, Inc., The Company
Office, Inc., Keystone Internet Services, Inc., Tweeds, LLC,
Silhouettes, LLC, Hanover Company Store, LLC and Domestications, LLC.
Incorporated by reference to the Company's Quarterly Report on Form
10-Q for the quarterly period ended June 24, 2000.
10.4010.41 Seventeenth Amendment to Loan and Security Agreement dated as of
January 5, 2001 by and among Congress, HDPA, Brawn, Gump's by Mail,
Gump's, LWI, HDVA, Hanover Realty, The Company Store Factory, Inc., The
Company Office, Inc., Keystone Internet Services, Inc., Tweeds, LLC,
Silhouettes, LLC, Hanover Company Store, LLC and Domestications, LLC.
Incorporated by reference to the Company's Annual Report on Form 10-K
for the year ended December 30, 2000.
10.4110.42 Eighteenth Amendment to Loan and Security Agreement, dated as of
November 12, 2001, among Congress, HDPA, Brawn, Gump's by Mail, Gump's,
LWI, HDVA, Hanover Realty, The Company Store Factory, Inc., The Company
Office, Inc., Keystone Internet Services, Inc., Tweeds, LLC,
Silhouettes, LLC, Hanover Company Store, LLC and Domestications, LLC.
Incorporated by reference to the Company's Quarterly Report on Form
10-Q for the quarterly period ended September 29, 2001.
10.4210.43 Nineteenth Amendment to Loan and Security Agreement, dated as of
December 18, 2001, by and among Congress, HDPA, Brawn, Gump's by Mail,
Gump's, LWI, HDVA, Hanover Realty, The Company Store Factory, Inc., The
Company Office, Inc., Keystone Internet Services, Inc., Tweeds, LLC,
Silhouettes, LLC, Hanover Company Store, LLC and Domestications, LLC.
Incorporated by reference to the Company's Current Report on Form 8-K
filed December 20, 2001.
10.4310.44 Twentieth Amendment to Loan and Security Agreement, dated as of March
5, 2002, by and among Congress, HDPA, Brawn, Gump's by Mail, Gump's,
HDVA, Hanover Realty, The Company Store Factory, Inc., The Company
Office, Inc., Keystone Internet Services, Inc., Silhouettes, LLC,
Hanover Company Store, LLC and Domestications, LLC. Incorporated by
reference to the Company's Annual Report on Form 10-K for the year
ended December 29, 2001.
10.4410.45 Twenty-first Amendment to Loan and Security Agreement, dated as of
March 21, 2002, among Congress, HDPA, Brawn, Gump's by Mail, Gump's,
HDVA, Hanover Realty, The Company Store Factory, Inc., The Company
Office, Inc., Keystone Internet Services, Inc., Silhouettes, LLC,
Hanover Company Store, LLC and Domestications, LLC. Incorporated by
reference to the Company's Annual Report on Form 10-K for the year
ended December 29, 2001.
10.45 Twenty-second Amendment to Loan and Security Agreement, dated as of
August 16, 2002, among Congress, HDPA, Brawn, Gump's by Mail, Gump's,
HDVA, Hanover Realty, The Company Store Factory, Inc., The Company
Office, Inc., Keystone Internet Services, Inc., Silhouettes, LLC,
Hanover Company Store, LLC and Domestications, LLC and Keystone Internet Services, Inc.LLC. Incorporated by
reference to the Company's QuarterlyAnnual Report on Form 10-Q10-K for the quarterly periodyear
ended JuneDecember 29, 2002.2001.
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10.46 Twenty-second Amendment to Loan and Security Agreement, dated as of
August 16, 2002, among Congress, HDPA, Brawn, Gump's by Mail, Gump's,
HDVA, Hanover Realty, The Company Store Factory, Inc., The Company
Office, Inc., Silhouettes, LLC, Hanover Company Store, LLC,
Domestications, LLC and Keystone Internet Services, Inc. Incorporated
by reference to the Company's Quarterly Report on Form 10-Q for the
quarterly period ended June 29, 2002.
10.47 Twenty-third Amendment to Loan and Security Agreement, dated as of
December 27, 2002, among Congress, HDPA, Brawn, Gump's by Mail, Gump's,
HDVA, Hanover Realty, The Company Store Factory, Inc., The Company
Office, Inc., Silhouettes, LLC, Hanover Company Store, LLC,
Domestications, LLC, Keystone Internet Services, Inc., Keystone
Internet Services, LLC and The Company Store Group, LLC. Incorporated
by reference to the Company's Annual Report on Form 10-K for the year
ended December 28, 2002.
10.4710.48 Twenty-fourth Amendment to Loan and Security Agreement, dated as of
February 28, 2003, among Congress, Brawn, Gump's by Mail, Gump's,
Hanover Realty, The Company Store Factory, Inc., The Company Office,
Inc., Silhouettes, LLC, Hanover Company Store, LLC, Domestications,
LLC, Keystone internet Services, LLC and The Company Store Group, LLC.
Incorporated by reference to the Company's Annual Report on Form 10-K
for the year ended December 28, 2002.
10.48 Long-Term Incentive Plan for Rakesh K. Kaul.10.49 Twenty-fifth Amendment to Loan and Security Agreement, dated as of
April 21, 2003, among Congress, Brawn, Gump's by Mail, Gump's, Hanover
Realty, The Company Store Factory, Inc., The Company Office, Inc.,
Silhouettes, LLC, Hanover Company Store, LLC, Domestications, LLC,
Keystone internet Services, LLC and The Company Store Group, LLC.
Incorporated by reference to the Company's AnnualQuarterly Report on Form
10-K10-Q for the yearquarterly period ended December
28, 1996.
10.49 Short-Term Incentive Plan for Rakesh K. Kaul.March 29, 2003.
10.50 Twenty-sixth Amendment to Loan and Security Agreement, dated as of
August 29, 2003, among Congress, Brawn, Gump's by Mail, Gump's, Hanover
Realty, The Company Store Factory, Inc., The Company Office, Inc.,
Silhouettes, LLC, Hanover Company Store, LLC, Domestications, LLC,
Keystone internet Services, LLC and The Company Store Group, LLC.
Incorporated by reference to the Company's AnnualQuarterly Report on Form
10-K10-Q for the yearquarterly period ended December
28, 1996.
10.50 Tandem Option PlanSeptember 27, 2003.
10.51 Twenty-seventh Amendment to Loan and Security Agreement, dated as of
August 23, 1996 between theOctober 31, 2003, among Congress, Brawn, Gump's by Mail, Gump's,
Hanover Realty, The Company Store Factory, Inc., The Company Office,
Inc., Silhouettes, LLC, Hanover Company Store, LLC, Domestications,
LLC, Keystone internet Services, LLC and Rakesh K. Kaul.The Company Store Group, LLC.
Incorporated by reference to the Company's AnnualCurrent Report on Form 10-K for the year ended December 28, 1996.
10.51 Closing Price Option8-K
filed October 31, 2003.
10.52 Twenty-eighth Amendment to Loan and Security Agreement, dated as of
August 23, 1996 between theNovember 4, 2003, among Congress, Brawn, Gump's by Mail, Gump's,
Hanover Realty, The Company Store Factory, Inc., The Company Office,
Inc., Silhouettes, LLC, Hanover Company Store, LLC, Domestications,
LLC, Keystone internet Services, LLC and Rakesh K. Kaul.The Company Store Group, LLC.
Incorporated by reference to the Company's AnnualQuarterly Report on Form
10-K10-Q for the yearquarterly period ended December 28, 1996.
10.52 Performance Price OptionSeptember 27, 2003.
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10.53 Twenty-ninth Amendment to Loan and Security Agreement, dated as of
August 23, 1996 between theNovember 25, 2003, among Congress, Brawn, Gump's by Mail, Gump's,
Hanover Realty, The Company Store Factory, Inc., The Company Office,
Inc., Silhouettes, LLC, Hanover Company Store, LLC, Domestications,
LLC, Keystone internet Services, LLC and Rakesh K. Kaul.The Company Store Group, LLC.
Incorporated by reference to the Company's AnnualCurrent Report on Form 10-K for the year ended December 28, 1996.
10.53 Six-Year Stock Option dated as of August 23, 1996 between NAR and
Rakesh K. Kaul. Incorporated by reference to the Company's Annual
Report on Form 10-K for the year ended December 28, 1996.8-K
filed November 30, 2003.
10.54 Seven-Year Stock Option dated as of August 23, 1996 between NAR and
Rakesh K. Kaul. Incorporated by reference to the Company's Annual
Report on Form 10-K for the year ended December 28, 1996.
10.55 Eight-Year Stock Option dated as of August 23, 1996 between NAR and
Rakesh K. Kaul. Incorporated by reference to the Company's Annual
Report on Form 10-K for the year ended December 28, 1996.
10.56 Nine-Year Stock Option dated as of August 23, 1996 between NAR and
Rakesh K. Kaul. Incorporated by reference to the Company's Annual
Report on Form 10-K for the year ended December 28, 1996.
10.57 Account Purchase and Credit Card Marketing and Services Agreement,
dated as of March 9, 1999, between the Company and Capital One
Services, Inc. and Capital One Bank. Incorporated by reference to the
Company's Annual Report on Form 10-K for the year ended December 25,
1999.
10.5810.55 Addendum to Account Purchase and Credit Card Marketing and Services
Agreement, dated as of July 7, 1999, between the Company and Capital
One Services, Inc. and Capital One Bank. Incorporated by reference to
the Company's Annual Report on Form 10-K for the year ended December
29, 2001.
10.56 Credit Agreement, dated as of March 24, 2000, by and among the Company,
HDPA, Brawn, Gump's By Mail, Gump's, LWI, HDVA, Keystone Internet
Services, Inc., Tweeds, LLC, Silhouettes, LLC, Hanover Company Store,
LLC, Domestications, LLC and Richemont. Incorporated by reference to
the Company's Quarterly Report on Form 10-Q for the quarterly period
ended March 25, 2000.
10.57 Subordination Agreement dated as of March 24, 2000, between Congress
and Richemont. Incorporated by reference to the Company's Quarterly
Report on Form 10-Q for the quarterly period ended March 25, 2000.
10.58 Letter Agreement, dated as of March 24, 2000, between Richemont and
Congress. Incorporated by reference to the Company's Quarterly Report
on Form 10-Q for the quarterly period ended March 25, 2000.
10.59 Services Agreement dated as of December 5, 2000 among Meridian
Ventures, LLC, Thomas C. Shull and the Company. Incorporated by
reference to the Company's Annual Report on Form 10-K for the year
ended December 30, 2000.
10.60 Stock Option Agreement made as of December 5, 2000 by the Company in
favor of Thomas C. Shull. Incorporated by reference to the Company's
Annual Report on Form 10-K for the year ended December 28, 2002.
10.61 Amendment No. 1 dated as of September 1, 2002 to Stock Option Agreement
between the Company and Thomas C. Shull. Incorporated by reference to
the Company's Annual Report on Form 10-K for the year ended December
28, 2002.
10.62 First Amendment of Services Agreement made as of the 23rd day of April
2001, by and among the Company, Thomas C. Shull and Meridian Ventures,
LLC. Incorporated by reference to the Company's Quarterly Report on
Form 10-Q for the quarterly period ended March 31, 2001.
10.63 Letter Agreement dated as of April 30, 2001 between the Company, Thomas
C. Shull and Meridian Ventures, LLC. Incorporated by reference to the
Company's Quarterly Report on Form 10-Q for the quarterly period ended
March 31, 2001.
10.64 Agreement dated May 14, 2001 between Hanover Direct, Inc. and Thomas C.
Shull. Incorporated by reference to the Company's Quarterly Report on
Form 10-Q for the quarterly period ended September 29, 2001.
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10.65 Amendment No. 1 to Agreement dated May 14, 2001 between Hanover Direct,
Inc. and Thomas C. Shull. Incorporated by reference to the Company's
Quarterly Report on Form 10-Q for the quarterly period ended June 29,
2002.
10.66 Services Agreement dated as of August 1, 2001 by and among Meridian
Ventures, LLC, Thomas C. Shull and the Company. Incorporated by
reference to the Company's Quarterly Report on Form 10-Q for the
quarterly period ended September 29, 2001.
10.67 Services Agreement dated as of December 14, 2001 by and among Meridian
Ventures, LLC, Thomas C. Shull and the Company. Incorporated by
reference to the Company's Current Report on Form 8-K filed December
14, 2001.
10.68 Amendment No. 1 of Services Agreement made as of the 23rd day of April,
2002, by and among the Company, Thomas C. Shull and Meridian Ventures,
LLC. Incorporated by reference to the Company's Quarterly Report on
Form 10-Q for the quarterly period ended March 30, 2002.
10.69 Stock Option Agreement made as of December 14, 2001 by the Company in
favor of Thomas C. Shull. Incorporated by reference to the Company's
Annual Report on Form 10-K for the year ended December 28, 2002.
10.70 Amendment No. 1 dated as of September 1, 2002 to Stock Option Agreement
between the Company and Thomas C. Shull. Incorporated by reference to
the Company's Annual Report on Form 10-K for the year ended December
28, 2002.
10.71 Employment Agreement dated as of September 1, 2002 between Thomas C.
Shull and the Company. Incorporated by reference to the Company's
Quarterly Report on Form 10-Q for the quarterly period ended June 29,
2002.
10.72 Amendment No. 1 to Employment Agreement dated as of September 1, 2002
between Thomas C. Shull and the Company. Incorporated by reference to
the Company's Quarterly Report on Form 10-Q for the quarterly period
ended September 28, 2002.
10.73 Amendment No. 2 to Employment Agreement dated as of June 23, 2003
between Thomas C. Shull and the Company. Incorporated by reference to
the Company's Quarterly Report on Form 10-Q for the quarterly period
ended June 28, 2003.
10.74 Amendment No. 3 to Employment Agreement effective as of August 3, 2003
between Thomas C. Shull and the Company. Incorporated by reference to
the Company's Quarterly Report on Form 10-Q for the quarterly period
ended June 28, 2003.
10.75 Final form of letter agreement between the Company and certain Level 8
executive officers. Incorporated by reference to the Company's
Quarterly Report on Form 10-Q for the quarterly period ended September
28, 2002.
10.76 Form of Transaction Bonus Letter. Incorporated by reference to the
Company's Annual Report on Form 10-K for the year ended December 28,
2002.
10.77 Agreement, dated as of December 19, 2001, between the Company and
Richemont. Incorporated by reference to the Company's Current Report on
Form 8-K filed December 20, 2001.
10.78 Release, dated December 19, 2001, executed by the Company in favor of
Richemont and others. Incorporated by reference to the Company's
Current Report on Form 8-K filed December 20, 2001.
10.79 Indemnification Agreement, dated as of December 19, 2001 between the
Company and Richemont. Incorporated by reference to the Company's
Current Report on Form 8-K filed December 20, 2001.
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10.80 Hanover Direct, Inc. Savings and Retirement Plan, as amended and
restated as of July 1, 1999. Incorporated by reference to the Company's
Annual Report on Form 10-K for the year ended December 29, 2001.
10.81 First Amendment to the Hanover Direct, Inc. Savings and Retirement
Plan, effective March 1, 2002. Incorporated by reference to the
Company's Annual Report on Form 10-K for the year ended December 29,
2001.
10.82 Hanover Direct, Inc. and Subsidiaries Code of Ethics. Incorporated by
reference to the Company's Annual Report on Form 10-K for the year
ended December 28, 2002.
10.83 Memorandum of Understanding dated November 10, 2003 by and among
Hanover Direct, Inc., Chelsey Direct, LLC and Regan Partners, L.P.
Incorporated by reference to the Company's Current Report on Form 8-K
filed November 10, 2003.
10.84 Recapitalization Agreement dated as of November 18, 2003 by and between
Hanover Direct, Inc. and Chelsey Direct, LLC. Incorporated by reference
to the Company's Current Report on Form 8-K filed November 18, 2003.
10.85 Registration Rights Agreement dated as of November 30, 2003 by and
among Hanover Direct, Inc., Chelsey Direct, LLC and Stuart Feldman.
Incorporated by reference to the Company's Current Report on Form 8-K
filed November 30, 2003.
10.86 Corporate Governance Agreement dated as of November 30, 2003 by and
among Hanover Direct, Inc. Chelsey Direct, LLC, Stuart Feldman, Regan
Partners, L.P., Regan International Fund Limited and Basil P. Regan.
Incorporated by reference to the Company's Current Report on Form 8-K
filed November 30, 2003.
10.87 Voting Agreement dated as of November 30, 2003 by and among Chelsey
Direct, LLC, Stuart Feldman, Regan Partners, L.P., Regan International
Fund Limited and Basil P. Regan. Incorporated by reference to the
Company's Current Report on Form 8-K filed November 30, 2003.
10.88 General Release dated November 30, 2003 given by Hanover Direct, Inc.
and its parents, affiliates, subsidiaries, predecessor firms,
shareholders, officers, directors, members, managers, employees, agents
and others to Chelsey Direct, LLC and its parents, affiliates,
subsidiaries, predecessor firms, shareholders, officers, directors,
members, managers, employees, attorneys, agents and others.
Incorporated by reference to the Company's Current Report on Form 8-K
filed November 30, 2003.
10.89 General Release dated November 30, 2003 given by Chelsey Direct, LLC
and its parents, affiliates, subsidiaries, predecessor firms,
shareholders, officers, directors, members, managers, employees, agents
and others to Hanover Direct, Inc. and its parents, affiliates,
subsidiaries, predecessor firms, shareholders, officers, directors,
members, managers, employees, attorneys, agents and others.
Incorporated by reference to the Company's Current Report on Form 8-K
filed November 30, 2003.
10.90 Stipulation of Discontinuance of the action entitled Hanover Direct,
Inc. v. Richemont Finance S.A. and Chelsey Direct, LLC in the Supreme
Court of the State of New York, County of New York (Index No.
03/602269) dated November 30, 2003. Incorporated by reference to the
Company's Current Report on Form 8-K filed November 30, 2003.
10.91 Code of Conduct of the Registrant. Incorporated by reference to the
Company's Annual Report on Form 10-K filed April 9, 2004.
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10.92 Thirtieth Amendment to Loan and Security Agreement, dated as of March
25, 2004, among Congress, Brawn, Gump's by Mail, Gump's, Hanover
Realty, The Company Store Factory, Inc., The Company Office, Inc.,
Silhouettes, LLC, Hanover Company Store, LLC, Domestications, LLC,
Keystone internet Services, LLC and The Company Store Group, LLC.
Incorporated by reference to the Company's Annual Report on Form 10-K
filed April 9, 2004.
21.1 Subsidiaries of the Registrant. Incorporated by reference to the
Company's Annual Report on Form 10-K filed April 9, 2004.
23.1 Consent of Independent Public Accountants. FILED HEREWITH.
31.1 Certification required by Rule 13a-14(a) or Rule 15d-14(a) signed by
Thomas C. Shull. Incorporated by reference to the Company's Annual
Report on Form 10-K filed April 9, 2004.
31.2 Certification required by Rule 13a-14(a) or Rule 15d-14(a) signed by
Charles E. Blue. Incorporated by reference to the Company's Annual
Report on Form 10-K filed April 9, 2004.
32.1 Certification required by Rule 13a-14(b) or 15d-14(b) and Section 1350
of Chapter 63 of Title 18 of the United States Code (18 U.S.C. 1350)
signed by Thomas C. Shull and Charles E. Blue.** Incorporated by
reference to the Company's Annual Report on Form 10-K filed April 9,
2004.
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* Hanover Direct, Inc., a Delaware corporation, is the successor by merger to
The Horn & Hardart Company and The Hanover Companies.
** This certification accompanies this Annual Report on Form 10-K, is not deemed
filed with the SEC and is not to be incorporated by reference into any filing
of the Company under the Securities Act of 1933, as amended, or the
Securities Exchange Act of 1934, as amended (whether made before or after the
date of this Annual Report on Form 10-K), irrespective of any general
incorporation language contained in such filing.
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