UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON,
Washington, D.C. 20549
                            ------------------------

                                  
_______________
FORM 10-K/A

                                AMENDMENT NO. 2

                 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

                  FOR THE FISCAL YEAR ENDED DECEMBER 27, 2003

                         COMMISSION FILE NUMBER 1-12082
                            ------------------------

                              
For The Fiscal Year Ended December 25, 2004
Commission File Number 1-08056
_______________
HANOVER DIRECT, INC.
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

                                    DELAWARE
         (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)

                                 
(Exact Name of Registrant as Specified in Its Charter)
Delaware
13-0853260
(State or Other Jurisdiction of Incorporation or Organization)
(IRS Employer Identification No.)
1500 Harbor Boulevard, Weehawken, New Jersey
07086
(Address of Principal Executive Offices)
(Zip Code)
(201) 863-7300
              (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)

SECURITIES REGISTERED PURSUANT TO SECTION
(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 SECTIONof the Act: Common Stock, $0.01 Par Value
Securities registered pursuant to Section 12(g) OF THE ACT: 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]o No [ ]

     x
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant'sregistrant’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]

     x
Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).
Yeso No x
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Securities Exchange Act of 1934). Act)
Yes [ ]o No [X]

     x
As of June 27, 2003,25, 2005, the last business day of the registrant'sregistrant’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 $15,069,965$6,200,166 (based on the closing price of the Common Stock on the American
Stock ExchangePink Sheets on June 27, 200325, 2005 of $0.27$0.88 per share; shares of Common Stock owned by directors and officers of the Company are excluded from this calculation; such exclusion does not represent a conclusion by the Company that all of such directors and officers are affiliates of the Company).
As of March 16, 2004,February 21, 2006, the registrant had 220,173,63322,426,296 shares of Common Stock outstanding (excluding treasury shares).
                            ------------------------
outstanding.
_______________


EXPLANATORY NOTE

     This Amendment No. 2
As explained herein, we have restated the consolidated financial statements for the fiscal years ended December 27, 2003 and December 28, 2002 in this Annual Report on Form 10-K/A amends certain10-K. We have also restated the quarterly financial information underfor fiscal 2003 and the caption "Reportfirst two quarters of fiscal 2004. See Note 2 to the accompanying consolidated financial statements (collectively, the “Restatement”). By way of summary, the Restatement also affects periods prior to fiscal 2002. The Restatement’s impact on periods prior to fiscal 2002 has been reflected as an adjustment to accumulated deficit as of December 29, 2001 in the accompanying Consolidated Statements of Shareholders’ Deficiency as well as the Selected Financial Data in Part 1, Item 6 of this Form 10-K. The Restatement corrects a revenue recognition issue that resulted in revenue being recorded in advance of the Stock Optionactual shipment of merchandise to the customer and Executive Compensation Committee on
Executive Compensation"the correction of an accounting policy to recognize revenue when the merchandise is received by the customer as opposed to when the merchandise is shipped, corrects an error in Item 11the accounting treatment of Part IIIdiscounts obligations for certain of the Company'sCompany’s buyers’ club programs, corrects two errors in the accounting treatment of a reserve for post-employment benefits including correcting the premature reversal of the reserve and other adjustments and recording legal fees in the proper periods that were inappropriately recorded related to the matter. The Restatement also records certain customer prepayments and credits inappropriately released and records other liabilities relating to certain miscellaneous catalog costs and other miscellaneous costs that were inappropriately not accrued in the appropriate periods. In addition we have made adjustments to the deferred tax asset and liability to reflect the effect of the Restatement adjustments. For a more complete description of the Restatement, refer to Note 2 to the attached consolidated financial statements. We have not amended our previously filed Annual Reports on Form 10-K or Quarterly Reports on Form 10-Q for the Restatement. As previously disclosed in our Current Report on Form 8-K filed with the Securities and Exchange Commission (“SEC”) on November 10, 2004, the consolidated financial statements and related financial information contained in such reports for the fiscal years ended December 25, 1999, December 30, 2000, December 29, 2001, December 28, 2002 and December 27, 2003 and the fiscal quarters ended March 29, 2003, June 28, 2003, September 27, 2003, March 27, 2004 and June 26, 2004 should no longer be relied upon. Throughout this Form 10-K all referenced amounts for prior periods and prior period comparisons reflect the balances and amounts after giving effect to the Restatement.
As a result of the Restatement, we were unable to timely file the Form 10-K for the fiscal year ended December 27, 2003 filed25, 2004.

PART I
Item 1. Business
This Annual Report on Form10-K, contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The use of words such as “anticipates,” “estimates,” “expects,” “projects,” “intends,” “plans,” and “believes,” among others, generally identify forward-looking statements. Forward-looking statements are predictions of future trends and events and as such, there are substantial risks and uncertainties associated with forward-looking statements, many of which are beyond management’s control. Some of the Securitiesmore material risks and Exchange Commission on April 9, 2004uncertainties are identified in “Item 7. Management’s Discussion and amended on April 26, 2004. No
attempt has been madeAnalysis of Financial Condition and Results of Operations—Risk Factors.” We do not intend, and disclaim any obligation, to modify or update any disclosures presented in any other
Items or Parts of the Form 10-K.


                                     PART I

ITEM 1.  BUSINESS

GENERAL

     forward-looking statements.
General
Hanover Direct, Inc. (the "Company") provides(collectively with its subsidiaries, referred to as the “Company,” “we” or “us” in this Form 10-K) is a direct marketer of quality, branded merchandise through a portfolio of catalogs and e-commerce platforms to consumers, as well
as a comprehensive rangewebsites. We also manufacture comforters and pillows that we sell in two of Internet,our catalogs and our retail outlet stores and manufacture Scandia Down branded comforters, pillows and featherbeds that we sellthrough specialty retailers. In addition, we provide product fulfillment, telemarketing, information technology and e-commerce and fulfillment services to businesses.

     The Company'sthird party businesses involved in the direct commercemarketing business.
Our direct marketing operations comprise its catalog and Web siteconsist of a portfolio of catalogs and associated websites in the home fashions, men’s and women’s apparel and gift categories including,that included during 2003,
2004, Domestications, The Company Store, The Company Kids, Scandia Down, Silhouettes, International Male Undergear and Gump's By Mail. Undergear. Each brandcatalog can be accessed on the Internet individually by name. In addition,We also owned and operated the Company owns Gump's, aGump’s retail store based in San Francisco California.

     and the Gump’s By Mail catalog and website until March 14, 2005, when we sold them to an unrelated third party. In addition, we manufacture high quality pillows and comforters for sale in The Company's business-to-business operations compriseCompany Store and Domestications catalogs and websites, through our retail outlet stores and super-premium down comforters, pillows and featherbeds under theScandia Down brand name, which we sell through third party luxury retailers in North and South America.
Leveraging our in-house expertise in product fulfillment business of Keystone Internet Services, LLC (formerly Keystone
Internet Services, Inc.), the Company'sand utilizing our excess capacity, we provide third party, end-to-end, fulfillment, logistics, telemarketing and e-care provider.

     information technology services to businesses formerly owned by the Company and select third party companies involved in the direct marketing business.
The Company is incorporated in Delaware and itsour executive offices are located at 115 River Road, Edgewater,1500 Harbor Boulevard, Weehawken, New Jersey 07020.07086. The Company'sCompany’s telephone number is (201) 863-7300. The Company is athe successor in interest toof the 1993 merger between The Horn & Hardart Company, a restaurant company founded in 1911,that traces its origins to 1888 and Hanover House Industries, Inc., which was founded in 1934.

     On or about May 19, 2003, Richemont Finance S.A.,
At the Company’s 2004 Annual Meeting of Shareholders held on August 12, 2004, the Company’s shareholders approved a Luxembourg company
("Richemont"), the then holder of approximately 21.3%one-for-ten reverse stock split of the Company'sCompany’s common stock (“Common Stock”), which became effective at the close of business on September 22, 2004. In this Annual Report on Form 10-K, the number of shares of Common Stock outstanding, per share amounts, stock warrants, stock option and exercise price data relating to the Company’s Common Stock for periods prior to the reverse stock split have been restated to reflect the effect of the reverse stock split. See Note 9 to the accompanying consolidated financial statements for more information regarding the reverse stock split and additional amendments to the Company’s Certificate of Incorporation.
Restatement of Prior Financial Information and Related Matters
We have restated the consolidated financial statements for the fiscal years ended December 27, 2003 and December 28, 2002 in this Annual Report on Form 10-K. We have also restated the quarterly financial information for fiscal 2003 and the first two quarters of fiscal 2004. See Note 2 to the accompanying consolidated financial statements (collectively, the “Restatement”). The Restatement also affects periods prior to fiscal 2002. The Restatement’s impact on periods prior to fiscal 2002 have been reflected as an adjustment to accumulated deficit as of December 29, 2001 in the accompanying Consolidated Statements of Shareholders’ Deficiency.

We have also restated the applicable financial information for fiscal 2000, fiscal 2001, fiscal 2002 and fiscal 2003 in “Item 6. Selected Consolidated Financial Data.”
The Restatement corrects a revenue recognition issue that resulted in revenue being recorded in advance of the actual receipt of merchandise by the customer, corrects an error in the accounting treatment of discounts obligations for certain of the Company’s buyers’ club programs, corrects two errors in the accounting treatment of a reserve, including re-establishing a reserve balance prematurely released based on a summary judgment decision which could be and was appealed, and recording legal fees in the proper periods that were inappropriately recorded related to the matter. The Restatement also records certain customer prepayments and credits prematurely released, and records other liabilities relating to certain miscellaneous catalog costs and other miscellaneous costs that were inappropriately not accrued in the appropriate periods. In addition, we have made adjustments to the deferred tax asset and liability to reflect the effect of the Restatement adjustments. We did not amend our previously filed Annual Reports on Form 10-K or Quarterly Reports on Form 10-Q for the Restatement. As previously disclosed in our Current Report on Form 8-K filed with the Securities and Exchange Commission (“SEC”) on November 10, 2004, the consolidated financial statements and related financial information contained in such reports for the fiscal years ended December 25, 1999, December 30, 2000, December 29, 2001, December 28, 2002 and December 27, 2003 and the fiscal quarters ended March 29, 2003, June 28, 2003, September 27, 2003, March 27, 2004 and June 26, 2004 should no longer be relied upon. Throughout this Form 10-K all referenced amounts for prior periods and prior period comparisons reflect the balances and amounts after giving effect to the Restatement.
As a result of the Restatement, we were unable to timely file our Quarterly Report on Form 10-Q for the fiscal quarter ended September 27, 2004 or this Form 10-K. As a result of our not filing our Quarterly Report on Form 10-Q for the fiscal quarter ended September 27, 2004 on a timely basis and our inability to meet the continued listing requirements of the American Stock Exchange (“AMEX”), trading in our Common Stock on the AMEX was halted and ultimately the Common Stock was delisted by the AMEX on February 16, 2005.
In response to the discovery of certain of the matters leading up to the Restatement, the Audit Committee of the Board of Directors launched an investigation in November 2004 relating to the restatement of the Company’s consolidated financial statements and other accounting-related matters and engaged the law firm of Wilmer Cutler Pickering Hale and Dorr LLP (“Wilmer Cutler”) as its independent outside counsel to assist with the investigation. In March 2005, the Audit Committee concluded its investigation and, with the assistance of Wilmer Cutler, reported its findings to the Board of Directors. The Audit Committee, again with the assistance of Wilmer Cutler, formulated a series of recommendations to the Company and the Board of Directors concerning potential improvements in the Company’s internal controls and procedures for financial reporting. The Board of Directors and management have begun implementing these recommendations.
The Company was notified in January 2005 by the SEC that the SEC was conducting an informal inquiry relating to the Company’s financial results and financial reporting since 1998. The SEC indicated in its letter to the Company that the inquiry should not be construed as an indication by the SEC that there has been any violation of the federal securities laws. The Company is cooperating fully with the SEC in connection with the inquiry and Wilmer Cutler has briefed the SEC and the Company’s independent registered public accounting firm, Goldstein Golub Kessler LLP (“GGK”) on the results of its investigation. The Company intends to continue to cooperate with the SEC in connection with its informal inquiry concerning the Company’s financial reporting.
We hired a new Chief Executive Officer in May 2004 who, together with current management, identified the issues leading to the Restatement. Based on recommendations of the Audit Committee concerning potential improvements in the Company’s internal controls and procedures for financial reporting, management has responded to the weaknesses in internal controls exposed by the Restatement by revamping and augmenting the Company’s accounting and finance functions, hiring a new Chief Financial Officer, strengthening the Company’s internal controls, hiring an internal general counsel and replacing the Company’s external counsel, and instituting a corporate culture that demands ethical behavior of all employees, the highest level of compliance and encourages free communication up and down the ranks. See “Controls and Procedures” for more information regarding these and other initiatives.

Significant Shareholder
After its January 10, 2005 purchase of an aggregate of 3,799,735 shares of Common Stock formerly held by Regan Partners, L.P., Regan International Fund Limited and Basil Regan, Chelsey Direct, LLC and related affiliates (“Chelsey”) beneficially own approximately 69% of the issued and outstanding common stock (the "Common Stock")Common Stock and approximately 75% of the Common Stock after giving effect to the exercise of all outstanding options and warrants to purchase Common Stock beneficially owned by Chelsey. In addition, Chelsey is holder of all of the Company's
Series 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 issuedCompany’s Series C Participating Preferred Stock (the "Series(“Series C ParticipatingPreferred”). Including the Series C Preferred Stock") and 81,857,833outstanding options and warrants beneficially owned by Chelsey, Chelsey maintains approximately 91% of the voting rights of the Company (after giving effect to the exercise of all outstanding options and warrants). Chelsey made its initial investment in the Company on May 19, 2003 by acquiring 2,944,688 shares of newly issued Common Stock for theand 1,622,111 shares of Series B Participating Preferred Stock (“Series B Preferred”) from Richemont Finance S.A (“Richemont”). Stuart Feldman, a Chelsey affiliate, held by Chelsey. As16,090 shares of Common Stock when Chelsey acquired Richemont’s shares. Chelsey’s Common Stock ownership has increased since its initial investment as a result of suchthree transactions:
•
The recapitalization of the Company on November 30, 2003 whereby the Series B Preferred was exchanged for 564,819 shares of Series C Preferred which has, in general, 100 votes per share and, as part of this transaction, the Company’s issuance of 8,185,783 shares of Common Stock to Chelsey.
•
On July 8, 2004, Chelsey Finance, LLC, (“Chelsey Finance”), a Chelsey affiliate, provided us with a $20.0 million junior secured credit facility, of which the entire $20.0 million was borrowed by the Company (the “Chelsey Facility”). As part of this transaction, the Company issued to Chelsey 434,476 shares of Common Stock in payment of a waiver fee and Chelsey Finance received a 10-year warrant to purchase 30.0% of the fully diluted shares of Common Stock (then equal to 10,259,366 shares of Common Stock). The terms of the Chelsey Facility are described in greater detail in Note 7 to the consolidated financial statements in Part II.
•
On January 10, 2005, Chelsey purchased an aggregate of 3,799,735 shares of Common Stock from Basil Regan, Regan International Fund Ltd. and Regan Partners, L.P, constituting all of the Common Stock held by them. Basil Regan had previously resigned from the Board of Directors on July 30, 2004.
Chelsey became
the holder of approximately 50.6%has designated four of the Company's outstanding common stock and
allseven members of the Company's Series C Participating Preferred Stock. Collectively, Basil
Regan and Regan Partners, L.P. ("Regan") are currently the holders of
approximately 17.6% of the Company's Common Stock. Pursuant to a 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) memberCompany’s Board of Directors. See "Additional Investments -- Series C Participating Preferred
Stock" and "Item 10(a) -- Directors and Executive Officers of the Registrant."

DIRECT COMMERCE

     including its Chairman.
Direct Commerce
General. The Company isWe are a leading specialty direct marketer with a diverse portfolio of branded home fashions, men'smen’s and women'swomen’s apparel and gift products marketed via direct mail-order catalogs, websites and retail stores and connected Internet
Web sites ("outlets (“direct commerce"commerce”). The Company's catalog titles are organized into
four categories -- The Company Store Group, Women's Apparel, Men's Apparel and
Gift -- each consisting of one or more catalog/Internet titles. All of these categories utilize centralour centralized purchasing and inventory management functions and the
Company'sour common systems platform and our telemarketing, fulfillment, distribution and administrative functions. During 2003, the CompanyWe mailed approximately 180.3172 million, 180 million and 191 million catalogs answered more than 6.3 million customer service/order callsfor the fiscal years ended 2004, 2003 and processed2002, respectively. Although the past three years indicate a downward trend in catalog circulation and shipped 6.4 million packagessales revenues, we began to customers.

     On June 29, 2001,reverse this trend during the Company sold certain assets and liabilitiessecond half of its
Improvements business to HSN, a division of USA Networks, Inc.'s Interactive
Group, for approximately $33.0 million. In conjunction2004 when catalog circulation increased by 6% compared with the sale,second half of 2003, and revenue trends began to rise due to several factors including improved customer service levels which were made possible by enhanced liquidity provided by the Company's KeystoneChelsey Facility. The enhanced liquidity also allowed us to increase inventory levels and realize a stronger catalog performance.
Sales revenues generated by our websites continue to increase, both in dollar terms and as a percentage of our net revenues. Website sales comprised 32.0% of combined Internet Services, Inc. (now Keystone Internet Services, LLC)
subsidiary agreed to provide telemarketing and fulfillment servicescatalog net revenues for the Improvements business under a service agreementyear ended December 25, 2004 compared 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.

                                        2


     The asset purchase agreement between the Company and HSN provided for a
reduction in the sale price if the performance of the Improvements business in
the 2001 fiscal year failed 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.
failed to perform its obligations during the first two years of the services
contract, the purchaser was 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. On March 27, 2003, the Company and HSN amended the asset
purchase agreement to provide27.9% for the release of the remaining $2.0comparable period in 2003, and have increased by approximately $11.6 million, balance of the escrow fund andor 10.8%, 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$118.7 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 HSNyear ended December 25, 2004 from $107.1 million 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 reviews itscomparable period in 2003.
We continually review our portfolio of catalogs as well as new opportunities
to acquire or develop catalogs from time to time. The Company did not
discontinue any of its businesses or print catalogs in 2003.

     In 2002, the Company consolidated a portion of its Hanover, Pennsylvania
fulfillment operations into the Company's Roanoke, Virginia facility. Inand websites. On March 2003, the Company closed its Kindig Lane facility in Hanover, Pennsylvania and
moved its remaining operations there to the Company's facility in Roanoke,
Virginia.

     The Company 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 established by the Company for the sale of
assets and no definitive agreements have been reached other than with respect to14, 2005, we completed the sale of the Company's Improvements businessGump’s By Mail catalog and its Kindig Lane facilityGump’s retail store located in prior years. San Francisco, California to an unrelated third party in part because the Gump’s operations, which were based primarily on the retail operation, did not fit within the Company’s direct marketing core competency.

While our back-end/fulfillment functions are centralized, we operate merchandising, purchasing and catalog production separately for each of The Recapitalization Agreement with ChelseyCompany Store/Company Kids, Domestications, Silhouettes and the Certificate of
DesignationsInternational Male/Undergear catalogs and websites. Previously, we operated The Company Store/Company Kids and Domestications as a single unit. During 2004, after a review of the 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 salestructure of the Company's non-core
assets in ordercatalogs, we determined that we would better served by having separate management teams to redeemguide each of the outstanding Series C Participating Preferred Stock
so long ascatalogs because of the salediversity of any individual asset or groupthe target customer base and sales volumes of assets is fair to all
the Company's stakeholders from a financial point of view. The Company is
considering the sale of certain non-core assets although no definitive
agreements have been reached and no assurance can be given that such assets
will, in fact, be sold.

     catalogs.
Each of the Company'sour specialty catalogs targets distinctits market segmentsby offering a focused assortment of merchandise designed to meet the needs and preferences of its targeteach catalog’s customers. Through market research and ongoing testing of new products and concepts, each brand group determines each catalog'scatalog has its own merchandise strategy, including appropriate price points, mailing plans and presentation of its products. The Company isWe are continuing itsour development of exclusive or private label products for a number of itsour catalogs including
Domestications, The Company Store, The Company Kids, Silhouettes, International
Male and Undergear, to further enhancedifferentiate the brand identity of the catalogs.
During 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 specialtycatalog’s identities.
Our catalogs typically range in size from approximately 2448 to 108 pages with six9 to twenty-five new27 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
catalogThe Company employs the services of an outside creative agencyagencies or has its own creative staff that is responsible for the 3
designs, layout, copy, feel and theme of the book.catalogs. Generally, the initial sourcing of new merchandise for a catalog begins six to nine months before the catalog is mailed. The Company has created commerce-enabled Web siteswebsites for each of its catalogs, whichcatalogs. The websites offer all of the catalog'sa particular catalog’s merchandise and in every
case, more extensive offerings than any single issue of a print catalog; take
catalog requests;catalog. Customers can request catalogs and acceptplace orders for not only Web sitewebsite merchandise, but also from any print catalog already mailed.
The following is a description of the Company's brands in each of the
Company's four categories:

our catalogs:
The Company Store Group:

     Domestications is a leading home fashions brand 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 brandcatalog focused on high quality down products that we manufacture and other private label and branded home furnishings.

     furnishings. Basic bedding lines produced at our LaCrosse, Wisconsin factory accounts for approximately 27% of The Company Kids offers both upscale apparelStore product in 2004.
Exclusive designs and furnishing focused towards
children.

     Scandia Downvibrant colors, along with a unique and sophisticated catalog presentation, gives The Company Store a strong identity within its market. Even as The Company Store website continued to grow with an increasing percentage of its revenue coming through this channel, catalogs remained the biggest catalyst for driving website orders.
Company Kids is a nationally known brand specializingcatalog developed from a category offered in luxury downThe Company Store catalogs and now accounts for approximately 17% of the total Company Store volume and has grown over the past three years to nine exclusive Company Kids mailings. The unique themes and full room views, gives the Company Kids customer the opportunity to purchase the “entire room” including bed, bedding, storage, wall hangings, lamps and rugs.
Creative design and varied color pallets for the complete bed ensemble are developed by The Company Store’s own design staff and sourced around the world. These exclusive designs and vibrant color pallets remain the signature identity for this quality oriented, better-priced catalog and position both The Company Store and Company Kids as strong competitors in the direct home textile market.
Domestications is “America’s Authority in Home Fashions®.” Celebrating our 20th anniversary in 2004, we continue to be the value minded customer’s top-of-mind choice when shopping for the latest in home furnishings. Domestications targets the mid-tier marketplace with its primary focus on bedding for every taste and lifestyle, featuring unique and novel ideas, hard to find problem solvers, and exclusive designs found nowhere else. We also offer a wide range of fashion and seasonal products for every other room of the house and home fashions.

Women's Apparel:

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

Silhouettes is a leadingmoderate-to-better priced fashion brandcatalog dedicated to woman’s styles starting at size 12W. The catalog carries the current trends in fashion along with core classics, seasonal favorites and Silhouettes® exclusives. Silhouettes carries a full range of apparel from boots to bathing suits, sleepwear to swimwear, and everything in between.
Silhouettes core strengths include exclusive designs and manufacturing sourced around the world. Utilizing key manufacturing plants allows Silhouettes to control costs and ensure the quality of these designs, offering large size women's upscale
apparelthe customer a product of style and accessories.

Men's Apparel:

     value.
The Silhouettes catalog and website create a virtual department store, carrying something for every 12W plus-sized woman. The catalog continues to be the primary driver for website orders. In each of the past four years Silhouettes® has enjoyed significant Internet sales growth. Improved on-site search capabilities and navigations have taken the tedium and frustration out of the search and have created a better virtual shopping experience, getting Silhouettes® closer to its goal of being the customer’s best friend.
International Male offers contemporary men'smen’s fashions and accessories at reasonable prices. As we celebrate International Male’s 30th Anniversary, the Company has relocated the business to its headquarters in Weehawken, New Jersey and hired a new management team for the catalog, which is in the process of repositioning International Male to return it to its roots as a young men’s “lifestyle” fashion leader. This merchandising shift will be evident in catalogs commencing in the fourth quarter of 2005.
International Male carries a full line of apparel, from sportswear to swimwear, underwear, shoes and accessories, offering a merchandise mix that is both exciting and eclectic.
Undergear was launched in 1985 as a “handbook of men’s underwear” from around the world. It is a market leader in fashionablethe men’s underwear catalog and functional men's underwear,
workout wearInternet business.
Core strengths include the production of our many exclusive styles, interpreted by our merchandising team using key manufacturing sources, allowing us to control costs and active wear.

Gift:

     Gump'sensure quality. 
Over the years, the names International Male and Undergear have become synonymous with our merchandise - from top vendors to our signature collections - as well as our world-famous catalogs, sparking the imaginations of countless readers ever since their inception.
Gump’s By Mailand Gump's San Francisco Gump’s are luxury sources for discerning customers of jewelry, gifts and home furnishings, as well asand are market leaders in offering Asian inspired products. On March 14, 2005, we sold both the Gump’s By Mail catalog and the Gump’s San Francisco retail store to an unrelated third party.
Catalog Sales.Sales. Net sales, including postagedelivery and handling,service charges, through the Company'sCompany’s catalogs were $280.1$252.3 million for the fiscal year ended December 27,
2003,25, 2004, a decrease of $61.8$24.6 million, or 18.1%8.9%, compared with the prior fiscal year. Overall circulation for continuing business in fiscal year 20032004 decreased by 5.9% in
fiscal 20034.2% primarily stemming from the Company's continued effortsour decision to reduce unprofitable circulation. In addition,circulation during the first half of the year due to liquidity issues facing the Company is currently analyzingthat constrained inventory levels and restricted catalog circulation. However, increased working capital provided by the extentChelsey Facility starting in the third quarter allowed the Company to begin increasing its inventory levels and investing in catalog circulation to strengthen its customer files and grow its catalog business. These steps took hold during the second half of cannibalization2004 as catalog circulation increased by 6.0% compared with the second half of catalog sales by 2003, which resulted in an upward trend in revenues in the fourth quarter of 2004.
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.Sales. The Internet continues to grow in importance as a source of new customers continues to
grow in importance.customers. Net sales, including postagedelivery and handling,service charges, through the Internet improved to $108.6$118.7 million for the fiscal year ended December 27, 2003,25, 2004, an increase of $21.2$11.6 million or 24.2%10.8%, over Internet sales in the prior fiscal year. As ofFor the year ended December 27, 2003,25, 2004, Internet sales had reached 27.9%32.0% of brand sales
(total revenues less third party fulfillment salescombined catalog and membership programs). The
Company maintains an active presence on the Internet by having a
commerce-enabled Web site for each of itsnet revenues. Customers can order 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 acceptsplace orders for not only Web sitewebsite merchandise but also for merchandise from any print catalog already mailed. The Web sitewebsite for each brandcatalog is prominently promoted within each catalog in traditional
print media advertising, and on third-party Web sites.

     websites.

During November 2002, Amazon.com began to offer Silhouettes, International Male and Undergear merchandise within Amazon.com'sAmazon.com’s Apparel & Accessories store under a multi-year strategic alliance between the Company and Amazon.com. During 2003, Company Kids, Domestications, The Company Store and Gump’s were also made available on Amazon.com. All orders resulting from this alliance are electronically transferred to and fulfilled by the Company. During the first quarter of 2003, Company Kids apparel
merchandise joined 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 utilizesAmazon.com charges us a commission on orders placed through its website.
We utilize other on-line marketing opportunities available to it by posting itsour catalog merchandise and accepting orders on third-party Web sites,websites for which it
iswe are charged a commission. The CompanyWe also undertakes relationships where third
party Web sites are paidenter into affiliate marketing agreements with third-party website operators and pay for every click that leads“click thrus” to the Company's sites.our websites. In addition to the Amazon.com arrangements, with Amazon.com described above,we have entered into third party Web
site advertising arrangements entered into by the Company include partnershipsaffiliate marketing agreements with ArtSelect.com, CatalogCity, Decorative Product Source, Inktomi, Google, MSN, NexTag, Overture, Shopping.com, Linkshare and GiftCertificates.com.

     Buyers' Clubs.
Scandia Down. Scandia Down manufactures luxury European down comforters, pillows and featherbeds from its LaCrosse, Wisconsin facility and distributes these products together with proprietary branded sheeting, towels and related accessories through its network of over 90 high end retailers in North and South America. Scandia Down’s core growth strategy is focused on expanding distribution in select markets with key retailers, expanding product lines and categories, and developing sales and marketing support programs for licensed retailers.
Divestitures.
Improvements. On June 29, 2001, we sold certain assets and liabilities of our Improvements business to HSN, a division of USA Networks, Inc.’s Interactive Group, for approximately $33.0 million. In March 1999,conjunction with the Company, throughsale, we agreed to provide telemarketing and fulfillment services for the Improvements business under a newly formed
subsidiary, started up and promotedservices agreement with a discount buyers' club to consumers known
as "The Shopper's Edge." In exchangethree year term that was later extended for an up-front membership fee,additional two years. To secure our performance, $3.0 million of the Shopper's Edge program enabled memberspurchase price was held in escrow. A portion of the escrow was released in 2002 and the balance was released in 2003. The services agreement for Improvements, which originally expired on June 27, 2006, was extended until August 31, 2007.
Gump’s and Gump’s By Mail. On March 14, 2005, we sold all of the stock of Gump’s Corp. and Gump’s By Mail, Inc. (collectively, “Gump’s”) to 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,Gump’s Holdings, LLC, an unrelated third party (“Purchaser”) for $8.9 million, including 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$0.4 million purchase price adjustment pursuant 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 a February 11, 2005 Stock Purchase Agreement. The Company recognized a gain of approximately $3.6 million in its quarter ended March 26, 2005. Chelsey, as the then-pending settlement
agreement betweenholder of all of the Federal Trade CommissionSeries C Preferred, consented to the application of the sales proceeds to reduce the outstanding balance of the senior secured credit facility (“Wachovia Facility”) provided by Wachovia National Bank, as successor by a merger with Congress Financial Corporation (“Wachovia”), in lieu of using the available proceeds to redeem the Series C Preferred (the number of shares to be redeemed would have been based on the available sales proceeds and Ira Smolev, the ownerthen current redemption price per share of FAR
Services. For the purposeSeries C Preferred). This waiver provided us with additional credit resources under the Wachovia Facility. Chelsey expressly retained its right to require redemption of monitoring and processing refundsapproximately $6.9 million (the Gump’s sales proceeds available for redemption) of the Series C Preferred subject to Wachovia’s approval.
After the sale, we continue as the guarantor of one of the two leases for the Company's
customers,San Francisco building where the Company remainedstore is located (we were released from liability on the other lease). The Purchaser is required to use its commercially reasonable efforts to secure the Company’s release from the guarantee within a year of the closing. If the Purchaser cannot secure our release within a year of the closing, an affiliate of the Purchaser will either (i) transfer a percentage interest in its position as bookkeeper forbusiness so that we will own, indirectly, 5.0% interest of the club
during 2001. The Company continued to actively perform the function of
bookkeeper until April 2003. 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 byPurchaser’s common stock, or (ii) provide us with a $2.5 million stand-by letter of credit obtained with funds belongingor other form of compensation acceptable to the ownerCompany to reimburse us for any liabilities we incur under the guarantee until we are released from the guarantee or the lease is terminated.
We entered into a Direct Marketing Services Agreement with the Purchaser to provide telemarketing and held byfulfillment services for the bookkeeper, that remain in placeGump’s catalog and direct marketing businesses for two and four
years beyondeighteen months. We have the last date of any membership.

     option to extend the term for an additional eighteen months.
Membership Services
Vertrue. In March 2001, the Companywe entered into a five-year marketing services agreement with MemberWorks,

Incorporated (now known as “Vertrue”) under which the Company'sour catalogs market and offer a variety of MemberWorksVertrue membership programs for a wide variety
of goods and services to the Company'sour catalog customers when they call to place an order. To the extent that the Company achievesVertrue membership programs offer members discounts on a certain acceptance rate by
reading scripts to its customers, the Company is guaranteed a certain revenue
stream dependent upon the actual numberwide variety 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. MemberWorksgoods and services. Vertrue has the exclusive rights to the first up-sell position on all merchandise order calls made to the Company,our call centers, after any cross-sells whichthat 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 brand may
choose not to read an up-sell script on all inbound order calls only due to
business necessities.products. Initially, prospective members participate in a 30-daythirty-day trial period that, unless canceled, is automatically converted into a full membership term, which is one year in duration. Memberships are automatically renewed at the end of each year unless canceled by the member. Vertrue pays us commissions that vary based on the actual number of offers and sales made and whether the membership is an initial sale or a renewal. In early 2002,
the Company tested the offer of membership terms that were one month in
duration. Memberships were automatically renewed and billed at the end of each
month unless canceled by the member. The Company no longer offers monthly
memberships and the program was discontinued; however, there remain some
customers who continue 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. No
marketing was done under this agreement. In December 2003, the Company entered
into a new agreement for Internet marketing with MemberWorks on more favorable
terms. In the first quarter of 2004, the Companywe began to test the marketing of
MemberWorksoffering Vertrue programs on one Company Web site 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 MemberWorksour websites. The Vertrue programs are offered to customers immediately uponwhen a customer reachingreaches the order confirmation page after placing an order.
The Company's revenue share will provide for a guaranteed
minimum revenue per page view. ToVertrue agreement expires in March 2006 and we are evaluating proposals from membership program providers to market membership programs to our customers after the extentVertrue agreement expires. We expect the program performs betterterms of any new membership marketing agreement to be no less favorable than a
pre-designated level, the Company will receive a higher level of revenue than
its guaranteed minimum per page view. Offers to customers on the Company's Web
sites will not be counted for purposes of determining the guaranteed minimumsthose under the master MemberWorks agreement.

     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 feescurrent agreement with Vertrue.
We also 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 itsour solicitation of the MemberWorks membership
programs and Magazine Direct magazine subscription programs. The commission
revenue recognized byprogram until the Company for the Magazine Direct magazine program iswas discontinued in May 2003. We were paid commissions based on a per-solicitation basis according to the number of solicitations made, with additional revenue recognized if the customer acceptsaccepted the solicitation.
Collectively,
Buyers’ Club. Customers may purchase memberships in a number of our catalogs’ Buyers’ Club programs for an annual fee. The Buyers’ Clubs offer members merchandise discounts or free delivery and service charge, advance notice of sales and other benefits. We use Buyers’ Club programs to promote catalog loyalty, repeat business and to increase sales.
In the amountpast, certain of the Buyers’ Club programs contained a guarantee whereby the customer would receive discounts or savings, at least equal to the cost of his or her membership or we would refund the difference with a merchandise credit at the end of the membership period. This guarantee was offered during the following periods: Silhouettes from July 1998 through March 2004; Domestications from April 2002 through March 2004; and Men’s Apparel from April 2003 through March 2004. We do not offer the guarantee currently.
In the first quarter of 2004, former management identified a potential issue with the accounting treatment for Buyers’ Club memberships that contained a guarantee related to discount obligations. At that time, an inappropriate conclusion regarding the accounting treatment was reached and during the third quarter of 2004, the issue was re-evaluated and we determined that an error in the accounting treatment had occurred. The cumulative impact of the error for which the Company restated resulted in the overstatement of revenues and the omission of the liability related to the guarantee of these discount obligations that aggregated $2.4 million as of June 26, 2004 (the end of the second quarter of 2004). The Company has developed a plan to satisfy its obligation to those Buyers’ Club members entitled to benefits as a result of the guarantee which will be implemented by the end of the first quarter of 2006. As reflected in the Restatement, for memberships purchased during those periods when the Buyers’ Club memberships contained a guarantee, revenue net of actual cancellations is recognized on a monthly basis over the membership period, commencing after the thirty-day cancellation period, with the revenue recognized equal to the lesser of the cumulative amount determined using the straight-line method or the actual benefit received by each customer as of the end of each period. At the end of the membership period, a liability equal to the residual guarantee is recorded on the Company’s Consolidated Balance Sheets.
For Buyers’ Club memberships that did not contain a guarantee, we recognize revenue net of actual cancellations on a monthly basis commencing after the thirty-day cancellation period, over the membership period using the straight-line method.
Collectively, we reported revenues from these sources was
$5.7membership services of $10.3 million, or 1.4%2.5% of net revenues, $5.1$9.3 million or 1.1%2.2% of net revenues, and $4.8$10.3 million or 0.9%2.2% of net revenues for fiscal years 2004, 2003 and 2002, and 2001,
respectively. As of May 2003, the Company discontinued its solicitation of the
Magazine Direct program. The Company willWe continue to consider opportunities to offer new and different goods and services to itsour 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.

     on our websites.

Marketing and Database Management. The Company maintainsWe maintain a proprietary customer list currently containing approximately 5.95.6 million names of customers who have purchased from one of the Company'sour catalogs or Web siteswebsites within the past 36 months.thirty-six months (including 0.2 million names relating to Gump’s By Mail). Approximately 2.42.2 million of the names on the list represent customers who have made purchases from at least one of the Company's brandsour catalogs within the last 12 months. The list contains name, gender, residence and
historical transaction data. This database is selectively enhanced with
demographic, socioeconomic, lifestyle and purchase behavior overlays from other
sources. The Companytwelve months (including 0.1 million names relating to Gump’s By Mail). We also maintainsmaintain a proprietary list of e-mail addresses totaling approximately 2.22.8 million addresses.

     The Company utilizesaddresses (including 0.2 million addresses relating to Gump’s By Mail). We consider our customer lists one of our most valuable assets.
We utilize modeling and segmentation analysis to devise catalog marketing and circulation strategies that are intended to maximize customer contribution by catalog. This analysis is the basis for the Company's
determination ofused by our catalogs to determine which of the Company'sour catalogs will be mailed and how frequently to a particular customer, as well as the promotional incentive content of the catalog(s) suchthat a customer receives.

     The Company utilizes
We utilize name lists rented from other mailers and compilers as a primary source of new customers for the Company'sour catalogs. Many of theour 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, theour main sources of the Company's new customers are from our catalogs, through the brands' affiliate programs, throughmarketing arrangements, search engines, and a variety of contractual Internet partnerships. An additional source of the Company's
Internet business is derived from print catalog mailings to prospective
customers.

     affiliate marketing arrangements.
Purchasing. The Company'sOur large sales volume permits itus 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'sour individual catalogs were they to operate independently. MajorWe use major goods and services used by the Companythat are purchased or leased from selected suppliers by itsour 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
We contract for our telemarketing phone service costs (both inbound and outbound calls) are typically contracted for a two to three-year period.under multi-year agreements. In the fourth
quarter of 1999, the CompanyFebruary 2004, we entered into a two-year call center service
agreement with MCI WorldCom 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-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-monthtwenty-six 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 agreementthat includes a two-month "ramp-up" period covering the monthsone year renewal option at our election. We are required to pay AT&T a minimum 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 ofat least $1.0 million after discounts, for each of the two twelve-month periods following an initial transitional ramp-up period. To date and because of our call volume, our payments have exceeded the "ramp-up" period.minimum $1.0 million threshold for the first two twelve-month periods. The Companycommitment is subject to a reduction based on certain events including but not limited to business downturn, corporate divestiture, or significant restructuring.
We generally entersenter 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 2003,2004, paper costs approximated 4.9%5.0% of the Company'sCompany’s net revenues. The Company experienced a 4.5% decrease3.0% to 5.0% increases in paper prices during 2003.2004 and further increases in paper prices in 2005 due to tight market conditions. The Company normally experiences increased costs of sales and operating expenses as a result of the general rate of inflation and commodity price fluctuations. Operating margins are generally maintained through internal cost reductions and operating efficiencies, and then through selective price increases where market conditions permit.
Inventory Management. The Company'sOur 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 managesWe manage inventory levels by monitoring sales and fashion trends, making purchasing adjustments as necessary and by promotional sales. Additionally, the Company sellswe sell excess inventory through special sale catalogs, sales/liquidation postings in brand Web sites,catalog websites, e-auctions, itsour outlet stores, off-price merchants and to jobbers.

     The Company acquires

We acquire products for resale in itsour catalogs from numerous domestic and foreign vendors. Over recent years, the Company has trended more towards obtaining goods from foreign as opposed to domestic vendors. No single third party source supplied more than 10%10.0% of the Company'sour products in 2003. The Company's2004. Our vendors are selected based on their ability to reliably meet the Company'sour production and quality requirements, as well as their financial strength and willingness to meet the
Company'sour needs on an ongoing basis.
At the end of fiscal 2003, the Company2004, we had received approximately $5.2$4.7 million in combined catalog and Internet orders that had not been shipped and were not included in the net revenues of the Company. This amount was a decrease of $0.3$1.0 million or 4.9% compared with the approximately $5.5$5.7 million of unshipped orders existing at the end of fiscal 2002.2003. These amounts consisted mainly of backorders, orders awaiting credit card authorization, open dropship orders and orders physically in the warehouse awaiting shipment to customers. The Company fully expects to complete the shipmentfulfilled substantially all of these orders within the 2004 fiscal year.

     first ninety days of 2005.
Because we import a large portion of our merchandise, we have, in the past, been subject to delays in merchandise availability and shipments due to customs, quotas, duties, inspections and other governmental regulation of international trade. We continue to monitor development in this area in an effort to minimize delays in international merchandise shipments that adversely impact our business.
Telemarketing and Distribution. The Company receivesDuring 2004, we received approximately 62.1%58.0% of itsour orders through itsour toll-free telephone service which offers customeras compared with 62.0% in 2003. As the migration to the Internet continues to increase, we expect to see the trend of decreased percentages of toll-free telephone orders continue. Customers can access our call centers seven days per week, 24twenty-four hours per day. The management information systems used by the Company are discussed below.
The Company mails itsIn addition, we answered more than 5.5 million customer service/order calls and processed and shipped 6.2 million packages to customers during 2004 (including our third party Business-to-Business processing).
We mail our catalogs through the United States Postal Service ("USPS"(“USPS”) utilizing pre-sort, bulk mail and other discounts. MostWe ship most of the Company'sour packages are shipped through the USPS.USPS (93.0%). Overall, catalog mailing and package-
shippingpackage-shipping costs approximated 19.5%19.2% of the Company'sour net revenues in 2004 as compared with 19.6% in 2003. There were no USPS rate increases during 2003. The Company2004 though one is scheduled for 2006. We also utilizesutilize United Parcel Service (1.0%) and other delivery services.services, including Federal Express (6.0%). In January 20032004 and 2004,2005, United Parcel Service increased its rates by 3.5% and 2.9%, respectively. for each year. The increase did not have a material adverse effect on the Company's 2003our 2004 results of operations. The
Company examinesoperations and we did not experience a material adverse effect in 2005. We examine alternative shipping services with competitive rate structures from time to time.

BUSINESS-TO-BUSINESS

     General.  
Order Processing and Product Fulfillment
Telemarketing. The Company through Keystone Internet Services, LLC
("Keystone"), provides back-end e-commerce transaction services to a roster of
Internet 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 27, 2003 include two
warehouse fulfillment centers, one leased temporary storage facility totaling
approximately 1.0 million square feet, and two telemarketing/e-care centers and
one satellite call center with approximately 750 agent positions.

     Telemarketing.  The Company has created a telephone network to link its
three primaryoperates telemarketing facilities in Hanover, Pennsylvania, York, Pennsylvania and LaCrosse, Wisconsin. The Company'sOur telemarketing facilities utilize state-of-the-art telephone switching equipment whichthat enables the
Companyus to route calls between telemarketing centers, balancing loads and thus provideproviding 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
We train our telemarketing service representatives to be courteous, efficient and knowledgeable about the Company'sour products and those of itsour third party customers. Telemarketing service representatives generally receive 40forty 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'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 utilizesWe utilize customer surveys as an important measure of customer satisfaction.
Distribution. The Company presently operates twoWe currently operate a distribution centers in
two principal locations: onecenter in Roanoke, Virginia and oneuntil June 2005, operated a smaller distribution center and storage facility in LaCrosse, Wisconsin. The Company uses these facilities to handledistribution centers handled merchandise distribution for itsour catalogs and websites as well as itsselect third party e-commerce clients. On June 30, 2004 we announced our plan to consolidate the operations of the LaCrosse, Wisconsin fulfillment center and storage facility into the Roanoke, Virginia fulfillment center by June 30, 2005. The LaCrosse fulfillment center and the storage facility were closed in June 2005 and August 2005, upon the expiration of their respective leases. These facilities were consolidated because of excess capacity at the Roanoke, Virginia fulfillment center, space constraints at the LaCrosse facilities and to realize the enhanced efficiencies afforded by our state-of-the-art Roanoke facility. Since

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

     “Properties.”
Management Information Systems. All of the Company'sour catalogs are part of itsour integrated mail order and catalog system operating on its mid-range computer systems. Additionally, itsour fulfillment centers are part of the Company'sour warehouse management system. The Company'sThese systems have been designed to meet itsour requirements as a high volume publisher of multiple catalogs. The Company is
continuingcatalogs and provider of back-end fulfillment services. We continue to devote resources to improving itsour systems.

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

     Keystone Internet
Business-to-Business Services. Launched inIn 1998 Keystone Internet Services
initially servicedwe began offering product fulfillment services to other direct marketers. We later expanded our service offerings to include e-commerce solutions. Currently we do not actively market these services, however, we do provide them to the needspurchasers ofImprovements and Gump’s By Mail as part of those purchase transactions and to select other direct marketers, without back-end
fulfillment resources. Keystone currently offers e-commerce solutionsincluding National Geographic. While the primary mission of our order processing 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 clients the complete spectrum ofproduct fulfillment services including List Services (Merge/ Purge, Hygiene, NCOA), paper/printis to support our catalogs, our third party services business allows us to productively leverage our expertise and utilize our excess infrastructure capacity thereby defraying a portion of our fixed expenses. Revenues recorded from the Company’s B-to-B services were $20.8 million, or 5.2% of net revenues, $20.0 million, or 4.8% of net revenues, and $20.1 million, or 4.4% of net revenues, for catalog production, telemarketing, data entry, distribution (Quality
Assurance/Quality Control, pick/pack/ship/returns), supply chain management2004, 2003 and such critical Information Technology services2002, respectively.
Credit Management
On February 22, 2005, and as Web site development and
hosting, e-mail, voice response units, credit card authorization and billing,
order processing, warehouse management systems, and inventory planning and

                                        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, had previously offered their own private
label credit cards. In 1999, the Companyamended by Amendment Number One on March 30, 2005, we entered into a new three-year account
purchaseseven year co-brand and credit card marketing and services agreement with Capital One
Services, Inc. and Capital One Bank under which Capital One provided for the
sale and servicing of accounts receivable originating from the Company's private label credit card program. The Companyagreement with World Financial Network National Bank (“WFNNB”) under which WFNNB will issue private label and Capital One terminated their
agreement during the second quarterco-brand (Visa and MasterCard) credit cards to our catalog customers. We began a phased roll out of 2003. The Company continues its search
for a more economical provider ofour private label credit card services.

FINANCING

     Changesprogram in April 2005 across our catalogs offering pre-approved credit to Congress Credit Facility.  On December 27, 2003,our core customers. In general the Company'sprogram extends credit facility, as amended (the "Congress Credit Facility"), with Congress
Financial Corporation ("Congress") containedto our customers at no credit risk to the Company. WFNNB provides a maximum credit line, subjectmarketing fund to certain limitations,support our promotion of upthe program.
Financing
Our business is dependent on having adequate financial resources to $56.5 million.fund our operations, catalog circulation and maintain appropriate inventory levels to meet customer demands. In October 2003,the past, the Company amendedhas experienced periods of constrained liquidity, which has adversely affected our financial performance. Our results for the Congress Creditsecond half of 2004 were positively impacted by the increased liquidity provided by the closing on July 8, 2004 of the new $20.0 million Chelsey Facility 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 millionconcurrent amendment 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.

     UnderWachovia Facility, which increased our capital availability under that facility. This increased liquidity enabled us to restore inventory to adequate levels for the Congress Creditsecond half of 2004, which resulted in substantial declines in backorder levels and higher initial customer order fill rates, reversing the trend experienced during the first six months of 2004. The improved inventory levels also increased our borrowing availability under the Wachovia Facility and alleviated constraints on vendor credit that we had previously experienced.

As described more fully in Note 7, Debt to the Companyconsolidated financial statements contained in Part II, we have two credit facilities: the Wachovia Facility and the $20.0 million Chelsey Facility provided by Chelsey Finance. The Wachovia Facility includes a revolving credit facility with a maximum loan amount of $34.5 million and a $5.0 million term loan. The Wachovia Facility expires on July 8, 2007 and bears interest at 0.5% over the Wachovia prime rate. The interest rate on December 25, 2004 was 5.5%.
The Chelsey Facility is requireda $20.0 million junior secured credit facility and has a three-year term. At December 25, 2004, the amount recorded as debt relating to maintain
minimumthe Chelsey Facility on the Consolidated Balance Sheet is $8.2 million, net worth, working capital and EBITDA as defined throughout the term of the agreement. Asremaining, un-accreted debt discount of $11.8 million. The Chelsey Facility bears interest at 5.0% over the Wachovia prime rate. The stated interest rate on December 27, 2003,25, 2004 was 10.0%. The annual effective interest rate of this debt instrument is approximately 62.7%, inclusive of the Company was notaccretion of the debt discount arising from the issuance of common stock warrants to Chelsey Finance in complianceconnection with the working capital covenant; however, it has subsequently receivedChelsey Facility. See Note 7 to the consolidated financial statements for more information regarding the Chelsey Facility and the common stock warrant . We used approximately $4.9 million of the proceeds of the Chelsey Facility to retire a waiver
from Congress addressingterm loan under the deficiency. The Company was in complianceWachovia Facility that bore interest at a 13.0% rate. As a result of this prepayment and the concurrent amendment of the Wachovia Facility, Wachovia provided us with all
other covenantsan additional $10.0 million of availability on the Wachovia Facility. There is no additional availability on the Chelsey Facility.
Total recorded borrowings as of December 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 due25, 2004, including financing 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.

     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 $21.5aggregated $27.9 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, $12.8which $11.2 million is classified as short-term to
be paid within twelve months with $8.7long term, excluding the Series C Preferred of $72.7 million, classified as long-termreflected on the Company'sCompany’s Consolidated Balance Sheet. AsSheet, and the remaining, un-accreted debt discount on the Chelsey Facility of $11.8 million. Remaining availability under the Wachovia Facility 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 was $14.0 million. We believe that we have adequate capital resources to continue to operate our business for at least the Company amendednext twelve months.
Preferred Stock
Chelsey holds all 564,819 outstanding shares of Series C Preferred, 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 sharesonly series 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 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 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 ofcurrently outstanding. Chelsey acquired the Series A ParticipatingC 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
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 redeemby first acquiring 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 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 (the "Series B
Participating Preferred Stock") and the reimbursement of expenses of $1 million
to Richemont. Richemont agreed, as part of the transaction, to
                                        11


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 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 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(“Series B Preferred”) and Common Stock repurchasedheld 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 abouton May 19, 2003,2003. Prior to the Chelsey acquisition, Richemont sold to Chelsey all of Richemont's securities inwas 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.Company’s second largest single stockholder. The
Company was not a party to such transaction. On November 30, 2003, the Company
consummated a transaction with Chelsey (the "Recapitalization")Richemont, 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 tofor 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 ParticipatingPreferred are summarized in greater detail in Note 8, Preferred Stock to the Financial Statements contained in Part II.
In general, the Series C Preferred holders are entitled to one hundred votes per share on any matter on which the Common Stock votes 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
thatvotes. If the Company defaults on its obligations under the Certificate of
Designations, the Recapitalization Agreementliquidates, dissolves or the Congress Credit Facility,
thenis wound up, 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 of approximately $56.5 million based on the shares of Series C Preferred currently owned by Chelsey, plus all accrued and unpaid dividends on the Series C Preferred. As described further below, commencing January 1, 2006, dividends will be payable quarterly on the Series C Preferred at the rate of 6.0% per annum, but such dividends may be accrued at the Company’s option. Effective October 1, 2008 and assuming the Company has elected to accrue all dividends from January 1, 2006 through such date, the maximum aggregate amount of $56,481,900.

     the liquidation preference plus accrued and unpaid dividends on the Series C Preferred will be approximately $72.7 million.
Commencing January 1, 2006, dividends will be payable quarterly on the Series C Participating Preferred Stock at the rate of 6%6.0% per annum, with the preferred dividend rate increasing by 1 1/2% per annum on each anniversary of the dividend commencement date until redeemed. At the Company'sCompany’s option, in lieu of paying cash dividends, the Company may instead elect to cause accrued and unpaidaccrue dividends tothat will compound at a rate equal to 1%1.0% 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
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
Companymandatorily redeemable on January 1, 2009 (the "Mandatory Redemption Date") for the Redemption
Price. If the Series C Participating Preferred Stock2009. The Company 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 entitledalso obligated 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 termsWachovia Facility. The proceeds from the sale of Gump’s would have required redemption of some of the 19th AmendmentSeries C Preferred. At the Company’s request, Chelsey agreed to permit the Loan and Security Agreement with
Congress Financial Corporation (as modified byCompany to apply the 29th AmendmentGump’s sales proceeds to reduce the Loan
and Security Agreement), andrevolving credit facility under the Wachovia Facility. Chelsey will be requiredexpressly retained its right to accept such
redemptions.

     Pursuant to the termsrequire redemption of the Certificate of Designationsapproximately $6.9 million (the Gump’s sales proceeds available for redemption) of the Series C 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 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.

                                        13
Wachovia’s approval.



     General.  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 Credit Facility as of
December 27, 2003 was $9.9 million. The liquidation preference relating to the
Series C Participating Preferred Stock as of December 27, 2003 was $56.5
million. There were nominal capital commitments (less than $0.2 million) at
December 27, 2003.

EMPLOYEES

     
Employees
As of December 27, 2003, the Company25, 2004, we employed approximately 1,722 people on
a1,800 full-time basisemployees and approximately 192 people on a400 part-time basis.employees. The number of part-time employees at December 27, 200325, 2004 reflects a temporary increase in headcount necessary to fill the seasonal increase in orders during the holiday season. Approximately 209 of the Company's164 employees atemployed by one of itsour subsidiaries are represented by a union. The Company entered into a new agreement with The Union of Needletrades, Industrial and Textile Employees (UNITE!). We entered into a new union agreement in March 2003 whichthat expires on February 26, 2006. The Company and the union are currently negotiating a new agreement.  While the Company believes itsthat a new union agreement can be reached on terms mutually acceptable to the Company and the union, there can be no assurances that such an agreement can be reached before the current agreement expires.   
We believe our relations with itsour employees are good.
During the fiscal year ended December 27, 2003, the Company25, 2004, we eliminated a total of approximately 39 FTE200 full-time equivalent positions, including approximately twoeight positions at or above the level of director, which included open positions that were eliminated. The CompanyAll separations were made prospective paymentsin accordance with normal pay practices, excluding those individuals who were terminated under a compensation continuation agreement, which provided for payment in the form of a lump sum.
Seasonality
Our business is subject to separated employees either
weekly or bi-weekly, based uponmoderate variations in demand. Historically, a larger portion of our revenues have been realized during the fourth quarter compared to each person's previous payment schedule.

SEASONALITY

     The Company does not consider its business seasonal. The revenues and
business forof the Company are proportionally consistent for each quarter during a
fiscalfirst three quarters of the year. The percentage of annual revenues for the first, second, third and fourth quarters recognized by the Company were as follows: 2004 — 22.4%, 24.0%, 23.4% and 30.2%; 2003 -- 24.7%— 23.5%, 25.5%25.4%, 23.4% and 27.7%; and 2002 — 22.8%, 24.5%, 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%29.4%.

COMPETITION

     The Company believes
Competition
We believe that the principal bases upon which it competeswe compete in itsour direct commerce business are quality, value, service, proprietary product offerings, catalog design, web sitewebsite design, convenience, speed and efficiency. The Company'sOur 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 brickbricks and mortar stores. Competitors also exist in each of the Company'sour catalog specialty areas of women's apparel, home fashions, men'swomen’s apparel, and gifts such as J.Crew,
Jockey, Calvin Klein, 2xist, Joe Boxer, Blair menswear and Bachrach, in the
men'smen’s apparel category, Lane Bryant, Roaman's and Jessica London in the women's
apparel category, andinclude Linen Source, Pottery Barn and BrylaneHome in the home fashions, Lane Bryant, Roaman’s, Jessica London and Spiegel in the women’s apparel category and J. Crew, Blair and Bachrach, in the men’s apparel category. The Gump's store in San Francisco competesOur catalogs also compete with Neiman
Marcus, Tiffany, Horchow, Williams Sonomabricks and Cratemortar department stores, specialty stores and discount stores including JC Penney, Wal-Mart, Target, Bed, Bath & Barrel. A numberBeyond, Bloomingdale’s and Pottery Barn. Many of the
Company'sour competitors have substantially greater financial, distribution and marketing resources than the Company.

     The Company is maintainingwe do.
We maintain an active e-commerce enabled Internet Web sitewebsite presence for all of itsour catalogs. A substantial number of each of the Company's
catalogour catalogs’ competitors maintain an active e-commerce enabled Internet Web site
presencewebsite presences as well. A number of suchthese competitors have substantially greater financial, distribution and marketing resources than the Company.we do. In addition, the Company haswe have entered into third party Web site advertisingwebsite affiliate marketing arrangements, including one with Amazon.com, as described above under "Direct“Direct Commerce --— Internet Sales." The Company believes in the future of” We believe the Internet and online commerce including thewill continue to be an ever increasing portion of our business and we plan to continue to explore additional marketing opportunities arising fromin 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 National Fulfillment Services, among
others. A number

                                        14


of the Company's competitors have substantially greater financial, distribution
and marketing resources than the Company.

TRADEMARKS

     medium.
Trademarks
Each of the Company'sour catalogs has its own federally registered trademarks that are owned directly by The Company Store Group, LLC and itsthe catalog company subsidiaries. The Company
Store Group, LLC and itsThese subsidiaries also own numerous trademarks, copyrights and service marks on logos, products and catalog offerings. The Company and its
subsidiariesWe have also have protected various trademarks internationally. The CompanyWe believe our trademarks, copyrights, service marks and its subsidiariesother intellectual property are valuable assets and we continue to vigorously protect suchthese marks.

GOVERNMENT REGULATION

     
Government Regulation

The Company is subject to Federal Trade Commission regulations governing its advertising and trade practices, Consumer Product Safety Commission regulations governing the safety of the products it sells and other regulations relating to the sale of merchandise to its customers. The Company isWe are also subject to the Department of Treasury --— Customs regulations with respect to any goods itwe directly imports.

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

LISTING INFORMATION

     By letter dated May 2, 2001,
Listing Information
The Common Stock was listed on the American Stock Exchange (the "Exchange")
notified the Company that it was below certainAMEX. Because of the Exchange'sRestatement, we could not file our Form 10-Q for the fiscal quarter ended September 25, 2004, a condition of continued listing guidelines set forthAMEX listing. Trading in the Exchange's Company Guide. The Exchange
instituted a review of the Company's eligibility for continuing listing of the
Company's common stockour Common Stock on the Exchange. On January 17, 2002,AMEX was halted on November 16, 2004, formally suspended on February 2, 2005 and delisted effective February 16, 2005. Current trading information about the Company
received a letter dated January 9, 2002Common Stock can be obtained from the Exchange confirming thatPink Sheets (www.pinksheets.com) under the American Stock Exchange determinedtrading symbol HNVD.PK.
Website Access 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

                                        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 internetInformation
Our corporate Internet address is www.hanoverdirect.com.

     www.hanoverdirect.com. Our catalogs operate the following websites:
•
www.thecompanystore.com
•
www.companykids.com
•
www.domestications.com
•
www.silhouettes.com
•
www.internationalmale.com
•
www.undergear.com
The Company recently beganwebsite for Keystone Internet Services, LLC (“Keystone”) which provides business to business services is www.keystoneinternet.com and Scandia Down’s is www.scandiadown.com.
We make available free of charge on or through its Web site itsour corporate website our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports and press releases as soon as reasonably practicable after such material isthese filings are electronically filed with or furnished to the Securities and Exchange Commission. Prior thereto,Commission or in the Company
voluntarily providedcase of press releases, released to the wire services. We will continue to provide electronic or paper copies of itsour filings free of charge upon request, which itrequest.
Item 1A. Risk Factors
Factors That May Affect Future Results.
There are many risks and uncertainties relating to our business; we have described some of the more important ones below. Additional risks and uncertainties not currently known to us or that we currently do not deem material may also become important factors that may harm our business. The success of our business could be impacted by any of these risks and uncertainties.
We have experienced several years of operating losses.
We had a history of losses prior to the 2004 fiscal year. As of December 25, 2004, our accumulated deficit was $498.6 million. We may not be able to sustain or increase profitability on an annual basis in the future. If we are unable to maintain and increase profitability our financial condition could be adversely affected.
We are dependent on having sufficient financing to meet our requirements.
Our business is dependent upon our access to adequate financing from our senior lender, Wachovia and our

junior lender, Chelsey Finance, so that we can support normal operations, purchase inventory, and secure letters of credit and other financial accommodations required to operate our business. Our credit facilities contain financial and other covenants and we have not been in compliance with these covenants at all times. In the past Wachovia and Chelsey Finance have granted us waivers and agreed to amendments to the Wachovia and Chelsey Facilities, though there can be no assurances that they will continue to do.

ITEMdo so. Our ability to borrow is also limited by the value of our inventory which is reappraised from time to time. Were either Wachovia or Chelsey Finance to deny or curtail the Company’s access to capital, our business would be adversely affected. Both lenders have liens on our assets and were we to default, they could commence foreclosing on our assets.
We are also dependent on our vendors or suppliers providing us with trade credit. If certain trade creditors were to deny us credit or convert the Company to a cash basis or otherwise change credit terms, or require the Company to provide letters of credit or cash deposits to support its purchase of inventory, paper, printing and other items essential to its business, our costs would be increased and we might have inadequate liquidity to operate our business or operate profitably.
The Restatement, the delay in filing financial statements and the commencement of an informal SEC inquiry have adversely affected us and may continue to do so in the future.
We have restated our financial results as a result of various errors identified in 2004. This has led to our inability to file financial information for several quarters, the commencement of an investigation by the Audit Committee of the Board of Directors, the delisting of our Common Stock from the AMEX, the commencement of an informal SEC inquiry. We dismissed our former independent auditors, who had identified material weaknesses in our internal controls, after they informed us that they needed to perform additional audit procedures on our prior period financial statements. We engaged new auditors which further delayed the filing of our financial statements. As a consequence of the foregoing, our business has been and will continue to be adversely affected as a result of the increased professional expenses, the diversion of senior management’s attention to resolving these matters and the damage to our Company’s reputation. There can be no assurances that the consequences of these events will not continue to adversely affect our business for the foreseeable future.
The SEC inquiry is ongoing and we cannot predict the outcome at this time. Were the SEC to convert the informal inquiry into a formal investigation, we would likely incur significant professional fees in addressing such investigation, and our relationships with our lenders, vendors, customers and other third parties could be adversely affected. Should the SEC find wrongdoing on our part, we may be subject to a censure or penalty that could adversely affect our results of operations, our relationships with our lenders, vendors, customers and other third parties, our reputation and our business in general.
There is limited liquidity in our shares of Common Stock.
The AMEX halted trading in our Common Stock during the fourth quarter of 2004 and delisted it on February 16, 2005. Current trading information about our Common Stock is available on the Pink Sheets. There is very little liquidity in our Common Stock at this point in time which adversely affects its price. There can be no assurances that an active market in our Common Stock will develop at any time in the foreseeable future.
There can be no assurance that we will be able to successfully remedy material weaknesses in our internal controls.
In connection with its audit of the Company’s consolidated financial statements for the year ended December 25, 2004, material weaknesses in internal control over financial reporting and other matters relating to the Company’s internal controls were identified. Although our current auditors have not brought to our attention any material weaknesses, there can be no assurance that additional weaknesses will not develop or be discovered in the future.
Our success depends on our ability to publish the optimal number of catalogs to the correct target customer with merchandise that our target customers will purchase.
Historically our catalogs have been the primary drivers of our sales. We must create, design, publish and distribute catalogs that offer and display merchandise that our customers want to purchase at prices that are attractive. Our future success depends on our ability to anticipate, assess and react to the changing demands of the customer-base of our catalogs and to design and publish catalogs that appeal to our customers. If we fail to anticipate fashion trends, select the right merchandise assortment, maintain appropriate inventory levels and creatively present merchandise in a way that is appealing to our customer-base on a consistent basis, our sales could

decline significantly. We must also accurately determine the optimal number of issues to publish for each catalog and the contents thereof and the optimal circulation for each of our catalogs to maximize sales at an appropriate cost level to achieve profitability while growing our customer base. Correctly determining the universe of catalog recipients also directly impacts our results. We can provide no assurance that we will be able to identify and offer merchandise that appeals to our customer-base or that the introduction of new merchandise categories will be successful or profitable or that we will mail the optimal number of catalogs to the appropriate target customer base.
Our catalogs are in highly competitive markets.
Our catalogs are in a highly competitive markets. Many of our competitors are considerably larger and have substantially greater financial, marketing and other resources, and we can provide no assurance that we will be able to compete successfully with them in the future.
We must effectively manage our inventories and control our product fulfillment costs.
We must manage our inventories to track customer preferences and demand. We order merchandise based on our best projection of consumer tastes and anticipated demand in the future, but we cannot guarantee that our projections of consumer tastes and the demand for our merchandise will be accurate. It is critical to our success that we stock our product offerings in appropriate quantities. If demand for one or more products outstrips our available supply, we may have large backorders and cancellations and lose sales. On the other hand, if one or more products do not achieve projected sales levels, we may have surplus or un-saleable inventory that would force us to take significant inventory markdowns, which could reduce our net sales and gross margins.
We must also effectively manage our product fulfillment and distribution costs. During 2005, we consolidated our La Crosse distribution facility into our Roanoke facility because of capacity constraints at our La Crosse facility and lower shipping costs available from the Roanoke facility. However since our consolidation into the Roanoke facility, we have experienced lower productivity and high employee turnover due, in part, to a tight labor market in Roanoke. This drop in productivity has increased our product fulfillment costs and adversely affected out results. There can be no assurances that this trend will not continue.
We may have difficulty sourcing our products, especially those sourced overseas.
Most of our products are manufactured by third-party suppliers. Some of these products are manufactured exclusively for us using our designs. If any of these manufacturers were to stop supplying us with merchandise or go out of business, it would take several weeks to secure a new manufacturer and there could be a disruption in our supply of merchandise. If we are unable to provide our customers with continued access to popular merchandise manufactured exclusively for us, our operating results could be harmed.
We also source many of our products overseas. While products sourced overseas typically have lower costs, our product margins may be slightly offset by an increase in inbound freight costs. As security measures around shipping ports increase, these additional costs may result in higher inbound freight costs. As we increase our overseas sourcing, we face the risk of these delays which could harm our business and results of operations. We cannot predict whether any of the countries in which our merchandise currently is manufactured or may be manufactured in the future will be subject to additional trade restrictions imposed by the U.S. and other foreign governments, including the likelihood, type or effect of any such restrictions. Trade restrictions, including increased tariffs or quotas, embargoes, and customs restrictions, against items that we offer or intend to offer to our customers, as well as U.S. or foreign labor strikes, work stoppages or boycotts, could increase the cost or reduce the supply of items available to us and adversely affect our business, financial condition and results of operations. Our sourcing operations also may be adversely affected by political and financial instability resulting in the disruption of trade from exporting countries, significant fluctuation in the value of the U.S. dollar against foreign currencies, restrictions on the transfer of funds and/or other trade disruptions. Any disruption or delays in, or increased costs of, importing our products could have an adverse effect on our business, financial condition and operating results.
Our success is dependent on the performance of our vendors and service providers.
Our business depends on the performance of third parties, including merchandise manufacturers and foreign buying agents, telecommunications service providers, the United States Postal Service (“USPS”), shipping companies, printers, professionals, photographers, creative designers and models, credit card processing companies and the service bureau that maintains our customer database.
Any interruptions or delays in the provision of these goods and services could materially and adversely affect our business and financial condition. Although we believe that, in general, the goods and services we obtain from third parties could be purchased from other sources, identifying and obtaining substitute goods and services could

result in delays and increased costs. If any significant merchandise vendor or buying agent were to suddenly discontinue its relationship with us, we could experience temporary delivery delays until a substitute supplier could be found.
Our business is subject to a number of external costs that we are unable to control.
Our business is subject to a number of external costs that we are unable to control, including labor costs, insurance costs, printing, paper and postage expenses, shipping charges associated with distributing merchandise to our customers and inventory acquisition costs, including product costs, quota and customs charges. In particular, the paper market is extremely tight at this time and we are experiencing increased costs for our paper needs for 2005. We also ship a majority of our merchandise by USPS and have experienced increases in postal rates in 2006. Increases in these or other external costs could adversely affect our financial position, results of operations and cash flows unless we are able to pass these increased costs along to our customers.
We have a new management team that is critical to our success.
Our success depends to a significant extent upon our ability to attract and retain key personnel. Moreover, four members of our senior management team, the new CEO, the new CFO, the General Counsel and the president of one of our catalogs, have each been with the Company for less than two years. Our success is dependent on the ability of our senior management and catalog presidents to successfully integrate into and manage our business and the individual catalogs. The loss of the services of one or more of our current members of senior management, or our failure to attract talented new employees, could have a material adverse effect on our business.
We are dependent on the continued growth of Internet sales.
We derive an increasing portion of our revenue from our websites. While we continue to believe that our catalogs are the primary sales drivers of our merchandise, e-commerce is an important part of our business. Factors which could reduce the widespread use of the Internet include actual or perceived lack of privacy protection, actual or perceived lack of security of credit card information, possible disruptions or other damage to the Internet or telecommunications infrastructure, increased governmental regulation and taxation and decreased use of personal computers. Our business would be harmed by any decrease or less than anticipated growth in Internet usage.
We have a majority shareholder who controls the Board and is also a secured lender.
Chelsey and Chelsey Finance, a Chelsey affiliate, control over 90% of the voting power (after giving effect to the exercise of all outstanding options and warrants to purchase Common Stock beneficially owned by Chelsey) and owns approximately 69% of the Company’s issued and outstanding Common Stock (including the January 10, 2005 purchase of 3,799,735 shares). Chelsey has appointed a majority of our Board of Directors including our Chairman, and Chelsey Finance is the Company’s junior secured lender. The interests of Chelsey and Chelsey Finance as the majority owners of the Common Stock, the holders of all of the Series C Preferred and as a secured lender may be in conflict with that of our other Common Stock holders, which may adversely affect their investment in the Common Stock. In addition, Chelsey has sufficient voting power to cause an extraordinary transaction (such as a merger or other business combination, a sale of all or substantially all of the Company’s assets or a going private transaction) to take place without the vote of any other shareholders.
Our Series C Preferred Stock begins to accrue dividends in 2006 and is subject to mandatory redemption in 2009.
Commencing January 1, 2006, dividends will be payable quarterly on the Series C Preferred at the rate of 6.0% per annum, with the preferred dividend rate increasing by 1 1/2% per annum on each anniversary of the dividend commencement date until redeemed. At the Company’s option, in lieu of cash dividends, the Company may accrue dividends that will compound at a rate 1.0% higher than the applicable cash dividend rate. The Wachovia Loan Agreement currently prohibits the payment of cash dividends. The Series C Preferred, if not redeemed earlier, must be redeemed by the Company on January 1, 2009 for the liquidation preference and all accrued and unpaid dividends. Assuming the Company has elected to accrue all dividends from and after January 1, 2006, the maximum aggregate amount of the liquidation preference plus accrued and unpaid dividends on the Series C Preferred will be approximately $72.7 million.
We have not fully assessed the effectiveness of our internal controls over financial reporting.
We are in the process of assessing the effectiveness of our internal controls over financial reporting in connection with the rules adopted by the Securities and Exchange Commission under Section 404 of the Sarbanes-Oxley Act of 2002. The SEC delayed implementation of Section 404 for companies with a market capitalization of less than $75.0 million such as the Company. Under the current rules and the Company’s current market

capitalization, Section 404 would apply to our 2007 financial statements. There can be no assurance that management will not identify significant deficiencies that would result in one or more material weaknesses in our internal controls over financial reporting. We cannot provide any assurance that testing of our internal controls will not uncover significant deficiencies that would result in a material weakness in our internal controls over financial reporting.
If we fail to comply in a timely manner with the requirements of Section404 of the Sarbanes-Oxley Act of 2002 or to remedy any material weaknesses in our internal controls that we may identify, such failure could result in material misstatements in our financial statements and cause a default under the Company’s credit facilities, cause investors to lose confidence in our reported financial information and have a negative effect on the trading price of our common stock.
For those material weaknesses previously identified and those that may be identified in the future, we will adopt and implement policies and procedures to remediate such material weaknesses. Designing and implementing effective internal controls is a continuous process that requires us to anticipate and react to changes in our business and the economic environment in which we operate, and to expend significant resources to maintain a system of internal controls that is adequate to satisfy our reporting obligations as a public company. We cannot assure you that the measures we will take will remediate any material weaknesses that we may identify, or that we will implement and maintain adequate controls over our financial process and reporting in the future.
Any failure to complete our assessment of our internal controls over financial reporting, to remediate any material weaknesses that we may identify, or to implement new or improved controls, could harm our operating results, cause us to fail to meet our reporting obligations, or result in material misstatements in our financial statements and cause a default under the Company’s credit facilities. Any such failure also could adversely affect the results of the periodic management evaluations and, in the case of a failure to remediate any material weaknesses that we may identify, would adversely affect the annual auditor attestation reports regarding the effectiveness of our internal control over financial reporting that are required under Section 404 in 2007. Inferior internal controls could also cause investors to lose confidence in our reported financial information, which could have a negative effect on the trading price of our common stock.
We receive a material portion of our operating profits from our sale of third party membership services and derive a material portion of our revenues by providing fulfillment services to third parties.
In 2004, we received approximately $7.0 million in revenues from our sale of Vertrue membership programs, which generates a material portion of our operating profit. Our agreement with Vertrue continues through March 2006 and we are evaluating proposals from membership program providers to market membership programs to our customers after the Vertrue agreement expires. Were we to lose this revenue stream, our operating results would be adversely affected. In addition, as more of our business transitions to the Internet, where customer response rates in these programs is lower than for those customers who place orders over the phone, this could negatively impact revenues generated from these programs.
We also derive a material portion of our revenues by providing order processing and product fulfillment services to third parties. These revenues offset some of our fixed costs associated with operating our distribution facility and our call centers and were we to lose this revenue stream, our results would be adversely affected unless our direct marketing operations made up for the lost revenues.
In light of these risks and uncertainties and others not mentioned above, the forward-looking statements contained in this Annual Report may not occur. Accordingly, readers should not place undue reliance on these forward-looking statements, which only reflect the views of the Company management as of the date of this report. The Company is not under any obligation and does not intend to publicly update or review any of these forward-looking statements, whether as a result of new information, future events or otherwise, even if experience or future events make it clear that any expected results expressed or implied by those forward-looking statements will not be realized.
Item 2. PROPERTIES

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

     - 
A 775,000 square foot warehouse and fulfillment facility located in Roanoke, Virginia;

     - A 48,000 square foot administrative and telemarketing facility located in
       LaCrosse, Wisconsin; and

     - A 150,000 square foot home fashion manufacturing facility located in
       LaCrosse, Wisconsin used to produce down filled comforters for sale under
       "The Company Store" and "Scandia Down" brand names.

     

•
A 48,000 square foot administrative and telemarketing facility located in LaCrosse, Wisconsin; and
•
A 150,000 square foot home fashion manufacturing facility located in LaCrosse, Wisconsin used to manufacture comforters, pillows and featherbeds for sale under “The Company Store” and “Scandia Down” names.
Each of these properties is subject to a mortgage in favor of the Company's
lender, Congress Financial Corporation.

     Wachovia and a second mortgage in favor of Chelsey Finance.
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;

     - A 28,700 square foot corporate headquarters and administrative offices located in Weehawken, New Jersey. On February 12, 2005, we entered into a 10-year lease extension and modification, effective June 2005, for 50,000 square feet of the 85,000 square feet that was previously leased. All catalog operations are based in the Weehawken facility as of the end of May 2005. In addition, we leased approximately 5,000 square feet in a storage facility in Jersey City, New Jersey, under a lease that expired in May 2005. We did not renew this lease, however we did secure a new lease expiring May 31, 2010, for a 6,900 square foot storage facility in Secaucus, New Jersey.
•
A 28,700 square foot office formerly used for corporate headquarters, administration and Silhouettes operations located in Edgewater, New Jersey under a lease that expired in May 2005. The Company has vacated this facility and has consolidated these functions into the Weehawken facility.
•
Five properties used as outlet stores located in Pennsylvania and Wisconsin having approximately 49,200 square feet of space in the aggregate, with leases running through February 2007. The Company decided to close and not renew the leases of three of these stores. Two of these closures were located in Wisconsin and were vacated by July 31, 2005. The remaining location is located in Pennsylvania and will be vacated no later than February 28, 2006.
•
A 65,100 square foot retail and office facility which includes the Gump’s retail store in San Francisco, California under two leases that expire in April 2010, of which approximately 37,800 square feet was occupied by the Company and the remaining 27,300 square feet are subleased. On March 14, 2005, the Company sold its Gump’s retail store operation. After the sale, the Company continued as the guarantor of one of the two leases. The Purchaser is required to use its commercially reasonable efforts to secure the Company’s release from the guarantee within a year of the closing.
•
A 151,000 square foot warehouse and fulfillment facility located in LaCrosse, Wisconsin under a lease that expired in June 2005. The Company also leased a 34,000 square foot facility, located in LaCrosse, Wisconsin that was used for storage under a lease extension that expired in August 2005. As part of the consolidation of the distribution function to the Roanoke facility, the Company vacated these facilities upon their lease expirations.
•
A 117,900 square foot telemarketing, customer service and administrative facility located in Hanover, Pennsylvania, under a lease extension expiring on June 30, 2006.
•
An 11,000 square foot satellite telemarketing facility in York, Pennsylvania under a lease expiring July 31, 2006.
•
A 30,000 square foot administrative facility in San Diego, California for the men’s apparel business under a lease that expired February 28, 2005. At the end of the lease, the Company vacated this space in conjunction with the relocation of the men’s apparel business to the Weehawken facility.
•
A 302,900 square foot warehouse and fulfillment facility located in Salem, Virginia for additional storage for the Roanoke distribution center under a lease commencing March 28, 2005. The lease was initially for 91,000 square feet and was amended in June 2005 and September 2005 to increase the leased space to the current 302,900 square feet. The lease expires on September 30, 2006 except for a portion that pertains to an additional 90,900 square feet added in September 2005 which is on a month-to-month basis.

A 5,100 square foot retail outlet store facility in Roanoke, Virginia under a lease expiring in May 2005,February 2009.
Item 3. Legal Proceedings
Rakesh K. Kaul v. Hanover Direct, Inc., No. 04-4410(L)-CV, 2nd Cir.S.D.N.Y., on appeal from 296 F. Supp.2d (S.D. NY 2004). On June 28, 2001, Rakesh K. Kaul, the former President and Chief Executive Officer of
       which approximately 16,000 square feet is occupied by the Company, approximately 2,600 square feet are subleased, and the remaining 10,100
       square feet are available for sublease;

     - Six properties currently or formerly used as outlet stores located in
       California, Pennsylvania and Wisconsin having approximately 55,400 square
       feet of spacefiled a five-count complaint in the aggregate, with leases running through December
       2005. The two retail storesFederal District Court in California have been closed.New York seeking relief stemming from his separation of employment from the Company including short-term bonus and severance payments of $2,531,352, attorneys’ fees and costs, and damages due to the Company’s failure to pay him a “tandem bonus” as well as Kaul’s alleged rights to benefits under a change in control plan and a long-term incentive plan. The Company currently subleasesfiled a Motion for Summary Judgment and in July 2004, the 6,200 square feetCourt entered a final judgment dismissing most of spaceMr. Kaul’s claims with prejudice and awarded Mr. Kaul $45,946 in San Diego. The Los
       Angeles store leasevacation pay and $14,910 in interest which the Company paid in July 2004. In August 2004, Kaul filed an appeal on three issues: severance and short-term bonus, tandem bonus and legal fees. On June 28, 2005 the Second Circuit Court of Appeals denied Kaul’s appeal, affirming the Summary Judgment decision in the Company’s favor. Mr. Kaul’s rights to appeal the Second Circuit’s decision expired in August 2003;

     - A 65,100 square foot retail and office facility which includes2005.
As of December 25, 2004, the Gump's
       retail store in San Francisco, California under two leases that expire
       during April 2010,Company had accrued $4.5 million related to this matter. This accrual remained on the Company’s Consolidated Balance Sheet until the third fiscal quarter of which approximately 37,800 square feet are occupied2005 when Kaul’s rights to pursue this claim expired.
SEC Informal Inquiry:
See Note 18 to the consolidated financial statements for a discussion of the informal inquiry being conducted by the SEC relating to the Company’s financial results and financial reporting since 1998.
Class Action Lawsuits:
The Company approximately 9,100 square feet are subleased, andwas a party to four class action/ representative lawsuits that all involved allegations that the remaining 18,200 square feet are availableCompany’s charges for sublease. In additioninsurance were invalid, unfair, deceptive and/or fraudulent. As described in greater detail below, the Company has leased 2,400 square feetresolved all of storage space relating tothese class action lawsuits.
Jacq Wilson v. Brawn of California, Inc. , Case No. CGC-02-404454 (Supp. Ct. San Francisco, CA 2002) (“Wilson Case”). On February 13, 2002, Jacq Wilson, suing on behalf of himself and other similarly situated persons, filed a representative suit in the Gump's retail store, expiring March 2008;

     - A 185,000 square foot warehouseSuperior Court of the State of California, City and fulfillment facility located in
       LaCrosse, Wisconsin under a lease expiring in December 2004; and

     - A 117,900 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,County of San Francisco, against the Company utilizesalleging that the Company charged an unlawful, unfair, and fraudulent insurance fee on orders, was engaged in untrue, deceptive and misleading advertising and unfair competition under the state’s Business and Professions Code. The plaintiffs sought relief including restitution and disgorgement of all monies wrongfully collected by defendants, including interest, an order enjoining defendants from imposing insurance on its order forms, and compensatory damages, attorneys’ fees, pre-judgment interest and costs of the suit. In November, 2003, the Court, after a temporary storage facilitytrial the previous April, entered judgment for the plaintiffs, requiring defendants to refund insurance charges collected from consumers for the period from February 13, 1998 through January 15, 2003, with interest. In April, 2004, the Court awarded plaintiff’s counsel approximately $445,000 of 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. attorneys’ fees.
The Company also leases a 34,000 square
foot facility usedappealed the Court’s decision and the order to pay attorneys’ fees, which appeals were consolidated. Enforcement of the judgment for storage under a lease expiring August 31, 2004 in La
Crosse, Wisconsin. In addition,insurance fees and the award of attorneys’ fees was stayed pending resolution of the appeal. On September 2, 2005 the California Court of Appeals reversed both the Court’s findings on the merits and its award of attorneys’ fees and awarded the Company leasesits cost on the appeal.
Teichman v. Hanover Direct, Inc. et. al., No. 3L641 (Supp. Ct. San Francisco, CA 2001). On August 15, 2001, Randi Teichman filed a 30,000 square foot
administrative facilitysummons and four-count complaint in the Superior Court for the City and County of San Diego, California underFrancisco seeking damages and other relief for herself and a lease expiring February
28, 2005. On February 28,

                                        16
class of similarly situated persons arising out of the insurance fee charged by catalogs and Internet sites operated by Company subsidiaries. This case had been stayed since May 2002 pending resolution of the Company terminatedWilson Case.

The plaintiffs in both Wilson and Teichman were represented by the telemarketing operations conducted at such
facility. Currently, the Company occupies approximately 16,000 square feet,
approximately 12,000 square feet are subleased,same counsel and the remaining 2,000 square
feet are availableplaintiffs in both cases agreed to dismiss the cases with prejudice in exchange for sublease.

     On May 3, 2001, the Company sold its 277,500 square foot warehouseCompany’s agreement to not seek reimbursement of costs in the Wilson case.
John Morris, individually and fulfillment facility in Hanover, Pennsylvania (the "Kindig Lane Property")on behalf of all other similarly situated person and certain equipment located therein for $4.7 million to an unrelated third party.
The Company continued to use the Kindig Lane Property under a month-to-month
lease agreement with the third party, the term of the last month to expire on
April 4, 2003. Effective March 31, 2003, the Company closed its Kindig Lane
facility and moved its remaining operations there to the Company's facility in
Roanoke, Virginia.

ITEM 3.  LEGAL PROCEEDINGS

     A class action lawsuit was commenced on March 3, 2000 entitled Edwin L.
Martinentities similarly situated v. Hanover Direct, Inc. and Hanover Brands, Inc., No. L 8830-02 (Sup. Ct. Bergen Co. – Law Div., NJ) October 28, 2002, John Does 1 through 10, bearing case no.
CJ2000-177 in the State Court of Oklahoma (District Court inMorris, individually and for Sequoyah
County). Plaintiff commenced the action on behalf of himself andother similarly situated persons in New Jersey filed a class of
persons who have at any time purchased a product fromaction alleging that (1) the Company improperly added a charge for “insurance” and (2) the Company’s conduct was in violation of the New Jersey Consumer Fraud Act as otherwise deceptive, misleading and unconscionable. Morris sought relief including damages equal to the amount of all insurance charges, interest, treble and punitive damages, injunctive relief, costs, and reasonable attorneys’ fees. On February 14, 2005, the Court denied class certification which limited the damages being litigated, absent an appeal of the denial of class certification, to Plaintiff’s individual injury of the $1.48 he paid for an "insurance charge." The complaint sets forth claimsinsurance which could be trebled pursuant to the New Jersey consumer protection statute plus attorney’s fees. This case was settled effective as of August 29, 2005 and the Company paid $39,500 in the aggregate for a nominal amount of damages and legal fees.
Martin v. Hanover Direct, Inc., et. al., No. CJ-2000 (D.C. Sequoyah Co., Ok.) (“Martin Case”). On March 3, 2000, Edwin L. Martin filed a class action lawsuit against the Company claiming breach of contract, unjust enrichment, recovery of money paid absent consideration, fraud and a claim under the New Jersey Consumer Fraud Act. The complaint alleges thatallegations stem from “insurance charges” paid to the Company charges its customers for delivery insurance even though, among other
things,by consumers who had placed orders from catalogs published by indirect subsidiaries of the Company's common carriers already provide insurance and the
insurance charge provides no benefit to the Company's customers. Plaintiff also
seeksCompany over a number of years. Martin sought relief including (i) a declaratory judgment as to the validity of the delivery insurance. The
damages sought are (i)insurance, (ii) an order directing the Company to return to the plaintiff and class members the "unlawful revenue"“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 perfor each class member, and (v) attorneys'(iv) attorneys’ fees and costs. On April 12,In July 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,
definingcertified 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 withclass certification. On October 25, 2005, the class certification was reversed. Martin filed an Application for Rehearing which was denied on January 3, 2006. On January 18, 2006, Martin filed a Petition for a Writ of Certiorari in the Oklahoma Supreme Court. The Company believes that it is unlikely that the Oklahoma Supreme Court will grant Martin’s petition.
The Company established a $0.5 million reserve during the third quarter of 2004 for the class action lawsuits described above for settlements and subsequently movedthe Company’s current estimate of future legal fees to stay proceedings
in the district court pending resolutionbe incurred. The balance 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 resolutionreserve as of the
appeal, that certain other issues would be subject to limited discovery, and
that the issue of a stayDecember 25, 2004 remained at $0.5 million.
Claims 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. Post-Employment Benefits
The Company believes it has defenses againstis involved in four lawsuits instituted by former employees arising from the claims
andCompany’s denial of change in control (“CIC”) benefits under compensation continuation plans to conduct a vigorous defensefollowing the termination of this action.

     On August 15, 2001,employment. 
Two of these cases arose from the Company was served with a summons and four-count
complaint filed in Superior Court forcircumstances surrounding the City and County of San Francisco,
California, entitled TeichmanRestatement: 
Charles Blue v. Hanover Direct, Inc., Hanover Brands, Inc.William Wachtel, Stuart Feldman, Wayne Garten and Robert Masson, Hanover Direct Virginia, Inc.(Supp. Ct. N.J., and Does 1-100.Law Div. Hudson Cty, Docket No.: L-5153-05) is an action instituted by the Company’s former Chief Financial Officer who was terminated for cause on March 8, 2005.  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
                                        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 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

                                        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 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. 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 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.attorney’s fees and alleges retaliation, mental anguish and reputational damage, loss of earnings and employment and racial discrimination.  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

                                        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 evidencebelieves 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 DirectorsBlue was properly terminated for cause and that his wife's leaseclaims are groundless. 
Frank Lengers v. Hanover Direct, Inc., Wayne Garten, William Wachtel, A. David Brown, Stuart Feldman, Paul S. Goodman,  Donald Hecht and related expenseRobert Masson, (Supp. Ct. N.J., Law Div. Hudson Cty, Docket No.: L-5795-05) 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, findingbrought as
a matter of law that Mr. Kaul is not entitled to fees incurred in prosecuting
this lawsuit but finding an issue of fact as to the amount of reasonable fees he
may have incurred in seeking advice and representation in connection with the
termination of his employment; granted summary judgment in favor of the Company
dismissing Mr. Kaul's claims related to change in control benefits on the
grounds that Mr. Kaul's participation in the plan was properly terminated when
his employment was terminated, the plan was properly terminated, and the
administrator and appeals committee properly denied Mr. Kaul's claim; granted
summary judgment in favor of the Company dismissing Mr. Kaul's claim for a
tandem bonus payment on the ground that payment is not owed to him; granted
summary judgment in part and denied 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 outcomeCompany terminating the employment 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 expensesformer Vice President, Treasury Operations & Risk Management, 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 claimMarch 8, 2005 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.cause.  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 soughtseeks compensatory damages in an amount, which was estimated to be not more than
$400,000, and punitive damages in the amountand attorney’s fees and alleges improper denial of $10 million; applicable
interest, incidentalCIC benefits, age and 21


consequential damages, plus costsdisability discrimination, handicap discrimination, aiding and disbursements, the expensesabetting and breach 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.contract.  The Company filed an answer to the
complaint on September 7, 1994. Discovery then commencedbelieves that Mr. Lengers was properly terminated for cause 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. his claims are groundless.
The Company filed papers in oppositionbelieves that it properly denied CIC benefits with respect 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
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 issuefour former employees

and that it has meritorious defenses 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 Nevadacases and Arizona cases in order to determineplans 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. 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 countries. See Note 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.

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

ITEMoperations, or cash flows.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

     Submission of Matters to a Vote of Security Holders
None.

                                        23
PART II

ITEM
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

     Market for Registrant’s Common Equity and Related Stockholder Matters
The Company's Common Stock trades onwas delisted from the AmericanAMEX effective February 16, 2005 as a result of the Company’s inability to timely file its periodic SEC reports and its failure to comply with the AMEX’s continued listing standards. Current trading information about our Common Stock Exchangecan be obtained from the Pink Sheets under the trading symbol "HNV." “HNVD.PK.”
The following table sets forth, for the periods shown, the high and low sale prices of the Company'sour Common Stock as reported on(as adjusted for the American
Stock Exchange Composite Tape.reverse stock split). As of March 16, 2004, the CompanyFebruary 21, 2006, we had 220,173,63322,426,296 shares of Common Stock outstanding (net of treasury shares).outstanding. Of these, 111,465,62115,380,413 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.its affiliates. As a result, 69,924,1837,045,883 shares of Common Stock were held by other public shareholders. There were approximately 3,635540 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
Stock as of January 24, 2006.
 
High 
Low 
Fiscal 2004
First Quarter (Dec. 28, 2003 to March 27, 2004)
$   3.00
$   2.00
Second Quarter (March 28, 2004 to June 26, 2004)
$   2.50
$   1.30
Third Quarter (June 27, 2004 to Sept. 25, 2004)
$   1.80
$   1.20
Fourth Quarter (Sept. 26, 2004 to Dec. 25, 2004)
$   1.59
$   1.26
 
 
 
Fiscal 2003
First Quarter (Dec. 29, 2002 to March 29, 2003)
$   2.70
$   1.90
Second Quarter (March 30, 2003 to June 28, 2003)
$   2.80
$   1.80
Third Quarter (June 29, 2003 to Sept. 27, 2003)
$   2.90
$   2.20
Fourth Quarter (Sept. 28, 2003 to Dec. 27, 2003)
$   3.00
$   2.00
The Company is restricted from paying dividends on its Common Stock or from acquiring its capital stockCommon Stock by certain debt covenants contained in the loan agreements for the Wachovia Facility and the Chelsey Facility. See Note 7 to the Notes to the consolidated financial statements for additional information regarding the certain debt covenants and loan agreements.
Reverse Stock Split. At our 2004 Annual Meeting of Shareholders held on August 12, 2004, our shareholders approved a one-for-ten reverse stock split of the Common Stock, which became effective at the Company is a party.

     Recent Salesclose of Unregistered Securities.  On November 30, 2003,business on September 22, 2004. In this Annual Report on Form 10-K, the Company
consummated a transaction with Chelsey in which the Company exchanged 564,819number of shares of a newly issued Series C Participating PreferredCommon Stock outstanding, per share amounts, stock warrants, stock option and 81,857,833
shares of newly issuedexercise price data relating to the Company’s Common Stock, for 1,622,111periods prior to the reverse stock split, have been restated to reflect the effect of the reverse stock split.
Amendments to the Company’s Certificate of Incorporation. On September 22, 2004, we filed a Certificate of Amendment to the Company’s Amended and Restated Certificate of Incorporation (1) reducing the par value of the Common Stock from $0.66-2/3 to $0.01 per share and reclassifying the outstanding shares of Series B
ParticipatingCommon Stock into such lower par value shares; (2) increasing the number of authorized shares of additional Preferred Stock then held by Chelsey. The transaction involved no
cash consideration. The Company relied uponfrom 5,000,000 shares to 15,000,000 shares and making a corresponding change to the exemption from registrationaggregate number of authorized shares of all classes of preferred stock; and (3) after giving effect to the Series C Participating Preferred Stock andreverse stock split, increasing the additionalauthorized number of shares of Common Stock provided by Rule 506from 30,000,000 shares to 50,000,000 shares and making a corresponding change to the aggregate number of Regulation D promulgatedauthorized shares of all classes of common stock.

Equity Compensation Plan Information Table
The following table provides information about the securities authorized for issuance under the Securities ActCompany’s equity compensation plans as 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


ITEMDecember 25, 2004:
 
(a)
 
(b)
 
(c)
 
 
 
 
 
 
 
 
Plan category
 
Number of
securities to be
issued upon
exercise of
outstanding options,
warrants and rights
 
 
 
 
Weighted-average
exercise price of
outstanding options,
warrants and rights
 
Number of securities
remaining available for
future issuance under equity compensation plans (excluding securities reflected
in column(a))
 
 
 
Equity compensation plans approved by security holders
1,048,883
 
$   6.23
 
1,871,117
Equity compensation plans not approved by security holders
270,000
 
2.50
 
270,000
 
 
 
Total
1,318,883
 
$   5.47
 
2,141,117
 
 
 
Item 6. SELECTED FINANCIAL DATA

     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
 
 
2004
 
2003
 
2002
 
2001
 
2000
 
 
 
 
As Restated
 
As Restated
 
As Restated
 
As Restated
 
 
 
 
 
 
 
 
(In thousands of dollars, except per share data )
Income Statement Data:
 
 
 
 
 
 
 
 
 
 
Net revenues
 
$    403,160
 
$   414,283
 
$    456,990
 
$       533,630
 
$    606,430
Special charges
 
1,536
 
1,308
 
4,398
 
11,277
 
19,126
Income (loss) from operations
 
10,742
 
1,445
 
(2,211)
 
(24,926)
 
(69,686)
Gain on sale of Improvements
 
--
 
(1,911)
 
(570)
 
(23,240)
 
--
Gain on sale of Kindig Lane Property
 
--
 
--
 
--
 
(1,529)
 
--
Income (loss) before interest and income taxes
 
10,742
 
3,356
 
(1,641)
 
(157)
 
(69,686)
Interest expense, net
 
5,567
 
12,088
 
5,477
 
6,529
 
10,083
Provision for income taxes
 
174
 
11,328
 
3,791
 
120
 
165
Net income (loss)
 
5,001
 
(20,060)
 
(10,909)
 
(6,806)
 
(79,934)
Preferred stock dividends and accretion
 
--
 
7,922
 
15,556
 
10,745
 
4,015
Net income (loss) applicable to common stockholders
 
$         4,877
 
$     (27,982)
 
$      (26,465)
 
$      (17,551)
 
$   (83,949)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net Income (Loss) Per Common Share:
 
 
 
 
 
 
 
 
 
 
Basic
 
$           0.22
 
$         (1.94)
 
$          (1.91)
 
$           (0.83)
 
$        (3.94)
 
 
 
 
 
 
Diluted
 
$           0.18
 
$         (1.94)
 
$          (1.91)
 
$           (0.83)
 
$        (3.94)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Weighted Average Number of Shares
 
 
 
 
 
 
 
 
 
 
Outstanding (in thousands):
 
 
 
 
 
 
 
 
 
 
Basic
 
22,220
 
14,439
 
13,828
 
21,054
 
21,325
 
 
 
 
 
 
Diluted
 
27,015
 
14,439
 
13,828
 
21,054
 
21,325
 
 
 
 
 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
2004
 
2003
 
2002
 
2001
 
2000
 
 
 
 
As Restated
 
As Restated
 
As Restated
 
As Restated
 
 
 
 
 
 
 
 
(In thousands of dollars)
Balance Sheet Data (End of Period):
 
 
 
 
 
 
 
 
 
 
Working capital (deficit)
 
$ 10,622
 
$ (10,399)
 
$ (6,200)
 
$ 658
 
$ (5,138)
Total assets
 
130,499
 
116,547
 
145,274
 
161,032
 
208,379
Total debt, excluding Preferred Stock
 
27,886
 
22,510
 
25,129
 
29,710
 
39,036
Series A Participating Preferred Stock
 
--
 
--
 
--
 
--
 
71,628
Series B Participating Preferred Stock
 
--
 
--
 
92,379
 
76,823
 
--
Series C Participating Preferred Stock
 
72,689
 
72,689
 
--
 
--
 
--
Shareholders’ deficiency
 
(37,652)
 
(56,339)
 
(63,011)
 
(38,119)
 
(25,882)
There were no cash dividends declared on the Common Stock in any of the periods presented. See Note 182 of Notes to Consolidated Financial Statementsconsolidated financial statements for more information regarding prior year restatements.

                See notes tothe Restatement.
Item 7. Management’s Discussion and Analysis of Consolidated Financial Statements.
                                        25


ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL
         CONDITION AND RESULTS OF OPERATIONS

     Condition and Results of Operations
The following table sets forth, for the fiscal years indicated, the percentage relationship to net revenues of certain items in the Company'sCompany’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
 
Fiscal Year
 
 
2004
 
 
2003
As Restated
 
2002
As Restated
 
 
 
Net revenues
100.0%
 
100.0%
 
100.0%
Cost of sales and operating expenses
60.3
 
63.1
 
63.5
Special charges
0.4
 
0.3
 
1.0
Selling expenses
24.9
 
24.1
 
23.1
General and administrative expenses
10.7
 
11.0
 
11.7
Depreciation and amortization
1.0
 
1.1
 
1.2
Gain on sale of Improvements
—
 
(0.4)
 
(0.1)
Income (loss) before interest and income taxes
2.7
 
0.8
 
(0.4)
Interest expense, net
1.4
 
2.9
 
1.2
Provision for Federal and state income taxes
0.0
 
2.7
 
0.8
Net income (loss)
1.2%
 
(4.8)%
 
(2.4)%
Restatement of Prior Year Financial Information and Related Matters
During the second quarter of 2004, the Company Overview.  The Company isidentified a specialty direct marketerrevenue recognition cut-off issue that markets
a diverse portfolioresulted in revenue being recorded in advance of branded home fashions, men's and women's apparel, and
gift products, through mail-order catalogs, retail stores and connected Internet
Web sites directlythe actual shipment of merchandise to the consumer.customer. The practice was stopped immediately. Subsequently, the Company recognizesdetermined that revenue should be recognized when merchandise is received by the customer rather than when shipped because the Company routinely replaces customer merchandise damaged or lost in transit as a customer service matter (even though risk of loss, as a legal matter, passes on shipment). As a consequence, the Company has restated all periods presented to recognize revenue when merchandise is received by the customer.
In the first quarter of 2004, former management identified a potential issue with the accounting treatment for catalogBuyers’ Club memberships that contained a guarantee. At that time, an inappropriate conclusion regarding the accounting treatment was reached and Internet sales upon shipmentduring the third quarter of 2004, the issue was re-evaluated and we determined that an error in the accounting treatment had occurred. The impact of the merchandiseerror resulted in an overstatement of revenues and the omission of a liability related to customersthe guarantee for discount obligations. The proper accounting treatment has been applied to all periods impacted including a calculation of the cumulative impact on previously reported periods.

Starting in fiscal 2001, the Company inappropriately reduced the liability for certain customer prepayments and atcredits. The impact of the timeinappropriate reduction of sale for retail sales, netthis liability resulted in the understatement of estimated returns. Postagegeneral and handling charges
billed to customers are also recognized as revenue upon shipmentadministrative expenses and the omission of the related merchandise. Shipping termsliability. During the fourth quarter of 2004, the Company re-evaluated the accounting treatment for catalogthese customer prepayments and Internet sales are FOB shipping
point, and title passescredits. As a consequence, the Company has applied the proper accounting treatment to all periods impacted including recording a liability in each respective previously reported period equivalent to the customer atcumulative impact of the time and place of shipment.
Priceserror.
The Company also corrected its accounting for all merchandise are listed in the Company's catalogs and on its Web
sites and are confirmed with the customer upon order. an accrual related to a claim for post-employment benefits by a former CEO. See “Legal Proceedings—Rakesh Kaul v. Hanover Direct, Inc.”
In addition, the Company continueshas recorded other liabilities relating primarily to certain miscellaneous catalog costs and other miscellaneous costs that were inappropriately not accrued in the necessary periods and has made adjustments to the deferred tax asset and liabilities to reflect the effect the Restatement.
The Audit Committee of the Board of Directors conducted an investigation related to these issues (except for the revenue recognition issue based on receipt of merchandise by the customer which was addressed by the Company subsequent to the conclusion of the investigation) and other accounting-related matters with the assistance of independent outside counsel. The Company’s inability to timely file its financial statements as well as its non-compliance with several of the AMEX’s listing criteria resulted in the AMEX halting trading in the Company’s common stock on November 16, 2004 and later delisting the common stock as of February 16, 2005. See Item 9A. “Controls and Procedures” for management’s evaluation and conclusions relating to this investigation. In addition, the SEC is currently conducting an informal inquiry relating to the Company’s financial results and financial reporting since 1998. We intend to continue our cooperation with the SEC with its informal inquiry concerning our financial reporting.
See Note 2 to the consolidated financial statements for additional information regarding the Restatement.
Executive Summary
Hanover Direct is a direct marketer owning a portfolio of catalogs and associated websites. During the first six months of 2004, the Company operated in a very challenging environment due to our liquidity constraints. The inability to maintain levels of inventory adequate to service existing third party clients with business-to-business
(B-to-B) e-commerce transaction services. These services includedemand created increased backorder levels, reduced initial customer order fill rates as well as higher order cancellation rates all of which contributed to lower net revenues. On May 5, 2004, the Board of Directors appointed a full rangenew chief executive officer (“CEO”), Wayne P. Garten, who quickly obtained the Chelsey Facility, a $20.0 million junior secured credit facility. The Company borrowed the entire $20.0 million and paid off the remaining outstanding balance ($4.9 million) of order processing, customer care, customer information, and shipping and
distribution services. Revenues froma term loan, which was part of the Company's e-commerce transaction
services are recognized as the related services are provided. Customers are
charged on an activity unit basis, which appliesWachovia Facility. As part of a contractually specified rate
accordingconcurrent amendment 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 ofWachovia Facility, the Chelsey transactionFacility freed up $10.0 million of availability under the Wachovia Facility that had previously been blocked. The increased liquidity enabled us to increase inventory to more adequate levels for the second half of 2004, which resulted in substantial declines in backorder levels and higher initial customer order fill rates, reversing the trend experienced during the first six months of 2004. The improved inventory levels increased the Company’s borrowing availability under the Wachovia Facility and alleviated constraints on November 30, 2003, which replacedvendor credit previously experienced. In addition, 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"),
requiredincreased working capital allowed the Company to reclassify its Series B Participating Preferred Stockinvest in catalog circulation in order to strengthen the customer name file base for the future as well as producing strong fourth quarter revenues of $121.6 million, which were an increase of $6.9 million, or 6.0%, over the comparable prior year period. Income from operations increased $9.3 million to $10.7 million for the year ended December 25, 2004 from $1.4 million in 2003. Although a liabilitysignificant improvement, certain items incurred during 2004 hindered income from operations from achieving a greater increase over 2003 and reflect2002. A summary of these expense / (income) items incurred during 2004, 2003 and 2002 are as follows (in thousands):
 
 
 
2004
 
 
2003
 
 
2002
Severance and Termination Costs
 
$
2,607
 
$
725
 
$
356
Special Charges
 
 
1,536
 
 
1,308
 
 
4,398
Class Action Litigation Reserve
 
 
535
 
 
--
 
 
--
Facility Exit Costs
 
 
201
 
 
--
 
 
--
Rakesh Kaul Accrual
 
 
196
 
 
24
 
 
3,648

Compensation Continuation Agreement Costs
 
 
--
 
 
3,083
 
 
--
Change in Vacation and Sick Policy
 
 
--
 
 
(1,634)
 
 
--
 
 
 
 
 
 
 
 
 
$
5,075
 
$
3,506
 
$
8,402
 
 
 
 
 
 
 
We also began developing and implementing strategies to reduce the accretioninfrastructure of the preferred stock balance as interest
expense. FromCompany. These strategies included the periodconsolidation of the operations of the LaCrosse, Wisconsin fulfillment center and storage facility into the Roanoke, Virginia fulfillment center, which was substantially completed by the end of June 29,2005; the relocation of the International Male and Undergear catalog operations from San Diego, California to the corporate headquarters in Weehawken, New Jersey, which was completed February 28, 2005; and the consolidation of the Edgewater facility into the Weehawken, New Jersey premises, which was completed by May 31, 2005. Since the consolidation of our fulfillment centers, our Roanoke fulfillment center has experienced lower productivity that has negatively impacted fulfillment costs and the Company’s overall performance. The projected annual savings from the consolidation of the San Diego, California and the Edgewater, New Jersey facilities into the Weehawken, New Jersey facility is approximately $2.1 million, however with this relocation and consolidation, the transition has negatively impacted the performance of the Men’s Apparelcatalogs in 2005.

Results of Operations
2004 Compared with 2003 through
Net Income (Loss). The Company reported net income applicable to common shareholders of $4.9 million, or $0.22 basic and $0.18 diluted income per share, for the Recapitalization on November
30, 2003,year ended December 25, 2004 compared with a net loss applicable to common shareholders of $28.0 million, or a loss of $1.94 basic and diluted income per share, in fiscal 2003.
In addition to improved operating results, the Company recorded $7.2 millionincrease in net income applicable to common shareholders was the result of additional interest expense
incurredthe following:
•
A favorable impact of $11.3 million due to a deferred Federal income tax provision recorded during the year ended December 27, 2003 to increase the valuation allowance and fully reserve the net deferred tax asset;
•
A favorable impact of $7.9 million on preferred stock dividends due to the June 2003 implementation of SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” (“SFAS 150”). The accretion of the Series B Participating Preferred Stock (“Series B Preferred”) was recorded as dividends through the June 2003 implementation of SFAS 150, and as interest expense thereafter;
•
A favorable impact of $6.5 million on net interest expense as the Series C Participating Preferred Stock (“Series C Preferred”) was recorded as of its November 30, 2003 issuance date at its maximum potential cash payments in accordance with SFAS No. 15, “Accounting by Debtors and Creditors for Troubled Debt Restructurings;” thus, we are currently not required to record accretion of the Series C Preferred. In 2003, the Series B Preferred dividends and accretion were recorded as interest expense after the implementation of SFAS 150; and
•
A favorable impact of $3.1 million due to Compensation Continuation Agreement costs incurred during the year ended December 27, 2003. These costs included payments made to various executives and non-employee directors of the Company.
Partially offset by:
•
An unfavorable impact due to the establishment of a $0.5 million reserve for risks of litigation related to all class action lawsuits including the Company’s current estimate of future legal fees to be incurred;
•
An unfavorable impact of $2.1 million due to severance, termination and facility exit costs associated with the implementation of strategies to reduce the Company’s infrastructure;
•
An unfavorable impact of $1.9 million due to the recognition of the deferred gain related to the 2001 sale of our Improvements business during the year ended December 27, 2003;
•
An unfavorable impact of $1.6 million due to a benefit recognized during 2003 from the revision of our vacation and sick policy; and
•
An unfavorable impact of $0.2 million of special charges due to facility exit costs associated with the consolidation of the LaCrosse and Roanoke operations.
Net Revenues. Net revenues decreased by approximately $11.1 million (2.7%) for the year ended December 25, 2004 to $403.2 million from $414.3 million in 2003. The decrease was primarily due to a 15.6% decline in Domestications revenue on a 19.2% reduction in circulation. During 2004, management purposely reduced circulation in Domestications during the first six months due to liquidity restraints and during the final six months due to the newly appointed President of Domestications assembling a team to stabilize and reposition the catalog. The impact of the decline in circulation and demand from Domestications was partially offset by increases in circulation for Silhouettes and The Company Store resulting in an increase in net revenues for these catalogs. Certain catalogs benefited from increased fill rates and reductions in backorders and lower order cancellations due to the additional capital secured through the Chelsey Facility and the amended Wachovia Facility. In addition, revenue relating to our membership programs increased by approximately $1.0 million for the year ended December 25, 2004 to $10.3 million from $9.3 million in 2003. Internet sales revenue comprised 32.0% of combined Internet and catalog net revenues for the year ended December 25, 2004 compared with 27.9% in 2003, and have increased by

approximately $11.6 million, or 10.8%, to $118.7 million for the year ended December 25, 2004 from $107.1 million in 2003.
Cost of Sales and Operating Expenses. Cost of sales and operating expenses decreased by $18.1 million to $243.2 million for the year ended December 25, 2004 as compared with $261.3 million in 2003. Cost of sales and operating expenses decreased to 60.3% of net revenues for the year ended December 25, 2004 as compared with 63.1% of net revenues in 2003. As a percentage of net revenues, this decrease was primarily due to a decline in merchandise costs associated with a shift from domestic to foreign-sourced goods (1.3%). The balance of the decline was attributable to a combination of factors including a decline in inventory write-downs due to reduced slow moving inventory and increased sales of clearance merchandise through the Internet resulting in lower variable costs as compared with utilizing catalogs as the clearance avenue and other cost reductions.
Special Charges. In December 2000, the Company began a strategic business realignment program that resulted in the recording of special charges for severance, facility exit costs and fixed asset write-offs. The actions related to this strategic business realignment program were taken in an effort to direct our resources primarily towards a loss reduction strategy and a return to profitability. On June 30, 2004, we decided to consolidate the operations of the LaCrosse, Wisconsin fulfillment center and storage facility into the Roanoke Virginia fulfillment center by June 30, 2005. The LaCrosse fulfillment center and the LaCrosse storage facility were closed in June 2005 and August 2005 upon the expiration of their leases. This plan was prompted by excess capacity at our Roanoke facility and the lack of sufficient warehouse space in the leased Wisconsin facilities to support the growth of The Company Store and to reduce the overall cost structure of the Company. In addition, on November 9, 2004, we decided to relocate the International Male and Undergear catalog operations to our Corporate offices in New Jersey. The relocation was effected to consolidate operations and reduce costs while leveraging our catalog expertise in New Jersey. The relocation was completed on February 28, 2005. However, since the relocation and consolidation of the Men’s apparel catalogs, the transition has negatively impacted the performance of the Men’s apparel catalogs in 2005.
Total special charges increased by approximately $0.2 million to $1.5 million for the year ended December 25, 2004 as compared with $1.3 million in 2003. During the year ended December 25, 2004, the Company recorded $0.5 million and $0.9 million in severance and related costs associated with the consolidation of the LaCrosse operations and the relocation of the International Male and Undergear catalog operations to New Jersey, respectively. In addition, we recorded an additional $0.3 million in severance and related costs during the fourth quarter of 2004 associated with the elimination of 15 full-time company-wide positions. These costs were partially offset by $0.1 million of reductions in the special charges reserve primarily due to decreases in estimated losses on the sublease arrangements for the Gump’s office facility in San Francisco, California. During the year ended December 27, 2003, we recorded $1.3 million of additional severance costs and charges incurred to revise estimated losses related to the sublease arrangements for the Gump’s office facility in San Francisco. The increase in anticipated losses on the sublease arrangements for the San Francisco office space resulted from the loss of a subtenant, coupled with declining real estate values in that area of the country.
Selling Expenses. Selling expenses increased by $0.5 million to $100.5 million for the year ended December 25, 2004 as compared with $100.0 million in 2003. Selling expenses increased to 24.9% of net revenues for the year ended December 25, 2004 from 24.1% in 2003. As a percentage of net revenues, this change was due primarily to an increase in Internet marketing and catalog paper costs, partially offset by reduced circulation during 2004.
General and Administrative Expenses. General and administrative expenses decreased approximately $2.3 million to $43.2 million for the year ended December 25, 2004 from $45.5 million in 2003. As a percentage of net revenues, general and administrative expenses decreased to 10.7% of net revenues for the year ended December 25, 2004 compared with 11.0% of net revenues in 2003. This decrease of $2.3 million was due primarily to the net
impact of certain items during 2004 and 2003, the largest of which was the higher payments for compensation continuation agreements in 2003 offset by items such as the establishment of a reserve of $0.5 million related to class action lawsuits in 2004. See “Executive Summary.”
Depreciation and Amortization. Depreciation and amortization decreased approximately $0.7 million to $4.0 million for the year ended December 25, 2004 from $4.7 million in 2003. The decrease was primarily due to property and equipment that have become fully depreciated, partially offset by the depreciation of newly purchased property and equipment.

Income from Operations. The Company’s income from operations increased by $9.3 million to $10.7 million for the year ended December 25, 2004 from income from operations of $1.4 million in 2003.
Gain on Sale of the Improvements Business. During the year ended December 27, 2003, the Company recognized the remaining deferred gain of $1.9 million consistent with the terms of the March 27, 2003 amendment made to the asset purchase agreement relating to the sale of the Improvements business. Effective March 28, 2003, the remaining $2.0 million escrow balance was received by the Company, thus terminating the escrow agreement. See Note 4 of Notes to the consolidated financial statements.
Interest Expense, Net. Interest expense, net, decreased $6.5 million to $5.6 million for the year ended December 25, 2004 from $12.1 million in 2003. The decrease in interest expense, net was due to the recording of $7.6 million of Series B Preferred dividends and accretion as interest expense for the year ended December 27, 2003 based upon the treatment of the Series B Preferred as a liability as a result of the implementation of SFAS 150. Due150 and lower average cumulative borrowings relating to concessions made by Chelsey and the resulting
application ofWachovia Facility. In November 2003, we exchanged the Series B Preferred for the Series C Preferred, which was accounted for in accordance with SFAS No. 15, “Accounting by Debtors and Creditors for Troubled Debt Restructurings.” Accordingly, the Series C Preferred was recorded at its total maximum potential cash payments including dividends and other contingent amounts, and thus no dividends or interest expense will no longer prospectively be
impactedon this stock has been recorded for the year ended December 25, 2004. In addition, the decrease was due to lower amortization of deferred costs as a result of the amendments to the Wachovia Facility, which have lengthened the life of the facility and therefore the amortization period. These decreases were partially offset by increases in interest expense and amortization of deferred issuance costs relating to the Chelsey Facility. See Note 7 of Notes to the consolidated financial statements.
Income Taxes. The Company’s income tax provision decreased by approximately $11.1 million to $0.2 million for the year ended December 25, 2004 as compared with $11.3 million in 2003. The Company had sufficient net operating loss carryovers (“NOLs”) and its taxable income was below its §382 limit to eliminate its entire 2004 regular Federal income tax. The 2004 Federal income tax provision of $0.1 million is comprised of the Federal alternative minimum tax (“AMT”). The Company has AMT net operating loss carryovers for which utilization is limited to a maximum of 90% of AMT taxable income. See Note 12 of Notes to the consolidated financial statements for further discussion of the Company’s income taxes. In addition, during the third quarter of 2003, due to a number of factors, management lowered its projections of taxable income for 2003 and 2004, which resulted in a decision to fully reserve the remaining net deferred tax asset and accordingly increased the valuation allowance by $11.3 million.
Preferred Stock Dividends. Through the end of the second quarter of 2003, the Company recorded preferred stock dividends relating to the Series B Participating Preferred Stock orPreferred. Upon the implementation of SFAS 150 beginning in the third quarter of 2003, we were required to begin recording the preferred stock dividends as interest expense. Additionally, the Series C Participating
Preferred Stock.

     The Company continues to refine and implementwas recorded at 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 reductionmaximum amount of the overhead cost structure. The costs eliminated by these actions total $0.9liquidation preference of $72.7 million, annually. General and administrative expenses continued to decline in
fiscal 2003 fromthus no preferred stock dividends were recorded. Therefore, during 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%25, 2004, no preferred stock dividends were recorded. See Note 8 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
customerNotes to the Internet Web siteconsolidated financial statements for non-recipientsan explanation regarding the Company’s accounting treatment 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.

     DuringSeries C Preferred.
2003 Compared with 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.Loss. The Company reported a net loss applicable to common shareholders of $15.4$28.0 million, or $.16$1.94 basic and diluted income per share, for the year ended December 27, 2003 compared with a net loss applicable to common shareholders of $9.1$26.5 million, or $.18$1.91 basic and diluted income per share, for the comparable period in the 2002 fiscal year. 2002.

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 applicable to common shareholders 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 reclassifyfollowing:
•
An increase of $7.6 million in the deferred Federal income tax provision incurred to increase the valuation allowance and fully reserve the remaining net deferred tax asset. Due to a number of factors, including the continued softness in the demand for our products, management lowered its projections of future taxable income for fiscal years 2003 and 2004. As a result of lower projections of future taxable income, the future utilization of our net operating losses were no longer “more-likely-than-not” to be achieved;
•
$7.6 million of additional interest expense incurred on the Series B Preferred as a result of the implementation of SFAS 150. Effective June 29, 2003, SFAS 150 required us to reclassify our Series B Participating Preferred Stock as a liability and reflect the accretion of the preferred stock balance as interest expense. However, this then reduced the preferred stock dividends by $7.6 million;
•
A favorable impact of $3.1 million due to the reduction of special charges recorded;
•
An unfavorable impact of $3.1 million due to Compensation Continuation Agreement costs incurred for the year ended December 27, 2003. These costs included payments made to various executives and non-employee directors of the Company;
•
A favorable impact of $3.6 million due to reduced legal expenses related to the ongoing litigation with Rakesh Kaul;
•
A favorable impact of $1.3 million due to recognition of the deferred gain related to the 2001 sale of the Company’s Improvements business; and
•
A favorable impact of $1.6 million due to the implementation of the revised vacation and sick benefit policy.
The increase in net loss applicable to common shareholders was partially offset by improved operating results of the 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.

     Company.
Net Revenues.Revenues. Net revenues decreased $42.8$42.7 million, or 9.4%9.3% for the year ended December 27, 2003 to $414.8$414.3 million from $457.6$457.0 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'sour products during the first six months of the year. In addition, the Company'sour 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.period. Internet sales have now reachedaccounted for 27.9% of combined Internet and catalog revenues for the Company's four categories and have improved by $21.2$20.8 million, or 24.2%, to $108.6$107.1 million from $87.4$86.3 million in 2002. Catalog sales have declined by $61.8$53.7 million, or 18.1%16.3%, for the year ended December 27, 2003 to $280.1$276.9 million from $341.9$330.6 million for the comparable
period in 2002.
Cost of Sales and Operating Expenses.Expenses. Cost of sales and operating expenses decreased to 63.0%63.1% of net revenues for the year ended December 27, 2003 as compared with 63.5% of net revenues for the comparable period in 2002. TheAs a percentage of net revenues, this decrease from the prior year was caused primarily by a reduction of total merchandise cost of 0.9% due to a more cost-efficient merchandise sourcing strategy and a
decrease of 0.1% in variable order processing costs. These declines werestrategy. This decline was partially offset by increased product shipping costs of 0.5% related to an increase in rates charged by third party shipping companies. Fixed distribution and telemarketing costs as a percentage of net revenues were constant between
the fiscal periodsduring 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 20012002 relating to the strategic business realignment program were $1.3 million $4.4 million and $11.3$4.4 million, respectively. The actions related to the strategic business realignment program were taken in an effort to direct the Company'sour 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'sour strategic business realignment program. During the second, third and fourth quarters of 2003, the Companywe recorded special charges of $0.2 million, $0.2 million and $0.6 million, respectively. These charges were incurred primarily to revise estimated losses related to sublease arrangements for the Gump’s office facilitiesfacility in San Francisco, California. Increased anticipated losses
on sublease arrangements forFor 2002, $4.4 million of special charges were recorded relating to the San Francisco office space resulted from the
lossstrategic business realignment program. These costs consisted of a subtenant, coupled with declining market valuesapproximately $1.8 million in that area of the
country.

                                        28
severance costs and $2.6 million in facility lease and exit costs.

Selling Expenses. Selling expenses decreased $5.7$5.5 million to $99.5$100.0 million for the year ended December 27, 2003 from $105.2$105.5 million for the comparable
fiscal period in 2002. As a percentage relationship to net revenues, sellingSelling expenses increased to 24.0%24.1% of net revenues for the year ended December 27, 2003 from 23.0%23.1% for the comparable period in 2002. This increase was due primarily to a combined increase of 1.2%1.1% in postage, catalog preparation and printing costs, which was partially offset by a 0.2%0.1% decline in paper prices.
General and Administrative Expenses.Expenses. General and administrative expenses decreased by $10.2$7.8 million to $45.5 million for the year ended December 27, 2003 over the prior
year.from $53.3 million in 2002. 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$3.0 million which had been incurred in the prior year and related to litigation pertaining to the Kaul and Schupak litigation,Company’s former Chief Executive Officer, benefits recognized from the implementation of the Company'sour new vacation and sick policy of $0.8 million, and other payroll and otherrelated cost reductions of $0.4
million.

     reductions.
Depreciation and Amortization.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.

     amortized, partially offset by the depreciation of newly purchased property and equipment.
Income from Operations. The Company'sCompany’s income from operations increased $6.5$3.6 million to $6.1$1.4 million for the year ended December 27, 2003 from a loss of $0.4$2.2 million for the comparable period in 2002. The increase iswas 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 24 to the Company's
Consolidated Financial Statements)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 iswas due to the recording of $7.2$7.6 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 Companyus to reclassify itsour 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, theThe increase in interest expense was also partially offset by a decrease in amortization of deferred financing costs relating to the Company'sour amendments to the Congress Credit Facility.

     Wachovia Facility, which lengthened the facility.
Income Taxes.Taxes. The Company’s income tax provision increased by approximately $7.5 million to $11.3 million for the year ended December 27, 2003 as compared with $3.8 million in 2002. During the 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 anby recording a $11.3 million deferred Federal income tax provision.provision as compared with a $3.7 million provision incurred in 2002. During the quarter ended September 27, 2003, management lowered its projections of future taxable income for fiscal years 2003 and 2004 due to a number of factors, including the continued softness in the demand for the
Company'sour products at that time and the impact of the May 19, 2003 change in control (see Note 1312 to the Company's Consolidated Financial Statements)Company’s consolidated financial statements). 2002 COMPARED WITH 2001

     Net Loss.  The Company reportedPartially offsetting this $7.6 million increase was a net loss of $9.1$0.1 million or $.18 per
sharedecrease in the provision for state income taxes 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 preferred27, 2003.
Preferred Stock Dividends. Preferred stock 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 mitigateddecreased 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 $6.4approximately $7.7 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

                                        30


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$7.9 million for the year ended December 28, 2002 from a loss27, 2003 as compared with $15.6 million in 2002. Through the end of $24.0 millionthe second quarter of 2003, the Company recorded Preferred stock dividends relating to the Series B Preferred, however, upon the implementation of SFAS 150 beginning in the third quarter of 2003, we were required to begin recording the preferred stock dividends as interest expense. Additionally, the Series C Preferred, which was exchanged on November 30, 2003 for the comparable period in 2001.

     Gain on SaleSeries B Preferred, was recorded at the maximum amount of the Improvements Business.  During fiscal 2002,liquidation preference of $72.7 million, thus no preferred stock dividends were recorded.

Liquidity and Capital Resources
Overview
By the Company
recognized approximately $0.6end of 2004, the Company’s liquidity significantly improved as compared with its position at the end of 2003. Our working capital at December 25, 2004 was $10.6 million, as compared with a working capital deficit of deferred gain consistent with$10.4 million at December 27, 2003. As a result of securing the $20.0 million Chelsey Facility on July 8, 2004 and concurrently amending the terms of the escrow agreement relatingWachovia Facility, our liquidity increased by approximately $25.0 million. The additional working capital has provided us the ability to restore inventory to more adequate levels in order to more effectively fulfill demand, reduce existing backorder levels, and increase initial customer order fill rates. In addition, the funding has eliminated substantially all vendor restrictions involving our credit arrangements. With lower than expected inventory levels in the fourth quarter of 2003 and the interruptions in the flow of merchandise, which prevented inventories from reaching adequate levels in the first half of 2004, we experienced a significant negative impact on revenues and cash flow in the first half of 2004. These lower inventory levels resulted in large part from tighter vendor credit and borrowing restrictions under our Wachovia Facility. This had a compounding effect on the business as a whole; lower levels of inventory reduced the amount of the financing available under the Wachovia Facility as well as the ability to meet customer demand, which resulted in a significant increase in our backorder position and cancellation of customer orders. During the second quarter of 2004, management determined that this inventory position was not sustainable for the long term, as we were experiencing a significant negative impact on second quarter net revenues due to the Improvements sale. The recognitiondecreased inventory levels. Management’s primary objective became the formulation and execution of additional gain of upa plan to approximately $2.0 million has been deferred untiladdress the contingencies described inliquidity issue facing the escrow agreement expire, which will occur no
later thanCompany. After reviewing available alternatives, the middleCompany entered into the Chelsey Facility and concurrently negotiated an amendment 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 reassessmentterms of the Company's ability to utilize certain net
operating losses prior to their expiration.

LIQUIDITY AND CAPITAL RESOURCES

     Wachovia Facility.
Net cash providedused by operating activities. For the year ended December 27,
2003,25, 2004, net cash providedused by operating activities was $8.1$17.3 million. Net losses,This was due primarily to increased inventory levels, payments to vendors to reduce accounts payable and increases in accounts receivable and prepaid catalog costs. These uses of cash were partially offset by $13.0 million of operating cash provided by net income, when adjusted for depreciation, amortization, special charges and other non-cash items, resulted
in $8.5 million of operatingnon 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.

     items.
Net cash providedused by investing activities. For the year ended December 27,
2003,25, 2004, net cash providedused by investing activities was $0.1$0.8 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 ofamount comprised capital

                                        31
 expenditures, consisting primarily of purchases and upgrades to various information technology hardware and software throughout the Company's distributionCompany and fulfillmentpurchases of equipment located at itsfor the Company’s Lacrosse, Wisconsin and 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 netlocations.
Net cash provided by investing activities.

     Net cash used by financing activities. For the year ended December 27,
2003,25, 2004, net cash usedprovided by financing activities was $6.7 million. Payments$16.3 million, which was primarily due to reduce
both Congressthe receipt of $20.0 million from the Chelsey Facility and a $0.3 million refund relating to withholding taxes remitted on behalf of Richemont Finance S.A. for estimated taxes due related to the Series B Preferred. These receipts were partially offset by net payments of $2.1 million under the Wachovia Facility, debt issuance costs of $1.2 million relating to the Chelsey Facility transaction and the amendment of the Wachovia Facility, and payments of $0.7 million for obligations under capital leases.
Financing Activities
Wachovia Facility. Wachovia and the Company are parties to a Loan and Security Agreement dated November 14, 1995 (as amended by the First through Thirty-Fourth Amendments, the “Wachovia Loan Agreement”) pursuant to which Wachovia provided the Company with the Wachovia Facility which has included, since inception, one or more term loans and a revolving credit facility (“Revolver”). The Wachovia Facility expires on July 8, 2007.
Prior to obtaining the Chelsey Facility, there were two term loans outstanding, Tranche A and Tranche B, Term Loan facilities were $3.8 million.under the Wachovia Facility. The Tranche B term loan had a principal balance of approximately $4.9 million and bore interest at 13% when the Company also paid $0.9used a portion of the proceeds of the Chelsey Facility to repay this loan on July 8, 2004. The Tranche A term loan had a principal balance of approximately $5.0 million in feesas of December 25, 2004, of which approximately $2.0 million was classified as short term and approximately $3.0 million was classified as long term on the Consolidated Balance Sheet. The Tranche A term loan bears interest at 0.5% over the Wachovia prime rate and requires monthly principal payments of approximately $166,000.

The Revolver has a maximum loan limit of $34.5 million, subject to amendinventory and accounts receivable sublimits that limit the Congress Credit Facility
(see Note 5credit available to the Company's Consolidated Financial Statements) and $1.3 million
in fees to enter intoCompany’s subsidiaries, that are borrowers under 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
PreferenceRevolver. The interest rate on the Series B Participating Preferred Stock (see Note 7Revolver is currently 0.5% over the Wachovia prime rate. As of December 25, 2004, the Company's Consolidated Financial Statements). In addition,interest rate on 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. Revolver was 5.5%.
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
CreditWachovia Facility is secured by substantially all of the assets of the Company and places restrictions oncontains certain restrictive covenants, including a restriction against the incurrence of additional indebtedness and on the payment of common stockCommon Stock dividends. AsIn addition, all of December 27, 2003, the revolvingreal estate owned by the Company is subject to a mortgage in favor of Wachovia and a second mortgage in favor of Chelsey Finance. The Wachovia Loan Agreement contains affirmative and negative covenants typical for loan facilityagreements for asset-based lending of $9.0 millionthis type including financial covenants requiring the Company to maintain specified levels of Consolidated Net Worth, Consolidated Working Capital and EBITDA, as those terms are defined in the Wachovia Loan Agreement.
Due to, among other things, the restatements which resulted in the Company violating several financial covenants and the Company’s inability to timely file its periodic reports with the SEC, the Company was recognized as a current liability onin technical default under the Company's Consolidated Balance
Sheet. Wachovia and Chelsey Facilities. The Company has obtained waivers from both Wachovia and Chelsey Finance for such defaults.
2004 Amendments to Wachovia Loan Agreement. On or before April 30,March 25, 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 CompanyWachovia amended the Congress Credit FacilityWachovia Loan Agreement to amendadjust 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 definitionlevels 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 feesConsolidated Working Capital as defined in the amount of $165,000.

     In October 2003,agreement, that the Company amended the Congress Credit Facility to extend
the expiration thereof frommust maintain during each month commencing 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, toand amend the EBITDA covenant to specify minimum levels of EBITDA that the Company must be
achievedachieve on a quarterly basis 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“Event of Default"Default” was amended by replacing thechanging an Event of Default which would have occurred onfrom the occurrence of a material adverse change in the business, assets, liabilities or condition of the Company and its subsidiaries with an Eventto the occurrence of Default which would occur if certain specific events such as a decrease in consolidated net revenues beyond certain specified levels or aging of inventory or accounts payable beyond certain specified levels, werelevels.
Concurrent with the closing of the Chelsey Facility on July 8, 2004, the Company and Wachovia amended the Wachovia Loan Agreement in several respects including: (1) releasing certain existing availability reserves and removing the excess loan availability covenant, which increased the Company’s availability by approximately $10.0 million, (2) reducing the amount of the maximum credit, the revolving loan limit and the inventory and accounts sublimits of the borrowers, and (3) permitting Chelsey Finance to occur.

     have a junior secured lien on the Company’s assets. In addition, Wachovia consented to (a) the Company’s issuance to Chelsey Finance of the Common Stock Warrant and the Common Stock as described below, (b) the proposed reverse stock split of the Common Stock and the Company making cash payments to repurchase fractional shares, (c) certain amendments to the Company’s Certificate of Incorporation, and (d) the issuance by the Company of Common Stock to Chelsey as payment of a waiver fee. The Company paid Wachovia a $400,000 fee in connection with this amendment. This fee was recorded as a deferred charge on the Company’s Consolidated Balance Sheets and is being amortized over the three-year term of the amended Wachovia Facility.
2005 Amendments to Wachovia Loan Agreement. On March 14, 2005, Wachovia consented to the sale of Gump’s and Gump’s By Mail. On March 11, 2005 the Wachovia Loan Agreement was amended to temporarily increase the amount of letters of credit that the Company could issue from $10.0 million to $13.0 million through June 30, 2005. The Company paid Wachovia a $25,000 fee in connection with this amendment.
Effective July 29, 2005 the Company and Wachovia amended the Wachovia Loan Agreement (“Thirty-Fourth Amendment”) to provide the terms under which the Company could enter into the World Financial Network National Bank (“WFNNB”) Credit Card Agreement which, among other things, prohibits the use of the proceeds of the Wachovia Facility to repurchase private label and co-brand accounts created under the WFNNB Credit Card Agreement should the Company become obligated to do so, prohibits the Company from terminating the WFNNB Credit Card Agreement without Wachovia’s consent and restricts the Company from borrowing on receivables generated under the WFNNB Credit Card Agreement. The amendment also waives enumerated defaults, resets the financial covenants, reallocates the availability that was previously allocated to Gump’s among other Company subsidiaries and, retroactive to June 30, 2005, increases the amount of letter of credits that the Company can issue to $15.0 million. The Company paid Wachovia a $60,000 fee in connection with this amendment.
On July 29, 2005 the Company and Chelsey Finance entered into a similar amendment of the Chelsey Facility.

Based on the provisions of EITF 95-22, “Balance Sheet Classification of Borrowings Outstanding under Revolving Credit Agreements that Include Both a Subjective Acceleration Clause and a Lock-Box Arrangement,” and certain provisions in the credit
agreement,Wachovia Loan Agreement, the Company is required to classify its revolving loan facilityRevolver as short-term debt. See Note 18 for further discussion regarding the restatement of
prior year borrowings outstanding
Remaining availability under the Congress CreditWachovia Facility was $14.0 million and the interest rate was 5.5% as of December 25, 2004.
Chelsey Facility. On July 8, 2004, the Company closed on the Chelsey Facility, the $20.0 million junior secured credit facility with Chelsey Finance that was recorded net of a debt discount at $7.1 million at issuance. The Chelsey Facility has a three-year term, subject to earlier maturity upon the occurrence of a change in control or sale of the Company (as defined), and carries an interest rate of 5.0% above the prime rate publicly announced by Wachovia. The financial and non-financial covenants contained in the Chelsey Facility mirror those in the Wachovia Facility except that the quantitative measures for the consolidated working capital and EBITDA covenants are 10.0% less restrictive and the consolidated net worth covenant is 5.0% less restrictive than the comparable financial covenants in the Wachovia Facility. The Chelsey Facility is secured by a second priority lien on substantially of the assets of the Company. As part of this transaction, Chelsey Finance entered into an intercreditor and subordination agreement with Wachovia. At December 25, 2004, the amount recorded as debt on the Consolidated Balance Sheet is $8.2 million, net of the un-accreted debt discount of $11.8 million.
Under the original terms of the Chelsey Facility, the Company was obligated to make payments of principal of up to the full outstanding amount of the Chelsey Facility in each quarter, provided, among other things that: (1) the aggregate amount of availability under the Wachovia Facility is considering replacingat least $7.0 million, (2) the Congress Creditcumulative EBITDA for the four fiscal quarters immediately preceding the quarter in which the payment is made is at least $14.0 million, and (3) the aggregate amount of principal prepayments is no more than $2.0 million in any quarter. Subsequent to the closing of the Chelsey Facility, 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.
Thethe Company is also considering a sale-lease back of its principal warehouse and distribution center,Chelsey Finance amended the funds from which would be usedChelsey Facility to reduce the Company's
debt, although no definitive agreements have been reached. There can be no
assuranceprovide that the Company will engagewas not obligated to make principal payments prior to July 8, 2007, except 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 reductionschange in catalog circulation, additional
expense reductions and sales of non-core assets.

     Series C Cumulative Participating Preferred Stock.  On November 30, 2003,
as partcontrol or sale of the Recapitalization,Company. This resulted in the recorded amount of the Chelsey Facility plus the accreted cost of the debt discount (as described below) being classified as long term on the Company’s Consolidated Balance Sheet as of December 25, 2004.
In consideration for providing the Chelsey Facility to the Company, issuedChelsey Finance received a closing fee of $200,000 and a warrant (the “Common Stock Warrant”) valued at $12.9 million, exercisable immediately and for a period of ten years to 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 holderspurchase 30.0% 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 additionalfully diluted shares of Common Stock of the Company (equal to Chelsey in accordance with SFAS No. 15 "Accounting by Debtors10,259,366 shares of Common Stock) at an exercise price of $0.01 per share. The closing fee of $200,000 was recorded as a deferred charge within Other Assets on the Company’s Consolidated Balance Sheets and Creditors for Troubled Debt Restructuring." As such,is being amortized over the $107.5 million
carrying valuethree-year term of the Series B Participating Preferred Stock as ofChelsey Facility. Because the consummation date of the exchange was compared with the fair valueissuance of the Common Stock of approximately $19.6 millionWarrant was subject to shareholder approval, the Company initially issued a warrant to Chelsey as of the consummation
date and the total maximum potential cash payments of approximately $72.7
million that could be made pursuantFinance to the terms of thepurchase newly-issued 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 CD Participating Preferred Stock (“Series D Preferred”) that was recordedautomatically exchanged for the Common Stock Warrant on September 23, 2004 following receipt of shareholder approval. See Note 7 to the Company’s consolidated financial statements for further information on the Chelsey Facility and the Common Stock Warrant.
Other Activities 
Consolidation of New Jersey Office Facilities. The Company entered into a 10-year extension of the lease for its Weehawken, New Jersey premises and has relocated its executive offices to that facility in 2005. We consolidated all of our New Jersey operations into the Weehawken facility when the Edgewater, New Jersey facility closed upon the expiration of the lease on May 31, 2005.
Consolidation of Men’s Apparel Business. The Company decided on November 9, 2004 to relocate and consolidate all functions of International Male and Undergear from San Diego, California to Weehawken, New Jersey by February 28, 2005. The decision was prompted by the business need to consolidate operations, reduce costs and leverage its catalog expertise in New Jersey. We accrued $0.9 million in severance and related costs during the fourth quarter of 2004 associated with the elimination of 32 California-based full-time equivalent positions. The payment of these costs began in February 2005 and continued through August 2005.

Since the relocation and consolidation of the Men’s apparel catalogs, the transition has negatively impacted the performance of the Men’s apparel catalogs in 2005.
The projected annual savings from the consolidation of the San Diego, California and the Edgewater, New Jersey facilities into the Weehawken, New Jersey facility is approximately $2.1 million, however with this relocation and consolidation, the transition has negatively impacted the performance of the Men’s Apparel catalogs in 2005.
Consolidation of Fulfillment Centers. On June 30, 2004 the Company announced plans to consolidate the operations of the LaCrosse, Wisconsin fulfillment center and storage facility into the Roanoke, Virginia fulfillment center by June 30, 2005. The LaCrosse fulfillment center and the LaCrosse storage facility were closed in June 2005 and August 2005 upon the expiration of their respective leases. The plan to consolidate operations was prompted by excess capacity at the amountRoanoke facility and the lack of total
potential cash payments (including dividendssufficient warehouse space in the leased Wisconsin facilities to support the growth of The Company Store and other contingent amounts) that
could be required pursuant to its terms. Since Chelsey was a significant
stockholder atreduce the timeoverall cost structure of the exchange,Company. The Company substantially completed the consolidation into the Roanoke, Virginia fulfillment center by the end of June 2005. Since the consolidation of our fulfillment centers, our Roanoke fulfillment center has experienced lower productivity that has negatively impacted fulfillment costs and as a result, athe Company’s overall performance. We accrued $0.5 million in severance and related party,costs and incurred $0.2 million of facility exit costs during 2004 associated with the "gain" was recorded in equity.

     Saleconsolidation of the Improvements Business.  On June 29, 2001,LaCrosse operations and the Company sold
certain assetselimination of 149 full and liabilitiespart-time positions. The payment of its Improvements businessthese costs began in January 2005 and is expected to HSN, a divisioncontinue into the fourth quarter of USA Networks, Inc.'s Interactive Group, for approximately $33.0 million. In2005.
Pursuant to and in conjunction with the sale, the Company's Keystone Internet Services, Inc.
subsidiary agreedabove actions 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 betweenreduce overhead costs, the Company eliminated an additional 15 full-time positions Company-wide, for which we accrued $0.3 million in severance and HSN provided that if
Keystone Internet Services failed to perform its obligationsrelated costs during the first
two yearsfourth quarter of the services contract, the purchaser could receive a reduction in
the original purchase price2004.
Sale 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.

     Improvements Business. On March 27, 2003, the Company and HSN, a division of USA Networks, Inc.’s Interactive Group and purchaser of certain assets and liabilities of the Company’s Improvements business on June 29, 2001, amended the asset purchase agreement to provide for the release of the remaining $2.0 million balance of the escrow fund and to terminate the escrow agreement. The asset purchase agreement had provided that if Keystone failed to perform its obligations during the first two years of the services contract, HSN could receive a reduction in the original purchase price of up to $2.0 million. By agreeing to the terms of the amendment, HSN forfeited its ability to receive a reduction in the original purchase price of up to $2.0 million if Keystone Internet Services failed to
perform its obligations during the first two years of the services contract.price. 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 thein March 2003
billing period.2003. 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. DuringProceeds related to the 13- weeks ended March 29, 2003, the Companydeferred gain were received on July 2, 2002 and December 30, 2002 for $0.3 million and $0.3 million, respectively. We recognized the remaining net deferred gain of $1.9 million fromupon 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
Delisting of Common Stock. The Common Stock Exchange Notification.  By letter dated Maywas delisted from the AMEX on February 16, 2005 ultimately because of the Restatement that prevented us from filing our Form 10-Q for the fiscal quarter ended September 25, 2004, a condition of continued AMEX listing. Trading in our Common Stock on the AMEX was halted on November 16, 2004 and formally suspended on February 2, 2001, the
American Stock Exchange (the "Exchange") notified2005.
Initially the Company that it was below
certain ofnotified by 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 stockAMEX on the
Exchange. On January 17, 2002,May 21, 2004 that 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'swas not in 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'sAMEX’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 stepsGuide because of its strategic business realignment program
shared with the Exchange in 2001insufficient shareholders equity and updated in 2002, the Exchange informed the
Company that it had now become strictly subject to the procedures and
requirementsa series 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.operations. The Company submitted a plan to the Exchange on
December 11, 2002, in an effortAMEX 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 evidencedregain compliance with the requirements necessarycontinued listing standards which the AMEX accepted and granted the Company an extension until November 21, 2005 to regain compliance with the continued listing standards. Because the Company could not timely file its Form 10-Q for the fiscal quarter ended September 25, 2004, a condition for the Company’s continued listing on the Exchange. Such compliance resulted from a recent rule change byAMEX, the Exchange
approved byAMEX began 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 requirementdelisting proceedings that each listed company maintain $15 million of public float.
The letter is subject to changesculminated in the AmericanFebruary 16, 2005 delisting.
Current trading information about the Company’s Common Stock Exchange Rules that might
supersedecan be obtained from the letter or requirePink Sheets (www.pinksheets.com) under the Exchange to re-evaluate its position.

     trading symbol HNVD.PK.

General. At December 27, 2003,25, 2004, the Company had $2.3$0.5 million in cash and cash equivalents compared with $0.8$2.3 million at December 28, 2002.27, 2003. Working capital and current ratio at December 27, 200325, 2004 were $(2.0)$10.6 million and 0.971.13 to 1.1, respectively. Total cumulativerecorded borrowings, including financing under capital lease
obligationsnet of the un-accreted debt discount of $11.8 million and excluding the Series C Participating Preferred, Stock, as of December 27, 2003,25, 2004, aggregated $22.5$27.9 million, $9.0$11.2 million of which is classified as long-term.long term. Remaining availability under the Congress Revolving Loan FacilityRevolver as of December 27, 200325, 2004 was $9.9$14.0 million. There were nominal
At December 25, 2004, the aggregate annual principal payments required on debt instruments (including capital commitments
(less than $0.2 million) at December 27, 2003.

     lease obligations) are as follows (in thousands): 2005 — $16,690; 2006 — $2,039; 2007 — $20,998.
Management believes that the Company has sufficient liquidity and availability under its credit agreementagreements to fund its planned operations through at least December 25, 2004. Achievementthe next twelve months. See “Risk Factors” below.
Use of the cost savingsEstimates 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

     Other Critical Accounting Policies
The preparation of financial statements in conformity with accounting
principlesU.S. generally accepted in the United Statesaccounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and revenues and expenses during the period. Significant accounting policies employed by the Company, including the use of estimates, are presented in the Notes to Consolidated
Financial Statements.

     On April 30, 2002, the Securities and Exchange Commission issued a proposed
rule to improve theconsolidated 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.
statements.
Critical accounting policies are those that are most important to the portrayal of the Company'sCompany’s financial condition and results of operations, and require management'smanagement’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'sCompany’s most critical accounting policies, discussed below, pertain to revenue recognition, inventory valuation, catalog costs, reserves related to the Company'sCompany’s strategic business realignment program and other accrued liabilities, reserves related to the Company's employee health, welfare and benefit plans, and the Company's net deferred tax asset.
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, eachmerchandise is received by the customer, net of estimated returns. PostageDelivery and handlingservice 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 inis received by the Company's catalogs and on
Internet Web sites and are confirmed with the customer upon order.customer. 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'sCompany’s revenue recognition policy includes the use of estimates for the time period between shipment of merchandise by the Company and receipt of merchandise by the customer and the future amount of returns to be received on the current period'speriod’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'sCompany’s total returns reserve at the end of 2004 and 2003 was $2.0 million. For the fiscal years 2003, 2002
and 2001year ended December 25, 2004, the Company’s return rate decreased 0.6% to 10.5% from 11.1% in 2003. A contributing factor to this decrease was $2.2 million, $1.9 million and $2.8 million, respectively. Duringthe modification of our return policy in 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
Membership Services — Customers may purchase memberships in a number of the Company’s Buyers’ Club programs for an annual fee. For memberships purchased during the following periods, certain of the Buyers’ Club programs contained a guarantee that the customer would receive discounts or savings, at least equal to the cost of his or her membership or the Company would refund the difference with a merchandise credit at the end of the membership period: Silhouettes from July 1998 through March 2004; Domestications from April 2002 through March 2004; and Men’s Apparel from April 2003 through March 2004. For memberships purchased during the periods in which the Buyers’ Club memberships contained a guarantee, revenue net of actual cancellations was recently adopted, itrecognized on a monthly basis over the membership period subsequent to the end of the thirty-day cancellation period, with the revenue recognized equal to the lesser of the cumulative amount determined using the straight-line method or the actual benefit received by each customer as of the end of each period. For the Buyers’ Club memberships that did not impactcontain a guarantee, revenue net of actual cancellations was recognized on a monthly basis over the Company's total returns reservemembership period subsequent to the end of the thirty-day cancellation period, using the straight-line method. We receive commission revenue related to our solicitation of the Vertrue membership programs. The Company receives a monthly commission based on the number of memberships sold with additional revenue recognized if certain program performance levels are attained for each fiscal year. Through May 2003, we received

commission revenue from the Magazine Direct magazine subscription program. The commission revenue we recognized for the fiscal year ended December
27,Magazine Direct magazine program was on a per-solicitation basis according to the number of solicitations made, with additional revenue recognized if the customer accepted the solicitation. Collectively, the amount of revenues the Company received from these sources was $10.3 million, or 2.5% of net revenues, $9.3 million or 2.2% of net revenues, and $10.3 million, or 2.2% of net revenues for 2004, 2003 however, it could potentially impactand 2002, respectively. In May 2003, we discontinued our solicitation of 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.

     Magazine Direct program.
Inventory Valuation -- — The Company'sCompany’s inventory valuation policy includes the use of estimates regarding the future loss on in-transit and on-hand inventory that will be sold at a price less than the cost of the inventory (inventory write-downs), andplus 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'sCompany’s Consolidated Balance Sheets. The Company'sOur 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). Any incremental gross margin that would result in inventory being sold at a higher amount after a write-down is recorded is not realized until that inventory is ultimately sold. The estimated amount of overstock inventory is determined using current and historical sales trends for each category of inventory as well as the content of future merchandise offers that will be produced by the Company. An estimate of the percentage of freight-in expense associated with each dollar of inventory received is used in calculating the amount of freight-in expense to include in the Company'sour 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'sour inventory valuation affect the balance of Inventories on the Company'sCompany’s Consolidated Balance Sheets and Cost of sales and operating expenses on the Company'sCompany’s Consolidated Statements of Income (Loss).
Catalog Costs -- — In accordance with Statement of Position 93-7, “Reporting on Advertising Costs,” catalog costs are deferred and amortized over the estimated period in which the sales related to such advertising are generated. An estimate of the future sales dollars to be generated from each individual catalog drop is used in the Company'simplementation of the Company’s catalog costscost amortization policy. The estimate of future sales is calculated for each catalog drop using historical trends for similar catalog drops mailed in prior periods as well as the overall current sales trend for the catalog brand. Thiscatalog. On a monthly basis, this estimate is evaluated and adjusted as necessary and then is compared with the actual sales generated to-date for the catalog drop to determine the percentage of total catalog costs to be classified as prepaid catalog costs on the Company'sCompany’s Consolidated Balance Sheets. The Company'scosts for each catalog drop are completely amortized, regardless of actual sales generated by the catalog drop, when the catalog has been in circulation for six months or the amount of the costs remaining to be amortized decreases below 3.0% of the catalog drop’s total cost. Our Prepaid catalog costs at the end of fiscal years2004, 2003 and 2002 and 2001 were $11.8$15.6 million, $13.5$12.5 million and $14.6$14.3 million, respectively. Prepaid catalog costs on the Consolidated Balance Sheets and Selling expenses on the Consolidated Statements of Income (Loss) are affected by these estimates.
Reserves related to the Company'sCompany’s strategic business realignment program and other Accrued Liabilities -- — Generally, the Company records severance in accordance with the Financial Accounting Standards Board (“FASB”) Statement No. 112, “Employers’ Accounting for Postemployment Benefits,” (“SFAS 112”) and reserves for leased properties were accounted in accordance with Emerging Issues Task Force No. 94-3 (“EITF 94-3”), “Liability Recognition for Certain Employee Termination Benefits & Other Costs to Exit an Activity (Including Certain Costs Incurred in Restructuring).” The reserves established by the Company related to its strategic business realignment program include employee severance and related costs, facility exit costs and estimates primarily associated with the potential subleasing of leased properties whichthat have been vacated by the Company. The properties that have available space for subleasingSubsequent to December 25, 2004, the Gump’s business was sold as described in Part I 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.this Form 10-K. The overall reserves for leased properties that have been vacated by the Company are developed using estimates that include the potential ability to sublet leased but unoccupied properties, the length of time needed to obtain suitable tenants and the amount of rent to be received for the sublet. Real estate broker representations regarding current and future market conditions are sometimes used in estimating these items. Current Accrued liabilities and Other Non-current liabilities on the Company'sCompany’s Consolidated Balance Sheets and Special charges on the Company'sCompany’s Consolidated Statements of Income (Loss) are impacted by these estimates. See Note 35 and Note 46 to the Company's Consolidated Financial Statements.

     Company’s consolidated financial statements.
The most significant estimates involved in evaluating the Company'sour accrued liabilities are used in the determination of the accrual for legal liabilities.
The Company accruesliabilities or those liabilities that will be resolved through litigation. We accrue for losspotential litigation losses when management determines that it is probable that an unfavorable outcome will result. The Company'sresult and the loss is reasonably estimable. Our policy is to accrue an amount equal to the estimated potential loss and associated legal

fees. For the fiscal year ended December 28, 2002,30, 2000, the Company used estimates to determine the accrued liability forrelated to Rakesh Kaul’s claims regarding benefits as a result of his resignation on December 5, 2000. As part of the Restatement, the Company corrected two accounting errors related to the Rakesh Kaul case. In calculatingliability. The first error identified was the premature reversal of the reserve in the fourth quarter of 2003 based upon the summary judgment decision in January 2004. As noted above, this accrual,decision could be, and subsequently was, appealed. Due to this fact, management has now determined that the reversal was premature. The second error identified was the accounting for legal fees associated with litigating this claim. Due to the fact that the Kaul reserve was recorded prior to the initiation of litigation, the Company used estimates includinghas determined that the likelihood that this case
would reach the trial stage,appropriate basis of accounting for the legal expenses associated with continuing this
legal action,fees related to the ultimate outcomelitigation would have been to treat such fees as period costs and, therefore, expensed as incurred. However, the Company had inappropriately recorded certain of these fees against the case, and the amountsreserve as opposed to be awarded if
the outcome was notrecording them as an expense 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 (seeincome statement. See Note 162 of Notes to the Consolidated Financial Statements). An accrued liability inconsolidated financial statements for additional information pertaining to this restatement adjustment. In addition, the amountCompany recorded a $0.5 million reserve during the third quarter of $0.2 million was maintained2004 for estimated costs associated with the fiscal year ended December 27,
2003 pendingClass Action Lawsuits the resolutionCompany is currently litigating. See Note 15 of Notes to 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.

     consolidated financial statements for additional information pertaining to this reserve.
Reserves related to employee health, welfare and benefit plans -- — The Company maintains a self-insurance program related to losses and liabilities associated with employee health and welfare claims. Stop-loss coverage is held on both an aggregate and individual claim basis;basis thereby limiting the amount of losses the Companywe will experience. Losses are accrued based upon estimates of the aggregate liability for claims incurred using the Company'sour experience patterns. General and administrative expenses on the Consolidated Statement of Income (Loss) and Accrued liabilities on the Consolidated Balance SheetSheets are affected by these estimates. Net At December 25, 2004 and December 27, 2003, the Company had an accrued liability recorded in the amount of $0.6 million.
Deferred Tax Asset --- In determining the Company'sCompany’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'sCompany’s net operating loss carryforwards are employed. These projections involve evaluations of the Company'sour future operating plans and ability to generate taxable income, as well as future economic conditions and the Company'sour 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'sCompany’s ability to utilize certain net operating losses prior to their expiration the Company'sand our history of losses and continued softness in demand for
the Company's products.losses. The Deferreddeferred tax asset and Deferreddeferred tax liability on the Company'sCompany’s Consolidated Balance Sheets and the Provision for deferred Federal
income taxes on the Company'sCompany’s Consolidated Statements of Income (Loss) are impacted by these projections.

NEW ACCOUNTING PRONOUNCEMENTS

     In July 2002,
New Accounting Pronouncements
On March 31, 2004, the FASBFinancial Accounting Standards Board (“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 ("03-6 (“EITF 94-3"03-6”)., “Participating Securities and the Two-Class Method under FASB Statement No. 128.” SFAS 146128 defines earnings per share (“EPS”) as “the amount of earnings attributable to each share of common stock” and indicates that the objective of EPS is to measure the performance of an entity over the reporting period. SFAS 128 addresses conditions under which a participating security requires the use of the two-class method of computing EPS. The two-class method is an earnings allocation formula that treats a liabilityparticipating security as having rights to earnings that otherwise would have been available to common shareholders, but does not require the presentation of basic and diluted EPS for securities other than common stock. The Company’s Series C Preferred is a cost associated withparticipating security and, therefore, we calculate EPS utilizing the two-class method, however, have chosen not to present basic and diluted EPS for its preferred stock.
In November 2004, the FASB issued SFAS No. 151, “Inventory Costs, an exit or disposal activity be
recognized whenAmendment of ARB No. 43, Chapter 4” (“SFAS 151”), which clarifies the liability is incurred whereas, under EITF 94-3, the
liability was recognized at the commitment dateaccounting for abnormal amounts of idle facility expense, freight, handling costs and spoilage. We are required to an exit plan. The Company has
adoptedadopt the provisions of SFAS 146 for exit or disposal activities initiated
after December 31, 2002.

     In151 effective January 2003, the Securities and Exchange Commission issued a new
disclosure regulation, "Conditions for Use of Non-GAAP Financial Measures"
("Regulation G"), which1, 2006; however, early adoption 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 thatpermitted. We are not in accordance
with generally accepted accounting principles ("GAAP") to includecurrently in the disclosure or release a presentationprocess of determining the impact of the most directly comparable GAAPadoption of this Statement on our 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.

     statements.
In May 2003,December 2004, the FASB issued SFAS 150. No. 123R, “Share Based Payment” (“SFAS 150 establishes standards123R”). SFAS 123R requires measurement and recording of compensation expense for how an issuer classifies and measures certain financial instruments with
characteristics of both liabilities and equity. It requires that an issuer
classifyall employee share-based compensation awards using a financial instrument that is withinfair value method. The Company currently accounts for its scope as a liability, many of
which had been previously classified as equity or betweenstock-based compensation to employees using the liabilities and
equity sections

fair value-based methodology under SFAS 123. We are currently assessing the impact of the consolidated balance sheet. The provisionsadoption of this Statement.
In May 2005, the FASB issued SFAS 150
are effectiveNo. 154, “Accounting Changes and Error Correction” (“SFAS 154”), which changes the requirements for financial instruments entered into or modified after May 31,
2003,the accounting for 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 adoptedprinciple. We are required to adopt the provisions of SFAS 150 and has been impacted by154 effective January 1, 2006; however, early adoption is permitted. The Company is currently assessing the requirement to reclassify its Series B
Participating Preferred Stock as a liability as opposed to between the
liabilities and equity sectionsimpact of the consolidated balance sheet. Based upon
the requirements set forth by SFAS 150,adoption of 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)Statement.
Off-Balance Sheet Arrangements 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

     Contractual Obligations
The Company has entered into no "off-balance“off-balance sheet arrangements"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),25, 2004, as required by Item 303(a)(5) of SEC Regulation S-K. In addition to obligations recorded on the Company'sCompany’s Consolidated Balance Sheets as of December 27, 2003,25, 2004, the schedule includes purchase obligations, which are defined as legally binding and enforceable agreements to purchase goods or services that specify all significant terms (quantity, price, and timing of transaction).

                             PAYMENT DUE BY PERIOD


                                                       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
                                            ========    =======     =======     ======      =======


- ---------------

Payment Due by Period (in thousands)
 
Contractual Obligations
 
Total
 
Less Than
1 Year
 
 
1-3 Years
 
 
3-5 Years
 
More Than
5 Years
 
Debt Obligations, excluding the Series C Participating Preferred Stock (a)
$    39,384
 
$  16,400
 
$ 22,984
 
$        —
 
$           —
 
Total Minimum Lease Payments Under Capital Lease Obligations (Including interest)
358
 
304
 
54
 
—
 
—
 
Operating Lease Obligations- excluding Gump’s (e)
2,164
 
1,735
 
421
 
8
 
—
 
Operating Lease Obligations- Gump’s (e) 
8,680
 
1,659
 
3,383
 
3,360
 
278
 
Operating Lease Obligations — Restructuring/ Discontinued Operations- excluding Gump’s (e)
1,051
 
979
 
72
 
—
 
—
 
Operating Lease Obligations — Restructuring/ Discontinued Operations- Gump’s (e)
5,179
 
1,002
 
2,004
 
2,006
 
167
 
Contractual Obligations (b)
1,478
 
1,289
 
189
 
—
 
—
 
Purchase Obligations- excluding Gump’s (c) (e)
27,661
 
27,661
 
—
 
—
 
—
 
Purchase Obligations- Gump’s (c) (e)
1,088
 
1,088
 
—
 
—
 
—
 
Other Long-Term Liabilities Reflected on the Registrant’s Balance Sheet under GAAP (d)
72,689
 
—
 
—
 
72,689
 
—
 
 
 
 
 
 
Total
$  159,732
 
$  52,117
 
$ 29,107
 
$ 78,063
 
$         445
 
 
 
 
 
(a) As disclosed inRepresents the Company’s debt obligations, including the $20.0 million Chelsey Facility principal amount due Chelsey Finance, recorded as $8.2 million on the Consolidated Balance Sheet. See Note 57 of Notes to the Company's Consolidated Financial Statements.

consolidated financial statements for additional detail regarding the Chelsey Facility.
(b) As disclosed in Note 14 to the Company's Consolidated Financial Statements.

(c)  The Company's purchaseCompany’s contractual 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, of which

approximately $1,246,000 had been fulfilled as of December 25, 2004, and of which the remaining $754,000 has been fulfilled as of February 6, 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$265,000 had been fulfilled as of December 27, 2003,25, 2004, and of which approximately $277,000 should be fulfilled during fiscal 2004 and the
     remaining $171,000an additional $161,000 had been fulfilled by September 10, 2005;2005, and of which the remaining $61,000 was offset by an extension of the original agreement by an amendment dated January 10, 2006; a total commitment of $375,000 for list processing services representing the maximum exposure for a service contract whichthat requires a three-month notice of termination for services costing $125,000 per month; and several commitments totaling approximately $151,000$127,000 to purchase various packaging materials from several vendors during the next 12 months, under contracts wherein the vendors warehouse varying minimum and maximum levels of materials to ensure immediate availability.
(c) The Company’s purchase obligations represent the estimated commitments at year-end to purchase inventory and raw materials in the normal course of business to meet operational requirements. The Company’s purchase orders are not unconditional commitments, but rather represent executory contracts requiring performance by vendors/suppliers. As such the Company has an absolute and unconditional right to cancel the Purchase Order if the vendor/supplier is unable to arrange for various consulting servicesthe products listed thereon to be provided
     duringdelivered to the period April 2003 through July 2004, of which approximately
     $88,000 had been fulfilled as of December 27, 2003.

destination by the date shown. The purchase obligations presented above include all such open orders and agreed upon raw material commitments that are not otherwise included in the Company’s recorded liabilities.
(d) Represents Series C Participating Preferred Stock as disclosed in Note 8 to the Company's Consolidated Financial Statements.

                                        40


FORWARD-LOOKING STATEMENTS

     The following statements constitute forward-looking statements withinCompany’s consolidated financial statements. In March 2005 at 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 agreementCompany’s request, Chelsey agreed 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 ofpermit the Company to reduce unprofitable circulation and to effectively manage its
       customer lists.

     - The abilityapply the sales proceeds from the sale of the Company to achieve projected levels of sales and the
       ability of the CompanyGump’s to reduce costs commensurate withthe Wachovia Facility. Chelsey retained the right to require redemption of approximately $6.9 million (the Gump’s sales projections. Increases in postage, printing and paper prices and/or the
       inabilityproceeds available for redemption) 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


     -subject to Wachovia’s approval. Since the redemption of approximately $6.9 million is subject to Wachovia’s approval the payment due period is presented as January 1, 2009.
(e)
Operating lease and purchase obligation amounts for Gump’s are being shown separately due to the Company’s sale of Gump’s on March 14, 2005.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Interest Rates: 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'sCompany’s exposure to market risk relates to interest rate fluctuations for borrowings under the Congress revolving credit facility
and itsWachovia Facility, including the term financing facility,loans, which bear interest at variable rates.rates, and the Chelsey Facility, which bears interest at 5.0% above the prime rate publicly announced by Wachovia. At December 27, 2003,25, 2004, outstanding principal balances under these facilitiesthe Wachovia Facility and Chelsey Facility subject to variable rates of interest were approximately $15.5 million.$19.4 million and $20.0 million, respectively. If interest rates were to increase by one percent from current levels, the resulting increase in interest expense, based upon the amount outstanding at December 27,
2003,25, 2004, would be approximately $0.15$0.4 million on an annual basis.

                                        43
In addition, the Company’s exposure to market risk relates to customer response to the Company’s merchandise offerings and circulation changes, effects of shifting patterns of e-commerce versus catalog purchases, costs associated with printing and mailing catalogs and fulfilling orders, effects of potential slowdowns or other disruptions in postal service, dependence on customers’ seasonal buying patterns, fluctuations in foreign currency exchange rates, and the ability of the Company to reduce unprofitable circulation and effectively manage its customer lists.



ITEM
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA -- Financial Statements and Supplementary Data — Report of the Independent Registered Accounting Firm
REPORT OF THE INDEPENDENT AUDITORS

                          INDEPENDENT AUDITORS' REPORT

     TheREGISTERED PUBLIC ACCOUNTING FIRM
To 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, 200325, 2004 and December 28, 200227, 2003, and the related consolidated statements of income (loss), shareholders' deficiency,
and cash flows and shareholders’ deficiency for the years then ended. In connection with our auditseach of the 2003 and 2002 consolidated financial statements, we also have audited the 2003
and 2002 consolidated financial statement schedule as listedthree fiscal years in the accompanying
index.period ended December 25, 2004. 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 auditaudits in accordance with auditingthe standards generally
accepted inof the United States of America.Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated 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 providesaudits provide 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 25, 2004 and December 27, 2003 and December 28, 2002 and
the results of theirits operations and theirits cash flows for each of the three years thenin the period ended December 25, 2004 in conformity with accounting principles generally accepted in the United States of America. Also
The information included on Schedule II is the responsibility of management, and although not considered necessary for a fair presentation of financial position, results of operations, and cash flows, it is presented for additional analysis and has been subjected to the auditing procedures applied in the audit of the basic consolidated financial statements. In our opinion, the relatedinformation included on Schedule II relating to the years ended December 25, 2004, December 27, 2003 and December 28, 2002 consolidated
financial statement schedule, when consideredis fairly stated in all material respects, in relation to the basic consolidated financial statements taken as a whole,whole. Also, such schedule presents fairly in all
material respects, the information set forth therein.

     As describedtherein in Note 18,compliance with the Company's consolidated balance sheet asapplicable accounting regulations of the Securities and Exchange Commission.
/s/ GOLDSTEIN GOLUB KESSLER LLP
New York, NY
February 8, 2006

HANOVER DIRECT, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
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 Liabilities25, 2004 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 DECEMBERDecember 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
                                                               =========      =========
 
 
 
 
December 25, 2004
 
 
 
December 27,
2003
As Restated
 
 
 
(In thousands of dollars,
 
Except share amounts)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents
$                 510
$         2,282
Accounts receivable, net of allowance for doubtful accounts of $1,367 in 2004 and $1,105 in 2003
17,819
14,335
Inventories, principally finished goods
53,147
42,806
Prepaid catalog costs
15,644
12,485
Other current assets
4,482
4,239
Total Current Assets
91,602
76,147
PROPERTY AND EQUIPMENT, AT COST:
Land
4,361
4,361
Buildings and building improvements
18,221
18,210
Leasehold improvements
10,156
10,108
Furniture, fixtures and equipment
53,792
53,212
 
86,530
85,891
Accumulated depreciation and amortization
(61,906)
(58,113)
Property and equipment, net
24,624
27,778
Goodwill
9,278
9,278
Deferred tax asset
2,179
1,769
Other non-current assets
2,816
1,575
Total Assets
$         130,499
$     116,547
 
LIABILITIES AND SHAREHOLDERS’ DEFICIENCY
CURRENT LIABILITIES:
Short-term debt and capital lease obligations
$           16,690
$       13,468
Accounts payable
29,544
42,742
Accrued liabilities
20,535
17,088
Customer prepayments and credits
12,032
11,479
Deferred tax liability
2,179
1,769
Total Current Liabilities
80,980
86,546
NON-CURRENT LIABILITIES:
Long-term debt, including $8,159 to a related party as of December 25, 2004
(see note 7)
11,196
9,042
Series C Participating Preferred Stock, authorized, issued and outstanding 564,819 shares at December 25, 2004 and December 27, 2003; liquidation preference was $56,482 at December 25, 2004 and December 27, 2003
72,689
72,689
Other
3,286
4,609
Total Non-current Liabilities
87,171
86,340
Total Liabilities
168,151
172,886
SHAREHOLDERS’ DEFICIENCY:
Common Stock, $0.01 par value, authorized 50,000,000 shares at December 25, 2004 and 30,000,000 shares at December 27, 2003; 22,426,296 shares issued and outstanding at December 25, 2004; 22,229,456 shares issued and 22,017,363 shares outstanding at December 27, 2003
225
222
Capital in excess of par value
460,744
450,407
Accumulated deficit
(498,621)
(503,622)
 
(37,652)
(52,993)
Less:
Treasury stock, at cost (0 shares at December 25, 2004 and 212,093 shares at December 27, 2003)
--
(2,996)
Notes receivable from sale of Common Stock
--
(350)
Total Shareholders’ Deficiency
(37,652)
(56,339)
Total Liabilities and Shareholders’ Deficiency
$         130,499
$     116,547
 
See notes to Consolidated Financial Statements.

                                        45

HANOVER DIRECT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (LOSS)
 FOR THE YEARS ENDED DECEMBER
For the Years Ended December 25 2004, December 27, 2003 DECEMBERand 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
                                                              ========    ========    ========
 
 
 
 
 
 
 
2004
 
2003
As Restated
 
2002
As Restated
 
��
 
 
(In thousands of dollars, except
 
per share amounts)
 
NET REVENUES
$     403,160
 
$      414,283
 
$        456,990
 
 
 
 
 
 
 
 
 
OPERATING COSTS AND EXPENSES:
 
 
 
 
 
Cost of sales and operating expenses
243,215
 
261,297
 
290,383
Special charges
1,536
 
1,308
 
4,398
Selling expenses
100,460
 
99,971
 
105,448
General and administrative expenses
43,213
 
45,543
 
53,322
Depreciation and amortization
3,994
 
4,719
 
5,650
 
 
 
 
392,418
 
412,838
 
459,201
 
 
 
 
 
 
 
 
 
INCOME (LOSS) FROM OPERATIONS
10,742
 
1,445
 
(2,211)
Gain on sale of Improvements, net
--
 
(1,911)
 
(570)
 
 
 
 
 
 
 
 
 
INCOME (LOSS) BEFORE INTEREST AND INCOME TAXES
10,742
 
3,356
 
(1,641)
Interest expense, net (including interest expense to a related party see note 7)
5,567
 
12,088
 
5,477
 
 
 
 
 
 
 
 
 
INCOME (LOSS) BEFORE INCOME TAXES
5,175
 
(8,732)
 
(7,118)
Provision for Federal income taxes
146
 
11,300
 
3,700
Provision for state income taxes
28
 
28
 
91
 
 
 
Provision for income taxes
174
 
11,328
 
3,791
 
 
 
 
 
 
 
 
 
NET INCOME (LOSS) AND COMPREHENSIVE INCOME (LOSS)
5,001
 
(20,060)
 
(10,909)
Preferred stock dividends
--
 
7,922
 
15,556
Earnings Applicable to Preferred Stock
124
 
--
 
--
 
 
 
 
 
 
 
 
 
NET INCOME (LOSS) APPLICABLE TO COMMON SHAREHOLDERS
$         4,877
 
$     (27,982)
 
$       (26,465)
 
 
 
 
NET INCOME (LOSS) PER COMMON SHARE:
 
 
 
 
 
Net income (loss) per common share – basic
$           0.22
 
$          (1.94)
 
$           (1.91)
Net income (loss) per common share – diluted
$           0.18
 
$          (1.94)
 
$           (1.91)
 
 
 
 
 
 
 
 
 
Weighted average common shares outstanding – basic (thousands)
22,220
 
14,439
 
13,828
 
 
 
Weighted average common shares outstanding – diluted (thousands)
27,015
 
14,439
 
13,828
 
 
 
See notes to Consolidated Financial Statements.
                                        46

HANOVER DIRECT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
 FOR THE YEARS ENDED DECEMBER
For the Years Ended December 25, 2004, December 27, 2003 DECEMBERand 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
 
 
2004
 
 
 
2003
As Restated
 
 
2002
As Restated
 
 
 
 
(In thousands of dollars)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)
$        5,001
$     (20,060)
$       (10,909)
Adjustments to reconcile net income (loss) to net cash provided (used) by operating activities:
 
 
Depreciation and amortization, including deferred fees
4,538
5,715
7,203
Provision for doubtful accounts
609
378
304
Special charges
1,536
1,308
4,398
Provision for deferred tax
—
11,300
3,700
Gain on the sale of Improvements
—
(1,911)
(570)
Gain on the sale of property and equipment
(11)
(4)
(167)
Interest expense related to Series B Participating Preferred Stock redemption price increase
—
7,235
—
Compensation expense related to stock options
184
1,141
1,332
Accretion of debt discount
1,098
—
—
Changes in assets and liabilities:
Accounts receivable
(4,093)
2,232
2,207
Inventories
(10,341)
11,700
5,997
Prepaid catalog costs
(3,159)
1,801
1,075
Accounts payable
(13,198)
(666)
(3,151)
Accrued liabilities
1,911
(11,434)
(2,345)
Customer prepayments and credits
553
1,478
433
Other, net
(1,893)
(2,140)
(4,848)
Net cash (used) provided by operating activities
(17,265)
8,073
4,659
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisitions of property and equipment
(840)
(1,895)
(639)
Proceeds from sale of Improvements
—
2,000
570
Costs related to early release of escrow funds
—
(89)
—
Proceeds from sale of property and equipment
14
78
169
Net cash (used) provided by investing activities
(826)
94
100
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings (payments) under Wachovia revolving loan facility
5,411
179
(4,704)
Borrowings under Wachovia Tranche B term loan facility
—
—
3,500
Payments under Wachovia Tranche A term loan facility
(1,493)
(1,991)
(1,991)
Payments under Wachovia Tranche B term loan facility
(6,011)
(1,800)
(1,314)
Borrowings under the Chelsey Facility
7,061
—
—
Issuance of Common Stock Warrant to related party
12,939
—
—
Payments of capital lease obligations
(690)
(466)
(104)
Payments of Series C Participating Preferred Stock financing costs
—
(1,334)
—
Payments of debt issuance costs
(1,045)
(910)
(722)
Payment of debt issuance costs to related party
(200)
—
—
Refund (payment) of estimated Richemont tax obligation on Series B Participating Preferred Stock accretion
347
(347)
—
Proceeds from issuance of common stock
—
—
25
Series B Participating Preferred Stock transaction cost adjustment
—
—
215
Other, net
—
(1)
—
Net cash provided (used) by financing activities
16,319
(6,670)
(5,095)
Net (decrease) increase in cash and cash equivalents
(1,772)
1,497
(336)
Cash and cash equivalents at the beginning of the year
2,282
785
1,121
Cash and cash equivalents at the end of the year
$           510
$         2,282
$              785
 

 
Supplemental Disclosures of Cash Flow Information
Cash paid during the year for:
Interest
$        3,340
$         3,325
$           3,405
Income taxes
$               9
$            705
$              193
Non-cash investing and financing activities:
 
 
 
Issuance of Common Stock to related party as payment of waiver fee
$           563
$              —
$                —
Series B Participating Preferred Stock redemption price increase
$             —
$         7,575
$         15,556
Redemption of Series B Participating Preferred Stock
$             —
$     107,536
$                —
Issuance of Series C Participating Preferred Stock
$             —
$       72,689
$                —
Issuance of Common Stock in conjunction with Recapitalization
$             —
$       19,646
$                —
Gain on issuance of Series C Participating Preferred Stock
$             —
$       13,867
$                —
Tandem share expirations
$           350
$              —
$                 54
Retirement of Treasury Stock
$        3,346
$              —
$                —
Capital lease obligations
$             —
$         1,459
$                 32
See notes to Consolidated Financial Statements.
                                        47

HANOVER DIRECT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS'SHAREHOLDERS’ DEFICIENCY
 FOR THE YEARS ENDED DECEMBER
For the Years Ended December 25, 2004, December 27, 2003 DECEMBERand 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)
                                         =======   ========     ========     =========   ======   =======    =======     ========
 
 
 
 
 
Notes
Receivable
from Sale
of Common
Stock
 
 
 
Capital
in Excess of
Par Value
 
 
 
 
Common Stock
 
 
 
 
$0.01 Par Value
Accumulated
Deficit
Treasury Stock
 
 
Shares
Amount
Shares
Amount
Total
 
(In thousands of dollars and shares)
 
 
 
 
 
 
 
 
 
Restated Balance at December 29, 2001
14,033
$    140
$ 444,976
$(479,888)
(210)
$ (2,942)
$      (405)
$(38,119)
 
 
 
 
 
 
 
 
 
 
Net loss applicable to common shareholders
(26,465)
 
 
 
(26,465)
Series B Participating Preferred stock liquidation preference accrual
(15,556)
15,556
 
 
 
—
Stock options expensed
1,332
 
 
 
1,332
Issuance of Common Stock for employee stock plan
10
25
 
 
 
25
Tandem share expirations
(2)
(54)
54
—
Series B Preferred Stock issuance cost adjustment
215
1
216
 
 
 
 
 
 
 
 
 
 
Restated Balance at December 28, 2002
14,043
$    140
$ 430,992
$(490,797)
(212)
$ (2,996)
$      (350)
$(63,011)
 
 
 
 
 
 
 
 
 
 
Net loss applicable to common shareholders
(27,982)
 
 
 
(27,982)
Series B Participating Preferred Stock liquidation preference accrual
(15,157)
15,157
 
 
 
—
Stock options expensed
1,141
 
 
 
 
1,141
Gain on Recapitalization, net of issuance costs of $1,334
13,867
 
 
 
 
13,867
Issuance of Common Stock in conjunction with Recapitalization
8,186
82
19,564
 
19,646
 
 
 
 
 
 
 
 
 
 
Restated Balance at December 27, 2003
22,229
$    222
$ 450,407
$(503,622)
(212)
$ (2,996)
$      (350)
$(56,339)
 
 
 
 
 
 
 
 
 
 
Net income applicable to common shareholders
4,877
 
 
 
4,877
Earnings applicable to Series C Preferred Stock
 
124
 
 
 
124
Stock options expensed
 
184
 
 
 
 
184
Issuance of Common Stock for Chelsey Facility waiver fee
434
4
559
 
 
 
 
563
Issuance of Chelsey Common Stock Warrants
 
 
12,939
 
 
 
 
12,939
Tandem share expirations
(14)
 
 
 
(11)
(350)
350
—
Retirement of Treasury Stock
(223)
(1)
(3,345)
223
 
3,346
 
—
 
 
 
 
 
 
 
 
 
 
Balance at December 25, 2004
22,426
$    225
$460,744
$(498,621)
—
—
—
$(37,652)
 
See notes to Consolidated Financial Statements.

                                        48

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

     YEARS ENDED DECEMBER
Years Ended December 25, 2004, December 27, 2003 DECEMBERand December 28, 2002 AND DECEMBER 29, 2001

1. BACKGROUND OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations -- — Hanover Direct, Inc., (the “Company” or we), a Delaware corporation, (the
"Company"), is a specialty direct marketer, that markets a diverse portfolio of branded home fashions, men'smen’s and women'swomen’s apparel, and gift products, through mail-order catalogs, retail stores and connected Internet Web siteswebsites directly to the consumer ("(“direct commerce"commerce”). The Company also manufactures super-premium down comforters, pillows and featherbeds under the Scandia Down brand name, which are sold through third party luxury retailers in North and South America. In addition, as excess capacity exists within its operating centers, the Company continues to service
existingprovides third party clients with business-to-business (B-to-B) e-commerce transaction services. These services includeincluding 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 developedthese services provided 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. Pursuantclients as a mechanism to Statementabsorb certain fixed costs 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).

     Company.
Basis of Presentation -- — The consolidated financial statements include all subsidiaries of the Company, and all intercompany transactions and balances have been eliminated. The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. All references in these consolidated financial statements to the number of shares outstanding, per share amounts, stock warrants, and stock option data relating to the Company’s common stock have been restated, as appropriate, to reflect the one-for-ten reverse stock split occurring at the close of business on September 22, 2004. See Note 9 for more information regarding the reverse stock split and additional amendments to the Company’s Certificate of Incorporation.
Fiscal Year -- — The Company operates on a 52 or 53-week fiscal year, ending on the last Saturday in December. The years ended December 25, 2004, December 27, 2003 and December 28, 2002 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'sCompany’s accounts receivable. A combination of historical and rolling bad debt rates are applied to the various receivables maintained by the Company to determine the amount of the allowance to be recorded. The Company also records additional specific allowances deemed necessary by management, based on known circumstances related to the overall receivable portfolio.
Inventories -- — Inventories consist principally of merchandise held for resale and are stated at the lower of cost or market. Cost, which is determined using the first-in, first-out (FIFO) method, includes the cost of the product as well as capitalized freight-in charges. Raw materials and work in process represented approximately 7% and 5% of the inventory balance as of December 25, 2004 and December 27, 2003, respectively. The Company considers slow moving inventory to be surplus and calculates a loss on the impairment as the difference between an individual item'sitem’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'sCompany’s Internet Web sites,websites, outlet stores and liquidations through off-price merchants. Such inventory is written down to its net realizable value if the expected proceeds of disposal are less than the cost of the merchandise.
Prepaid Catalog Costs -- — Prepaid catalog costs consist of direct response advertising costs related to catalog production and mailing. In accordance with Statement of Position 93-7, "Reporting“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$99.4 million, $104.1$99.0 million and $139.4$104.3 million for fiscal years2004, 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 operatingSelling expenses in the Company'sCompany’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 — The Company accounts for goodwill in accordance with SFAS No. 141, "Business Combinations" ("SFAS 141") and No. 142, "Goodwill“Goodwill and Other Intangible Assets" ("SFAS 142"). SFAS 141Assets,” which requires all
business combinations initiated after June 30, 2001 to be accounted for using
the purchase method. Under SFAS 142,that goodwill and intangible assets with
indefinite lives are no longer be amortized but are reviewed annually (or more
frequentlyfor impairment 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 onarise and, at 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.minimum, annually. 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 firmperforms its annual impairment review during theits second quarter ended June 28, 2003 to
assist in the assessmenteach fiscal year. The fair value is determined using a combination 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, 2001market 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)
                                                                =======
discounted cash flow approaches.
Impairment of Long-lived Assets -- — In accordance with SFAS No.144, "Accounting“Accounting for the Impairment or Disposal of Long-lived Assets" ("Assets” (“SFAS 144"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 analysesa review, at a total company-wide level since the Company is viewed as one segment, of long-lived assets using a fair-value approach utilizing appraisals to determine if impairment exists. If impairment is determined to exist, any related impairment loss is calculated based on fair value, which is generally based on discounted future cash flows.

     Long-lived assets to be disposed of would be separately presented in the
balance sheet
Reserves 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

           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."

     Reservesaccruals related to loss contingencies, litigation and legal expenses -- — The Company accrues for losspotential litigation losses 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'sestimable in accordance with SFAS No. 5, “Accounting for Contingencies.” In addition, when a loss contingency is accrued pursuant to SFAS 5, the Company’s policy is to accrue for all of the related legal fees as contemplated in EITF D-77, “Accounting for Legal Costs Expected to Be Incurred in Connection with a Loss Contingency.” For the year ended December 30, 2000, the Company used estimates to determine the liability related to Rakesh Kaul’s claims regarding benefits to which he was entitled as a result of his resignation as CEO on December 5, 2000, which resulted in an amount equalaccrual of $5.0 million. As part of the restatement as discussed in Note 2, the Company corrected two accounting errors related to the estimated potential loss, including associated legal fees.

     Rakesh Kaul liability.
Reserves related to the Company'sCompany’s strategic business realignment program -- Reserves — The reserves established by the Company related to its strategic business realignment program include employee severance and related costs, facility exit costs and estimates primarily associated with the potential subleasing of leased properties which have been establishedvacated by the Company. The overall reserves for leased properties that have been vacated by the Company are developed using estimates that include the potential ability to sublet leased but unoccupied properties, the length of time needed to obtain suitable tenants and currently subleased or available for sublease. For leases with
remaining termsthe amount of greater than one year, the Company records charges on a
discounted basis to reflect the present value of such costsrent to be incurred.
Propertiesreceived for which reserves have been recorded include portions of the corporate headquarterssublet. Real estate broker representations regarding current and administrative offices locatedfuture market conditions are sometimes used in Weehawken, New
Jersey and in Edgewater, New Jersey; andestimating these items. See Note 5 for additional information regarding the Gump's retail store located in San
Francisco, California.

     reserves.
Reserves related to employee health and welfare claims -- — The Company maintains a self-insurance program related to losses and liabilities associated with employee health and welfare claims. Stop-loss coverage is held on both an aggregate and individual claim basis; thereby, limiting the amount of losses the Company will experience. Losses are accrued based upon estimates of the aggregate liability for claims incurred using the Company'sCompany’s experience patterns. At December 25, 2004 and December 27, 2003, the Company had an accrued liability recorded in the amount of $0.6 million.
Employee Benefits --— Vacation and Sick Compensation -- — During June 2003, the Company established and issued a new Company-wide vacation and sick policy to better administer vacation and sick benefits. For purposes of the policy, employees were converted to a fiscal year for earning vacation and sick benefits. Under the new policy, vacation and sick benefits are deemed earned and thus accrued ratably throughout the fiscal year and employees must utilize all vacation and sick earned by the end of the same year. Generally, any unused vacation and sick benefits not utilized by the end of a fiscal year will be forfeited. In prior periods,Before the establishment of this new policy, employees earned vacation and sick in the twelve months prior to the year that it would be utilized. The policy has

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
yearin 2003. Approximately $0.8 million of both general and administrative expenses was
reduced as a result of the recognition of this benefit for fiscal year 2003.
Approximately $0.8 million ofand operating expenses was reduced as a result of the recognition of this benefit for fiscalthe year ended December 27, 2003.
Cost of Sales and operating expenses — Cost of sales and operating expenses in the Consolidated Statements of Income (Loss) include the cost of merchandise sold and merchandise delivery expenses in addition to fulfillment, telemarketing and information technology expenses. Merchandise delivery expenses consist of the cost to ship packages to the customer utilizing a variety of shipping services, as well as the cost of packaging the merchandise for shipment. Total merchandise postage expense for 2004, 2003 and 2002 was $36.5 million, $39.9 million and $41.6 million, respectively. These costs are recognized upon receipt of delivery by the customer and are included in Cost of sales and operating expenses in the Company’s Consolidated Statements of Income (Loss). The total costs deferred for shipments in transit for 2004 and 2003 were $1.8 million and $1.3 million, respectively.
General and administrative expenses —General and administrative expenses in the Consolidated Statements of Income (Loss) reflect payroll and benefit expenses for the catalog and corporate management personnel, costs associated with the New Jersey facilities as well as professional fees and other corporate expenses.
Stock-Based Compensation -- — The Company accounts for its stock-based compensation to employees using the fair value-based methodology under SFAS No. 123, "Accounting“Accounting for Stock-Based Compensation."

     ”
Income Taxes -- — The Company accounts for income taxes in accordance with SFAS No. 109, "Accounting“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'sCompany’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"“more-likely-than-not” basis. A deferred tax liability represents future taxes that may be due arising from the reversal of temporary differences. DueIn 2003, due to a number of factors, including the annual limitation on utilization of net operating losses caused by the Chelsey Direct, LLC (“Chelsey”) purchase of Richemont Finance, S.A.'s’s (“Richemont”) stockholdings in the Company during the year (Note(see Note 8), and continued softness in the market for the Company's
products, management has lowered itslower 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,years, 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 then existing valuation allowance and deferred tax liability) by increasing the valuation allowance viaand recorded an $11.3 million deferred Federal income tax provision. At December 25, 2004, the Company’s net deferred tax asset remains fully reserved with no additional deferred income tax provision required.
Net LossIncome (Loss) Per Share -- — Net lossincome (loss) per share is computed using the weighted average number of common shares outstanding in accordance with the provisions of SFAS No. 128, "Earnings“Earnings Per Share." The” Basic net income (loss) per common share is calculated by dividing net income (loss) available to common shareholders, reduced for participatory interests, by the weighted average number of common shares used
inoutstanding during the calculation for bothperiod. Diluted net income (loss) per common share is calculated using the weighted average number of common shares outstanding adjusted to include the potentially dilutive effect of stock options and stock warrants. The computations of basic and diluted net income (loss) per common share are as follows (in thousands except per share amounts):

 
 
December 25, 2004
 
December 27, 2003
As Restated
 
December 28, 2002
As Restated
 
 
 
 
 
 
 
 
 
 
Net income (loss)
 
$              5,001
 
$    (20,060)
 
$       (10,909)
Less:
 
 
 
 
 
 
Preferred stock dividends
 
--
 
7,922
 
15,556
Earnings applicable to preferred stock
 
124
 
--
 
--
 
 
 
 
Net income (loss) applicable to common shareholders
 
$              4,877
 
$    (27,982)
 
$       (26,465)
 
 
 
 
Basic net income (loss) per common share
 
$                0.22
 
$        (1.94)
 
$           (1.91)
 
 
 
 
 
 
 
 
 
 
 
Weighted-average common shares outstanding
 
22,220
 
14,439
 
13,828
 
 
 
 
 
 
 
 
 
 
 
Diluted net income (loss)
 
$              4,877
 
$    (27,982)
 
$       (26,465)
 
 
 
 
Diluted net income (loss) per common share
 
$                0.18
 
$        (1.94)
 
$           (1.91)
 
 
 
 
 
 
 
 
 
 
 
Weighted-average common shares outstanding
 
22,220
 
14,439
 
13,828
Effect of Dilution:
 
 
 
 
 
 
Stock options
 
9
 
--
 
--
Stock warrants
 
4,786
 
--
 
--
 
 
 
 
Weighted-average common shares outstanding assuming dilution
 
 
27,015
 
 
14,439
 
 
13,828
 
 
 
 
Diluted net loss per common share excluded incremental weighted-average shares 20,979 and 93,318 for fiscalthe years ended December 27, 2003 and December 28, 2002, and 2001 was 144,387,672, 138,280,196 and 210,535,959respectively. These incremental weighted-average shares respectively. Diluted earnings per share equals basic earnings per share as the
dilutive calculation for preferred stock andwere related to employee stock options would have anand were excluded due to their 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.

     effect.
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, eachmerchandise is received by the customer, net of estimated returns. Postagereturns in accordance with the provisions of Staff Accounting Bulletin (“SAB”) No. 101, “Revenue Recognition in Financial Statements,” as amended by SAB No. 104, “Revenue Recognition.” Delivery and handlingservice 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 merchandise is received by the customer. The Company’s revenue recognition policy includes the use of estimates for the time period between shipment of merchandise by the Company and placereceipt of shipment. Prices for all merchandise are listed in the Company's catalogs and on
Internet Web sites and are confirmed withby the customer upon order. The customer
has no cancellation privileges after shipment other than customary rightsand the future amount of return that are accounted for in accordance with SFAS No. 48, "Revenue
Recognition When Right of Return Exists."returns to be received on the current period’s sales. The Company accrues for expected future returns that relate to sales prior to the balance sheet date utilizing a combination of historical and current trends. During October 2003, the Company modified its returns policy, which previously allowed unlimited returns, by adopting a policy that limits returns to a maximum of 90ninety 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'Company’s Buyers’ Club programs for an annual fee. For memberships purchased during the following periods, certain of the Buyers’ Club programs contained a guarantee that the customer would receive discounts or savings, at least equal to the cost of his or her membership or we would refund the difference with a merchandise credit at the end of the membership period Silhouettes from July 1998 through March 2004; Domestications from April 2002 through March 2004; and Men’s Apparel from April 2003 through March 2004. In the first quarter of 2004, we identified a potential issue with the accounting treatment for Buyers’ Club memberships that contained a guarantee. At that time, an inappropriate conclusion was reached and during the third quarter of 2004, the issue was re-evaluated and we determined an error in the accounting treatment had occurred. The Company defers
revenue recognition for membership fees received in its Buyers'identified guarantee obligations to members of certain of the Company’s Buyers’ Club programs untilfor its catalogs. The impact of the cancellation period ends. Thereafter,error resulted in the overstatement of revenues and the omission of the related liability for guarantee obligations. The proper accounting treatment was applied to all periods impacted including a calculation of the cumulative impact of the error on previously reported periods. See Note 2 for further explanation and amounts. Currently, and as reflected by the restatement of the

Company’s consolidated financial statements, for memberships purchased during the periods in which the Buyers’ Club memberships contained a guarantee, revenue net of actual cancellations iswas recognized on a monthly basis over the remaining membership period subsequent to the end of the thirty-day cancellation period, with the revenue recognized equal to the lesser of the cumulative amount determined using the straight-line method or the actual benefit received by each customer as of the end of each period. The CompanyFor the Buyers’ Club memberships that did not contain a guarantee, revenue net of actual cancellations was recognized on a monthly basis over the membership period subsequent to the end of the thirty-day cancellation period, using the straight-line method. We also receivesreceive commission revenue related to itsour solicitation of the MemberWorksVertrue membership programs and Magazine Direct magazine subscription
programs. For the MemberWorks program, theThe Company is guaranteedreceives 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 commission based on the number of acceptancesmemberships sold with additional revenue recognized if certain program performance levels are attained for each fiscal year. The additional revenue is not recognized until the performance level is attained. We received using a formula that has
been contractually agreed upon bycommission revenue from the Company and MemberWorks.Magazine Direct magazine subscription program through May 2003 when the program was discontinued. The commission revenue recognized by the Company for the Magazine Direct magazine program iswas on a per-solicitation basis according to the number of solicitations made, with additional revenue recognized if the customer acceptsaccepted the solicitation. Collectively, the amount of revenues the Company recordedreceived from these sources was $5.7$10.3 million, or 1.4%2.5% of net revenues, $5.1$9.3 million, or 1.1%2.2% of net revenues, and $4.8$10.3 million, or 0.9%2.2% of net revenues for fiscal yearsin 2004, 2003 and 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'sCompany’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'sCompany’s B-to-B services were $20.8 million, or 5.2% of net revenues, $20.0 million, or 4.8% of net revenues, and $20.1 million, or 4.4% of net revenues, for 2004, 2003 and $22.2 million or 4.2% of net revenues, for
fiscal years 2003, 2002, and 2001, respectively.

     Fair Value of 
— Financial Instruments -- Instruments: The carrying amounts for cash and cash equivalents, accounts receivable, accounts payable, short- and long-term debt (including the short-term debtWachovia Facility and excluding the Chelsey Facility) and capital lease obligations approximate fair value due to the short maturities of these instruments. Additionally,The carrying amounts for long-term debt related to the currentChelsey Facility are net of the remaining un-accreted debt discount of $11.8 million. The fair value of the 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
measurerelated to the most directly comparable GAAP financial measure. The Company
became subjectChelsey Facility is approximately equal to Regulation G in fiscal 2003 and believes that itthe gross amount outstanding under the facility of $20.0 million since the interest rate on this loan is in
compliance witha floating rate of 5.0% above the new disclosure requirements.

     prime rate publicly announced by Wachovia.
In May 2003, the FASB issued SFAS No. 150, "Accounting“Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity"
("Equity” (“SFAS 150"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.Consolidated Balance Sheet. The provisions of SFAS 150 arewere effective for financial instruments entered into or modified after May 31, 2003, and otherwise iswere 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 bywhich resulted in the requirement to reclassifyreclassification of its Series B Participating Preferred Stock as(“Series B Preferred”) to a liability as opposed torather than between the liabilities and equity sections of the consolidated balance sheet.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 accretionsubsequent increases in liquidation preference of the preferred stock balanceSeries B Preferred as an increase in Total Liabilities with a corresponding reduction in capital in excess of par value, because the Company has an accumulated deficit. Such accretion has beenAccretion was 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.expense. 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'sCompany’s classification of the instrument prior to June 29, 2003. On November 30, 2003, the Company and Chelsey consummated the transactions contemplated by a Recapitalization Agreement, dated as of November 18, 2003 under which the Company recapitalized, completed the reconstitution of its Board of Directors and outstanding litigation between the Company and Chelsey was settled (the “Recapitalization”). As part of the Recapitalization, the Company exchanged the Series B Preferred for Series C Preferred Stock, which was recorded at its maximum amount of the liquidation preference. Therefore, there have been no preferred stock dividends recorded since November 30, 2003. See Note 8 for additional information regarding the Recapitalization.
New Accounting Pronouncements
On March 31, 2004, the Financial Accounting Standards Board (“FASB”) issued Emerging Issues Task Force Issue No. 03-6 (“EITF 03-6”), “Participating Securities and the Two-Class Method under FASB Statement No.

128.” SFAS 128 defines earnings per share (“EPS”) as “the amount of earnings attributable to each share of common stock” and indicates that the objective of EPS is to measure the performance of an entity over the reporting period. SFAS 128 addresses conditions under which a participating security requires the use of the two-class method of computing EPS. The two-class method is an earnings allocation formula that treats a participating security as having rights to earnings that otherwise would have been available to common shareholders, but does not require the presentation of basic and diluted EPS for securities other than common stock. The Company’s Series C Preferred is a participating security and, therefore, we calculate EPS utilizing the two-class method, however, have chosen not to present basic and diluted EPS for its preferred stock.
In addition, thereNovember 2004, the FASB issued SFAS No. 151, “Inventory Costs, an Amendment of ARB No. 43, Chapter 4” (“SFAS 151”), which clarifies the accounting for abnormal amounts of idle facility expense, freight, handling costs and spoilage. We are required to adopt the provisions of SFAS 151 effective January 1, 2006; however, early adoption is no cumulative effectpermitted. We are currently in the process of determining the impact of the adoption of this Statement on our financial statements.
In December 2004, the FASB issued SFAS No. 123R, “Share Based Payment” (“SFAS 123R”). SFAS 123R requires measurement and recording of compensation expense for all employee share-based compensation awards using a fair value method. The Company currently accounts for its stock-based compensation to employees using the fair value-based methodology under SFAS 123. We are currently assessing the impact of the adoption of this Statement.
In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections” (“SFAS 154”), which changes the requirements for the accounting for and reporting of a change in accounting principleprinciple. We are required to adopt the provisions of SFAS 154 effective January 1, 2006; however, early adoption is permitted. The Company is currently assessing the impact of the adoption of this Statement.
2. RESTATEMENT OF FINANCIAL STATEMENTS AND OTHER RELATED MATTERS
We have restated the consolidated financial statements for the fiscal years ended December 27, 2003 and December 28, 2002 in this Annual Report on Form 10-K. We have also restated the quarterly financial information for fiscal 2003 and the first two quarters of fiscal 2004 (collectively, the “Restatement”).
Buyers’ Club Program. In the first quarter of 2004, former management identified a potential issue with the accounting treatment of discount obligations due to members of certain of the Company’s buyers’ club programs, and at that time, an inappropriate conclusion regarding the accounting treatment was reached. During the third quarter of 2004, the issue was re-evaluated and we determined that an error in the accounting treatment had occurred. The impact of the error resulted in the overstatement of revenues and the omission of a liability related to the guarantee for discount obligations. The proper accounting treatment has been applied to all periods impacted including a calculation of the cumulative impact of the error on previously reported periods.
Revenue Recognition Issues. During the second quarter of 2004, the Company identified a revenue recognition cut-off issue that resulted in revenue being recorded in advance of the actual shipment of merchandise to the customer. The practice was stopped immediately. Subsequently, the Company determined that revenue should be recognized when merchandise is received by the customer rather than when shipped because the Company routinely replaces customer merchandise damaged or lost in transit as a customer service matter (even though risk of loss, as a legal matter, passes on shipment). As a consequence, the Company has restated all periods presented to recognize revenue when merchandise is received by the customer.
Kaul Accrual. During the year ended December 30, 2000, the Company estimated its liability related to Rakesh Kaul’s claims regarding benefits to which he was entitled as a result of his resignation as CEO on December 5, 2000. The accompanying consolidated financial statements contain a restatement related to the Kaul reserve that corrects two errors in the accounting treatment of the reserve. The first error identified was the premature reversal of the reserve in the fourth quarter of 2003 based upon the summary judgment decision in January 2004. As noted above, because this decision could be, and subsequently was, appealed, management has determined that the reversal was premature. The second error identified was the accounting for legal fees associated with litigating this claim. Due to the fact that the Kaul reserve was recorded prior to the initiation of litigation, the Company has determined that the appropriate basis of accounting for the legal fees related to the litigation would have been to

treat such fees as period costs and, therefore, expensed as incurred. However, the Company had inappropriately recorded certain of these fees against the reserve as opposed to recording them as an expense in the income statement. As of December 25, 2004, the Company had accrued $4.5 million related to this matter. This accrual remained on the Company’s Consolidated Balance Sheet until the third quarter of 2005 when Kaul’s rights to pursue this claim expired.
Customer Prepayments and Credits. Starting in fiscal 2001, the Company inappropriately reduced the liability for certain customer prepayments and credits. The impact of the inappropriate reduction of this liability resulted in the understatement of general and administrative expenses and the omission of the related liability. During the fourth quarter of 2004, the Company re-evaluated the accounting treatment for these customer prepayments and credits. As a consequence, the Company has applied the proper accounting treatment to all periods impacted including recording a liability in each respective previously reported period equivalent to the cumulative impact of the error.
Other Accruals. The Company has recorded other liabilities relating primarily to certain miscellaneous catalog costs and other miscellaneous costs that were inappropriately not accrued in the appropriate periods.
The summary of the effects of the Restatement, inclusive of any tax implications, on the Company’s annual consolidated financial statements is as follows:
 
 
Year ended December 27, 2003
 
 
 
As
Previously Reported
 
Buyers’ Club Adjustment
 
Revenue Recognition Adjustments
 
Kaul
Accrual
Adjustment
Customer Prepayments and Credit Adjustments
 
Other
Accrual
Adjustments
 
 
 
As Restated
 
 
 
 
(In thousands, except per share amounts)
Inventories
 
$      41,576
--
1,230
--
--
--
$        42,806
Prepaid catalog costs
 
$      11,808
--
677
--
--
--
$        12,485
Other current assets
 
$        3,951
--
288
--
--
--
$          4,239
Total current assets
 
$      73,952
--
2,195
--
--
--
$        76,147
Deferred tax asset
 
$        1,453
--
316
--
--
--
$          1,769
Accounts payable
 
$      41,880
--
--
--
--
862
$        42,742
Accrued liabilities
 
$      12,918
--
(184)
4,354
--
--
$        17,088
Customer prepayments and credits
 
$        5,485
1,897
3,230
--
867
--
$        11,479
Deferred tax liability
 
$        1,453
--
316
--
--
--
$          1,769
Total current liabilities
 
$      75,204
1,897
3,362
4,354
867
862
$        86,546
Accumulated deficit
 
$ ( 494,791)
(1,897)
(851)
(4,354)
(867)
(862)
$    (503,622)
Total shareholders’ deficiency
 
$    (47,508)
(1,897)
(851)
(4,354)
(867)
(862)
$      (56,339)
Net revenues
 
$    414,874
(899)
308
--
--
--
$      414,283
Cost of sales and operating expenses
 
$    261,118
--
179
--
--
--
$      261,297
Selling expenses
 
$      99,543
--
150
--
--
278
$        99,971
General and administrative expenses
 
$      42,080
--
4
3,297
114
48
$        45,543
Income before interest and income taxes
 
$        8,017
(899)
(25)
(3,297)
(114)
(326)
$          3,356
Net loss and comprehensive loss
 
$    (15,399)
(899)
(25)
(3,297)
(114)
(326)
$      (20,060)
Net loss applicable to common shareholders
 
$    (23,321)
(899)
(25)
(3,297)
(114)
(326)
$      (27,982)
Net loss per share-basic and diluted
 
$       (1.62)
(0.06)
(0.00)
(0.23)
(0.01)
(0.02)
$         (1.94)

 
 
Year ended December 28, 2002
 
 
 
As
Previously Reported
 
Buyers’ Club Adjustment
 
Revenue Recognition Adjustments
 
Kaul
Accrual
Adjustment
Customer Prepayments and Credit Adjustments
 
Other
Accrual
Adjustments
 
 
 
As Restated
 
 
 
 
(In thousands, except per share amounts)
Accumulated deficit
 
$   (486,627)
(998)
(826)
(1,057)
(753)
(536)
$      (490,797)
Total shareholders’ deficiency
 
$     (58,841)
(998)
(826)
(1,057)
(753)
(536)
$        (63,011)
Net revenues
 
$      457,644
(306)
(348)
--
--
--
$        456,990
Cost of sales and operating expenses
 
$      290,531
--
(148)
--
--
--
$        290,383
Selling expenses
 
$      105,239
--
(86)
--
--
295
$        105,448
General and administrative expenses
 
$       52,258
--
(4)
777
261
30
$          53,322
Income (loss) before interest and income taxes
 
$           138
(306)
(110)
(777)
(261)
(325)
$         (1,641)
Net loss and comprehensive loss
 
$       (9,130)
(306)
(110)
(777)
(261)
(325)
$        (10,909)
Net loss applicable to common shareholders
 
$     (24,686)
(306)
(110)
(777)
(261)
(325)
$        (26,465)
Net loss per share-basic and diluted
 
$        (1.79)
(0.02)
(0.01)
(0.05)
(0.02)
(0.02)
$           (1.91)
 
 
Year ended December 29, 2001
 
 
 
As
Previously Reported
 
Buyers’ Club Adjustment
 
Revenue Recognition Adjustments
 
Kaul
Accrual
Adjustment
Customer Prepayments and Credit Adjustments
 
Other
Accrual
Adjustments
 
 
 
As Restated
 
 
 
 
(In thousands)
Accumulated deficit
 
$    (477,497)
(692)
(716)
(280)
(492)
(211)
$    (479,888)
Total shareholders’ deficiency
 
$      (35,728)
(692)
(716)
(280)
(492)
(211)
$      (38,119)
The Restatement did not result in a change to the Company’s cash flows during the restated periods.
As further discussed below in Note 18, as a result of the implementation of SFAS 150. As of December 27,
2003,Restatement, 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 classificationAudit Committee 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,Board of Directors hired independent outside counsel to assist with an investigation of certain of the matters relating to the restatements of the Company’s consolidated financial statements and other accounting-related matters. The Securities and Exchange Commission (“SEC”) also informed the Company sold the following businesses and assets:

     Sale of the Improvements Business.  On June 29, 2001,that it was conducting an informal inquiry.
3. DIVIDEND RESTRICTIONS
The Company is restricted from paying dividends on its Common Stock or from acquiring its Common Stock by covenants contained in loan agreements to which the Company sold
certain assets and liabilities of its Improvements business to HSN,is 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.

     party.
4. DIVESTITURES
On March 27, 2003, the Company and HSN, a division of USA Networks, Inc.’s Interactive Group and purchaser of certain assets and liabilities of the Company’s Improvements business on June 29, 2001, amended the asset purchase agreement to provide for the release of the remaining $2.0 million balance of the escrow fund and to terminate the escrow agreement. The asset purchase agreement had provided that if the Company’s subsidiary, Keystone Internet Services LLC (“Keystone”) failed to perform its obligations during the first two years of the services contract, HSN could receive a reduction in the original purchase price of up to $2.0 million. By agreeing to the terms of the amendment, HSN forfeited its ability to receive a reduction in the original purchase price of up to $2.0 million if Keystone Internet Services failed to
perform its obligations during the first two years of the services contract.price. 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.2003. 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.  
5. SPECIAL CHARGES
2004 Plan
On May 3, 2001, as partJune 30, 2004 the Company announced its plan to consolidate the operations of the Company's
strategic business realignment program,LaCrosse, Wisconsin fulfillment center and storage facility into the Roanoke, Virginia fulfillment center by June 30, 2005. The LaCrosse fulfillment center and storage facility were closed in June 2005 and August 2005 upon the expiration of their respective leases. The plan to consolidate operations was prompted by excess capacity at the Roanoke facility and the lack of sufficient warehouse space in the leased Wisconsin facilities to support the growth of The Company sold its fulfillment
warehouse in Hanover, Pennsylvania (the "Kindig Lane Property")Store and certain
equipment located therein for $4.7 million to an unrelated third party.
Substantially allreduce the overall cost structure of the net proceedsCompany. The Company substantially completed the consolidation 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 atVirginia fulfillment center by the end of each term unless canceledJune 2005. The Company has incurred approximately $0.6 million in facility exit costs through June 25, 2005. The Company accrued $0.5 million in severance and related costs during 2004 associated with the LaCrosse operations and the elimination of 149 full and part-time positions, of which 96 employees will be provided severance benefits by the member. Effective December 1999,Company. Since the consolidation of our fulfillment centers, our Roanoke fulfillment center has experienced lower productivity that has negatively impacted fulfillment costs and the Company’s overall performance.
On November 9, 2004, the Company solddecided to relocate its interestInternational Male and Undergear catalog operations to its offices in New Jersey. The Shopper's Edge subsidiaryCompany completed the relocation on February 28, 2005. The relocation was done primarily to an unaffiliated
third party for a nominal fair value based upon an independent appraisal. In
January 2000,consolidate operations, reduce costs, and leverage its catalog expertise in New Jersey. The Company accrued $0.9 million in severance and related costs during the fourth quarter associated with the elimination of 32 California-based full-time equivalent positions. Since the relocation and consolidation of the Men’s apparel catalogs, the transition has negatively impacted the performance of the Men’s apparel catalogs in 2005.
Pursuant to and in conjunction with the above actions to reduce overhead costs, the Company entered into a solicitation services agreement,
effectively amendingeliminated an additional 15 full-time positions Company-wide, for which the Company accrued $0.3 million in severance and restatingrelated costs during 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 millionfourth quarter of fee revenue for fiscal
years 2002 and 2001, respectively, for solicitation services provided.

3.  SPECIAL CHARGES

     2004.
2000 Plan
In December 2000, the Company began a strategic business realignment program that resulted in the recording of special charges for severance, facility exit costs and fixed asset write-offs. 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'sCompany’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'sCompany’s closed 497,200746,000 square foot warehouse and telemarketing facility located in Maumelle, Arkansas. The agreement provided for the payment by the Company to the sublandlord of $1.6
million plus taxes through April 30, 2002 in the amount of $0.2$1.8 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'sCompany’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$4.4 million. These charges consisted primarilyof $1.8 million of severance costs related to the elimination of an
additional 10 FTE positionsCompany’s strategic business realignment program, 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. divisions. The remaining $1.2$1.3 million consisted primarily of a $0.4 million credit reflecting the reduction of the deferred rental liabilities applicable to the portions of the facilities previously included in the Company'sCompany’s strategic business realignment program, and a $1.6$1.7 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$1.3 million primarily offor additional severance costs

associated with the Company'sCompany’s strategic business realignment program. During the
second, third,program 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 Gump’s office facilitiesfacility in San Francisco, California. Increased
anticipated losses on sublease arrangements for the San Francisco office space
resulted fromCalifornia, as a result of the loss of a subtenant, coupled with declining market values in that area of the country.

                                        56


           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     
During 2004, special charge credits were recorded in the amount of $0.1 million. These credits consisted principally of reductions of estimated losses on the sublease arrangements for the office facility in San Francisco due to the acquisition of additional subtenants for the vacant space.
Plan Summary
At December 27, 2003 and December 28, 2002, liabilities25, 2004, a current liability of $2.4approximately $2.5 million and
$3.3 million, respectively, werewas included within Accrued Liabilities and liabilitiesa long-term liability of $3.4approximately $2.4 million and $4.7 million, respectively, werewas included within Other Non-Current Liabilities. These liabilities relateLiabilities relating to future payments in connection with the Company's strategic business realignment programCompany’s 2000 and 2004 plans. They are expected to be satisfied no later than February 2010 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
 
 
Severance &
Personnel
Costs
 
Real Estate
Lease &
Exit Costs
 
Information Technology Leases
 
 
 
 
 
 
 
2004 Plan
2000 Plan
 
2000 Plan
 
2000 Plan
 
Total
 
 
 
 
 
 
 
 
 
 
Balance at December 29, 2001
 
$              --
$       2,546
 
$          8,137
 
$             373
 
$        11,056
2002 expenses
 
--
1,817
 
2,952
 
--
 
4,769
Paid in 2002
 
--
(2,911)
 
(4,672)
 
(210)
 
(7,793)
 
 
 
 
 
Balance at December 28, 2002
 
$              --
$       1,452
 
$          6,417
 
$             163
 
$          8,032
2003 expenses
 
--
291
 
1,013
 
--
 
1,304
Paid in 2003
 
--
(1,538)
 
(1,841)
 
(163)
 
(3,542)
 
 
 
 
 
Balance at December 27, 2003
 
$              --
$          205
 
$          5,589
 
$                --
 
$          5,794
2004 expenses
 
1,664
--
 
--
 
--
 
1,664
2004 revisions of previous estimate
 
--
(31)
 
(97)
 
--
 
(128)
Paid in 2004
 
(146)
(174)
 
(2,132)
 
--
 
(2,452)
 
 
 
 
 
Balance at December 25, 2004
 
$       1,518
$              --
 
$          3,360
 
$                --
 
$          4,878
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
The following is a summary of the liability related to Real Estate Leasereal estate lease and Exit Costs,exit costs, by location, as of the end ofDecember 25, 2004 and December 27, 2003 and 2002, is as followsincludes lease and exit costs related to the Gump’s operations that were sold on March 14, 2005 (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.
 
 
 
December 25,
2004
 
 
December 27,
2003
 
 
 
 
 
 
 
 
Gump’s facility, San Francisco, CA
 
$              2,885
 
$            3,788
Corporate facility, Weehawken, NJ
 
386
 
1,447
Corporate facility, Edgewater, NJ
 
68
 
261
Administrative and telemarketing facility, San Diego, CA
 
21
 
93
 
 
 
Total Real Estate Lease and Exit Costs
 
$             3,360
 
$             5,589
 
 
 

6. 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.
 
 
December 25,
2004
 
 
December 27,
2003
As Restated
 
 
Special charges
$        2,460
 
$         2,362
Reserve for future sales returns
1,985
 
1,981
Compensation and benefits
5,670
 
4,341
Income and other taxes
470
 
258
Litigation and other related accruals
5,023
 
4,554
Other
4,927
 
3,592
 
 
Total
$      20,535
 
$       17,088
 
 
7. DEBT
The Company has two credit facilities: a senior secured credit facility (the “Wachovia Facility”) provided by Wachovia National Bank, as successor by merger to Congress Financial Corporation (“Wachovia”) and a $20.0 million junior secured facility (the “Chelsey Facility”), provided by Chelsey Finance, LLC (“Chelsey Finance”), of which the entire $20.0 million was borrowed by the Company. Chelsey Finance is an affiliate of Chelsey, the Company’s principal shareholder.
Debt consists of the following (in thousands):

                                                                             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
 
 
December 25,
 
December 27,
 
 
2004
 
2003
 
 
 
Wachovia facility:
 
 
 
 
Tranche A term loans – Current portion, interest rate of 5.5% in 2004 and 4.75% in 2003
 
$       1,992
 
$         1,992
Tranche B term loan – Current portion, interest rate of 13.0% in 2003
 
--
 
1,800
Revolver, interest rate of 5.5% in 2004 and 4.5% in 2003
 
14,408
 
8,997
Capital lease obligations – Current portion
 
290
 
679
 
 
 
Short-term debt
 
$     16,690
 
$       13,468
 
 
 
 
 
Wachovia facility:
 
 
 
 
Tranche A term loans – interest rate of 5.5% in 2004 and 4.75% in 2003
 
$       2,985
 
$         4,478
Tranche B term loan – interest rate of 13.0% in 2003
 
--
 
4,211
Chelsey facility – stated interest rate of 10.0% (5.0% above prime rate) in 2004
 
8,159
 
--
Capital lease obligations
 
52
 
353
 
 
 
Long-term debt
 
$     11,196
 
$         9,042
 
 
 
Total debt
 
$     27,886
 
$       22,510
 
 
 
Wachovia Facility -- 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,
Wachovia and the Company are parties to a Loan and Security Agreement dated November 14, 1995 (as amended by the First through Thirty-Fourth Amendments, the “Wachovia Loan Agreement”) pursuant to which Wachovia provided the Company with the Wachovia Facility which has included, since inception, one or more term loans and a revolving credit facility (“Revolver”). The Wachovia Facility expires on July 8, 2007.
Prior to the Chelsey Facility, there were two term loans outstanding, Tranche A and Tranche B, under the Wachovia Facility. The Tranche B term loan had a principal balance of approximately $4.9 million and bore interest at 13.0% when the Company used a portion of the proceeds of the Chelsey Facility to repay this loan on July 8, 2004. The Tranche A term loan had a principal balance of approximately $5.0 million as of December 25, 2004, of which approximately $2.0 million is required to maintainclassified as short term and approximately $3.0 million is classified as long term on the Consolidated Balance Sheet. The Tranche A term loan bears interest at 0.5% over the Wachovia prime

rate and requires monthly principal payments of excessapproximately $166,000.
The Revolver has a maximum loan limit of $34.5 million, subject to inventory and accounts receivable sublimits that limit the credit availability at all times.available to the Company’s subsidiaries, which are borrowers under the Revolver. The Congress Creditinterest rate on the Revolver is currently 0.5% over the Wachovia prime rate. As of December 25, 2004, the interest rate on the Revolver was 5.5%.
The Wachovia Facility is secured by substantially all of the assets of the Company and places restrictions oncontains certain restrictive covenants, including a restriction against the incurrence of additional indebtedness and on the payment of common stockCommon Stock dividends. AsIn addition, all of December 27,
2003, the revolvingreal estate owned by the Company is subject to a mortgage in favor of Wachovia and a second mortgage in favor of Chelsey Finance. The Wachovia Loan Agreement contains affirmative and negative covenants typical for loan facilityagreements for asset-based lending of $9.0 millionthis type including financial covenants requiring the Company to maintain specified levels of Consolidated Net Worth, Consolidated Working Capital and EBITDA, as those terms are defined in the Wachovia Loan Agreement.
Due to, among other things, the Restatement which resulted in the Company violating several financial covenants and the Company’s inability to timely file its periodic reports with the SEC, the Company was recognized as a current
liability onin technical default under the Company's Consolidated Balance Sheet. Wachovia and Chelsey Facilities. The Company has obtained waivers from both Wachovia and Chelsey Finance for such defaults.
2004 Amendments to Wachovia Loan Agreement
On or before April 30,March 25, 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 CompanyWachovia amended the Congress Credit Facility to amendWachovia Loan Agreement, which adjusted 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 definitionlevels 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,Consolidated Working Capital that the Company amended the Congress Credit Facilityhad to extend
the expiration thereof frommaintain during each month commencing 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
amendand amended the EBITDA covenant to specify minimum levels of EBITDA that must be
achievedthe Company had to achieve on a quarterly basis 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“Event of Default"Default” was amended by replacing thechanging an Event of Default which would have occurred onfrom the occurrence of a material adverse change in the business, assets, liabilities or condition of the Company and its subsidiaries with an Eventto the occurrence of Default which would occur if certain specific events such as a decrease in consolidated net revenues beyond certain specified levels or aging of inventory or accounts payable beyond certain specified levels, werelevels.
Concurrent with the closing of the Chelsey Facility on July 8, 2004, the Company and Wachovia amended the Wachovia Loan Agreement in several respects including: (1) releasing certain existing availability reserves and removing the excess loan availability covenant that increased the Company’s availability by approximately $10.0 million, (2) reducing the amount of the maximum credit, the revolving loan limit and the inventory and accounts sublimits of the borrowers, and (3) permitting Chelsey Finance to occur.

     have a junior secured lien on the Company’s assets. In addition, Wachovia consented to (a) the Company’s issuance to Chelsey Finance of the Common Stock Warrant and the Common Stock as described below, (b) the proposed reverse stock split of the Common Stock and the Company making cash payments to repurchase fractional shares, (c) certain amendments to the Company’s Certificate of Incorporation, and (d) the issuance by the Company of Common Stock to Chelsey as payment of a waiver fee. The Company paid Wachovia a $400,000 fee in connection with this amendment. This fee was recorded as a deferred charge on the Company’s Consolidated Balance Sheets and is being amortized over the three-year term of the amended Wachovia Facility.
2005 Amendments to Wachovia Loan Agreement
On March 11, 2005, Wachovia consented to the sale of Gump’s and Gump’s By Mail (collectively “Gump’s”). On March 11, 2005 the Wachovia Loan Agreement was amended to temporarily increase the amount of letters of credits that the Company could issue from $10.0 million to $13.0 million through June 30, 2005. The Company paid Wachovia a $25,000 fee in connection with this amendment.
On July 29, 2005 the Company and Wachovia amended the Wachovia Loan Agreement to provide the terms under which the Company could enter into the World Financial Network National Bank (“WFNNB”) Credit Card Agreement which, among other things, prohibits the use of the proceeds of the Wachovia Facility to repurchase private label and co-brand accounts created under the WFNNB Credit Card Agreement should the Company become obligated to do so, prohibits the Company from terminating the WFNNB Credit Card Agreement without Wachovia’s consent and restricts the Company from borrowing on receivables generated under the WFNNB Credit

Card Agreement. The amendment also waives enumerated defaults, resets the financial covenants, reallocates the availability that was previously allocated to Gump’s among other Company subsidiaries and, retroactive to June 30, 2005, increases the amount of letter of credits that the Company can issue to $15.0 million. The Company paid Wachovia a $60,000 fee in connection with this amendment.
On July 29, 2005 the Company and Chelsey Finance entered into a similar amendment of the Chelsey Facility.
Based on the provisions of EITF 95-22, “Balance Sheet Classification of Borrowings Outstanding under Revolving Credit Agreements that Include Both a Subjective Acceleration Clause and a Lock-Box Arrangement,” and certain provisions in the credit
agreement,Wachovia Loan Agreement, the Company is required to classify its revolving loan facilitythe Revolver as short-term debt.

     Achievement
Remaining availability under the Wachovia Facility as of December 25, 2004 was $14.0 million.
Chelsey Facility
On July 8, 2004, the Company closed on the Chelsey Facility, a $20.0 million junior secured credit facility with Chelsey Finance that was recorded net of a debt discount, at $7.1 million at issuance. The Chelsey Facility has a three-year term, subject to earlier maturity upon the occurrence of a change in control or sale of the Company's strategic business realignment programCompany (as defined), and carries a stated interest rate of 5.0% above the prime rate publicly announced by Wachovia. The financial and non-financial covenants contained in the Chelsey Facility mirror those in the Wachovia Facility except that the quantitative measures for the consolidated working capital and EBITDA covenants are 10.0% less restrictive and the consolidated net worth covenant is critical5.0% less restrictive than the comparable financial covenants in the Wachovia Facility. The Chelsey Facility is secured by a second priority lien on substantially all of the assets of the Company. As part of this transaction, Chelsey Finance entered into an intercreditor and subordination agreement with Wachovia. At December 25, 2004, the amount recorded as debt on the Consolidated Balance Sheet is $8.2 million, net of the un-accreted debt discount of $11.8 million.
Under the original terms of the Chelsey Facility, the Company was obligated to make payments of principal of up to the maintenance of adequate liquidity, as is compliance with the
terms and provisionsfull outstanding amount of the Congress CreditChelsey Facility in each quarter, provided, among other things: (1) the aggregate amount of availability under the Wachovia Facility is at least $7.0 million, (2) the cumulative EBITDA for the four fiscal quarters immediately preceding the quarter in which the payment is made is at least $14.0 million, and (3) the Company's abilityaggregate amount of principal prepayments is no more than $2.0 million in any quarter. Subsequent to operate effectively during the 2004 fiscal year. Inclosing of the Chelsey Facility, the Company and Chelsey Finance amended the Chelsey Facility to provide that the Company was not obligated to make principal payments prior to the July 8, 2007, except in the event of a softer
change in control or sale of the Company. This resulted in the recorded amount of the Chelsey Facility plus the accreted cost of the debt discount (as described below) being classified as long term on the Company’s Consolidated Balance Sheets as of December 25, 2004.
In consideration for providing the Chelsey Facility to the Company, Chelsey Finance received a closing fee of $200,000 and a warrant (the “Common Stock Warrant”) with a fair value of $12.9 million, exercisable immediately and for a period of ten years to purchase 30.0% of the fully diluted shares of Common Stock of the Company (equal to 10,259,366 shares of Common Stock) at an exercise price of $0.01 per share. The closing fee of $200,000 was recorded as a deferred charge in other assets on the Company’s Consolidated Balance Sheets and is being amortized over the three-year term of the Chelsey Facility utilizing the interest-method. Because the issuance of the Common Stock Warrant was subject to shareholder approval, the Company initially issued a warrant to Chelsey Finance to purchase newly-issued Series D Participating Preferred Stock (“Series D Preferred”) that was automatically exchanged for the Common Stock Warrant on September 23, 2004 following receipt of shareholder approval.
In connection with the closing of the Chelsey Facility, Chelsey waived its blockage rights over the issuance of senior securities and received in consideration a waiver fee equal to 1.0% of the liquidation preference of the Series C Preferred, payable in 434,476 shares of Common Stock (calculated based upon the fair market value thereof two business days prior to the closing date). The $0.6 million waiver fee was recorded as a deferred charge within other assets on the Company’s Consolidated Balance Sheets and is being amortized over the remaining redemption period of the Series C Preferred utilizing the interest-method. After consideration of the waiver fee paid in Common Stock and the change in the par value of Common Stock (see Note 9), the Company’s Common Stock increased by less

than $0.1 million and Capital in excess of par value increased by $0.6 million. Both the shares underlying the Common Stock Warrant and the shares issued in payment of the waiver fee are subject to an existing Registration Rights Agreement between the Company and Chelsey.
As part of the Chelsey Facility, the Company and its subsidiaries agreed to indemnify Chelsey Finance and its affiliates, which includes Chelsey, from any losses suffered arising out of the Chelsey Facility other than liabilities resulting from Chelsey Finance and its affiliates’ gross negligence or willful misconduct. The indemnification agreement is not limited as to term and does not include any limitations on maximum future payments thereunder.
The terms of the Chelsey Facility were approved by the Company’s Audit Committee, all of whose members are independent, and the Company’s Board of Directors.
On July 8, 2004, approximately $4.9 million of the proceeds from the Chelsey Facility were used to repay the Tranche B Term Loan with the balance used to provide ongoing working capital for the Company, which has been used to reduce outstanding payables and increase inventory. The Chelsey Facility, together with the concurrent amendment of the Wachovia Facility, increased the Company’s liquidity by approximately $25.0 million.
In accordance with Accounting Principles Board Opinion No. 14, “Accounting for Convertible Debt and Debt Issued with Stock Purchase Warrants” (“APB 14”), proceeds received from the sale of debt with detachable stock purchase warrants should be allocated to both the debt and warrants, with the portion allocable to the warrants to be accounted for as Capital in excess of par value of $7.1 million with the remaining portion classified as debt. The fair value of the Common Stock Warrant of $12.9 million was determined using the Black-Scholes option pricing model and is being treated as debt discount, which will be accreted as interest expense utilizing the interest method over the 36-month term of the Chelsey Facility. The assumptions used for the Black-Scholes option pricing model were as follows: risk-free interest rate of 4.5%, expected economic climate, managementvolatility of 80.59%, an expected life of ten years and no expected dividends. A summary of the debt relating to the Chelsey Facility is as follows (in thousands):
Amount Borrowed Under the Chelsey Facility
$    20,000
Fair Value of Common Stock Warrant (Recorded as Capital in excess of par value)
(12,939)
Accretion of Debt Discount (Recorded as Interest Expense)
1,098
Balance at December 25, 2004
$      8,159
The annual effective interest rate of the Chelsey Facility is approximately 62.7%. For the 52- weeks ended December 25, 2004, the Company has available several coursesincurred approximately $0.9 million of actioninterest expense and have made interest payments of approximately $0.8 million related 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.

     the Chelsey Facility.
General -- 
At December 27, 2003,25, 2004, the aggregate future annual principal payments required on debt instruments (including capital lease obligations) are as follows (in thousands): 2004 -- $13,468; 2005 -- $4,092;— $16,690; 2006 -- $3,840; and
thereafter -- $1,110.

6.  SERIES A CUMULATIVE PARTICIPATING— $2,039; 2007 — $20,998.
8. PREFERRED STOCK
Currently, the Company has one series of preferred stock outstanding, Series C Preferred. Chelsey holds all 564,819 outstanding shares of Series C Preferred which it acquired after a series of transactions that began with its May 19, 2003 acquisition of all of the Series B Participating Preferred Stock (“Series B Preferred”) from Richemont. The transactions leading up to Chelsey’s acquisition of the Series C Preferred and the terms of the Series C Preferred are summarized below.

Series A Cumulative Participating Preferred Stock and Series B Participating Preferred Stock
On August 24, 2000, the Company issued 1.4 million shares of preferred
stock designated asnewly created Series A Cumulative Participating Preferred Stock (“Series A Preferred”) to Richemont, the then holder of approximately 47.9% of the Company'sCompany’s Common Stock, for $70$70.0 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 theand Richemont Transaction, the Company repurchased from Richemontagreed to exchange all of the outstanding shares of the Series A Participating Preferred Stock and 74,098,7697,409,876 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 partPreferred. The effect 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
Transactionexchange was to reflect the reductionelimination of the Series A Participating Preferred
Stock for the then $82.4 million 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 Common Stock’s $0.7 million 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'shareholders’ deficiency of $5.6 million as a result of the Richemont Transaction.transaction. The shares of the Series A Participating Preferred Stock that were repurchased from Richemont represented all of the outstanding shares of such
series.Series A Preferred. 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.
Preferred.
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 toand a liquidation preference which was initially of $47.36 per share. During each period
set forthshare, increasing thereafter to a maximum of $86.85 per share 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.

     2005.
The Company was required to redeem the Series B Participating Preferred
Stock on August 23, 2005 consistent with Delaware General Corporation Law. The
Company could redeem all or less than all of the then outstanding shares of
Series B Participating Preferred Stock at any time prior to that date. 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 oflearned from filings made by Richemont and certain related parties with the SEC that on May 21,19, 2003 the Company learned that Richemont sold to Chelsey on
May 19, 2003, all of Richemont'sits securities in the Company consisting of 29,446,8882,944,688 shares of Common Stock and 1,622,111 shares of Series B Participating
Preferred Stock for a purchase price equal to $40$40.0 million. The Company was not a party to suchthe transaction and did not provide Chelsey with any material non-public information in connection with such transaction, nor did the Company'sCompany’s Board of Directors endorse the transaction. As a result of the transaction, Chelsey purportedly succeeded to Richemont'sRichemont’s rights in the Common SharesStock and the Series B Participating Preferred, Stock, including the right of
the holderrights of the Series B Participating Preferred Stockholder to a liquidation preference with respect to such shares whichthat was equal to $98,202,600approximately $98.2 million on May 19, 2003, the date of the sale of the Shares,by Richemont, and whichthat could have increased to and
capped at $146,168,422a maximum of approximately $146.2 million 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 redemption date.
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 and Chelsey consummated the transactions contemplated by thea Recapitalization Agreement, dated as of November 18, 2003 with Chelsey
andunder which the Company recapitalized, the Company completed the 63

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

reconstitution of theits Board of Directors of the Company and settled outstanding litigation between the Company and Chelsey (the "Recapitalization").

     Inwas settled. As part of the transaction,Recapitalization, the Company exchanged all of the 1,622,111 outstandingChelsey’s Series B Preferred for 564,819 shares of newly created $0.01 par value Series C Preferred and 8,185,783 shares of Common Stock. The Company filed a certificate in Delaware eliminating the Series B 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.

     Preferred.
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.members. For a period of two (2) years from the closing of the Recapitalization, five (5) of the nine (9) directors of the Company will at all timeswere to 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
timeswas to be a director of the Company designated by Regan Partners, (who initially
wasL.P. Effective July 30, 2004, Basil Regan). The rightRegan, the general partner of Regan Partners, to designate a nomineeL.P. and its designee 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 seriesresigned 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 amendmentRegan Partners, L.P. held the right to its Loan and Security Agreement with
the Company and its subsidiaries in which it consentedappoint a designee to the transactions
betweenCompany’s Board of Directors until the CompanyJanuary 10, 2005 sale of Common Stock held by Regan Partners, L.P., Regan International Fund Limited and Chelsey and received a fee of $150,000. See Note 5.

     Basil Regan to Chelsey.

Because itsthe Series B Participating Preferred Stock was mandatorily redeemable and thus accounted for as a liability pursuant to SFAS 150, the Company accounted for the exchange of the 1,622,111 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 additionalthe 8,185,783 shares of Common Stock
of the Company to Chelsey in accordance with SFAS No. 15, "Accounting“Accounting by Debtors and Creditors for Troubled Debt Restructuring."Restructurings.” As such, the $107.5 million carrying value of the Series B Participating Preferred Stock as of the consummation date of the exchange was compared with the fair value of the Common Stock of approximately $19.6 million issued to Chelsey as of the consummation date and the total maximum potential cash payments of approximately $72.7 million that could be made pursuant to the terms of the Series C Participating
Preferred Stock.Preferred. Since the carrying value, net of issuance costs of approximately $1.3 million, exceeded these amounts by approximately $13.9 million, pursuant to SFAS No. 15, such excess was determined to be a "gain"“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. SinceBecause Chelsey was a significant stockholder at the time of the exchange and, as a result, a related party, the "gain"“gain” was recorded to “Capital in equity.

                                        64

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

8.  SERIES C CUMULATIVE PARTICIPATING PREFERRED STOCK

     On November 30, 2003, as partExcess of Par Value” within “Shareholders’ Deficiency” on the Recapitalization, the Company issued
to Chelsey 564,819 shares of accompanying Consolidated Balance Sheets.
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 to 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.Preferred. In addition, in the event thatif the Company defaults on its obligations under the Certificate of Designations, the Recapitalization Agreement or the Congress CreditWachovia 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
If the Company effective through December 31, 2005,liquidates, dissolves or is wound up, 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.approximately $56.5 million based on the shares of Series C Preferred currently owned by Chelsey, plus all accrued and unpaid dividends on the Series C Preferred. As described further below, commencing January 1, 2006, dividends will be payable quarterly on the Series C Preferred at the rate of 6% per annum, but such dividends may be accrued at the Company’s option. Effective October 1, 2008 and assuming the Company has elected to accrue all dividends from January 1, 2006 through such date, the maximum aggregate amount of the liquidation preference is $72,689,337, which would occur
if the Company elects to accrueplus accrued and unpaid dividends as mentioned below.

     on the Series C Preferred will be approximately $72.7 million.
Commencing January 1, 2006, dividends will be payable quarterly on the Series C Participating Preferred Stock at the rate of 6%6.0% per annum, with the preferred dividend rate increasing by 1 1/2% per annum on each anniversary of the dividend commencement date until redeemed. At the Company'sCompany’s option, in lieu of cash dividends, the Company may instead elect to cause accrued and unpaidaccrue dividends tothat will compound at a rate equal to 1%1.0% 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 toon the Common Stock. The right to participate has anti-dilution protection. The Company's credit
agreement with CongressWachovia Loan Agreement 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"“Redemption Price”). The Series C Participating Preferred, Stock, if not redeemed earlier, must be redeemed by the Company on January 1, 2009 (the "Mandatory“Mandatory Redemption Date"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'sCompany’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 CorporationWachovia pursuant to the terms of the 19th Amendment to
theWachovia 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. PursuantAt the Company’s request, Chelsey agreed to permit the termsCompany to apply the sales proceeds from the sale of Gump’s to reduce the CertificateWachovia Facility. Chelsey retained the right to require redemption of Designationsapproximately $6.9 million (the Gump’s sales proceeds available for redemption) 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.

Wachovia’s approval.

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, 2002,25, 2004 there were 222,294,562 and 140,436,72922,426,296 shares of Common Stock issued and outstanding
(including treasury shares), respectively.outstanding. Additionally, an aggregate of 14,251,4461,318,883 and 10,259,366 shares of Common Stock were reserved for issuance pursuant to the exercise of outstanding options and common stock warrants, respectively, at December 27, 2003.

     Treasury stock consisted25, 2004. After its January 10, 2005 purchase of 2,120,929an aggregate of 3,799,735 shares of Common Stock at both
December 27, 2003formerly held by Regan Partners, L.P., Regan International Fund Limited and December 28, 2002, respectively. During fiscal year 2002,Basil Regan, which was reported in an SEC filing, Chelsey and related affiliates beneficially owned approximately 69% of the Company retained 20,000 shares ofissued and outstanding Common Stock held in escrow on
behalf of certain participants in the Company's Executive Equity Incentive Plan
whose rights, under the termsand approximately 75% of the plan,Common Stock after giving effect to the exercise of all outstanding options and warrants to purchase Common Stock beneficially owned by Chelsey. In addition, Chelsey is holder of all of the Company’s Series C Preferred. Including the Series C Preferred and outstanding options and warrants (after giving effect to the exercise of all outstanding options and warrants) beneficially owned by Chelsey, Chelsey maintains approximately 91% of the voting rights of the Company. Effective July 30, 2004, Basil Regan resigned from the Board of Directors and continued to hold the right to appoint a designee to the Company’s Board of Directors until the January 10, 2005 sale of Common Stock held by Regan Partners, L.P., Regan International Fund Limited and Basil Regan to Chelsey.
Recapitalization — On November 30, 2003 as part of the Recapitalization, the Company issued 8,185,783 shares of Common Stock to Chelsey.
Reverse Stock Split — At the 2004 Annual Meeting of Shareholders of the Company held on August 12, 2004, the Company’s shareholders approved a one-for-ten reverse stock split of the Common Stock that became effective at the close of business on September 22, 2004. The number of shares of Common Stock in these consolidated financial statements and footnotes have expired.

     been adjusted to take into account the effect of the reverse stock split.
Amendment to the Company’s Certificate of Incorporation — On September 22, 2004, the Company filed a Certificate of Amendment to the Company’s Amended and Restated Certificate of Incorporation (1) reducing the par value of the Common Stock from $0.66-2/3 to $0.01 per share and reclassifying the outstanding shares of Common Stock into such lower par value shares; (2) increasing the number of authorized shares of additional Preferred Stock from 5,000,000 shares to 15,000,000 shares and making a corresponding change to the aggregate number of authorized shares of all classes of preferred stock; and (3) after giving effect to the reverse split, increasing the authorized number of shares of Common Stock from 30,000,000 shares to 50,000,000 shares and making a corresponding change to the aggregate number of authorized shares of all classes of common stock.
Retirement of Treasury Stock — The Company approved the retirement of the Company’s 212,093 treasury shares on November 16, 2004. Pursuant to the Delaware General Corporation Law, such shares will assume the status of authorized and unissued shares of Common Stock of the Company.
Dividend Restrictions -- — The Company is restricted from paying dividends on its Common Stock or from acquiring its capitalCommon Stock under the Wachovia and Chelsey Facilities.
10. MANAGEMENT AND COMPENSATION
Chief Executive Officer
Garten Employment Agreement. On May 6, 2004, Wayne P. Garten became the Company’s Chief Executive Officer and President. Mr. Garten is employed pursuant to the terms of a May 6, 2004 Employment Agreement. Under Mr. Garten’s Employment Agreement he will be paid an annual salary of $600,000 over a term expiring on May 6, 2006. The Company also granted Mr. Garten options to acquire 200,000 shares of the Company’s common stock, by certain debt covenants
containedhalf pursuant to its 2000 Management Stock Option Plan and half outside the plan. All of the options have an exercise price of $1.95 per share, the Common Stock’s average closing price for the ten trading days preceding the grant date and the ten trading days after the grant date. One third of each of the options vested upon execution of the Employment Agreement and the balance will vest in agreementstwo equal installments over a two-year period, vesting on the anniversary of the original grant date, subject to whichearlier vesting in the event of a change in control of the Company (as that term is defined in the Employment Agreement). Mr. Garten is entitled to participate in the Company’s bonus plan for executives, as established by the Board of Directors.

The Employment Agreement provides for a party.

10.  SEGMENT REPORTING

     Inlump sum change in control payment equal to 200% of Mr. Garten’s annual salary if a change in control occurs during the term. The Employment Agreement also provides for eighteen months of severance payments if Mr. Garten is not otherwise entitled to change in control benefits and (i) is terminated without cause or terminates his employment for good reason (as both terms are defined in the Employment Agreement) during the term or (ii) his Employment Agreement is not renewed.
Shull Employment and Severance Agreement. Thomas Shull, the Company’s prior yearsChief Executive Officer, resigned from 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 Decemberon May 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 between2004. Mr. Shull and the Company executed a General Release and Separation Agreement dated effective as of May 5, 2004 which provided for the Company to pay Mr. Shull $900,000 of severance in lieu of any other benefits provided for in the Employment Agreement dated September 1, 2002, as amended by Amendment No. 1 thereto,
dated as(the “Shull Employment Agreement”). The severance was paid with a $300,000 lump sum on execution and the balance in biweekly installments that were completed in 2004. The Company also agreed to pay for eighteen months of 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"),COBRA coverage for Mr. Shull.
Prior to his resignation, Mr. Shull was employed pursuant to which Mr.the 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, 2002which provided for an $855,000 base salary and will
terminatehad term expiring on March 31, 2006 (the "2002 Employment Agreement Term").

     Under the 2002 Employment Agreement,2006. 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 describedwas a participant 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'sCompany’s Key Executive Eighteen Month Compensation Continuation Plan (the "Change“Change of Control Plan"Plan”) and its transaction bonus program. The Company is
also to reimburse Mr. Shull for his reasonable out-of-pocket expenses incurredRecapitalization was a change in connection with his employment bycontrol under the Company.

                                        66

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     Under the 2002 Employment Agreement,Change in Control Plan and therefore the Company paid the remaining unpaid
$300,000 of Mr. Shull's fiscal 2001 bonusShull $1,350,000 in 2003. The Company also paid Mr. Shull $450,000 under the Company's 2001 Management
Incentive Plantransaction bonus program in December 2002.2003. Mr. Shull also received $450,000 in 2002 related to the sameterms of his agreement.
Chief Operating Officer
Michael Contino, the Company’s Executive Vice President and Chief Operating Officer, is employed pursuant to a October 29, 2002 letter agreement. Under the letter agreement, Mr. Contino is to receive an annual salary of $387,000 and is entitled to participate in the Company’s bonus amountplan for fiscal 2002executives, as established by the Board of Directors. Mr. Contino was awarded options to purchase 100,000 shares under the Company's 20022000 Management Incentive Plan as allStock Option Plan. Under the agreement, if Mr. Contino is terminated other Level 8 participantsthan “for cause” or terminates his employment for “good reason” (as those terms are defined in such plan) received under suchthe agreement), he is entitled to eighteen months of severance pay and health benefits. Mr. Contino was a participant in the Company’s 18 month change in control plan for such
period, subjectand was entitled to alla Transaction Bonus equal to half of his base salary on a change in control. Mr. Contino was paid the terms and conditions applicable generally to Level
8 participants thereunder. Mr. Shull earned an annual bonus for fiscal 2003
underTransaction Bonus following 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 approveRecapitalization in a manner consistent with bonuses awarded to other
senior executives under such plan.

     Under the 2002 Employment Agreement,2003. In addition, in January 1998, the Company made two installment
payments in September and November 2002 to satisfy the obligation of $450,000a $75,000 non interest-bearing loan to Mr. Shull previously dueContino for the purchase by Mr. Contino of a new principal residence. The terms of the loan agreement, as amended, included a provision for the Company to forgive the original amount of the loan on the fifth anniversary of the loan. The Company forgave the loan in accordance with its terms in January 2003 and paid the applicable withholding taxes of $64,063.
Chief Financial Officer
On April 4, 2005 John W. Swatek joined the Company as its Senior Vice President, Chief Financial Officer and Treasurer. Mr. Swatek will report directly to the Company’s Chief Executive Officer. Under the March 15, 2005 Employment Agreement between the Company and Mr. Swatek, Mr. Swatek will be paid an annual salary of $270,000 and has been granted options to Meridian on June 30, 2002. In addition,acquire 50,000 shares of the Company agreedCompany’s common stock pursuant to make two equal lump sum cash paymentsits 2000 Management Stock Option Plan. All of $225,000 each to
Mr. Shull on March 31, 2003the options have an exercise price of $0.81 per share, the Common Stock’s average closing price for the ten trading days preceding the grant date and September 30, 2004, provided the 2002 Employment
Agreement has not terminated due to Willful Misconduct (as defined inten trading days after 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 terminationgrant date. One third of the options vested upon execution of the Employment Agreement and the balance will vest in two equal annual installments over the next two years on orthe anniversary of the original grant date, subject to earlier vesting in the event of a change in control of the Company (as that term is defined in the Employment Agreement). Mr. Swatek will be entitled to participate in the Company’s bonus plan for executives. The Employment Agreement expires on May 6, 2006 and provides for a sign-on bonus of up to $25,000 to the extent his bonus from his prior to such date oremployer was reduced as a result of another event constituting a Change of Control.his decision to join the Company. The March 31, 2003
payment was made on or prior to such date. The Recapitalization constituted a
"change of control"Company paid Mr. Swatek $17,208 under the 2002this provision.
The 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 makeprovides for a lump sum cashchange in control payment equal to Mr. Shull onSwatek’s annual salary if his employment is terminated due to a change in control during the dateterm 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 2002agreement. The Employment Agreement as a resultalso provides for one year of a termination thereof uponseverance payments if Mr. Swatek is not otherwise entitled to

change in control benefits and (i) is terminated without cause or terminates his employment for good reason (as both terms are defined in the first day after the
acquisition of the Company (whether by mergerEmployment Agreement) 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 throughif his agreement is not renewed at 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 hasterm.
Charles E. Blue had 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 acquisitionappointed Chief Financial Officer of the Company (whether by merger oreffective November 11, 2003, replacing Edward M. Lambert. Mr. Blue joined 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 deemedCompany in 1999 and prior 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,his appointment had most recently served as Senior Vice President, Finance. Mr. Shull shall be
entitledLambert continued 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
acquisitionserve as Executive Vice President 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)until his January 2, 2004 resignation. Mr. Lambert 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 optionseverance agreement with Thomas C. Shull to
evidencedated November 4, 2003 providing for payments of $640,000, as well as other benefits that were accrued and paid in the grant tofourth quarter of 2003. Mr. ShullLambert received a payment of an option to purchase 2.7 million shares of$72,512 under the Company's common stock (the "Shull 2000 Stock Option Agreement"). Effective
as of September 1, 2002,Company’s 2003 Management Incentive Plan.
Mr. Blue’s employment with 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,was terminated effective March 8, 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 intoreported in a stock option agreement
withCurrent Report on Form 8-K that he had resigned voluntarily. The Company and Mr. ShullBlue were unable to evidenceagree on the grant to Mr. Shullterms 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,his voluntary resignation and the Company has amendednotified Mr. Blue that his employment had been terminated for cause.
General Counsel
On January 31, 2005, 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,Company appointed Daniel J. Barsky as its Senior Vice President 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 intoGeneral Counsel. Under a letter agreement with the Company, (the "Shull
Transaction Bonus Letter") under which he wouldMr. Barsky will be paid a bonus on the
occurrencean annual salary 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,$265,000 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 issuedgranted options to purchase 3,750,00050,000 shares of Common Stock. One third of the Company's Common Stockoptions vested on February 17, 2005 and the balance will vest in two equal annual installments over the next two years on the anniversary of the original grant date, subject to certain Management
Incentive Plan ("MIP") Level 7 and 8 employees, including various executive
officers, atearlier vesting in the event of a change in control of the Company. All of the options have an exercise price of $0.24$1.03 per share, the Common Stock’s average closing price for the ten trading days preceding the grant date and services rendered under the Company's 2000 Management Stock Option Plan. In addition,ten trading days after the grant date. Mr. Barsky will be entitled to participate in the Company’s bonus plan for executives. The agreement also provides for six months of severance payments if Mr. Barsky is terminated without cause or terminates his employment for good reason. Mr. Barsky was appointed as the Company’s Secretary on August 8, 2002, the
Company authorized the President to grant options to purchase up to an aggregate
of 1,045,000March 7, 2005.
Other Severance 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.

     Compensation Related Agreements
Charles F. Messina. During September 2002, Charles F. Messina resigned as Executive Vice President, Chief Administrative Officer and Secretary of the Company. In connection with suchhis resignation, the Company and Mr. Messina entered into a severance agreement dated September 30, 2002 severance agreement 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 ofEffective February 15, 2004, the Company effective
December 2, 2002 andeliminated Mr. Harriss’ position 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,part of its ongoing strategic business realignment program. 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 $545,000payments of cash payments,$545,000, as well as other benefits that were accrued and paid in the first quarter of 2004. Mr. Harriss is also entitled to receivereceived a payment of $61,091 under the Company'sCompany’s 2003 Management Incentive Plan.

     Chief Financial Officer.  On November 3, 2003, Charles E. Blue was
appointed Chief Financial Officer of
William C. Kingsford. William C. Kingsford, the Company’s Senior Vice President Treasury and Control (Corporate Controller) resigned from 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,September 22, 2004. In connection with such change,his resignation, the Company and Mr. Lambert and
the CompanyKingsford entered into a Separation Agreement and General Release under which the Company agreed to pay him severance agreement dated November 4, 2003 providingat his then current salary of $200,000, payable over the shorter of one year following resignation or the date Mr. Kingsford secured a new job. The Company paid Mr. Kingsford one year of severance payments.
Compensation Continuation Agreements. The Company has entered into and established a number of compensation continuation agreements and programs (some of which were included in employment agreements and transaction bonus letters) for $640,000its executives and its non-employee directors. In general, the plans provided that a plan participant whose employment is terminated other than for cause or for a resignation without good reason within two years of cash payments, as well as other benefits that were accrued and
paida change in the fourth quarter of 2003. Mr. Lambertcontrol is also entitled to receive a
payment underchange in control benefits. These benefits for 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") pursuantplans applicable to which it agreedemployees included payments equal 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 or six months (depending on the level of severance pay,the plan participant) of salary and COBRA reimbursementbenefits and Exec-U-Careoutplacement services.

The Board of Directors determined that the November 30, 2003 recapitalization was a change in control for purposes of the plans and that the plans would be maintained solely for persons who were plan coverage inparticipants on that date and who became eligible for plan benefits within two years thereafter. As of December 25, 2004, the event his employment withpotential maximum salary payout was $6.5 million.
During 2005 and before the Company was terminated either byNovember 30, 2005 termination of 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,plans, the Company terminated the Hanover Direct, Inc.
Key Executive Thirty-Six Month Compensation Continuation Planemployment of three plan participants but denied them benefits because the terminations had been “for cause.” A fourth plan participant resigned and sought plan benefits on the Hanover
Direct, Inc. Key Executive Twenty-Four Month Compensation Plan. Effective April
27, 2001,grounds that she had resigned for good reason. The Company denied her benefits as well. Each of the former employees has commenced an action against the Company establishedseeking post employment benefits and/or compensatory and punitive damages and legal fees. As of December 1, 2005, 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,plans were terminated and other employees selected by its
Chief Executive Officer. The purposeno further benefits were available.
In December 2003, Messrs. Shull, Harriss and Contino received payments of the Executive Plan is to attract$450,000, $168,500 and retain key management personnel by reducing uncertainty and providing greater
personal security$193,500, respectively, under their “single trigger” change 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.control plans. On December 18, 2003, each of the eight non-employee directors (Messrs. Brown, James, Krushel, Sonnenfeld, Masson, Regan, Garten and Edelman) received aan $87,000 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,No other plan participants received change 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 receivedcontrol payments in the aggregate
amount of $450,000, $168,5002003 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 thetriggered change in control benefits underin 2004 totaling $1,194,257 (excluding the Executive PlanShull Severance Agreement). Of these five, three received payments in 2004 totaling $772,257 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
namedtwo 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.

     2005 totaling $422,000.
Salary Reduction. The Company effected salary reductions of 5%5.0% of base pay for participants in its 2003 Management Incentive Plan, including Executive Officers, effective with the pay period starting August 3, 2003. These salary reductions are beingwere restored to those participants at or below the Vice-President level effectivelevels on March 28, 2004.

     Vacation2004 and Sick Policies.  During June 2003,levels above Vice-President on August 1, 2004.
Summary of Severance Costs. For the year ended December 25, 2004, the Company establishedagreed to pay termination benefits to eight director level and implemented a new Company-wide vacationabove positions (including the Shull Severance Agreement and sick policy applicablefive change in control benefits, excluding positions eliminated due to all
employees, including Executive Officers,the International Male and Undergear relocation). These costs totaled $2.6 million, of which $0.8 million was recorded during the 1st quarter of 2004, $0.9 million recorded during the 2nd quarter of 2004, $0.3 million during the third quarter of 2004 and $0.6 million in the fourth quarter of 2004. The Company recorded costs relating to better administer vacationtermination benefits for director level and sick
benefits (see Note 1above positions 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$1.5 million and Chief Operating Officer,$1.6 million 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
Directorsyears ended December 27, 2003 and the Committees thereof on which he served effective February 15,
2004.

12.December 28, 2002, respectively.
11. EMPLOYEE BENEFIT PLANS
The Company maintains severaltwo defined contribution (401-k)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.Company. The Company matches a percentage of employee contributions to the plans up to $10,000.$13,000. Matching contributions for allboth plans werewas $0.5 million $0.5 million and $0.6 million for each of the fiscal years 2004, 2003 2002 and 2001, respectively.

13.2002.
12. 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 consist382, which places an annual limit of $355.6 million of NOLs
subject to a $3.0 million annual limitation under Section 382on the utilization of the Company’s Federal income tax net operating loss (“NOLs”) carryovers and $1.3 million
of NOLs not subjectalternative minimum tax net operating loss (“AMT NOLs”) carryovers that existed prior to a limitation.the change in control date. The unused portion of the $3.0 million annual limitation for any year may be carried forward to succeeding years to increase the annual limitation for those succeeding years. In addition to the Section 382 annual limit, the utilization of AMT NOLs in any year is further limited to 90% of that year’s Federal alternative minimum taxable income. The annual Section 382 limit, discussed above, may be increased, under certain circumstances, up to the amount of net unrealized built-in gains that existed on the change in control date, which are recognized within five years of that date. The Company does not have any transactions, in the foreseeable future, that would enable it to realize any net built-in gains within the requisite period.
At December 27, 2003,
$59.525, 2004, the Company’s NOLs and AMT NOLs significantly exceeded the maximum utilizable pursuant to the above limits. The Company estimates that maximum utilizable carryforwards consist of $54.3 million of NOLs are utilizable priorand AMT NOLs, expiring between 2019 and 2023, subject to expirationa $3.0 million annual limitation under Section 382 and the remaining
$297.4$1.1 million of NOLs may expire unused.

     and $1.2 million of AMT NOLs, both expiring in 2023, not subject to such limitation.

SFAS 109 requires management to assess the realizability of the Company'sCompany’s deferred tax assets. Realization of the future tax benefits is dependent, in part, on the Company'sCompany’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)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. 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$5.5 million deferred tax asset (excluding the $3.7$5.5 million deferred tax liability), as of December 27, 2003,25, 2004, represents a "more-
likely-than-not"“more-likely-than-not” estimate of the future utilization of the NOLs and the reversal of temporary differences. The valuation allowance decreased by $1.3 million in 2004 and increased by $4.5$108.6 million in 2003 and $6.4 million in 2002.2003. Management will continue to routinely evaluate the likelihood of future profits and the necessity of future adjustments to the valuation allowance.
The Company'sCompany’s Federal income tax provision consists of $0.1 million of current income taxes for 2004, $11.3 million of deferred income tax for 2003 and $3.7 million of deferred income tax for 2002 and
zero for fiscal 2001.2002. The Company'sCompany’s current state income tax provision was $28,000 in 2004, $28,000 in 2003 and $91,000 in 20022002.
The Company has adjusted the calculation of its deferred tax assets and $120,000liabilities as of December 27, 2003 to also consider the effect of deferred state income taxes as of that date, in 2001.

     addition to calculating deferred taxes on only those NOL carryforwards that may be utilizable in the future. These adjustments resulted in a decrease of the deferred tax assets and liabilities by $0.8 million and $0.8 million, respectively, as of December 27, 2003. As the Company’s net deferred tax asset had a full valuation allowance at that date, there was no impact on the Company’s financial position, cash flows or operating results for this change.
The components of the net deferred tax asset at December 25, 2004 and December 27, 2003 are as follows (in millions):

                                                        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
 
2004
 
2003
As Restated
 
 
 
Current
Non-
Current
 
Total
 
Current
Non-
Current
 
Total
Deferred Tax Assets
Federal and state tax NOL, alternative minimum tax and business tax credit carry forwards
$    1.4
$    20.1
$    21.5
$    2.4
$    21.0
$    23.4
Allowance for doubtful accounts
0.5
—
0.5
0.4
—
0.4
Property and equipment
—
4.0
4.0
—
4.0
4.0
Mailing lists and trademarks
—
0.3
0.3
—
0.4
0.4
Accrued liabilities
4.7
—
4.7
3.2
—
3.2
Customer prepayments and credits
4.6
—
4.6
3.8
—
3.8
Deferred rent credits
0.7
1.3
2.0
1.0
1.8
2.8
 
Total
11.9
25.7
37.6
10.8
27.2
38.0
Valuation allowance
10.2
21.9
32.1
9.5
23.9
33.4
 
Deferred tax asset, net of valuation allowance
1.7
3.8
5.5
1.3
3.3
4.6
 
Deferred Tax Liabilities
Inventories
(0.3)
—
(0.3)
(0.2)
—
(0.2)
Prepaid catalog costs
(3.5)
—
(3.5)
(2.7)
—
(2.7)
Other current assets
(0.1)
—
(0.1)
(0.1)
—
(0.1)
Excess of net assets of acquired business
—
(1.5)
(1.5)
—
(1.5)
(1.5)
Other
—
(0.1)
(0.1)
(0.1)
—
(0.1)
 
Deferred tax liability
(3.9)
(1.6)
(5.5)
(3.1)
(1.5)
(4.6)
 
Net deferred tax (liability) asset
$  (2.2)
$      2.2
$      0.0
$  (1.8)
$      1.8
$      0.0
 


           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     
The Company'sCompany’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.
 
 
 
 
2004
Percent
of
Pre-tax
Income
2003
Percent of
Pre-tax
Loss
As Restated
2002
Percent of
Pre-tax
Loss
As Restated
Tax expense (benefit) at Federal statutory rate
35.0%
(35.0)%
(35.0)%
State and local taxes, net of Federal benefit
0.3
0.2
0.8
Permanent differences:
$1 million salary limit and stock option compensation
1.2
16.0
15.0
Non-deductible interest expense on Series B Preferred Stock
—
29.0
—
Other permanent differences
0.8
(1.0)
2.0
Change in valuation allowance
(33.9)
120.5
70.5
 
Tax expense at effective tax rate
3.4 %
129.7%
53.3%
 
13. LEASES

     Certain leases to which the
The Company is a party provide for payment ofthe lessee under certain leases that require it to pay real estate taxes and common area maintenance by the Company. Most leases are accounted for as operating leases and include various renewal options with specified minimum rentals. Rental expense for operating leases, 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
 
Year Ended 
 
2004 
2003 
2002 
Rent expense by lease type:
Land and building
$   4,626
$   4,798
$   4,682
Computer equipment
362
1,359
3,516
Plant, office and other
336
548
446
 
Rent expense
$   5,324
$   6,705
$   8,644
Sublease income
—
—
(53)
 
Net rent expense
$   5,324
$   6,705
$   8,591
 
The amounts above include the net minimum lease payments under non-cancelable operating leases
relating to ongoingrentals for the Gump’s operations by lease type, that have initial or remaining
terms in excess of one year, together with the present value of the net(in thousands) $1,428, $1,526 and $1,567 for 2004, 2003 and 2002, respectively.
Future minimum lease payments as of December 27, 2003,25, 2004 under non-cancelable operating leases, by lease type 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
 
 
Year Ending
Land
and
Buildings
 
Computer
Equipment
 
Plant, Office
and Other
 
 
Total
2005
$     3,056
$   130
$   208
$     3,394
2006
1,963
9
74
2,046
2007
1,720
—
38
1,758
2008
1,676
—
24
1,700
2009
1,668
—
—
1,668
Thereafter (extending to 2015)
278
—
—
278
Total future minimum lease payments
$   10,361
$   139
$   344
$   10,844
 
The amounts above include the future commitments of non-cancelable operating leases for the Gump’s operations of (in thousands) $8,585 for Land and Buildings and $95 for Plant, Office and Other.
On February 12, 2005, the Company entered into a ten-year lease extension and modification for 50,000 square feet of the 85,000 square feet previously leased for our corporate headquarters and administrative offices located in Weehawken, New Jersey. Effective June 2005, the annual rent is approximately $1,075,000 for the first five years of the extension, and increases to an annual rent of approximately $1,175,000 during the final five years. These amounts are not reflected in the table above.
Effective October 1, 2005, the Company entered into a one-year lease for auxiliary warehouse storage space in Salem, Virginia. The lease provides for an annual rental of $477,000 for 212,000 square feet of space. An


           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     
additional 90,880 square feet of space in the same facility is being leased on a month-to-month basis at a monthly rental of $15,147. These amounts are not reflected in the table above.
The Company leases certain machinery and equipment under agreements that are classified as capital leases. The cost of equipment under capital leases is included in the Balance Sheet asin Furniture, fixtures and equipment and was $1,505,312$1,506,512 at both December 25, 2004 and $46,162 at December 27, 2003 and December 28, 2002, respectively.2003. Accumulated amortization of the leased equipment at December 25, 2004 and December 27, 2003 was $1,139,155 and December 28, 2002 was $434,661 and $4,098,$434,509, respectively. The future minimum lease payments as of December 27, 200325, 2004 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
                                                              ======
Year Ending
Total 
2005
$      305
2006
49
2007
4
 
Total minimum lease payments
$      358
Less:
Amount representing interest computed at annual
 
rates ranging from 7.5% to 9.0% 
(16)
 
Present value of net minimum lease payments
342
Less:
Current maturities of capital lease obligations
(290)
 
Long-term capital lease obligations
$        52
 
The Company has established reserves for certain future minimum lease payments under noncancelable operating leases due to the restructuring of business operations related towhich previously utilized such leases.leased space. The future commitments under such leases, net of related sublease income under noncancelable subleases, as of December 27,
200325, 2004 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
                                                              ======      =======      ======
 
 
Year Ending
Minimum
Lease
Commitments 
 
Sublease
Income 
 
Net Lease
Commitments 
2005
$   1,624
$      (785)
$      839
2006
1,002
(581)
421
2007
1,002
(469)
533
2008
1,003
(292)
711
2009
1,003
(296)
707
Thereafter (extending to 2010)
167
(49)
118
 
Total minimum lease payments
$   5,801
$   (2,472)
$   3,329
 
The amounts above include the future commitments under noncancelable operating leases, net of related sublease income under noncancelable subleases, for the Gump’s operations of (in thousands) $5,179 of minimum lease commitments less $2,275 of sublease income for a net lease commitment of $2,904.
The future minimum lease payments under non-cancelable leases that remain from the Company'sCompany’s discontinued restaurant operations as of December 27, 200325, 2004 are 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
 
 
Year Ending
Minimum
Lease
Payments 
 
Sublease
Income 
2005
357
(329)
2006
72
(100)
 
Total minimum lease payments
$   429
$   (429)
 


           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

15.
14. STOCK-BASED COMPENSATION PLANS
The Company has established several stock-based compensation plans for the benefit of its officers and employees. As discussed in the Summary of Significant Accounting Policies, (Note 1), the Company applies the fair-value-based methodology of SFAS No. 123 and, accordingly, has recorded stock compensation expense of $0.2 million, $1.1 million and $1.3 million for 2004, 2003 and $1.8 million for
fiscal 2003, 2002, and 2001, respectively. The information below details each of the Company'sCompany’s stock compensation plans, including any changes during the years presented.
1999 Stock Option Plan for Directors -- During — In 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 eligiblenon-employee directors who were neither employees of the Company nor non-resident aliens (the "Directors'“Directors’ Option Plan"Plan”). The Directors'Company’s shareholders ratified the Directors’ Option Plan was ratified by the
Company's shareholders at the 2000 Annual Meeting of Shareholders. TheUnder the Directors’ Option Plan, the Company may issuegrant stock options to purchase up to 700,00070,000 shares of Common Stock to eligible directors at an exercise price equal to the fair market value as of the date of grant.grant date. An eligible director shall receive areceived an initial stock option grant to purchase 50,0005,000 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 10,0001,000 shares of Common Stock. Stock options granted have terms of 10not to exceed ten years and shall vestbe exercisable in accordance with the terms and becomeconditions specified in each option agreement. In addition, options became exercisable over three (3) years from the date of grant. Paymentgrant date. Option holders may pay for shares purchased uponon exercise of options shall be in cash or stock ofCommon Stock.
The following table summarizes information concerning the Company.

     Optionsoptions outstanding, granted and the weighted average exercise prices of options granted under the Directors'Directors’ Option Plan:
1999 Stock 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
                                  ========              ========              =========
for Directors
 
2004
 
2003
 
2002
 
 
 
 
 
 
 
Shares
 
Weighted
Average
Exercise
Price
 
 
 
 
Shares
 
Weighted
Average
Exercise
Price
 
 
 
 
Shares
 
Weighted
Average
Exercise
Price
 
 
 
 
 
Options outstanding, beginning of period
42,000
 
$     16.15
 
42,000
 
$     16.15
 
37,000
 
$    17.82
Granted
—
 
—
 
—
 
—
 
5,000
 
3.80
Exercised
—
 
—
 
—
 
—
 
—
 
—
Forfeited
(35,000)
 
$     15.68
 
—
 
—
 
—
 
—
 
 
 
 
 
 
 
 
 
Options outstanding, end of period
7,000
 
$     18.50
 
42,000
 
$     16.15
 
42,000
 
$    16.15
 
 
 
 
 
 
Options exercisable, end of period
7,000
 
$     18.50
 
36,667
 
$     17.98
 
31,667
 
$    20.15
 
 
 
 
 
 
Weighted average fair value of options granted
$            —
 
 
$        —
 
 
$       2.90
 
 
 
 
 
 
 
 
 
 
The fair value of each option granted is estimated on the grant date of grant using the Black-Scholes option-pricing model. The weighted average assumptions for grants in fiscal 2002 and 2001 under the Directors'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, 200325, 2004 under the Directors'1999 Stock Option Plan:

                      Plan for Directors:

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
                                            =======         ===        =====       =======      =====
Stock Option Plan for Directors
 
 
Options Outstanding
 
Options Exercisable
 
 
 
Exercise Prices
 
Number
Outstanding
Weighted
Average
Remaining
Contractual
Life
 
Weighted
Average
Exercise
Price
 
Number
Exercisable
Weighted
Average
Exercise
Price
 
 
$         2.00
 
1,000
0.25
$   2.00
 
1,000
$     2.00
$       10.00
 
1,000
0.25
$ 10.00
 
1,000
$   10.00
$       23.50
 
5,000
0.25
$ 23.50
 
5,000
$   23.50
 
 
 
 
 
 
 
 
7,000
0.25
$ 18.50
 
7,000
$   18.50
 
 
 
2002 Stock Option Plan for Directors -- During — In 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'“2002 Directors’ Option Plan"Plan”). TheUnder the 2002 Directors'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 eligible directors to purchase up to 900,00090,000 shares of Common Stock to eligible directors at an exercise price equal to the fair market value as of the date of grant.grant date. An eligible director shall receive a stockreceived an initial option grant to purchase 50,0005,000 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 bewere 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 25,0002,500 shares of Common Stock. For the August 1, 2003 and August 3, 2004 Award Dates, each eligible director is to bewas granted stock options to purchase an additional 35,0003,500 shares of Common Stock. Stock options granted have terms of 10ten years and shall vest and become exercisable over three (3) years from the date of grant;grant date; however, due to the change in control effectiveRecapitalization on November 18,30, 2003, certain options fully vested and became exercisable immediately. PaymentOption holders may pay for shares purchased uponon exercise of options shall be in cash or stock
ofCommon Stock.
The following table summarizes information concerning the Company.

                                        79

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     Optionsoptions outstanding, granted, forfeited and the weighted average exercise prices of options granted under the 2002 Directors'Directors’ Option Plan:
2002 Stock 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
                                                       ========              ========
for Directors
 
2004
 
2003
 
2002
 
 
 
 
 
 
 
Shares
Weighted
Average
Exercise
Price
 
 
 
 
Shares
Weighted
Average
Exercise
Price
 
 
 
 
Shares
Weighted
Average
Exercise
Price
 
 
 
Options outstanding, beginning of period
71,000
$2.40
 
10,000
$       2.30
 
—
$        —
Granted
26,000
1.60
 
61,000
2.41
 
10,000
2.30
Exercised
—
—
 
—
—
 
—
—
Forfeited
(31,500)
2.49
 
—
—
 
—
—
 
 
 
 
 
 
Options outstanding, end of period
65,500
$2.04
 
71,000
$       2.40
 
10,000
$     2.30
 
 
 
Options exercisable, end of period
36,167
$2.35
 
47,167
$       2.39
 
—
$        —
 
 
 
Weighted average fair value of options
granted
 
$      1.11
 
 
$   1.83
 
 
$     1.56
 
 
 
 
 
 
The fair value of each option granted is estimated on the grant date of grant using the Black-Scholes option-pricing model. The weighted average assumptions for grants in fiscal2004, 2003 and 2002 under the 2002 Directors'Directors’ Option Plan were as follows: risk-free interest rate of 3.30%, 3.64% and 3.76%, respectively, expected volatility of 99.68%, 90.74% and 89.36%, respectively, expected life of four, six, and six years, respectively, and no expected dividends.

The following table summarizes information about stock options outstanding at December 27, 200325, 2004 under the 2002 Directors'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
                                            =======         ===         ====       =======       ====
Stock Option Plan for Directors
 
Options Outstanding 
Options Exercisable 
 
 
 
 
Exercise Price 
 
 
 
Number
Outstanding 
Weighted
Average
Remaining
Contractual
Life 
 
Weighted
Average
Exercise
Price 
 
 
 
Number
Exercisable 
 
Weighted
Average
Exercise
Price 
$1.43
21,000
9.6
$1.43
--
$1.43
$1.95
5,000
8.0
$1.95
5,000
$1.95
$2.20
15,000
8.9
$2.20
11,667
$2.20
$2.30
7,500
6.3
$2.30
2,500
$2.30
$2.51
7,000
8.6
$2.51
7,000
$2.51
$2.54
5,000
8.6
$2.54
5,000
$2.54
$2.69
5,000
8.8
$2.69
5,000
$2.69
 
 
 
 
 
65,500
8.7
$2.04
36,167
$2.35
 
2004 Stock Option Plan for Directors – During 2004, the Board of Directors adopted the 2004 Stock Option Plan for Directors providing stock options to purchase shares of Common Stock of the Company to certain non-employee directors (the “2004 Directors’ Option Plan”). The Company’s shareholders ratified the 2004 Directors’ Option Plan at the 2004 Annual Meeting of Shareholders. The Company may grant options to purchase up to 100,000 shares of Common Stock to eligible directors at an exercise price equal to the fair market value as of the grant date. An eligible director will receive an initial option grant to purchase 5,000 shares of Common Stock as of the effective date of his/her appointment or election to the Board of Directors. On each Award Date, defined as August 3, 2004, August 3, 2005 and August 3, 2006, eligible directors are to be granted options to purchase additional shares of Common Stock (to the extent the 2002 Stock Option Plan for Directors did not have enough remaining shares). Stock options granted have terms of 10 years and vest over three years from the grant date; however, if there is a Change in Control (as defined in the Hanover Direct, Inc. Directors Change of Control Plan), the participant has the cumulative right to purchase up to 100% of the option shares. Option holders may pay for shares purchased on exercise in cash or Common Stock. As of December 25, 2004 no options have been granted under the 2004 Directors’ Option Plan. In addition, options that were to be granted on the August 3, 2005 Award Date have been deferred until the Company issues its December 25, 2004 audited financial statements.
1993 Executive Equity Incentive Plan -- — In December 1992, the Board of Directors adopted the 1993 Executive Equity Incentive Plan (the "Incentive
Plan"“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, under which executives were given an opportunityoptions 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 atfrom 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.Company. As of December 27, 200325, 2004 and December 28, 2002,27, 2003, 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
                                                              ========   ========   ========
Executive Equity Incentive Plan
 
2004 
2003 
2002 
Notes Receivable, beginning of period
$   269,400
$   269,400
$   313,400
Payments
—
—
—
Forfeitures
(269,400)
—
(44,000)
 
Notes Receivable, end of period
$              --
$   269,400
$   269,400
 
The Common Stock is beingissued under the Incentive Plan was held in escrow as collateral on behalf ofsecurity for the loans extended to each remaining participant of the Incentive Plan and may be transferred to and
retained byplan participant. During 2004, the Company transferred and retired the Common Stock held in satisfaction ofescrow to satisfy the aforementioned promissoryoutstanding notes which are no longer required to be settled. Furthermore,receivable and the related
participants have forfeited their initial 20% cash down payment, which was
required for entry into the Incentive Plan.

     payment.
Management Stock Option Plans -- — The Company approved for issuance to employees 20,000,0002,000,000 shares of the Company'sCompany’s Common Stock pursuant to the Company'sCompany’s 2000 Management Stock Option Plan and 7,000,000700,000 shares of the Company'sCompany’s Common Stock pursuant the Company'sCompany’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.grant date. However, for stock options granted to an employee owning more than 10%10.0% of the total combined voting power of all classes of Company stock, the exercise price is equal to 110%110.0% of the fair market value of the Company'sCompany’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 1,000,000100,000 shares of the Company'sCompany’s Common Stock. Stock options granted to an individual employee under the 1996 Stock Option Plan may not exceed 500,00050,000 shares of the Company'sCompany’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 suchthis limitation is exceeded, the option shall be treated as a non-qualified stock option. Stock options may be granted for terms not to exceed 10ten years and shall be exercisable in accordance with the terms and conditions specified in each option agreement. In the case of an employee who owns common stock possessing more than 10%10.0% of the total combined voting power of all classes of common stock, the options must become exercisable within 5five years. Due to the change in control transaction effectivethat occurred on November 18,30, 2003, certain options became fully vested and became exercisable immediately. Paymentvested. Option holders may pay for shares purchased uponon exercise of options shall be in cash or stock ofCommon Stock.
The following table summarizes information concerning 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:of options granted under the 1996 ANDand 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
                       ===========                ===========                ===========
Management Stock Option Plans:
1996 and 2000 Management Stock Option Plans
 
2004
 
2003
 
2002
 
 
 
 
 
 
 
Shares
Weighted
Average
Exercise
Price
 
 
 
 
Shares
Weighted
Average
Exercise
Price
 
 
 
 
Shares
Weighted
Average
Exercise
Price
 
 
 
Options outstanding, beginning of period
822,145
$     8.08
 
923,027
$     8.13
 
396,278
$   24.59
Granted
127,000
1.84
 
6,500
2.32
 
676,100
2.43
Exercised
—
—
 
—
—
 
—
—
Forfeited
(172,762)
6.39
 
(107,382)
8.13
 
(149,351)
25.98
 
 
 
 
 
 
Options outstanding, end of period
776,383
$     7.44
 
822,145
$     8.08
 
923,027
$     8.13
 
 
 
Options exercisable, end of period
671,216
$     8.32
 
802,920
$     8.21
 
191,327
$   21.81
 
 
 
Weighted average fair value of options granted
$      1.34
 
$     1.62
 
$       1.84
 
 
 
 
 
 
The fair value of each option granted is estimated on the grant date of grant using the Black-Scholes option-pricing model. The weighted average assumptions for grants in fiscal2004, 2003 2002 and 20012002 are as follows: risk-free interest rate of 3.58%3.44%, 3.81%3.58% and 4.96%3.81%, respectively, expected volatility of 90.96%103.78%, 89.58%90.96% and 83.93%89.58%, respectively, expected lives of four, six and six years, respectively, for fiscal years2004, 2003 2002 and 2001,2002, and no expected dividends.
The following table summarizes information about stock options outstanding at December 27, 200325, 2004 under both the 1996 and 2000 Management Stock Option Plans:
1996 ANDand 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 OfficerManagement 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
 
Options Outstanding
 
Options Exercisable
 
 
 
 
Weighted
 
 
 
 
 
 
Average
Weighted
 
Weighted
 
 
Remaining
Average
 
Average
 
Number
Contractual
Exercise
Number
Exercise
Range of Exercise Prices 
Outstanding
Life
Price
Exercisable
Price
 
 
$ 1.44 to $2.10
127,000
9.4
$       1.84
 
33,333
$       1.95
$ 2.40 to $2.70
500,000
7.6
$       2.44
 
488,500
$       2.44
$ 10.10 to $14.38
12,000
2.5
$     13.67
 
12,000
$     13.67
$ 17.30 to $23.80
17,500
2.1
$     22.87
 
17,500
$     22.87
$ 26.61 to $31.88
119,883
3.9
$     31.38
 
119,883
$     31.38
 
 
 
 
 
 
776,383
7.1
$       7.44
 
671,216
$       8.32
 
 


           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
Wayne P. Garten 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,Agreement – During 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 optionsMr. Garten an option (the “Garten Option”) to certain employees for the
purchase of an aggregate of 1,000,000up to 100,000 shares of the Company'sCompany’s Common Stock. The
options vested over three years, hadStock for an exercise price of $0.75$1.95 per share. The Garten Option was not issued pursuant to any of the Company’s plans and expired
during 2003. Mr. Garten has registration rights for these options. The options vest over a two year period: one-third upon execution of the Garten Employment Agreement, one-third on May 5, 2005 and the final one-third on May 5, 2006; provided that all of the options vest and become fully exercisable upon the earliest to occur of (i) Mr. Garten’s resignation “For Good Reason” (ii) a “Change of Control” or (iii) the Company’s termination of Mr. Garten’s employment other than “For Cause” (as defined in the Garten Employment Agreement). The options expire on May 4, 2014.
The fair value of the options at the date of grant was estimated to be $0.52$1.45 per share at the grant date based on the following weighted average assumptions: risk-free interest rate of 6.48%3.45%, expected life of four years, expected volatility of 59.40%103.71%, 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 — In December 2000, the Company granted and the
Company's Board of Directors approved, options ("2000(the “2000 Meridian Options"Options”) for the purchase of an aggregate of 4,000,000400,000 shares of Common Stock with an exercise price of $0.25$2.50 per share.share to Meridian, an affiliate of Mr. Shull. These options have beenwere allocated as follows: 84

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Thomas C. Shull, 2,700,000270,000 shares; Paul Jen, 500,00050,000 shares; John F. Shull, 500,00050,000 shares; Evan M. Dudik, 200,00020,000 shares; and Peter Schweinfurth, 100,00010,000 shares. In December 2001, an additional Services Agreement (the "2001 Services
Agreement") was entered into byAll of the Company by and among Meridian, Mr. Shull,
and the Company. Under the 2001 Services Agreement, theremaining 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 Optionsare vested and became exercisableare due to expire 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.

     March 31, 2006.
The fair value of the 2000 Meridian Options was estimated to be $0.07 cents$0.70 per share at the grant 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'sCompany’s Board of Directors approved, options to Meridian ("2001(the “2001 Meridian Options"Options”) for the purchase of an additional 1,000,000100,000 shares of Common Stock with an exercise price of $0.30.$3.00. These options have beenwere allocated as follows: Thomas C. Shull, 500,00050,000 shares; Edward M. Lambert, 300,00030,000 shares; Paul Jen, 100,00010,000 shares; and John F. Shull, 100,00010,000 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 Optionsand are due to (i) adjust the final expiration date for such stock options
toexpire on March 31, 2006, and (ii) replace all references therein to the 2001 Services
Agreement with references to the 2002 Employment Agreement.

     2006.
The fair value of the 2001 Meridian Options was estimated to be $0.16 cents$1.60 per share at the grant 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
The following table summarizes information concerning the options outstanding, granted and the weighted average exercise price underprices of options granted for 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
                               =========              ==========              ==========
Options:
Meridian Option Plans
 
2004
 
2003
 
2002
 
 
 
 
 
Weighted
 
 
Weighted
 
 
Weighted
 
 
Average
 
 
Average
 
 
Average
 
 
Exercise
 
 
Exercise
 
 
Exercise
 
Shares
Price
 
Shares
Price
 
Shares
Price
 
 
 
Options outstanding, beginning of period
490,000
$2.60
 
490,000
$2.60
 
500,000
$2.60
Granted
—
—
 
—
—
 
—
—
Exercised
—
—
 
—
—
 
(10,000)
2.50
Forfeited
(120,000)
2.50
 
—
—
 
—
—
 
 
 
 
 
 
Options outstanding, end of period
370,000
$2.64
 
490,000
$2.60
 
490,000
$2.60
 
 
 
Options exercisable, end of period
370,000
$2.64
 
490,000
$2.60
 
390,000
$2.50
 
 
 
The following table summarizes information about stock options outstanding and exercisable at December 27, 2003 under25, 2004 for 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

Meridian Option Plans
 
Options Outstanding
 
Options Exercisable
 
 
 
 
Exercise Prices
 
 
 
Number
Outstanding
Weighted
Average
Remaining
Contractual
Life
 
Weighted
Average
Exercise
Price
 
 
 
 
Number
Exercisable
 
Weighted
Average
Exercise
Price
 
 
$ 2.50
270,000
2.3
$ 2.50
 
270,000
$    2.50
$ 3.00
100,000
2.3
$ 3.00
 
100,000
$    3.00
 
 
 
 
 
 
370,000
2.3
$ 2.64
 
370,000
$    2.64
 
 
15. CONTINGENICES
Rakesh K. Kaul v. Hanover Direct, Inc., No. 04-4410(L)-CV, 2nd Cir.S.D.N.Y., on appeal from 296 F. Supp.2d (S.D. NY 2004). On June 28, 2001, Rakesh K. Kaul, the former President and Chief Executive Officer of the Company, filed a five-count complaint in the Federal District Court in New York seeking relief stemming from his separation of employment from the Company including short-term bonus and severance payments of $2,531,352, attorneys’ fees and costs, and damages due to the Company’s failure to pay him a “tandem bonus” as well as Kaul’s alleged rights to benefits under a change in control plan and a long-term incentive plan. The Company filed a Motion for Summary Judgment and in July 2004, the Court entered a final judgment dismissing most of Mr. Kaul’s claims with prejudice and awarded Mr. Kaul $45,946 in vacation pay and $14,910 in interest which the Company paid in July 2004. In August 2004, Kaul filed an appeal on three issues: severance and short-term bonus, tandem bonus and legal fees. On June 28, 2005 the Second Circuit Court of Appeals denied Kaul’s appeal, affirming the Summary Judgment decision in the Company’s favor. Mr. Kaul’s rights to appeal the Second Circuit’s decision expired in August 2005.
As of December 25, 2004, the Company had accrued $4.5 million related to this matter. This accrual remained on the Company’s Consolidated Balance Sheet until the third fiscal quarter of 2005 when Kaul’s rights to pursue this claim expired.
SEC Informal Inquiry:
See Note 18 to the consolidated financial statements for a discussion of the informal inquiry being conducted by the SEC relating to the Company’s financial results and financial reporting since 1998.
Class Action Lawsuits:
The Company was a party to four class action/ representative lawsuits that all involved allegations that the Company’s charges for insurance were invalid, unfair, deceptive and/or fraudulent. As described in greater detail below, the Company has resolved all of these class action lawsuitlawsuits.
Jacq Wilson v. Brawn of California, Inc. , Case No. CGC-02-404454 (Supp. Ct. San Francisco, CA 2002) (“Wilson Case”). On February 13, 2002, Jacq Wilson, suing on behalf of himself and other similarly situated persons, filed a representative suit in the Superior Court of the State of California, City and County of San Francisco, against the Company alleging that the Company charged an unlawful, unfair, and fraudulent insurance fee on orders, was commencedengaged in untrue, deceptive and misleading advertising and unfair competition under the state’s Business and Professions Code. The plaintiffs sought relief including restitution and disgorgement of all monies wrongfully collected by defendants, including interest, an order enjoining defendants from imposing insurance on March 3, 2000 entitled Edwin L.
Martinits order forms, and compensatory damages, attorneys’ fees, pre-judgment interest and costs of the suit. In November, 2003, the Court, after a trial the previous April, entered judgment for the plaintiffs, requiring defendants to refund insurance charges collected from consumers for the period from February 13, 1998 through January 15, 2003, with interest. In April, 2004, the Court awarded plaintiff’s counsel approximately $445,000 of attorneys’ fees.
The Company appealed the Court’s decision and the order to pay attorneys’ fees, which appeals were consolidated. Enforcement of the judgment for insurance fees and the award of attorneys’ fees was stayed pending resolution of the appeal. On September 2, 2005 the California Court of Appeals reversed both the Court’s findings on the merits and its award of attorneys’ fees and awarded the Company its cost on the appeal.

Teichman v. Hanover Direct, Inc. et. al., No. 3L641 (Supp. Ct. San Francisco, CA 2001). On August 15, 2001, Randi Teichman filed a summons and four-count complaint in the Superior Court for the City and County of San Francisco seeking damages and other relief for herself and a class of similarly situated persons arising out of the insurance fee charged by catalogs and Internet sites operated by Company subsidiaries. This case had been stayed since May 2002 pending resolution of the Wilson Case.
The plaintiffs in both Wilson and Teichman were represented by the same counsel and the plaintiffs in both cases agreed to dismiss the cases with prejudice in exchange for the Company’s agreement to not seek reimbursement of costs in the Wilson case.
John Morris, individually and on behalf of all other similarly situated person and entities similarly situated v. Hanover Direct, Inc. and Hanover Brands, Inc., No. L 8830-02 (Sup. Ct. Bergen Co. – Law Div., NJ) October 28, 2002, John Does 1 through 10, bearing case no.
CJ2000-177 in the State Court of Oklahoma (District Court inMorris, individually and for Sequoyah
County). Plaintiff commenced the action on behalf of himself andother similarly situated persons in New Jersey filed a class of
persons who have at any time purchased a product fromaction alleging that (1) the Company improperly added a charge for “insurance” and (2) the Company’s conduct was in violation of the New Jersey Consumer Fraud Act as otherwise deceptive, misleading and unconscionable. Morris sought relief including damages equal to the amount of all insurance charges, interest, treble and punitive damages, injunctive relief, costs, and reasonable attorneys’ fees. On February 14, 2005, the Court denied class certification which limited the damages being litigated, absent an appeal of the denial of class certification, to Plaintiff’s individual injury of the $1.48 he paid for an "insurance charge." The complaint sets forth claimsinsurance which could be trebled pursuant to the New Jersey consumer protection statute plus attorney’s fees. This case was settled effective as of August 29, 2005 and the Company paid $39,500 in the aggregate for a nominal amount of damages and legal fees.
Martin v. Hanover Direct, Inc., et. al., No. CJ-2000 (D.C. Sequoyah Co., Ok.) (“Martin Case”). On March 3, 2000, Edwin L. Martin filed a class action lawsuit against the Company claiming breach of contract, unjust enrichment, recovery of money paid absent consideration, fraud and a claim under the New Jersey Consumer Fraud Act. The complaint alleges thatallegations stem from “insurance charges” paid to the Company charges its customers for delivery insurance even though, among other
things,by consumers who had placed orders from catalogs published by indirect subsidiaries of the Company's common carriers already provide insurance and the
insurance charge provides no benefit to the Company's customers. Plaintiff also
seeksCompany over a number of years. Martin sought relief including (i) a declaratory judgment as to the validity of the delivery insurance. The
damages sought are (i)insurance, (ii) an order directing the Company to return to the plaintiff and class members the "unlawful revenue"“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 perfor each class member, and (v) attorneys'(iv) attorneys’ fees and costs. On April 12,In July 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,
definingcertified 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 withclass certification. On October 25, 2005, the class certification was reversed. Martin filed an Application for Rehearing which was denied on January 3, 2006. On January 18, 2006, Martin filed a Petition for a Writ of Certiorari in the Oklahoma Supreme Court. The Company believes that it is unlikely that the Oklahoma Supreme Court will grant Martin’s petition.
The Company established a $0.5 million reserve during the third quarter of 2004 for the class action lawsuits described above for settlements and subsequently movedthe Company’s current estimate of future legal fees to stay proceedings
in the district court pending resolutionbe incurred. The balance 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 resolutionreserve as of the
appeal, that certain other issues would be subject to limited discovery, and
that the issue of a stayDecember 25, 2004 remained at $0.5 million.
Claims 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. Post-Employment Benefits
The Company believes it has defenses againstis involved in four lawsuits instituted by former employees arising from the claims
andCompany’s denial of change in control (“CIC”) benefits under compensation continuation plans to conduct a vigorous defensefollowing the termination of this action.

     On August 15, 2001,employment. 
Two of these cases arose from the Company was served with a summons and four-count
complaint filed in Superior Court forcircumstances surrounding the City and County of San Francisco,
California, entitled TeichmanRestatement: 
Charles Blue v. Hanover Direct, Inc., Hanover Brands, Inc.William Wachtel, Stuart Feldman, Wayne Garten and Robert Masson, Hanover Direct Virginia, Inc.(Supp. Ct. N.J., and Does 1-100.Law Div. Hudson Cty, Docket No.: L-5153-05) is an action instituted by the Company’s former Chief Financial Officer who was terminated for cause on March 8, 2005.  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.attorney’s fees and alleges retaliation, mental anguish and reputational damage, loss of earnings and employment and racial discrimination.  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 evidencebelieves 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 DirectorsBlue was properly terminated for cause and that his wife's
leaseclaims are groundless. 
Frank Lengers v. Hanover Direct, Inc., Wayne Garten, William Wachtel, A. David Brown, Stuart Feldman, Paul S. Goodman,  Donald Hecht and related expenseRobert Masson, (Supp. Ct. N.J., Law Div. Hudson Cty, Docket No.: L-5795-05) 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, findingbrought 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 outcomeCompany terminating the employment 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 expensesformer Vice President, Treasury

Operations & Risk Management, 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 claimMarch 8, 2005 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.cause.  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 soughtseeks compensatory damages in an amount, which was estimated to be not more than
$400,000, and punitive damages in the amountand attorney’s fees and alleges improper denial of $10 million; applicable
interest, incidentalCIC benefits, age and consequential damages, plus costsdisability discrimination, handicap discrimination, aiding and disbursements,
the expensesabetting and breach 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.contract.  The Company filed
an answer to the complaint on September 7, 1994. Discovery then commencedbelieves that Mr. Lengers was properly terminated for cause 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. his claims are groundless.
The Company filed papers in
oppositionbelieves that it properly denied CIC benefits with respect 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 issuefour former employees and that it has meritorious defenses 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 Nevadacases and Arizona cases in order to determineplans 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 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.

     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.

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

17.  AMERICANoperations, or cash flows.
16. DELISTING OF COMMON STOCK EXCHANGE NOTIFICATION

     By letter dated May 2, 2001,
The Company’s Common Stock was delisted from the American Stock Exchange (the "Exchange"“AMEX”) notifiedon February 16, 2005 as a result of the Company’s inability to comply with the AMEX’s continued listing standards and because the Company that it was below certaindid not file on a timely basis its Form 10-Q for the fiscal quarter ended September 25, 2004 as a result of the Exchange's continued
listing guidelines set forth inRestatement.
Initially the Exchange's Company Guide. The Exchange
institutedreceived a May 21, 2004 letter from the AMEX advising that a review of the Company's eligibilityCompany’s Form 10-K for continuing listing of the Company's common stock on the Exchange. On January 17, 2002,fiscal period ended December 27, 2003 indicated that the Company received a letter dated January 9, 2002 fromdid not meet 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'sfollowing continued listing standards as set forth in Part 10 of the Exchange'sAMEX’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:Guide: (i) Section 1003(a)(i) with shareholders'shareholders’ equity of less than $2,000,000$2.0 million and losses from continuing operations and/or net losses in two out of its three most recent fiscal years; and (ii) Section 1003(a)(ii) with shareholders'shareholders’ equity of less than $4,000,000$4 million and losses from continuing operations and/or net losses in three out of its four most recent fiscal years; and (iii) Section 1003(a)(iii) with shareholders'shareholders’ equity of less than $6,000,000$6.0 million 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 thatTo maintain its AMEX listing, the Company was required to submit a plan to the ExchangeAMEX by December 11, 2002,June 22, 2004, advising the ExchangeAMEX of action it
has taken, or will take, that would bring it into compliance with the continued listing standards of the AMEX by December 28, 2003.November 21, 2005 (18 months of receipt of the original letter from the AMEX). The Company submitted a plan to the ExchangeAMEX on December 11, 2002, inJune 22, 2004 and on August 3, 2004 the AMEX notified the Company that it accepted the Company’s plan and granted the Company an effortextension until November 21, 2005 to maintainregain compliance with the continued listing of the
Company's common stock on the Exchange.

     On January 28, 2003, thestandards.
The Company received a December 9, 2004 letter from the Exchange
confirmingAMEX notifying the Company that as of the date of the letter,it had failed to satisfy an additional continued listing standard because the Company had evidenced
compliance withyet to file its Quarterly Report on Form 10-Q for the requirements necessaryfiscal quarter ended September 25, 2004, a condition for the Company’s continued listing on the Exchange. Such compliance resultedAMEX under Sections 234 and 1101 of the Company Guide. The AMEX advised that if the Company did not file the Form 10-Q by December 31, 2004, the AMEX staff would initiate delisting proceedings as appropriate.
The Company received a January 24, 2005 letter from a recent rule change by the Exchange
approved byAMEX notifying it that the SecuritiesAMEX had determined to proceed with the filing of an application with the SEC to strike the Common Stock of the Company from listing and Exchange Commission related to continued listingregistration on the basis ofAMEX based on the Company’s failure to regain compliance with total market capitalization or total assetsthe AMEX’s filing requirements as set forth in Section 134 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 provisions1101 of the Congress Credit FacilityCompany Guide by December 31, 2004 and based on EITF 95-22 and certain provisions in the credit agreement,fact that 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,in compliance with Sections 1003(a)(i), 1003(a)(ii) and 1003(a)(iii) of the Company reclassified $8.8 million as of
December 28, 2002 from Long-term debtGuide. The Company had a limited right to Short-term debtappeal the AMEX’s determination which it did not because, in addition to its continued inability to file its Quarterly Report on Form 10-Q for the fiscal quarter ended September 25, 2004 and capital lease
obligations that is classified as Current liabilities.

     A summaryits inability to satisfy the requirements for minimum stockholders’ equity, the Company did not meet the alternative financial standards set forth in Section 1003 of the effects of the restatementCompany Guide.
The Company’s common stock was formally suspended from trading 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
AMEX on February 2, 2005 and removed from listing and registration effective February 16, 2005. Current trading information about the Company’s common stock can be obtained from the Pink Sheets (www.pinksheets.com) under the trading symbol HNVD.PK.


           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

19.
17. SELECTED QUARTERLY FINANCIAL INFORMATION (UNAUDITED)

                                                      FIRST      SECOND     THIRD      FOURTH
                                                     QUARTER    QUARTER    QUARTER    QUARTER
                                                     --------   --------   --------   --------
                                                     (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

2003
Net revenues.......................................  $102,474   $105,765   $ 96,633   $110,002
Income (loss) before interest and income taxes.....     1,655      1,805        (64)     4,621
Net income (loss) and comprehensive income
  (loss)...........................................       192        690    (16,645)       364
Preferred stock dividends and accretion............     3,632      4,290         --         --
Net (loss) income applicable to common
  shareholders.....................................  $ (3,440)  $ (3,600)  $(16,645)  $    364
                                                     ========   ========   ========   ========
Net (loss) income per share -- basic and diluted...  $  (0.02)  $  (0.02)  $  (0.12)  $   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)
                                                     ========   ========   ========   ========


                                        95
 
First
Quarter
 
Second
Quarter
 
Third
Quarter
 
Fourth
Quarter
 
 
As Reported
As Restated
 
As Reported
As Restated
 
 
 
 
 
 
 
 
 
 
 
 
 
(in thousands, except per share amounts)
 
2004
 
 
 
 
 
 
 
 
 
 
 
 
Net revenues
$       95,312
$     90,184
 
$      96,545
$ 96,886
 
$     94,443
 
$  121,647
 
Income before interest and income taxes
1,445
10
 
1,276
933
 
2,476
 
7,323
 
Net income (loss) and comprehensive income (loss)
418
(796)
 
586
33
 
711
 
5,053
 
Net income (loss) applicable to common shareholders
$            417
$       (796)
 
$           585
$ 33
 
$         711
 
$       4,929
 
Net income (loss) per share – basic
$           0.02
$      (0.04)
 
$          0.03
$ 0.00
 
$        0.03
 
$        0.22
 
 
 
 
 
 
Net income (loss) per share – diluted
$           0.02
$      (0.04)
 
$          0.03
$ 0.00
 
$        0.02
 
$        0.15
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
First
Quarter
 
Second
Quarter
 
Third
Quarter
 
Fourth
Quarter
 
 
As Reported
As Restated
 
As Reported
As Restated
 
As Reported
As Restated
 
As Reported
As Restated
 
 
 
 
 
(in thousands, except per share amounts)
 
2003
 
 
 
 
 
 
 
 
 
 
 
 
Net revenues
$     102,474
$     97,311
 
$   105,765
$   105,317
 
$     96,633
$     96,925
 
$    110,002
$  114,730
 
Income (loss) before interest and income taxes
1,655
245
 
1,805
1,235
 
(64)
(219)
 
4,621
2,095
 
Net income (loss) and comprehensive income (loss)
192
(1,209)
 
690
115
 
(16,645)
(16,810)
 
364
(2,156)
 
Preferred stock dividends and accretion
3,632
3,632
 
4,290
4,290
 
--
--
 
--
--
 
Net income (loss) applicable to common shareholders
$      (3,440)
$    (4,841)
 
$    (3,600)
$     (4,175)
 
$   (16,645)
$   (16,810)
 
$          364
$   (2,156)
 
Net income (loss) per share – basic and diluted
$        (0.25)
$      (0.35)
 
$      (0.26)
$      (0.30)
 
$      (1.20)
$      (1.22)
 
$         0.00
$     (0.13)
 
 
 
 
 
 
The quarterly amounts above include the impact of the Restatement identified in Note 2.
18. SUBSEQUENT EVENTS
Gump’s Business
On March 14, 2005, the Company sold all of the stock of Gump’s to Gump’s Holdings, LLC, an unrelated third party (“Purchaser”) for $8.9 million, including a purchase price adjustment of $0.4 million, pursuant to the terms of a February 11, 2005 Stock Purchase Agreement. The Company will recognize a gain on the sale of approximately $3.6 million in the quarter ended March 26, 2005. Chelsey, as the holder of all of the Series C Preferred, consented to the application of the sales proceeds to reduce the outstanding balance of the Wachovia Facility in lieu of the current redemption of a portion of the Series C Preferred. Chelsey expressly retained its right to require redemption of approximately $6.9 million (the Gump’s sales proceeds available for redemption) of the Series C Preferred subject to Wachovia’s approval.
After the sale, the Company continues as the guarantor of one of the two leases for the San Francisco building where the store is located (the Company was released from liability on the other lease). The Purchaser is required to use its commercially reasonable efforts to secure the Company’s release from the guarantee within a year of the closing. If the Purchaser cannot secure the Company’s release within a year of the closing, an affiliate of the Purchaser will either (i) transfer a percentage interest in its business so that the Company will own, indirectly, 5% interest of the Purchaser’s common stock, or (ii) provide the Company with a $2.5 million stand-by letter of credit or other form of compensation acceptable to the Company to reimburse the Company for any liabilities the Company may incur under the guarantee until the Company is released from the guarantee or the lease is terminated. As of February 6, 2006 there are $7.1 million (net of $0.5 million of expected sublease income) in lease commitments for which the Company is the guarantor. Based on its evaluation, the Company has concluded it is unlikely any payments will be required under the guarantee.

The Company entered into a Direct Marketing Services Agreement with the Purchaser to provide telemarketing and fulfillment services for the Gump’s catalog and direct marketing businesses for eighteen months. We have the option to extend the term for an additional eighteen months.
Listed below are the carrying values of the major classes of assets and liabilities of Gump’s included in the Consolidated Balance Sheets:
In thousands (000’s)
December 25, 2004
 
December 27, 2003
 
 
 
Total current assets
 
$       10,842
 
 
$       10,995
Total non-current assets
$         3,221
 
$         3,801
Total assets
$       14,063
 
$       14,796
Total current liabilities
$         6,727
 
$         7,980
Total non-current liabilities
$         3,283
 
$         3,995
Total liabilities
$       10,010
 
$       11,975
Listed below are the revenues and income before income taxes included in the Consolidated Statements of Income (Loss) (these results exclude certain corporate overhead charges allocated to Gump’s for services provided by the Company to run the business):
In thousands (000’s)
For the Year
Ended
December 25,
2004
 
For the Year
Ended
December 27,
2003
 
 
 
Net revenues
 
$          42,634
 
 
$                     44,188
Income before income taxes
$            2,967
 
$                       1,215
Private Label and Co-Brand Credit Card Agreement
On February 22, 2005, the Company entered into a seven year co-brand and private label credit card agreement (as amended by Amendment Number One on March 30, 2005, the “Credit Card Agreement”) with WFNNB under which WFNNB will provide private label (branded) and co-brand credit cards to the Company’s customers. The Company began offering the private label credit card to its customers in April 2005. The program extends credit to our customers at no credit risk to the Company and is expected to lead to increased sales and lower expenses. WFNNB will provide a fixed dollar amount as marketing funds in the first year of which 25% of any unused amount can be utilized in the first six months of the second year and a percentage of the lesser of private label net sales or average accounts receivable balance in later years to support the Company’s promotion of the program. In general, WFNNB will pay the Company proceeds from sales of Company merchandise using the cards issued under the program with no discount. In addition, WFNNB paid the Company an up-front fee when the private label plan commenced and will pay a per card fee for each card issued under the co-brand program and a percentage of the net finance charges on co-brand accounts.
If the Credit Card Agreement is terminated or expires other than as a result of a default by WFNNB, the Company will be obligated to purchase any outstanding private label accounts at their fair market value. The Company will have the option of purchasing any outstanding co-brand accounts at their fair market value when the Credit Card Agreement terminates unless the termination is attributable to the Company’s default. Under the 34th Amendment to the Loan & Security Agreement executed by the Company and Wachovia on July 29, 2005, the Company is prohibited from using the Wachovia Facility to fund the purchase of the private label and co-brand accounts. As a consequence, should the Company become obligated to purchase the accounts and should it not have secured a replacement credit card program with a new credit card issuer, the Company will be forced to seek financing from a different source which financing will be subject to Wachovia’s and Chelsey’s approval.
Audit Committee Investigation; SEC Inquiry

The Audit Committee of the Board of Directors began an investigation of matters relating to restatements of the Company’s financial statements and other accounting-related matters with the assistance of independent outside counsel Wilmer Cutler Pickering Hale and Dorr LLP (“Wilmer Cutler”).
The Audit Committee concluded its investigation and, with the assistance of Wilmer Cutler, reported its findings to the Board of Directors. The Audit Committee, again with the assistance of Wilmer Cutler, formulated a series of recommendations to the Company and the Board of Directors concerning potential improvements in the Company’s internal controls and procedures for financial reporting. The Board of Directors and management have begun implementing these recommendations.
The Company was notified by the SEC that it was conducting an informal inquiry relating to the Company’s financial results and financial reporting since 1998. The SEC indicated in its letter to the Company that the inquiry should not be construed as an indication by the SEC that there has been any violation of the federal securities laws. The Company is cooperating fully with the SEC in connection with the inquiry and Wilmer Cutler has briefed the SEC and the Company’s independent registered public accounting firm, Goldstein Golub Kessler LLP (“GGK”) on the results of its investigation. The Company intends to continue to cooperate with the SEC in connection with its informal inquiry concerning the Company’s financial reporting.

SCHEDULE II
HANOVER DIRECT, INC.
VALUATION AND QUALIFYING ACCOUNTS
                YEARS ENDED DECEMBER
Years Ended December 25, 2004, December 27, 2003 DECEMBER
and December 28, 2002
                             AND DECEMBER 29, 2001
                           (IN THOUSANDS OF DOLLARS)

(In thousands of dollars)
Column A
Column B 
Column C
Column D 
Column E 
 
 
Additions
 
 
 
 
Description
 
 
Restated
Balance at
Beginning
of Period
 
 
 
Charged to
Costs and
Expenses
 
 
Charged to
Other Accounts
(Describe)
 
 
 
 
Deductions
(Describe)
 
 
 
Balance at
End of
Period
2004:
Allowance for Doubtful Accounts Receivable
$     1,105
$    609
-
$ 347(4)
$     1,367
Reserve for Closed Restaurant Operations
69
42
-
90(5)
21
Special Charges Reserve
5,794
1,536
-
2,452(5)
4,878
Reserves for Sales Returns
1,981
3,549
-
3,545(6)
1,985
Deferred Tax Asset Valuation Allowance
33,414
-
618(1)
1,921(7)
32,111
2003 (As Restated):
Allowance for Doubtful Accounts Receivable
1,560
378
-
833(4)
1,105
Reserve for Closed Restaurant Operations
322
40
-
293(5)
69
Special Charges Reserve
8,032
1,304
-
3,542(6)
5,794
Reserves for Sales Returns
1,710
2,551
-
2,280(6)
1,981
Deferred Tax Asset Valuation Allowance
142,054
-
11,300(2)
119,940(8)
33,414
2002 (As Restated):
Allowance for Doubtful Accounts Receivable
2,117
304
-
861(4)
1,560
Reserve for Closed Restaurant Operations
737
40
-
455(5)
322
Special Charges Reserve
11,056
4,769
-
7,793(6)
8,032
Reserves for Sales Returns
2,547
345
-
1,182(6)
1,710
Deferred Tax Asset Valuation Allowance
137,252
-
4,802(3)
-
142,054

COLUMN A                               COLUMN B             COLUMN 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)
$  1,560      618 increase in the valuation allowance used to offset net increases in temporary differences.
(2)
$  378                       11,300 increase in the valuation allowance charged to deferred income tax provision.
(3)
$   833(1)   3,700 charged to deferred income tax provision, $1,102 increase in the valuation allowance used to offset net increase in temporary differences.
(4)
Written-off.
(5)
Utilization and reversal of reserves.
(6)
Utilization of reserves.
(7)
Represents the utilization and expiration of NOLs.
(8)
$    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...............      2,117         304                           861(1)        1,560
Reserves for Discontinued
  Operations........................        737          40                           455(2)          322
Special Charges Reserve.............     11,056       4,769                         7,793(3)        8,032
Reserves for Sales Returns..........      2,764         306                         1,182(3)        1,888
Deferred Tax Asset Valuation
  Allowance.........................    121,600                      3,700(4)      (2,700)(5)     128,000
2001:
Allowance for Doubtful Accounts
  Receivable, Current...............      5,668          91                         3,642(1)        2,117
Reserves for Discontinued
  Operations........................        588         275                           126(3)          737
Special Charges Reserve.............     13,023       7,963                         9,930(3)       11,056
Reserves for Sales Returns..........      3,371       2,692                         3,299(3)        2,764
Deferred Tax Asset Valuation
  Allowance.........................    123,900                                     2,300(5)      121,600
117,671 represents the expiration of NOL and tax credit carryovers and $2,269 is attributable to the net reversal of temporary differences.


- ---------------

(1) Written-off.

(2) Utilization
Item 9. Changes in and reversal of reserves.

(3) Utilization of reserves.

(4) Increase in the valuation allowance charged to deferred income tax
    provision.

(5) Represents the change in the valuation allowance offset by the change in the
    gross deferred tax asset.

                                        96


ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
         FINANCIAL DISCLOSURE

     Disagreements with Accountants on Accounting and Financial Disclosure
There were no disagreements with accountants on accounting and financial disclosure.

ITEM

Item 9A. CONTROLS AND PROCEDURES

     An evaluation was performed under the supervisionControls and Procedures
Disclosure Controls and Procedures
Our management, with the participation of the Company's management, including itsour Chief Executive Officer and Chief Financial Officer, has completed an evaluation of the effectiveness of the Company'sdesign and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e)Rule 13a-15 under the Securities Exchange Act of 1934, as amended) asamended (the “Exchange Act”)) pursuant to Item 307 of Regulation S-K for the end of the periodfiscal quarter covered by this quarterly report. BasedThis evaluation has allowed management to make conclusions, as set forth below, regarding the state of the Company’s disclosure controls and procedures as of December 25, 2004. While management has made significant improvements in its disclosure controls and procedures and has completed various action plans to remedy identified weaknesses in these controls (as more fully discussed below), based on thatmanagement’s evaluation, the Chief Executive Officer and Chief
Financial Officermanagement has concluded that thesethe Company’s disclosure controls and procedures were effective. There has been no changenot effective in alerting management on a timely basis to material information relating to the Company required to be included in the Company'sCompany’s periodic filings under the Exchange Act. In coming to this conclusion, management considered, among other things, the control deficiency related to periodic review of the application of generally accepted accounting principles, which resulted in the Restatement as disclosed in Note 2 to the accompanying consolidated financial statements included in this Form 10-K.
As background, the following occurred during 2004 and 2005:
•
During the second quarter of 2004, the Company identified a revenue recognition cut-off issue that resulted in revenue being recorded in advance of the actual shipment of merchandise to the customer. The practice was stopped immediately. Subsequently, the Company determined that revenue should be recognized when merchandise is received by the customer rather than when shipped because the Company routinely replaces customer merchandise damaged or lost in transit as a customer service matter (even though risk of loss, as a legal matter, passes on shipment). As a consequence, the Company has restated all affected periods presented to recognize revenue when merchandise is received by the customer.
•
In the first quarter of 2004, former management identified a potential issue with the accounting treatment of discount obligations due to members of certain of the Company’s buyers’ club programs, and at that time, an inappropriate conclusion regarding the accounting treatment was reached. During the third quarter of 2004, the issue was re-evaluated and it was determined that an error in the accounting treatment had occurred. The cumulative impact of the error for which the Company restated resulted in the overstatement of revenues and the omission of the related liability to the guarantee of these discount obligations that aggregated $2.4 million as of June 26, 2004 (the end of the second quarter of 2004). The Company immediately implemented accounting policies to appropriately account for all obligations due to members of the buyers’ club programs.
•
On November 9, 2004, the Company’s Audit Committee discussed the two matters noted above with the Company’s former independent registered public accounting firm, KPMG LLP (“KPMG”) and then on November 17, 2004, the Audit Committee launched an investigation relating to the restatement of the Company’s consolidated financial statements and other accounting-related matters and engaged Wilmer Cutler as its independent outside counsel to assist with the investigation.
•
The Company was notified on January 11, 2005 by the SEC that the SEC was conducting an informal inquiry relating to the Company’s financial results and financial statements since 1998. The Audit Committee, the Board of Directors and the Company’s management have been cooperating fully with the SEC in connection with the inquiry.
•
On February 3, 2005, the Company reported that its Common Stock was being delisted by the AMEX as a consequence, among other reasons, of the Company’s inability to meet the AMEX’s continued listing requirements and its inability to timely file its Form 10-Q for the fiscal quarter ended September 25, 2004.
•
On March 14, 2005, the Audit Committee reported that it had concluded its investigation and, with the assistance of Wilmer Cutler, reported its findings to the Board of Directors. The Audit Committee, with Wilmer Cutler’s assistance, formulated recommendations to the Company and the Board of Directors concerning ways of improving the Company’s internal controls and procedures for financial reporting which the Board of Directors and the Company began to implement.

•
The Audit Committee subsequently instructed Wilmer Cutler to cooperate fully with the SEC in connection with its inquiry and share the results of its investigation with the SEC, KPMG and Goldstein Golub Kessler LLP (“GGK”), whom had been engaged by the Audit Committee on November 2, 2005 as the Company’s new auditors after the dismissal of KPMG on October 20, 2005. Wilmer Cutler has presented the results of its investigation to the SEC, KPMG and GGK.
•
During the course of preparing its 2004 consolidated financial statements, the Company evaluated a previously reversed litigation reserve relating to post employment benefits allegedly owed to its former CEO. In the course of evaluating the accounting treatment of the restoration of the reserve, the Company identified that the original reserve had been improperly established as a litigation reserve rather than an accrual for post employment benefits and that legal expenses had been improperly charged against the reserve rather than treated as period expenses. Management corrected these errors and restated all affected periods presented in accordance with the corrected treatment of the reserve.
•
During the course of preparing its 2004 consolidated financial statements, the Company determined that an accrual related to certain customer prepayments and credits had been inappropriately released and that other liabilities relating primarily to certain miscellaneous catalog costs and other miscellaneous costs had not been appropriately accrued in the appropriate periods. The Company re-established the improperly released accrual and accrued certain miscellaneous catalog costs in the appropriate periods and restated all affected periods presented in accordance with the corrected treatment of these items.
Internal Control Over Financing Reporting
KPMG, the Company’s former auditors, identified material weaknesses in internal control over financial reporting duringbased upon its audit of the Company's recent fiscal quarter that has
materially affected, or is reasonably likely to materially affect,2004 consolidated financial statements which it did not complete. After their engagement, we informed GGK of the Company'sidentified material weaknesses in internal control over financial reporting.

                                        97
reporting and other matters relating to the Company’s internal controls based upon KPMG’s incomplete audit of the 2004 consolidated financial statements. Upon completion of their audit of fiscal 2004, GGK has not brought to our attention any material weaknesses. Our management considered the material weaknesses identified by KPMG in evaluating the adequacy of the Company’s internal controls.
A control deficiency exists when the design or operation of a control does not allow management or employees, in the normal course of performing their assigned functions, to detect or prevent misstatements on a timely basis. A deficiency in design exists when (a) a control necessary to meet the control objective is missing, or (b) an existing control is not properly designed so that even if the control operates as designed, the control objective is not always met. A deficiency in operation exists when a properly designed control does not operate as designed, or when the person performing the control does not posses the necessary authority or qualification to perform the control effectively. A material weakness is a significant deficiency, or combination of significant deficiencies, that result in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. The following material weaknesses had been identified:
•
The Company lacks a sufficient number of financial and tax personnel with the appropriate level of expertise to independently monitor, interpret and implement the application of financial accounting standards in accordance with generally accepted accounting principles,
•
The environment of the Company was such that members of management were not encouraged to discuss transactions and events that could impact the appropriate financial reporting of the Company, and
•
The Company does not have adequate policies and procedures relating to the origination and maintenance of contemporaneous documentation to support key accounting judgments or to effectively document the terms of all significant contracts and agreements and the related accounting treatment for these contracts and agreements.

The Company has strengthened and replaced its senior management commencing with the May 5, 2004 appointment of a new Chief Executive Officer. Under new management, the Company is committed to meeting and enhancing its internal control obligations as part of the Company’s overall commitment to establishing a new corporate culture that focuses on ethics, unfettered communication within the organization and compliance, and sets a new standard for corporate behavior within the Company. Toward this end during 2004, the Company has:
•
Appointed a new Chief Executive Officer;
•
Replaced its Corporate Controller and Director of Internal Audit; 
•
Instituted a policy of open channels of communication including regularly scheduled meetings of and with senior management;
•
Instituted weekly meetings between the CEO and Director of Internal Audit to review the status of internal audits and assess internal controls; and
•
Instituted periodic trips by senior management to the Company’s remote facilities to foster communication and ensure compliance with the Company’s reporting, internal control and ethics policies.
The Company continued to implement changes to its internal controls during 2005 and has:
•
Replaced its Chief Financial Officer, and filled other open finance positions which resulted from earlier terminations and other departures; 
•
Hired a General Counsel and replaced its outside counsel;  
•
Instituted weekly reviews of financial results with the Chief Financial Officer and senior management to enhance transparency and accountability;
•
Instituted a policy that requires review and approval of all material agreements and marketing plans by the legal and financial departments;
•
Instituted a policy that requires all systems changes that could impact financial reporting be subject to approval by the financial department;
•
Revised the Company’s reporting structure to have the catalog finance directors report to the CFO;
•
Documented the Company’s significant accounting policies and implemented a procedure to periodically review and update these policies; and
•
Implemented a policy that requires the preparation of contemporaneous memoranda and related documentation to support key accounting judgments and to maintain and document the significant terms of material contracts and the accounting treatment thereof.
As a result of the restatement of our prior period financial statements and the delay in the completion of the audits and reviews of those statements and the change in our auditors, the burden on our accounting and financial staff has been greatly increased and has thus far caused us to be unable to file our periodic SEC reports on a timely basis. While management believes that current practices and procedures are sufficient to bring to its attention items required to be disclosed in our periodic SEC filings, after an evaluation of those practices, we have determined to institute procedures to enhance the effectiveness of our disclosure controls. Subject to the foregoing, management believes that our disclosure controls are effective for purposes of Item 307 of Regulation S-K.

Item 9B. Other Information.
None.
PART III

ITEM
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

     (a) Directors and Executive Officers of the Registrant
(a)
Identification of Directors
As provided in the Company’s Certificate of Incorporation and Bylaws, Directors hold office until the next annual meeting or until their successors have been elected or until their earlier death, resignation, retirement, disqualification or removal 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.

     removal.
Pursuant to the Corporate Governance Agreement, dated as of November 30, 2003, by and among the Company, Chelsey, Stuart Feldman and the Regan Partners, L.P.,
Regan International Fund Limited and Basil P. Regan, the parties agreed thatEntities, 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 Companywere to have been designated by Chelsey (who initially were Martin L. Edelman, William Wachtel,
Stuart Feldman, Wayne Garten and Donald Hecht) and one ofby the nine directors of
the Company will at all times be a director of the Company designated by Regan Partners (who initiallyEntities. The Corporate Governance Agreement was terminated when Basil Regan). The right of Regan Partners to
designate a nominee toresigned from 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


     Seton July 31, 2004.
The following sets forth below is certain information regarding the current directors of the Company as of the date hereof:
 
Name
Age
 
Title and Other Information
Director
Since
Robert H. Masson
70
Robert H. Masson served as Senior Vice President, Finance and Administration and Vice President and Chief Financial Officer of Parsons & Whittemore, Inc., a global pulp and paper manufacturer, from May 1990 until his retirement June 30, 2002. Prior thereto, Mr. Masson held various executive, financial and treasury roles with The Ford Motor Company, Knutson Construction Company, Ellerbe, PepsiCo, Inc. and Combustion Engineering (now part of the ABB Group). Mr. Masson currently serves as a Trustee and as the Chairman of the Finance Committee of The Naval Aviation Museum Foundation, Inc. in Pensacola, Florida. Mr. Masson was elected a director of the Company effective January 1, 2003. Mr. Masson is the Chairman of the Audit Committee and a member of the Corporate Governance and Nominating Committees.
2003
A. David Brown
63
Mr. Brown is the co-founder of Bridge Partners LLC, a consumer financial services and diversity headhunting firm. Prior to co-founding Bridge Partners, Mr. Brown served as a Managing Director of Whitehead Mann after having served as Vice President of the Worldwide Retail/Fashion Specialty Practice at Korn/Ferry International. Previously, Mr. Brown served for 12 years as Senior Vice President for Human Resources at R.H. Macy & Co. He was responsible for human resources and labor relations for 50,000 employees in five U.S. divisions and 17 foreign buying offices around the world. He serves on the Boards of Zale Corporation and Selective Insurance Group, Inc. He is a member of the Board of Trustees of Morristown Memorial Hospital, Drew University and the Jackie Robinson Foundation. Mr. Brown was elected a director of the Company effective July 29, 2003 and is the Chairman of the Corporate Governance and Transaction Committees and a member of the Audit Committee.
2003

Wayne P. Garten
53
Mr. Garten was elected a director of the Company by Chelsey effective September 29, 2003 and appointed President and Chief Executive Officer of the Company on May 5, 2004. Mr. Garten is a member of the Executive and Nominating Committees. Prior to his appointment, Mr. Garten served as the President of Caswell-Massey Ltd., Inc., a retailer and direct marketer of fragrance and other personal care products, from January 2004. Prior thereto, Mr. Garten was a financial consultant specializing in the direct marketing industry. He was Chief Executive Officer and President of Popular Club, Inc., a direct selling, catalog marketer of apparel and general merchandise products, from 2001 to 2003. From 1997 to 2000, he was Executive Vice President and Chief Financial Officer of Micro Warehouse, Inc., an international catalog reseller of computer products. From 1983 to 1996, Mr. Garten held various financial positions at Hanover Direct and its predecessor, The Horn & Hardart Company, including Executive Vice President and Chief Financial Officer from 1989 to 1996. Mr. Garten is a Certified Public Accountant.
2003
William B. Wachtel
51
Mr. Wachtel has been a managing partner of Wachtel & Masyr, LLP, or its predecessor law firm (Gold & Wachtel, LLP), since its founding in August 1984. He is the co-founder of the Drum Major Institute, a not-for-profit organization carrying forth the legacy of Dr. Martin Luther King, Jr. Mr. Wachtel is the Manager of Chelsey. Mr. Wachtel was elected a director of the Company effective November 18, 2003, the date of the Recapitalization Agreement. Mr. Wachtel was appointed the Chairman of the Board of Directors on May 5, 2004 and is Chairman of the Nominating Committee and is a member of the Executive and Corporate Governance Committees. Mr. Wachtel is the Manager of Chelsey and Chelsey Finance and the trustee of Chelsey Capital Profit Sharing Plan which is the sole member of Chelsey and Chelsey Finance.
2003
Stuart Feldman
46
Mr. Feldman has been a principal of Chelsey Capital, LLC, a private hedge fund, for more than the past five years. Mr. Feldman is the principal beneficiary of Chelsey Capital Profit Sharing Plan, which is the sole member of Chelsey. Mr. Feldman was elected a director of the Company effective November 18, 2003, the date of the Recapitalization Agreement and is Chairman of the Executive Committee and a member of the Compensation Committee. Mr. Feldman is the principal beneficiary of the Chelsey Capital Profit Sharing Plan, which is the sole member of Chelsey and Chelsey Finance and the sole officer and director of DSJ International Resources Ltd., the sole sponsor of the Chelsey Capital Profit Sharing Plan. Mr. Feldman was elected a director of the Company effective November 18, 2003, the date of the Recapitalization and is Chairman of the Executive Committee and a member of the Compensation Committee.
2003
Donald Hecht
72
Mr. Hecht has, since 1966, together with his brother Michael Hecht, managed Hecht & Company, an accounting firm. Mr. Hecht was elected a director of the Company effective November 18, 2003, the date of the closing of the Recapitalization and is a member of the Audit and Compensation Committees.
2003
Paul S. Goodman
51
Mr. Goodman is the Chief Executive Officer of Billybey Ferry Company, LLC, a ferry company that provides commuter ferry service between Manhattan and New Jersey and also provides ferry cruise services. Since 2003, Mr. Goodman has been CEO of Chelsey Broadcasting Company, LLC, which owns middle market network-affiliated television stations. Until October 2002, Mr. Goodman had served as a director of Benedek Broadcasting Corporation from November 1994 and as a director of Benedek Communications Corporation from its inception. From 1983 until October 2002, Mr. Goodman was also corporate counsel to Benedek Broadcasting and Benedek Communications since its formation in 1996 until October 2002. From April 1993 to December 2002, Mr. Goodman was a member of the law firm of Shack Siegel Katz Flaherty & Goodman, P.C. From January 1990 to April 1993, Mr. Goodman was a member of the law firm of Whitman & Ransom. Mr. Goodman became a director of the Company effective April 12, 2004. Mr. Goodman is a member of the Corporate Governance Committee.
2004

                                                                                           DIRECTOR
NAME                        AGE                TITLE AND OTHER INFORMATION                  SINCE
- ----                        ---                ---------------------------                 --------

Thomas C. Shull             52     Thomas C. Shull has been Chairman
(b)
Identification 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.
Officers


                                        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'sCompany’s Bylaws, itsthe Company’s officers are chosen annually by the Board of Directors and hold office until their respective successors are chosen and qualified.
On May 5, 2004, Thomas C. Shull was replaced as the Company’s Chief Executive Officer by Wayne P. Garten. On November 3, 2003, Charles E. Blue was appointed Chief Financial Officer of the Company effective November 11, 2003, replacing Edward M. LambertLambert. Mr. Blue resigned as Chief Financial Officer and Secretary on March 8, 2005 and John W. Swatek was appointed as Chief Financial Officer and Treasurer effective on such date in connection withApril 4, 2005. During the Company's
ongoing strategic business realignment program.interim period, Mr. Blue joined the Company in
1999 and had most recentlyGarten 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. HarrissChief Financial Officer. Daniel J. Barsky 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

Senior Vice President and General Counsel on January 31, 2005 and Secretary on March 8, 2005.

Set forth below is certain information regarding the current executive officers of the Company
 
Name
 
Age
 
Title and Other Information
Office Held
Since
Wayne P. Garten
53
Chief Executive Officer, President and Director. Information concerning Mr. Garten appears above under Directors.
 
2004
Michael D. Contino
44
Executive Vice President and Chief Operating Officer since April 25, 2001. Senior Vice President and Chief Information Officer from December 1996 to April 25, 2001 and President of Keystone since November 2000. Mr. Contino joined the Company in 1995 as Director of Computer Operations and Telecommunications. Prior to 1995, Mr. Contino was the Senior Manager of IS Operations at New Hampton, Inc., a subsidiary of Spiegel, Inc.
 
2001
John W. Swatek
41
Senior Vice President, Chief Financial Officer and Treasurer. Prior to joining the Company Mr. Swatek was Vice President and Controller of Linens ‘n Things, Inc. Before joining Linens ‘n Things, Inc. in 2001, Mr. Swatek held various positions with Micro Warehouse, Inc. including serving as its Senior Vice President, Finance from 2000 to 2001.
 
2005
Daniel J. Barsky
50
Senior Vice President, General Counsel and Secretary. Prior to joining the Company, Mr. Barsky was an independent legal consultant. Mr. Barsky served as acting General Counsel to Directrix, Inc. from 2001 to 2003, Executive Vice President, General Counsel and Secretary to American Interactive Media, Inc. from 1999 to 2001 and Executive Vice President, General Counsel and Secretary to Spice Entertainment Companies, Inc. from 1994 to 1999.
 
2005
Steven Lipner
57
Vice President, Taxation since October 2000. Mr. Lipner served as Director of Taxes from February 1984 to October 2000. Prior thereto, he served as Director of Taxes at Avnet, Inc. and held various positions in public accounting. He holds a license as a Certified Public Accountant in New York.
 
2000

                                                                                         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
(c)
Audit Committee 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.
Expert


                                       102


     (c) Audit Committee Financial Expert

     
The Company'sCompany’s Board of Directors has determined that the Company has at least one "audit“audit committee financial expert"expert” serving on the Audit Committee of the Board of Directors who is "independent"“independent” of management within the definition of such term in the Securities Exchange Act of 1934, as amended, and the listing
requirementsunder Rule Section 121A of the American Stock Exchange.AMEX listing standards. Robert H. Masson, a member of the Board of Directors and the Chairman of its Audit Committee, is the "audit“audit committee financial expert"expert” serving on the Company'sCompany’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 thean “audit committee financial expert.”
The current 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 ofMr. Garten was an Audit Committee member until he became CEO and resigned from the Audit Committee is independent, as defined in Rule Section 121(A) of the American
Stock Exchange's listing standards.

     (d) Code of Ethics

     Committee.

(d)
Code of Ethics
The Company has adopted a code of ethics that applies to the Company'sCompany’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'sCompany’s 2002 Annual Report on Form 10-K. The Company has also adopted a code of conduct that applies to the Company'sCompany’s directors, officers and employees. A copy of the code of conduct was filed as an Exhibit to thisthe 2003 Annual Report on Form 10-K.

     (e) Section 16(a) Beneficial Ownership Reporting Compliance

     
(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'sCompany’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
Item 11. EXECUTIVE COMPENSATION

     Executive Compensation
The following table shows salaries, bonuses, and long-term compensation paid during the last three years for the Chief Executive Officer (including Mr. Shull who resigned during 2004) and the Company'sCompany’s four next most highly compensated executive officers who were serving as executive officers at the end of the Company’s 2004 fiscal year.
 
 
 
Long Term Compensation
 
 
 
 
 
 
 
 
Awards
 
 
 
 
 
 
 
 
 
 
Securities
 
 
 
 
 
Underlying
 
Name and
 
Annual Compensation
Other Annual
Options/
All Other
Principal Position
Year
Salary
Bonus
Compensation
SARs
Compensation
 
 
 
 
 
 
 
Wayne P. Garten(1)
2004
$    380,769 (2)
$  300,000 (6)
$ 14,500 (11)
200,000 (16)
$ 4,846 (18)
President and Chief
2003
—
—
$ 101,500 (11)
5,000 (16)
—
Executive Officer
 
 
 
 
 
 
 
 
 
 
 
 
Michael D. Contino(1)
2004
$          375,837
—
—
—
$ 13,083 (19)
Executive Vice President
2003
$          393,698
$  263,656 (7)
—
—
$ 151,282 (20)
And Chief Operating Officer
2002
$          382,270
$  565,988 (7)
$ 4,000 (12)
100,000 (17)
$  9,873 (21)
 
 
 
 
 
 
 
John DiFrancesco(1)
2004
$          309,300
$  253,500 (8)
—
—
$ 11,442 (22)
President, The Company
2003
$          317,400
$   55,180 (8)
—
—
$ 10,531 (23)
Store Group, LLC
2002
$          307,846
$  412,000 (8)
$ 4,000 (13)
40,000 (17)
$ 8,237 (24)
 
 
 
 
 
 
 
Steven Lipner(1)
2004
$          175,520
$   10,000 (9)
—
—
$ 3,927 (25)
Vice President
2003
$          172,924
$   7,768 (9)
—
—
$ 4,220 (26)
Taxation
2002
$          163,900
$   78,877 (9)
—
5,000 (17)
$ 3,849 (27)
 
 
 
 
 
 
 
Thomas C. Shull(1)
2004
$    295,962 (3)
—
—
—
$ 906,776 (28)
Former President and Chief
2003
$    915,588 (4)
$2,250,000 (4)
 
—
$ 12,369 (29)
Executive Officer
2002
$    905,923 (5)
$1,327,500 (5)
$ 165,000 (14)
—
$ 2,116 (30)
 
 
 
 
 
 
 
Charles E. Blue(1)
2004
$          271,029
—
—
—
$ 13,608 (31)
Former Senior Vice
2003
$          231,096
$  47,133 (10)
 
—
$ 12,218 (32)
President and Chief
2002
$          197,000
$  206,938 (10)
$ 4,000 (15)
25,000 (17)
$ 10,212 (33)
Financial Officer
 
 
 
 
 
 
__________

(1)
Thomas C. Shull was named President and Chief Executive Officer and was elected to the Company’s Board of Directors on December 5, 2000. He resigned on May 5, 2004. Wayne P. Garten was appointed to the Board of Directors on September 30, 2003 and was named President and Chief Executive Officer on May 5, 2004. Charles E. Blue was appointed Senior Vice President and Chief Financial Officer on November 11, 2003. Mr. Blue’s employment was terminated on March 7, 2005. Mr. Garten served as interim Chief Financial Officer until April 4, 2005 when Mr. Swatek became Chief Financial Officer. Mr. Contino was appointed Executive Vice President and Chief Operating Officer on April 25, 2001. Mr. DiFrancesco was appointed as President of The Company Store Group in September 2001 and resigned on December 8, 2005. Mr. Lipner was appointed Vice President of Taxation in 2000.
(2)
$380,769 of salary under the May 5, 2004 Employment Agreement between Mr. Garten and the Company (“Garten Employment Agreement”).
(3)
Salary until resignation on May 5, 2004.
(4)
$915,588 of salary, a $450,000 stay bonus and a $1,350,000 change of control payment was paid to Mr. Shull under an Employment Agreement between Mr. Shull and the Company, dated as of September 1, 2002 (as amended, the “Shull Employment Agreement”). An additional $450,000 transaction bonus was paid to Mr. Shull under the Shull Transaction Bonus Letter (as defined below).
(5)
$276,923 of salary and a $450,000 stay bonus was paid to Mr. Shull under the Shull Employment Agreement. Includes an $877,500 performance bonus for 2002 paid in 2003 under the Shull Employment Agreement. The remaining $629,000 of salary and bonus was paid to Meridian Ventures, LLC, a limited liability company controlled by Mr. Shull (“Meridian”) pursuant to an agreement (“Meridian Services Agreement”) that predated the Shull Employment Agreement. See “Employment Contracts, Termination of Employment and Change-in-Control Arrangements.”
(6)
Includes for 2004, a $300,000 2004 performance bonus scheduled to be paid during 2005.
(7)
Includes the following payments made to Mr. Contino: for 2003 a $193,500 transaction bonus and a $70,156 2003 performance bonus paid in 2004; for 2002, a $565,988 2002 performance bonus paid in 2003.
(8)
Includes the following payments made to Mr. DiFrancesco: for 2004 a $253,500 2004 performance bonus scheduled to be paid during 2005; for 2003 a $55,180 2003 performance bonus paid in 2004; for 2002, a $412,000 2002 performance bonus paid in 2003.
(9)
Includes the following payments made to Mr. Lipner: for 2004 a $10,000 performance bonus scheduled to be paid during 2005; for 2003 a $7,768 performance bonus paid in 2004; for 2002, a $78,877 2002 paid in 2003.
(10)
Includes the following payments made by the Company to Mr. Blue: for 2003, a $47,133 performance bonus for 2003 paid in 2004; for 2002, a $206,938 performance bonus for 2002 paid in 2003.
(11)
Mr. Garten received the following payments as a member of the Board of Directors: for 2004 $14,500 prior to his employment as President and Chief Executive Officer of the Company; for 2003 $101,500. He was granted options to purchase 5,000 shares of Common Stock in 2003.
(12)
Includes the following payments made by the Company on behalf of Mr. Contino: $4,000 in car allowance and related benefits in 2002.
(13)
Includes the following payments made by the Company on behalf of Mr. DiFrancesco: $4,000 in car allowance and related benefits in 2002.
(14)
Paid to Meridian pursuant to the Meridian Services Agreements for Meridian’s over-head (including legal and accounting), health care costs, payroll costs, and other expenses relating to Mr. Shull. See “Employment Contracts, Termination of Employment and Change in Control Arrangements.”
(15)
Includes the following payments made by the Company on behalf of Mr. Blue: $4,000 in car allowance and related benefits in 2002.
(16)
200,000 options granted per the Garten Employment Agreement, half under the 2000 Management Stock Option Plan and half outside the 2000 Management Stock Option Plan. 5,000 options granted under the 2002 Stock Option Plan for directors.
(17)
Granted by the Company pursuant to the Company’s 2000 Management Stock Option Plan. See “Report of the Stock Option and Executive Compensation Committee on Executive Compensation—2000 Management Stock Option Plan.”

(18)
Includes the following payments made by the Company on behalf of Mr. Garten in 2004: $170 in group term life insurance premiums; $24 in accidental death and disability insurance premiums; $119 in core life insurance premiums; $103 in dental insurance premiums; $85 in long-term disability premiums; $4,345 in health care insurance premiums.
(19)
Includes payments made by the Company on behalf of Mr. Contino in 2004: $120 in group term life insurance premiums; $40 in accidental death and disability insurance premiums; $182 in core life insurance premiums; $219 in dental insurance premiums; $146 in long-term disability premiums; $8,959 in health care insurance premiums; and $3,417 in matching contributions under the Company’s 401(k) Savings Plan.
(20)
Includes payments made on behalf of Mr. Contino in 2003; $125 in group term life insurance premiums; $40 in accidental death and disability insurance premiums; $162 in core life insurance premiums; $205 in dental insurance premiums; $159 in long-term disability premiums; $8,195 in health care insurance premiums; $3,333 in matching contributions under the Company’s 401 (k) Savings Plan. Also includes forgiveness of a $75,000 non-interest-bearing loan made by the Company to Mr. Contino in January 1998. The loan was forgiven in full in accordance with its terms during January 2003. In addition to the loan forgiveness, the Company paid all applicable withholding taxes totaling $64,063.
(21)
Includes payments made on behalf of Mr. Contino in 2002; $120 in group term life insurance premiums; $40 in accidental death and disability insurance premiums; $162 in core life insurance premiums; $143 in dental insurance premiums; $484 in long-term disability premiums; $5,589 in health care insurance premiums; $2 in vision assistance; $3,333 in matching contributions under the Company’s 401(k) Savings Plan.
(22)
Includes the following payments made by the Company on behalf of Mr. DiFrancesco in 2004: $516 in group term life insurance premiums; $40 in accidental death and disability insurance premiums; $182 in core life insurance premiums; $170 in dental insurance premiums; $146 in long-term disability premiums; $6,990 in health care insurance premiums; and $3,398 in matching contributions under the Company’s 401(k) Savings Plan.
(23)
Includes the following payments made by the Company on behalf of Mr. DiFrancesco in 2003: $287 in group term life insurance premiums; $40 in accidental death and disability insurance premiums; $162 in core life insurance premiums; $160 in dental insurance premiums; $158 in long-term disability premiums; $6,391 in health care insurance premiums; and $3,333 in matching contributions under the Company’s 401(k) Savings Plan.
(24)
Includes the following payments made by the Company on behalf of Mr. DiFrancesco in 2002: $276 in group term life insurance premiums; $40 in accidental death and disability insurance premiums; $162 in core life insurance premiums; $116 in dental insurance premiums; $407 in long-term disability premiums; $4,601 in health care insurance premiums; $2 in vision assistance, $2,633 in matching contributions under the Company’s 401(k) Savings Plan.
(25)
Includes the following payments made by the Company on behalf of Mr. Lipner in 2004: $516 in group term life insurance premiums; $40 in accidental death and disability insurance premiums; $182 in core life insurance premiums; $146 in long-term disability premiums; and $3,043 in matching contributions under the Company’s 401(k) Savings Plan.
(26)
Includes the following payments made by the Company on behalf of Mr. Lipner in 2003: $527 in group term life insurance premiums; $40 in accidental death and disability insurance premiums; $162 in core life insurance premiums; $158 in long-term disability premiums; and $3,333 in matching contributions under the Company’s 401(k) Savings Plan.
(27)
Includes the following payments made by the Company on behalf of Mr. Lipner in 2002: $276 in group term life insurance premiums; $40 in accidental death and disability insurance premiums; $162 in core life insurance premiums; $38 in dental insurance premiums; $260 in long-term disability premiums; and $3,073 in matching contributions under the Company’s 401(k) Savings Plan.
(28)
Includes the following payments made by the Company on behalf of Mr. Shull in 2004: $900,000 in severance payments; $96 in group term life insurance premiums; $14 in accidental death and disability insurance premiums; $56 in core life insurance premiums; $78 in dental insurance premiums; $55 in long-term disability premiums; $3,060 in health care insurance premiums; $3,417 in matching contributions under the Company’s 401(k) Savings Plan;

(29)
Includes the following payments made by the Company on behalf of Mr. Shull in 2003: $276 in group term life insurance premiums; $40 in accidental death and disability insurance premiums; $162 in core life insurance premiums; $205 in dental insurance premiums; $158 in long-term disability premiums; $8,195 in health care insurance premiums; and $3,333 in matching contributions under the Company’s 401(k) Savings Plan.
(30)
Includes the following payments made by the Company on behalf of Mr. Shull in 2002: $85 in group term life insurance premiums; $12 in accidental death and disability insurance premiums; $50 in core life insurance premiums; $44 in dental insurance premiums; $49 in long-term disability premiums; $1,876 in health care insurance premiums.
(31)
Includes the following payments made by the Company on behalf of Mr. Blue in 2004: $120 in group term life insurance premiums; $40 in accidental death and disability insurance premiums; $182 in core life insurance premiums; $219 in dental insurance premiums; $146 in long-term disability premiums; $8,959 in health care insurance premiums; and $3,402 in matching contributions under the Company’s 401(k) Savings Plan.
(32)
Includes the following payments made by the Company on behalf of Mr. Blue in 2003: $125 in group term life insurance premiums; $40 in accidental death and disability insurance premiums; $162 in core life insurance premiums; $205 in dental insurance premiums; $158 in long-term disability premiums; $8,195 in health care insurance premiums; and $3,333 in matching contributions under the Company’s 401(k) Savings Plan.
(33)
Includes the following payments made by the Company on behalf of Mr. Blue in 2002: $120 in group term life insurance premiums; $40 in accidental death and disability insurance premiums; $162 in core life insurance premiums; $143 in dental insurance premiums; $285 in long-term disability premiums; $6,195 in health care insurance premiums; and $3,265 in matching contributions under the Company’s 401(k) Savings Plan; and $2 in vision plan premiums.
Stock Options and Stock Appreciation Rights
The following table contains information concerning options granted to the Chief Executive Officer and the Company’s four next most highly compensated executive officers who were serving as executive officers at the end of the Company’s 2004 fiscal year. There were no stock appreciation rights (“SARs”) granted during fiscal 2004.
Option/SAR Grants in Fiscal 2004
 
Individual Grants 
 
 
Number of
 
 
 
 
 
Securities
Percentage of
 
 
 
 
 
Underlying
Total Options/
 
 
 
 
 
Options/
SARs Granted
Exercise
Market Price
 
 
SARs
to Employees in
or Base
on Date of
 
Grant Date
Name
Granted 
Fiscal Year 2004 
Price 
Grant 
Expiration Date 
Value($) 
 
 
 
 
 
 
 
Wayne P. Garten
200,000
88.1%
$1.95
$2.00
5/5/2014
289,600
The following table contains information concerning the fiscal 2004 year-end values of all options and SARs granted to the Chief Executive Officer and the Company’s four (4) next most highly compensated executive officers who were serving as executive officers at the end of the Company's 2003Company’s 2004 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 
Aggregated Option/SAR Exercises in 2004 Fiscal Year
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
2004 Option/SAR Values
Number of Securities
Underlying Unexercised
Options/SARs at
December 25, 2004
Value of Unexercised
In-the-Money
Options/SARs at
December 25, 2004
Name
Shares Acquired
on Exercise(#)
Value
Realized($)
Exercisable/
Unexercisable
Exercisable/
Unexercisable
Wayne P. Garten
--
--
71,666 exercisable
$0/$0
133,334 unexercisable



President and Chief Financial Officer of the
Director Compensation
Standard Arrangements. The Company and Michael D. Contino
became Executive Vice President and Chief Operating Officer of the Company.
Effective January 28, 2002, Mr. Harriss resignedpays its non-employee directors a $58,000 annual fee; no supplemental fees are paid for serving 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 a Board committee or for attending Board meetings. Non-employee directors also participated in 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. Shull1999 Stock Option Plan for Directors (“1999 Directors’ Plan”) and the Company, dated as of September 1, 2002 as amended by
     Amendment No. 1 thereto dated as of September 1, Stock Option Plan for Directors (“2002 Amendment No. 2
     thereto dated as of June 23, 2003,Directors’ Plan”) and Amendment No. 3 thereto dated as of
     August 3, 2003 (as amended,may in the "2002 Employment Agreement"), pursuant to
     which Mr. Shull is employed byfuture participate in 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)2004 Stock Option Plan for Directors (the “2004 Directors’ Option Plan”). (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“Employment Contracts, Termination of Employment and Change-in-Control Arrangements."

 (4) Paid to Meridian Ventures, LLC under the Services Agreements.

 (5) $406,923” The Company does not compensate its employees, or employees of salary and $640,000 of severance was paid to Mr. Lambert in
     connection with a severance agreement withits subsidiaries, who serve as directors. During fiscal 2004, 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, Terminationalso provided $50,000 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
     contributionsfor each director.
Effective January 1, 2003, the 2002 Directors’ Plan was amended to increase the annual award for non-employee directors from options to purchase 2,500 shares to 3,500 shares of Common Stock. In November 2003, the 2002 Directors’ Plan was amended to increase the pool of options to purchase shares of Common Stock from 50,000 to 90,000 shares of Common Stock.
During 2004, options to purchase 5,000 shares of Common Stock were granted to a new non-employee director under the Company's 401(k) Savings Plan.

(19) Includes the following payments made by the Company on behalf2002 Directors’ Plan and options to purchase 21,000 shares 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")Common Stock were 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. Shullsix non-employee directors under the December 2000 Services
    Agreement. All of such options were exercisableautomatic annual grant 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 amountDirectors’ Plan. No options were exercised by Directors during 2004. As 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 option25, 2004, 7,000 options 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 Management1999 Directors’ Plan were outstanding and exercisable. As of December 25, 2004, 65,500 options to purchase Common Stock under the 2002 Stock Option Plan (the "Shull 2001for Directors were outstanding, 36,167 of which were exercisable.
2004 Stock Option Agreement"). Effective asPlan for Directors – During 2004, the Board of September 1, 2002,Directors adopted the Company has amended the Shull 2001 Stock2004 Directors’ Option AgreementPlan, pursuant 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 issuedstock options to purchase 3,750,000 shares of the Company's Common Stock may be granted to certain Management
Incentivenon-employee directors. The Company’s shareholders ratified the 2004 Directors’ Option Plan ("MIP") Level 7 and 8 employees, including various executive
officers, at a pricethe 2004 Annual Meeting of $0.24 per share and services rendered under the
Company's 2000 Management Stock Option Plan. In addition, on August 8, 2002, theShareholders. The Company authorized the President tomay grant options to purchase up to an aggregate
of 1,045,000 and 1,366,000100,000 shares of the Company's Common Stock to certain MIP
Level 4 and MIP Level 5 and 6 employees, respectively,eligible directors at aan exercise 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 Stockequal 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 whofair market value as of the dategrant date. An eligible director will receive an initial option grant to purchase 5,000 shares 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 DirectorCommon Stock as of the effective date of the Executive Plan
will be deemed to be an Incumbent Director if such Director was electedhis/her appointment or election 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, qualifiedDirectors. On each Award Date, defined as Incumbent Directors either
actually or by prior operation of (iii),August 3, 2004, August 3, 2005 and any persons (and their successors
from time to time) whoAugust 3, 2006, eligible directors 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) whengranted options to purchase additional shares of Common Stock (to the Company sells, assigns or transfers more than 50%extent the 2002 Stock Option Plan for Directors did not have enough remaining shares). Stock options granted have terms of its interest in, orten years and vest over three years from the assets of, one or more of its subsidiaries (each, a
"Sold Subsidiary" and, collectively, the "Sold Subsidiaries"); provided,grant date; however, that such a sale, assignment or transfer will constituteif there is a Change ofin 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), the participant has the cumulative right to purchase up to 100% of the option shares. Option holders may pay for shares purchased on exercise in cash or Common Stock. As of December 25, 2004 no options have been granted under the 2004 Directors’ Option Plan.
The non-employee directors waived their right to the automatic grant of options to be granted on August 3, 2005.
Director Compensation Continuation Agreement. Effective May 3, 2001, the Company'sCompany’s Board of Directors established the Hanover Direct, Inc. Directors Change of Control Plan (the "Directors Plan"“Director Compensation Continuation Agreement”) for 114
all non-employee 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.

     Company.
A participant in the Directors Plan shall beDirector Compensation Continuation Agreements is entitled to receive a Change of Control Payment under the Directors Plan if there occurs a Change of Control and he/she isoccurs while a Directordirector on the effective date of suchthe Change of Control. AThe Change of Control Payment under the Directors Plan shall be an amount equal toDirector Compensation Continuation Agreement is the greater of (i) $40,000 or (ii) 150% of the sum of the annual retainer fee, meeting fees and per diem fees paid to a Director for his/her service on the Board of Directors of the Company during the 12-monthtwelve month period immediately preceding the effective date of the Change of Control. The Recapitalization transaction was a "Change“Change of Control"Control” for purposes of the Directors Plan. The Company was permitted to make all payments thereunderDirector Compensation Continuation Agreement and on
or after the closing of the Recapitalization. On December 18, 2003, each of the then eight non-employee directors (Messrs. Brown, James, Krushel, Sonnenfeld, Masson, Regan, Garten and Edelman) received a payment in the amount ofan $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
payment.

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
Garten Employment Agreement." In December 2003, Messrs. Shull,
HarrissOn May 6, 2004, Wayne P. Garten became the Company’s Chief Executive Officer and Contino received payments in the amount of $450,000, $168,500 and
$193,500, respectively, underPresident. Mr. Garten is employed pursuant to the terms of a May 6, 2004 Employment Agreement. Under Mr. Garten’s Employment Agreement he will be paid an annual salary of $600,000 over a term expiring on May 6, 2006. The Company also granted Mr. Garten options to acquire 200,000 shares of the Company’s common stock, half pursuant to its 2000 Management Stock Option Plan (“2000 Management Option Plan”) and half outside the plan. All of the options have an exercise price of $1.95 per share, the Common Stock’s average closing price for the ten trading days preceding the grant date and the ten trading days after the grant date. One third of each of the options vested upon execution of the Employment Agreement and the balance will vest in two equal annual installments on the anniversary of the original grant date, subject to earlier vesting in the event of a change in control of the Company (as that term is defined in the Employment Agreement). Mr. Garten is entitled to participate in the Company’s bonus plan for executives, as established by the Board of Directors.
The Employment Agreement provides for a lump sum change in control payment equal to 200% of Mr. Garten’s annual salary if a change in control occurs during the term. The Employment Agreement also provides for eighteen months of severance payments if Mr. Garten is not otherwise entitled to change in control benefits and (i) is terminated without cause or terminates his employment for good reason (as both terms are defined in the Employment Agreement) during the term or (ii) his Employment Agreement is not renewed at the end of the term.
Contino Letter Agreement. Michael Contino, the Company’s Chief Operating Officer, is employed pursuant to a October 29, 2002 letter agreement. Under the letter agreement, Mr. Contino was to receive an annual salary of $387,000 and is entitled to participate in the Company’s bonus plan for executives, as established by the Board of Directors. Mr. Contino was awarded options to purchase 100,000 shares under the 2000 Management Stock Option Plan. Under the agreement, if Mr. Contino is terminated other than “for cause” or terminates his employment for “good reason” (as those terms are defined in the agreement), he is entitled to eighteen months of severance pay and health benefits. Mr. Contino was a participant in the Company’s eighteen month change in control plan and was entitled to a Transaction Bonus equal to half of his base salary on a change in control. Mr. Contino was paid the Transaction Bonus Letters to
which they are a party. See "Employment Contracts, Termination offollowing the Recapitalization in 2003.
Shull Employment and Change-in-Control Arrangements -- Transaction Bonus Letters." On December 18,
2003, eachSeverance Agreement. Thomas Shull, the Company’s prior Chief Executive Officer resigned from the Company on May 5, 2004. Mr. Shull and the Company executed a General Release and Separation Agreement dated effective as of May 5, 2004 which provided for the Company to pay Mr. Shull $900,000 of severance in lieu of any other benefits provided for in the Employment Agreement dated September 1, 2002, as amended (the “Shull Employment Agreement”). The severance was paid with a $300,000 lump sum on execution and the balance in biweekly installments that were completed in 2004. The Company also agreed to pay for eighteen months of COBRA coverage for Mr. Shull.
Prior to his resignation, Mr. Shull was employed pursuant to the Shull Employment Agreement which provided for an $855,000 base salary and had a term expiring on March 31, 2006. Mr. Shull was a participant in the Company’s Key Executive Eighteen Month Compensation Continuation Plan (the “Change of Control Plan”) and its transaction bonus program. The Recapitalization was a change in control under the Change in Control Plan and the Company paid Mr. Shull $1,350,000 in 2003. The Company also paid Mr. Shull $450,000 under the transaction bonus program in 2003.
Charles E. Blue had been appointed Chief Financial Officer of the eight non-employee directors (Messrs. Brown, James, Krushel,
Sonnenfeld, Masson, Regan, GartenCompany effective November 11, 2003, replacing Edward M. Lambert. Mr. Blue joined the Company in 1999 and Edelman) receivedprior to his appointment had most recently served as Senior Vice President, Finance. Mr. Lambert continued to serve as Executive Vice President of the Company until his January 2, 2004 resignation. Mr. Lambert and the Company entered into a paymentseverance agreement dated November 4, 2003 providing for $640,000 of cash payments, as well as other benefits that were accrued and paid in the amountfourth quarter of $87,000 under2003.
Mr. Blue’s employment with the Company was terminated effective March 8, 2005 and the Company reported in a Current Report on Form 8-K that he had resigned voluntarily. The Company and Mr. Blue were unable to agree on the terms of his voluntary resignation and the Hanover Direct, Inc. Directors ChangeCompany notified Mr. Blue that his employment had been terminated for cause.

Mr. DiFrancesco resigned on December 8, 2005. The Company agreed to pay Mr. DiFrancesco $312,000 in severance benefits payable in installments over a 12 month period and an additional $156,000 payable in installments over a 6 month period if Mr. DiFrancesco was employed by a competitor of Control Plan. See "Employment Contracts, TerminationThe Company Store business at the end of Employmentthe initial 12 month severance period. The Company also agreed to pay his COBRA health care continuation premiums during the same period over which he receives severance payments.
Barsky Letter Agreement. On January 31, 2005, the Company appointed Daniel J. Barsky as its Senior Vice President 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 intoGeneral Counsel. Under a letter agreement with the Company, (a "Transaction Bonus Letter")
under which the Participant wouldMr. Barsky will be paid a bonusan annual salary of $265,000 and was granted options to purchase 50,000 shares of Common Stock. One third of the options vested on February 17, 2005 and the balance will vest in two equal annual installments over the next two years on the occurrence of certain
transactions involving the sale of certainanniversary of the Company's businesses. In
addition, Mr. Shull is a partyoriginal grant date, subject to a "Letter Agreement" with the Company, dated
April 30, 2001, pursuant to which, following the termination of the December
2000 Services Agreement,earlier vesting in the event heof a change in control of the Company. All of the options have an exercise price of $1.03 per share, the Common Stock’s average closing price for the ten trading days preceding the grant date and the ten trading days after the grant date. Mr. Barsky will be entitled to participate in the Company’s bonus plan for executives. The agreement also provides for six months of severance payments if Mr. Barsky is terminated without cause during any
period ofor terminates his continued employment for good reason. Mr. Barsky was appointed as the Company’s Secretary on March 7, 2005.
Swatek Employment Agreement. On April 4, 2005, John W. Swatek became Senior Vice President, Chief ExecutiveFinancial Officer and Treasurer of the Company he shallunder a March 15, 2005 Employment Agreement. Under the agreement, Mr. Swatek will be paid an annual salary of $270,000 and was granted options to acquire 50,000 shares of the Company’s common stock pursuant to its 2000 Management Stock Option Plan. The options have an exercise price of $0.81 per share, the Common Stock’s average closing price for the ten trading days preceding the grant date and the ten trading days after the grant date. One third of the options vested on execution of the agreement and the balance will vest in two equal annual installments over the next two years on the anniversary of the original grant date, subject to earlier vesting in the event of a change in control of the Company (as that term is defined in the Employment Agreement). The Employment Agreement has a term expiring on May 6, 2006 and provides for a sign-on bonus of up to $25,000 to the extent his bonus from his prior employer was reduced as a result of his agreeing to join the Company. The Company paid Mr. Swatek $17,208 under this provision.
The Employment Agreement provides for a lump sum change in control payment equal to Mr. Swatek’s annual compensation if his employment is terminated during the term and a change in control occurs during that time. The Employment Agreement also provides for one year’s severance if Mr. Swatek is terminated without cause or terminates his employment for good reason (as both terms are defined in the Employment Agreement) during the term and he is not otherwise entitled to change in control benefits. Mr. Swatek will also be entitled to one year of severance payments equal to his annual base salary (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 shallif his agreement is 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.

                                       116


     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 officersrenewed 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
term.
Compensation Committee became A. David Brown (Chairman), WayneInterlocks and Insider Participation
Mr. Garten, and Stuart
Feldman who are also the current members of the Stock Option and Executive
Compensation Committee. None of such personsCEO, 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 absenceCompensation Committee until his April 29, 2004 resignation before becoming CEO. Stuart Feldman, a Compensation Committee member during 2004, is a principal of such committee,
the entire board of directors) of another entity, one of whose executive
officers served as a memberChelsey and Chelsey Finance.
Report 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

     Committee
The report of the Stock Option and Executive Compensation Committee (the "Compensation Committee"“Compensation Committee”) for the fiscal year ended December 27, 2003,25, 2004, is as follows:
The Compensation Committee, consistingwhose members are A. David Brown (Chairman), Donald B. Hecht and Stuart Feldman as of the date of this report and for the fiscal year ended December 27, 2003 of A. David Brown (Chairman), Wayne
Garten and Stuart Feldman,25, 2004, has the responsibility, under delegated authority from the Company'sCompany’s Board of Directors, for developing, administering and monitoring the executive compensation policies of the Company and making recommendations to the Company'sCompany’s Board of Directors with respect to these policies. The Board of Directors has accepted the Compensation Committee'sCommittee’s recommendations for 20032004 compensation.
Executive Compensation Philosophy
The Compensation Committee'sCommittee’s executive compensation philosophy supports the Company'sCompany’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.annual bonuses tied to Company performance. In addition, executives are encouraged to hold a significantan 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'sCompany’s executives consists of three components, which are discussed below: salary, annual incentive awards and long-term incentive awards.to a limited extent, equity compensation. Base salary levels have been established in order to attract and retain key executives, commensurate with their level of responsibility within the organization. Annual incentives closely link executive pay with performance in areas that are critical to the Company'sCompany’s short-term operating success. Long-term incentives in the form of equity compensation are intended to motivate executives to make decisions that are in the best interests of the Company'sCompany’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'sCompany’s compensation philosophy, reinforce the Company'sCompany’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'sexecutive’s level of responsibility within the organization, pay levels at firms whichthat 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'sCompany’s executives are subject to periodic review and adjustment. Annual salary adjustments are made based on the factors described above.
Mr. Garten, the Company’s Chief Executive Officer, is employed pursuant to the terms of a May 6, 2004 Employment Agreement. Under Mr. Garten’s Employment Agreement he is paid an annual salary of $600,000 over a term expiring on May 6, 2006. Mr. Garten’s salary was based in part on a review of the compensation of similarly situated executives in the direct marketing industry and in public companies of similar size, compensation trends in the direct marketing industry, his experience both as an executive officer and as chief executive officer of other companies and the Company’s financial position.
Annual Incentive Awards
In addition to base salaries, each of the Company'sCompany’s executives and selected key managers participate in the Company'sCompany’s Management Incentive Plan. As of the
date of this report (May 2004), approximately 207Approximately 160 executives and key managers are eligible to participate inreceived bonuses under the annual 2004 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 policyportion 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 for
executives 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 purposesexcess, if any, of the 2003
Management Incentive Plan, Mr. Shull's base salary was deemed to be $600,000.

     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 onCompany’s Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA), net sales, variable contribution and other business
objectives. Goals are set at both over the corporate and business unit levels,
dependingCompany’s budgeted level of EBITDA was made available for discretionary bonuses. An individual’s entitlement to a bonus was based on the participant's scope ofperson’s responsibility thus encouraging teamwork
amongstlevel in 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.

     organization.
Payouts of awards have been determined based on the Company'sCompany’s performance during fiscal 2003. Payments related to fiscal year 2003 are scheduled to be
made to2004. Mr. Garten’s bonus was set at $300,000 by the Chief Executive OfficerCompensation Committee. Mr. Lipner was awarded a $10,000 bonus and the four (4) most highly compensated
executive officers in the amount of approximately $149,366Mr. DiFrancesco was awarded a $253,500 bonus for Mr. Shull,
$99,577 for Mr. Lambert, $83,894 for Mr. Harriss, $96,341 for Mr. Contino and
$69,369 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
2000 Management Stock Option 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
Because of issues concerning the continued listing of the Common Stock, the Compensation Committee granted options 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 opportunityonly select new hires during 2004.
During 2004, Mr. Garten was granted options to purchase 100,000 shares of Common Stock with upunder the 2000 Management Option Plan and options to 80%purchase 100,000 shares outside of the Company’s option plans. The new President of Domestications was granted 25,000 options and one other mid level management hire was granted options during 2004. During the first fiscal quarter of 2005, Messrs. Barsky and Swatek were each granted options

to purchase price financed with a full recourse Company loan. For each share of
stock an employee purchased, he/she received an option to acquire two additional50,000 shares of Common Stock. All of these options had an exercise price equal to the average closing price of the Common Stock to a maximum of 250,000 shares inon the aggregate, which
vestten trading days before and after three (3)the grant date, were exercisable for ten years and expire after six (6) years. By creating this
opportunity,were one third vested on 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 increasedgrant date with the executive's level of responsibility within the
organization.

     In December 1999, the rights of certain participantsbalance vesting 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,two equal annual installments 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 termsanniversaries 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.

     1999date.
2002 Stock Option Plan for Directors
The purpose of the 1999 Stock Option2002 Directors’ Plan for Directors is to advance the interests of the Company by providing non-employee directors of the Company, through the grant of options to purchase shares of Common Stock, with a larger personal and financial interest in the success of the Company. Under the terms of the plan, non-employee directors who are neither employees of the Company nor nonresident
aliens shall be granted an option to purchase 50,0005,000 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 dateand automatic annual grants of the plan, and shall be granted
an optionoptions to purchase 10,0003,500 shares of Common Stock onin August 4, 2000 and August
3, 2001, provided that such directors continue to serve as directors on such
dates.of each year during which the non-employee Director served. The exercise price at which shares of Common Stock may be purchased upon the
exercise of the options granted under the plan shall beis equal to the fair market value of such shares on the date of grant of the options.date. The plan provides that options shall be granted forhave terms of 10ten years and shall vest one-third one-third and
one-third on each of the first, second and third anniversaries of the date of grant.grant date. In addition, options may not be exercised more than 3three months after a participant ceases to be a Company director, of the Company, except in the case of death or disability, in which cases options may be exercised within 12twelve months after the date of such death or disability.
During 2003, no2004, a total of 26,000 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.2002 Directors’ Plan. 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 OptionDirectors’ 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, 710,00025, 2004, 65,500 options to purchase Common Stock under the 2002 Directors’ Plan were outstanding, 36,167 of which were exercisable.
2004 Stock Option Plan for Directors
During 2004, the Board of Directors adopted the 2004 Directors’ Option Plan, pursuant to which stock options to purchase shares of Common Stock may be granted to certain non-employee directors. The Company’s shareholders ratified the 2004 Directors’ Option Plan at the 2004 Annual Meeting of Shareholders. The Company may grant options to purchase up to 100,000 shares of Common Stock to eligible directors at an exercise price equal to the fair market value as of the grant date. An eligible director will receive an initial option grant to purchase 5,000 shares of Common Stock as of the effective date of his/her appointment or election to the Board of Directors. On each Award Date, defined as August 3, 2004, August 3, 2005 and August 3, 2006, eligible directors are to be granted options to purchase additional shares of Common Stock (to the extent the 2002 Stock Option Plan for Directors were outstanding, 471,666did not have enough remaining shares). Stock options granted have terms of which were exercisable.

  Chief Executive Officer Compensation

     On December 5, 2000, Thomas C. Shull was named Presidentten years and Chief
Executive Officer and was elected tovest over three years from 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."grant date; however, if there is a Change in Control Payments

     Pursuant to the Recapitalization Agreement, upon completion of the
Recapitalization, there was a "change(as defined 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), the participant has the cumulative right to purchase up to 100.0% of the option shares. Option holders may pay for shares purchased on exercise in cash or Common Stock. As of December 25, 2004 no options have been granted under the 2004 Directors’ Option Plan. See "Employment Contracts, TerminationIn addition, options that were to be granted on the August 3, 2005 Award Date have been deferred until the Company issues its December 25, 2004 audited financial statements.
Compensation Continuation Agreement Payments
The Board of EmploymentDirectors determined that the November 30, 2003 recapitalization was a change in control for purposes of the Company’s Compensation Continuation Plans and Change-in-Control Arrangements -- Hanover Direct, Inc. Directors Changethat the plans would be maintained solely for persons who were plan participants on that date and who became eligible for benefits within two years thereafter. During 2004, the Company paid a total amount of Control Plan."

  $772,257 to three individuals who were plan participants. Two additional individuals triggered plan benefits during 2004 and the Company paid a total of $442,000 in 2005. Neither of these individuals were named executive officers.
During 2005 and before the November 30, 2005 termination of the agreements, the Company terminated the employment of three plan participants, one of whom was a named executive officer, but denied them benefits because the terminations had been “for cause.” A fourth plan participant resigned and sought plan benefits on the grounds that she had resigned for good reason. The Company denied her benefits as well. Each of the former employees has commenced an action against the Company seeking post employment benefits and/or compensatory and punitive damages and legal fees. As of December 1, 2005, the plans were terminated and no further benefits were available.

Nondeductible Compensation
Section 162(m) of the Internal Revenue Code, as amended (the "Code"“Code”), generally disallows a tax deduction to public companies for compensation over $1,000,000 (the "$“$1 Million Limit"Limit”) paid to a company'scompany’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
There was no compensation paid in 2003 relating to Thomas Shull and Edward Lambert exceeded the $1
Million Limit; consequently, in each case, the excess of such payments2004 over the $1 Million Limit was not deductible.

                                          Limit.
Respectfully Submitted,
The Stock Option and Executive Compensation
Committee (May 2004)

                                          (February 2006)
A. David Brown (Chairman)
Stuart Feldman
                                          Paul S. Goodman

                                       122
Donald Hecht



REPORT OF THE AUDIT COMMITTEE

     The Audit Committee has reviewed
Item 12. Security Ownership of Certain Beneficial Owners and discussed with managementManagement 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

     Related Stockholder Matters
Certain Beneficial Owners
The following table lists the beneficial owners known by management of at least 5%5.0% of the Company'sCompany’s Common Stock or 5%5.0% of the Company'sCompany’s Series C Preferred Stock as of March 27, 2004.June 25, 2005. The information is determined in accordance with Rule 13d-3 promulgated under the Securities Exchange Act of 1934, as amended (the "Exchange Act"“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'sCompany’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)
- --------------    -------------------                               -----------------------   -----------
Title of Class
Name and Address
of Beneficial Owner
Amount and Nature of
Beneficial Ownership(1)
Percentage
of Class(1)
Series C
Chelsey Direct, LLC,...........................              564,819(2)         100%
564,819 (1)
100.0%
Participating
William B. Wachtel and
Preferred Stock
Stuart Feldman
c/o Wachtel & Masyr, LLP
                    110 East 59th
152 West 57th Street
New York, New York 10022
10019
Common Stock
Chelsey Direct, LLC,...........................          111,465,621(2)          51%
                    
25,652,113 (2)
76.0%
William B. Wachtel and
Stuart Feldman
c/o Wachtel & Masyr, LLP
                    110 East 59th
152 West 57th Street
New York, New York 1002210019
__________
(1)
In the case of Common Stock, Regan Partners, L.P.includes shares of Common Stock issued upon exercise of options or warrants exercisable within 60 days for the subject individual only. Percentages of Common Stock are computed on the basis of 22,426,296 shares of outstanding Common Stock, 10,259,366 exercisable warrants and Basil P. Regan........           38,821,683(3)          18%
                    32 East 57th Street
                    New York, New York 10022
1,051,751 exercisable options as of June 25, 2005. Percentages of the Series C Preferred are computed on the basis of 564,819 shares of Series C Preferred outstanding as of June 25, 2005.


- ---------------
(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
(2)
Information concerning the number of shares beneficially owned has been taken from Amendment No. 12 to the Statement on Schedule 13D filed by Chelsey on January 10, 2005 with the SEC. Chelsey is the record holder of shares of Common Stock and 564,819 shares of Series C Preferred. Chelsey Capital Profit Sharing Plan (the “Chelsey Plan”) is the sole member of Chelsey and Mr. Wachtel is the Manager of Chelsey. The sponsor of the Chelsey Plan is DSJ International Resources Ltd. (“DSJI”). Mr. Feldman is the sole officer and director of DSJI and a principal beneficiary of the Chelsey Plan. Mr. Feldman is also the owner of 16,090 shares of Common Stock. Mr. Wachtel, in his capacity as the Manager of Chelsey and Chelsey Finance, will have sole voting and dispositive power with respect to 25,629,856 shares of Common Stock, options and warrants and 564,819 shares of Series C Preferred owned by Chelsey. Each of Messrs. Wachtel and Feldman have vested options to purchase 6,167 shares of Common Stock exercisable within 60 days. The shares of Common Stock and Series C Preferred which are owned by Chelsey and Messrs. Wachtel and Feldman collectively represent approximately 91.0% of the combined voting power of the Company’s securities (after giving effect to the exercise of all outstanding options and warrants to purchase Common Stock beneficially owned by Chelsey).



                SECURITY OWNERSHIP OF MANAGEMENT OF THE COMPANY

MANAGEMENT OWNERSHIP

     
Management Ownership
The following table lists share ownership of the Company'sCompany’s Common Stock and Series C Preferred Stock as of March 27, 2004.June 25, 2005. The information includes beneficial ownership by (i) each of the Company'sCompany’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'sCompany’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)
- ------------------------                              -----------------------    -------------
Name of Beneficial Owner
Amount and Nature of
Beneficial Ownership(1)
Percentage of
Class(1)
William B. Wachtel
25,629,856 (2)
76.0%
564,819 (2)
100.0%
A. David Brown
9,667 (1)
*
Stuart Feldman
25,645,946 (2)
76.0%
564,819 (2)
100.0%
Paul S. Goodman
2,833 (1)
*
Donald Hecht
2,833 (1)
*
Robert H. Masson....................................             85,000(2)            Masson
9,667 (1)
*
Basil
Wayne P. Regan......................................         38,821,683(3)           17.6%
Garten
138,334 (1)
*
Michael D. Contino
125,240 (1)(5)
*
John W. Swatek
16,667 (1)
*
Daniel J. Barsky
16,667 (1)
*
Steven Lipner
7,000 (1)
*
John DiFrancesco
55,000 (1)
*
Thomas C. Shull.....................................          3,250,000(4)            1.5%
Wayne P. Garten.....................................             51,905(5)            Shull
320,000 (1)
*
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%
26,356,021 (3)
78.1%
564,819 (4)
100.0%


- ---------------
  
* Less than one percent

 (1) 
(1)
Represents options to purchase shares of Common Stock exercisable within 60 days.
(2)
Chelsey and its related affiliate, Chelsey Finance, is the record holder of 15,364,323 shares of Common Stock, 10,259,366 outstanding Common Stock warrants and 564,819 shares of Series C Preferred. Chelsey Capital Profit Sharing Plan (the “Chelsey Plan”) is the sole member of Chelsey and Mr. Wachtel is the Manager of Chelsey. The sponsor of the Chelsey Plan is DSJ International Resources Ltd. (“DSJI”). Mr. Feldman is the sole officer and director of DSJI and a principal beneficiary of the Chelsey Plan. Mr. Feldman is also the owner of 16,090 shares of Common Stock. Mr. Wachtel, in his capacity as the Manager of Chelsey, has sole voting and dispositive power with respect to 15,364,323 shares of Common Stock and 564,819 shares of Series C Preferred owned by Chelsey, and Mr. Feldman has sole voting and dispositive power with respect to 16,090 shares of Common Stock owned by him. Each of Messrs. Wachtel and Feldman have vested options to purchase 6,167 shares of Common Stock exercisable within 60 days. The shares of Common Stock and Series C Preferred Stock owned by Chelsey and Messrs. Wachtel and Feldman collectively represent approximately 91% of the combined voting power of the Company’s securities (after giving effect to the exercise of all outstanding options and warrants to purchase Common Stock beneficially owned by Chelsey).
(3)
Shares of Common Stock; includes options to purchase 716,002 shares exercisable within 60 days and 10,259,366 warrants.
(4)
Shares of Series C Preferred Stock.
(5)
Includes 240 shares owned by Mr. Contino.

Item 13. Certain Relationships and Related Transactions
On July 8, 2004, the Company closed on the Chelsey Facility, a $20.0 million junior secured credit facility with Chelsey Finance. The Chelsey Facility has a three-year term, subject to earlier maturity upon the occurrence of a change in each casecontrol or sale of the Company (as defined), and carries a stated interest rate of 5.0% above the prime rate publicly announced by Wachovia. In consideration for providing the Chelsey Facility to the Company, Chelsey Finance received a closing fee of $200,000 and a warrant exercisable immediately and for a period of ten years to purchase 30.0% of the then fully diluted shares of Common Stock issuable uponof the Company (equal to 10,259,366 shares of Common Stock) at an exercise price of options$0.01 per share.
As part of the Chelsey Facility, the Company and its subsidiaries agreed to indemnify Chelsey Finance from any losses suffered arising out of the Chelsey Facility other than liabilities resulting from such parties’ gross negligence or warrants exercisable within 60 days forwillful misconduct. The indemnification agreement is not limited as to term and does not include any limitations on maximum future payments thereunder.
In connection with the subject individual
     only. Percentages are computed onclosing of the basisChelsey Facility, Chelsey waived its blockage rights over the issuance of 220,173,633senior securities and received in consideration a waiver fee equal to 1.0% of the liquidation preference of the Company’s outstanding Series C Preferred payable in 434,476 shares of Common Stock and 564,819 shares(calculated based upon the fair market value thereof two business days prior to the closing date).
The Company retained the law firm of Series C Preferred Stock outstanding asWachtel & Masyr LLP to handle the appeal 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 andKaul litigation. Mr. Wachtel, is the Manager of Chelsey. The sponsor of the
     Chelsey Plan is DSJ International Resources Ltd. ("DSJI"). Mr. Feldman is
     the sole officerCompany’s Chairman 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 soleis a partner in Wachtel & Masyr. Wachtel & Masyr agreed to handle the appeal for a $150,000 fixed fee, of which half was incurred and paid in 2004 and the balance was paid and incurred in 2005.
The Company completed the reverse stock split effective on September 22, 2004. The voting 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 termsrights 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
wouldwere 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 sufferedadjusted as a result of any third party claim which is based upon Richemont's acts as a
stockholder or lenderthe reverse stock split and consequently, Chelsey’s voting control was increased vis-à-vis the other Common Stock holders.
Either the majority 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 Officerindependent directors 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'sCompany’s Board of Directors, a committee of the Company'sCompany’s Board of Directors consisting of independent directors, or, in certain cases, the stockholders have approved these relationships and transactions and, to the extent that such arrangements are available from nonaffiliated parties, all relationships and transactions are on terms no less favorable to the Company than those available from non affiliatednonaffiliated parties.

                                       131


ITEM
Item 14. PRINCIPAL ACCOUNTANTS FEES AND SERVICES

FEES AND INDEPENDENCEPrincipal Accountants Fees and Services
Fees and Independence -
Prior to their dismissal on October 20, 2005, KPMG LLP provided audit services to the Company consisting of the annual audit of the Company'sCompany’s 2003 and 2002 consolidated financial statements contained in the Company'sCompany’s Annual Report on Form 10-K for eachthe 2003 fiscal year and reviews of the financial statements contained in the Company'sCompany’s Quarterly Reports on Form 10-Q for the 2003first and second fiscal yearquarters of 2004 and the final three fiscal quarters of the 2002 fiscal year.
Arthur Anderson LLP billed the Company an aggregate of $29,800 for2003. KPMG started but did not complete 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 20022004 fiscal year. The following table shows the fees that were billed to the Company by KPMG LLPand subsequently paid by the Company for professional services rendered forwith respect to the fiscal years ended December 25, 2004 and December 27, 2003.
Fee Category
Fiscal Year 2004 
% of Total 
Fiscal Year 2003 
% of Total 
Audit Fees(1)(2)
$1,448,000
97.4%
$   814,500
84.6%
Audit-Related Fees(3)
38,000
2.6%
133,500
13.9%
Tax Fees(4)
-0-
0%
14,500
1.5%
Total Fees
$1,486,000
100.0%
$   962,500
100.0%
The Audit Committee appointed GGK on November 2, 2005 as the Company’s principal independent auditors. (KPMG withdrew their opinions for 2002 and 2003 fiscal year end audits as a result of the Restatement.) GGK provided audit services to the Company consisting of the annual audit of the Company’s 2004, 2003 and 2002

consolidated financial statements contained in the Company’s Annual Report on Form 10-K for 2004 and a review of the financial statements contained in the Company’s Quarterly Report on Form 10-Q for the third fiscal quarter of 2004. The following table shows the fees that were billed to the Company by GGK for professional services rendered with respect to the fiscal years ended December 25, 2004, December 27, 2003 (as restated) 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 professional2002 (as restated). Due to the restated fiscal years, amounts billed by GGK have been allocated over each of the three years.
 
Fee Category
Fiscal Year
2004
 
% of Total
Fiscal Year
2003
 
% of Total
Fiscal Year
2002
 
% of Total
Audit Fees(2)
$275,000
100.0%
$250,000
100.0%
$250,000
100.0%
Audit-Related Fees(3)
-0-
0%
-0-
0%
-0-
0%
Tax Fees(4)
-0-
0%
-0-
0%
-0-
0%
Total Fees
$275,000
100.0%
$250,000
100.0%
$250,000
100.0%
_________
Through September 30, 2005, GGK (the “Firm”) had a continuing relationship with American Express Tax and Business Services Inc. (“TBS”) from which it leased auditing staff who were full time, permanent employees of TBS and through which its partners provided non-audit services. Subsequent to September 30, 2005 this relationship ceased and the Firm established a similar relationship with RSM McGladrey, Inc. (“RSM”). The Firm has no full time employees, and, therefore, none of the audit services performed were provided by permanent, full-time employees of the Firm. The Firm manages and supervises the audit and audit staff and is exclusively responsible 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
    providedopinion rendered 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.

     its examination.
(1)
Does not include approximately $516,000 of fees billed by KPMG after their dismissal (approximately $415,000 relates to the 2004 audit and the remainder relates to quarterly reviews in 2005), a portion of which is in excess of the audit fees previously approved by the Audit Committee. The Company disputes owing KPMG any of the audit fees billed after their dismissal.
(2)
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.
(3)
Audit-Related Fees are fees for assurance and related services that are reasonably related to the performance of the audit or review of the Company’s financial statements. This includes: employee benefit and compensation plan audits; due diligence related to mergers and acquisitions; auditor attestations that are not required by statute or regulation; and professional services related to the application of financial accounting / reporting standards. 100% and 100% of these fees for fiscal years 2004 and 2003, respectively, were approved by the Audit Committee pursuant to Paragraph (c)(7)(i)(C) of Rule 2-01 of Regulation S-X.
(4)
Tax Fees are fees for professional services performed with respect to tax compliance, tax advice and tax planning. 100% and 100% of these fees for fiscal years 2004 and 2003, respectively, were approved by the Audit Committee pursuant to Paragraph (c)(7)(i)(C) of Rule 2-01 of Regulation S-X.
Pre-Approval Policy
The Audit Committee of the Board of Directors has considered whetheradopted an audit and non-audit services pre-approval policy, whereby it may pre-approve the provision of services to us by KPMG described above are compatiblethe independent auditors. The policy of the Audit Committee is to pre-approve the audit, audit-related, tax and non-audit services to be performed during the year on an annual basis, in accordance with maintaining
KPMG's independence asa schedule of such services approved by the Company's principal accountant.

PRE-APPROVAL POLICYAudit Committee. The annual audit services engagement terms and fees will be subject to the specific pre-approval of the Audit Committee. Audit-related services and tax services to be provided by the auditors will be subject to general pre-approval by the Audit Committee. The Audit Committee may grant specific case-by-case approval for permissible non-audit services. The Audit Committee will establish pre-approval fee levels or budgeted amounts for all services to be provided on an annual basis. Any proposed services exceeding those levels or amounts will require specific pre-approval by the Audit Committee. The Audit Committee has policies and procedures that requiredelegated pre-approval authority to the pre-approval byChairman of the Audit Committee, of all fees paidwho will report any such pre-approval decisions to and all services
performed by, our independent auditors. Each year, the Audit Committee approves
the proposed services, including the nature, typeat its next scheduled meeting.

PART IV
Item 15. Exhibits 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:

Financial Statement Schedules

                                                                           PAGE
                                                                           NO.
                                                                           ----
        
(a)
The following documents are filed as part of this report:
Page
No.
1.
Index to Financial Statements
Report of Independent Registered Public Accountants --Accounting Firm — Hanover Direct, Inc. and Subsidiaries Financial Statements...........................   44
             Statements
42
Consolidated Balance Sheets as of December 25, 2004 and December 27, 2003 and
             December 28, 2002...........................................   45
             (as restated)
43
Consolidated Statements of Income (Loss) for the years ended December 25, 2004, December 27, 2003 (as restated) and December 28, 2002 and December 29,
             2001........................................................   46
             (as restated)
44
Consolidated Statements of Cash Flows for the years ended December 25, 2004, December 27, 2003 (as restated) and December 28, 2002 and December 29,
             2001........................................................   47
             (as restated)
45
Consolidated Statements of ShareholdersShareholders’ Deficiency for the years ended December 25, 2004, December 27, 2003 (as restated) and December 28, 2002 and
             December 29, 2001...........................................   48
             (as restated)
47
Selected Quarterly Financial Information (unaudited) for the 13- week fiscal yearperiods ended March 27, 2004 (as restated), June 26, 2004 (as restated), September 25, 2004, December 25, 2004, March 29, 2003 (as restated), June 28, 2003 (as restated), September 27, 2003 (as restated) and December 27, 2003.........................   94
         2003 (as restated).
80
2.
Index to Financial Statement Schedule
Schedule II --— Valuation and Qualifying Accounts for the years ended December 25, 2004, December 27, 2003 (as restated) and December 28, 2002 and
             December 29, 2001...........................................   96
             (as restated)
83
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.
106


     (b) Reports on Form 8-K:

        1.1 Form 8-K, filed October 2, 2003 -- 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
            Charles E. Blue as Chief Financial Officer of the Company effective
            November 11, 2003, replacing Edward M. Lambert as Chief Financial
            Officer effective on such date.

        1.4 Form 8-K, filed November 7, 2003 -- reporting pursuant to Items 5
            and 7 of such Form scheduling information concerning its quarterly
            conference call with management to review the operating results for
            the 13 and 39 weeks ended September 29, 2003.

        1.5 Form 8-K, filed November 10, 2003 -- reporting pursuant to Items 7,
            9 and 12 of such Form the issuance of a press release announcing
            operating results for the 13 and 39 weeks ended September 29, 2003.

                                       133



        1.6 Form 8-K, filed November 10, 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 2003 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
            the parties' execution of the Recapitalization Agreement.

        1.9 Form 8-K, filed December 1, 2003 -- reporting pursuant to Items 1, 5
            and 7 of such Form the consummation of the transactions contemplated
            by the Recapitalization Agreement.

        1.10 Form 8-K, filed January 8, 2004 -- reporting pursuant to Item 5 of
             such Form the grant of summary judgment in favor of the Company
             dismissing certain of those claims made by Rakesh Kaul in an action
             filed against the Company on June 28, 2001 in the Supreme Court of
             the State of New York, County of New York.

        1.11 Form 8-K, filed February 13, 2004 -- reporting pursuant to Items 5
             and 7 of such Form the elimination of the position of Executive
             Vice President, Finance and Administration, the acceptance of the
             resignation of 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 February 13, 2004 -- reporting pursuant to Items 5
             and 7 of such Form the resignation of Martin L. Edelman as a member
             of the Board of Directors effective February 15, 2004 and the
             issuance of a press release announcing Mr. Edelman's resignation.

        1.13 Form 8-K, filed March 25, 2004 -- reporting pursuant to Items 5 and
             7 of such Form the issuance of a press release announcing that the
             conference call with management to review the Company's fiscal year
             2003 operating results 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. 2 to the
report to be signed on its behalf by the undersigned, thereunto duly authorized.

Date:  May 3, 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)

     
Date: February 21, 2006
HANOVER DIRECT, INC.
(Registrant)
By: /s/ Wayne P. Garten
Wayne. P. Garten,
President
and Chief Executive Officer
(On behalf of the registrant
and as principal executive officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Amendment No. 2 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
  -------------------------------------------------
                  Charles E. Blue,
              John W. Swatek
By: /s/ Hallie Sturgill
John W. Swatek,
Hallie Sturgill
Senior Vice President, and
               Chief Financial Officer
            (principal
and Treasurer
Vice President and Corporate Controller
(principal financial officer)




            By: /s/ WILLIAM C. KINGSFORD
  -------------------------------------------------
                William C. Kingsford,
          Senior Vice President of Treasury
     and Control (principal
(principal accounting officer)
Board of Directors:




                 /s/ BASIL P. REGAN
- -----------------------------------------------------
              Basil P. Regan,
/s/ William Wachtel
/s/ Donald Hecht
William Wachtel, Chairman of the Board of Directors
Donald Hecht, Director



                /s/ ROBERT
/s/ Robert H. MASSON
- -----------------------------------------------------
             Masson
/s/ Stuart Feldman
Robert H. Masson, Director



- -----------------------------------------------------
              William Wachtel,
Stuart Feldman, Director



                 /s/
/s/ A. DAVID BROWN
- -----------------------------------------------------
              David Brown
/s/ Wayne P. Garten
A. David Brown, Director



- -----------------------------------------------------
              
Wayne P. Garten
/s/ Paul S. Goodman
Paul S. Goodman, Director



- -----------------------------------------------------
               Donald Hecht, Director



                 /s/ THOMAS C. SHULL
- -----------------------------------------------------
              Thomas C. Shull, Director



- -----------------------------------------------------
              Stuart Feldman, Director



                 /s/ WAYNE P. GARTEN
- -----------------------------------------------------
              Wayne P. Garten, Director
Date: May 3, 2004

                                       135
February 21, 2006

EXHIBIT INDEX

EXHIBIT NUMBER
 ITEM
Exhibit Number
Item 601 OF
REGULATIONof
Regulation S-K  DESCRIPTION OF DOCUMENT AND INCORPORATION BY REFERENCE WHERE APPLICABLE
- --------------  -----------------------------------------------------------------------
Description of Document and Incorporation by Reference Where Applicable
2.1        Asset
Stock Purchase Agreement dated as of June 13, 2001,February 11, 2005 by and among theHanover Direct, Inc., The Company LWI Holdings, Inc., HSN LP, HSN Improvements,Store Group, LLC and HSN Catalog
                Services, Inc.Gump’s Holdings, LLC Incorporated by reference to the Company's Current
                Report on Form 8-K filed August 9, 2001.
     2.2        Amendment No. 1, dated asFebruary 17, 2005.
3.1
Restated Certificate 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.
                Incorporation. Incorporated by reference to the Company's Current Report on Form 8-K
                filed August 9, 2001.
     2.3        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 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.
3.7
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'sCompany’s Quarterly Report on Form 10-Q for the quarterly period ended September 27, 1997.
3.12
Amendment to By-laws. Incorporated by reference to the Company's
                Current Report on Form 8-K filed November 30, 2003.


                                       136

EXHIBIT NUMBER
 ITEM 601 OF
REGULATION S-K  DESCRIPTION OF DOCUMENT AND INCORPORATION BY REFERENCE WHERE APPLICABLE
- --------------  -----------------------------------------------------------------------

     10.1       Hanover Direct, Inc. Savings Plan as amended. 
3.13
Amendment to By-laws. Incorporated by reference to the Company's Annual Report on Form 10-K forForm10-Q filed August 10, 2004.
3.14
Certificate of the year ended January
                1, 1994.
     10.2       RestrictedDesignations, Powers, Preferences and Rights of Series D Participating Preferred Stock Award Plan. of Hanover Direct, Inc., dated July 8, 2004. Incorporated by reference to the Company's
                Registration Statement on Form S-88-K filed on February 24, 1993,
                Registration No. 33-58760.
     10.3       All Employee Equity Investment Plan. July 12, 2004.
3.15
Certificate of Amendment to Amended and Restated Certificate of Incorporation dated September 22, 2004.
3.16
Certificate of Elimination of the Series D Participating Preferred Stock dated September 30, 2004. Incorporated by reference to the Company's* Registration Statement on Form S-810-Q filed on February 24,
                1993, Registration No. 33-58756.
     10.4       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.
     10.5       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.
     10.6       1996 Stock Option Plan, as amended. Incorporated by reference to the
                Company's 1997 Proxy Statement.
     10.7       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.
     10.8       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.
     10.9       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.
    10.10       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.
    10.11       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.
    July 12, 2005.

10.12
Hanover Direct, Inc. Key Executive Eighteen Month Compensation Continuation Plan. Incorporated by reference to the Company'sCompany’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2001.
10.13
Amendment No. 1 to the Hanover Direct, Inc. Key Executive Eighteen Month Compensation Continuation Plan, dated as of June 1, 2001. Incorporated by reference to the Company'sCompany’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2001.
10.14
Amendment No. 2 to the Hanover Direct, Inc. Key Executive Eighteen Month Compensation Continuation Plan, effective as of August 1, 2001. Incorporated by reference to the Company'sCompany’s Quarterly Report on Form 10-Q for the quarterly period ended March 30, 2002.
10.15
Amendment No. 3 to Hanover Direct, Inc. Key Executive Eighteen Month Compensation Continuation Plan, effective October 29, 2003. Incorporated by reference to the Company'sCompany’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'sCompany’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2001.


                                       137

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10.17
Amendment No. 1 to the Hanover Direct, Inc. Key Executive Twelve Month Compensation Continuation Plan, effective as of August 1, 2001. Incorporated by reference to the Company'sCompany’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'sCompany’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'sCompany’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'sCompany’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'sCompany’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.
    10.23       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.
    10.24       
Loan and Security Agreement dated as of November 14, 1995 by and among Congress Financial Corporation ("Congress"(“Congress”), HDPA, Brawn, Gump'sGump’s by Mail, Gump's,Gump’s, The Company Store, Inc. ("(“The Company Store"Store”), Tweeds, Inc. ("Tweeds"(“Tweeds”), LWI Holdings, Inc. ("LWI"(“LWI”), Aegis Catalog Corporation ("Aegis"(“Aegis”), Hanover Direct Virginia, Inc. ("HDVA"(“HDVA”) and Hanover Realty Inc. ("(“Hanover Realty"Realty”). Incorporated by reference to the Company's
                Annual Report on Form 10-K for the year ended December 30, 1995.
    10.25       
10.23
First Amendment to Loan and Security Agreement dated as of February 22,
                199622,1996 by and among Congress, HDPA, Brawn, Gump'sGump’s by Mail, Gump's,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.
    10.26       
10.24
Second Amendment to Loan and Security Agreement dated as of April 16, 1996 by and among Congress, HDPA, Brawn, Gump'sGump’s by Mail, Gump's,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.
    10.27       
10.25
Third Amendment to Loan and Security Agreement dated as of May 24, 1996 by and among Congress, HDPA, Brawn, Gump'sGump’s by Mail, Gump's,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       

10.26
Fourth Amendment to Loan and Security Agreement dated as of May 31, 1996 by and among Congress, HDPA, Brawn, Gump'sGump’s by Mail, Gump's,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       
10.27
Fifth Amendment to Loan and Security Agreement dated as of September 11, 1996 by and among Congress, HDPA, Brawn, Gump'sGump’s by Mail, Gump's,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       
10.28
Sixth Amendment to Loan and Security Agreement dated as of December 5, 1996 by and among Congress, HDPA, Brawn, Gump'sGump’s by Mail, Gump's,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.
    10.31       
10.29
Seventh Amendment to Loan and Security Agreement dated as of December 18, 1996 by and among Congress, HDPA, Brawn, Gump'sGump’s by Mail, Gump's,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.
    10.32       
10.30
Eighth Amendment to Loan and Security Agreement dated as of March 26, 1997 by and among Congress, HDPA, Brawn, Gump'sGump’s by Mail, Gump's,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.
    10.33       
10.31
Ninth Amendment to Loan and Security Agreement dated as of April 18, 1997 by and among Congress, HDPA, Brawn, Gump'sGump’s by Mail, Gump's,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.
    10.34       
10.32
Tenth Amendment to Loan and Security Agreement dated as of October 31, 1997 by and among Congress, HDPA, Brawn, Gump'sGump’s by Mail, Gump's,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.
    10.35       
10.33
Eleventh Amendment to Loan and Security Agreement dated as of March 25,
                199825,1998 by and among Congress, HDPA, Brawn, Gump'sGump’s by Mail, Gump's,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.
    10.36       
10.34
Twelfth Amendment to Loan and Security Agreement dated as of September 30, 1998 by and among Congress, HDPA, Brawn, Gump'sGump’s by Mail, Gump's,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.
    10.37       
10.35
Thirteenth Amendment to Loan and Security Agreement dated as of September 30, 1998 by and among Congress, HDPA, Brawn, Gump'sGump’s by Mail, Gump's,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       
10.36
Fourteenth Amendment to Loan and Security Agreement dated as of February 28, 2000 by and among Congress, HDPA, Brawn, Gump'sGump’s by Mail, Gump's,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.


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    10.39       
10.37
Fifteenth Amendment to Loan and Security Agreement dated as of March 24, 2000 by and among Congress, HDPA, Brawn, Gump'sGump’s by Mail, Gump's,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'sCompany’s Quarterly Report on Form 10-Q for the quarterly period ended March 25, 2000.
    10.40       
10.38
Sixteenth Amendment to Loan and Security Agreement dated as of August 8, 2000 by and among Congress, HDPA, Brawn, Gump'sGump’s by Mail, Gump's,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'sCompany’s Quarterly Report on Form 10-Q for the quarterly period ended June 24, 2000.
    10.41       
10.39
Seventeenth Amendment to Loan and Security Agreement dated as of January 5, 2001 by and among Congress, HDPA, Brawn, Gump'sGump’s by Mail, Gump's,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.
    10.42       
10.40
Eighteenth Amendment to Loan and Security Agreement, dated as of November 12, 2001, among Congress, HDPA, Brawn, Gump'sGump’s by Mail, Gump's,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'sCompany’s Quarterly Report on Form 10-Q for the quarterly period ended September 29, 2001.
    10.43       
10.41
Nineteenth Amendment to Loan and Security Agreement, dated as of December 18, 2001, by and among Congress, HDPA, Brawn, Gump'sGump’s by Mail, Gump's,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.
    10.44       
10.42
Twentieth Amendment to Loan and Security Agreement, dated as of March 5, 2002, by and among Congress, HDPA, Brawn, Gump'sGump’s by Mail, Gump's,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       
10.43
Twenty-first Amendment to Loan and Security Agreement, dated as of March 21, 2002, among Congress, HDPA, Brawn, Gump'sGump’s by Mail, Gump's,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.


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    10.46       
10.44
Twenty-second Amendment to Loan and Security Agreement, dated as of August 16, 2002, among Congress, HDPA, Brawn, Gump'sGump’s by Mail, Gump's,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'sCompany’s Quarterly Report on Form 10-Q for the quarterly period ended June 29, 2002.
    10.47       
10.45
Twenty-third Amendment to Loan and Security Agreement, dated as of December 27, 2002, among Congress, HDPA, Brawn, Gump'sGump’s by Mail, Gump's,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.
    10.48       
10.46
Twenty-fourth Amendment to Loan and Security Agreement, dated as of February 28, 2003, among Congress, Brawn, Gump'sGump’s by Mail, Gump's,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.
    10.49       

10.47
Twenty-fifth Amendment to Loan and Security Agreement, dated as of April 21, 2003, among Congress, Brawn, Gump'sGump’s by Mail, Gump's,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'sCompany’s Quarterly Report on Form 10-Q for the quarterly period ended March 29, 2003.
    10.50       
10.48
Twenty-sixth Amendment to Loan and Security Agreement, dated as of August 29, 2003, among Congress, Brawn, Gump'sGump’s by Mail, Gump's,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'sCompany’s Quarterly Report on Form 10-Q for the quarterly period ended September 27, 2003.
    10.51       
10.49
Twenty-seventh Amendment to Loan and Security Agreement, dated as of October 31, 2003, among Congress, Brawn, Gump'sGump’s by Mail, Gump's,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 Current Report on Form 8-K filed October 31, 2003.
    10.52       
10.50
Twenty-eighth Amendment to Loan and Security Agreement, dated as of November 4, 2003, among Congress, Brawn, Gump'sGump’s by Mail, Gump's,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'sCompany’s Quarterly Report on Form 10-Q for the quarterly period ended September 27, 2003.


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    10.53       
10.51
Twenty-ninth Amendment to Loan and Security Agreement, dated as of November 25, 2003, among Congress, Brawn, Gump'sGump’s by Mail, Gump's,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 Current Report on Form 8-K filed November 30, 2003.
    10.54       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.
    10.55       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       
10.52
Employment Agreement dated as of September 1, 2002 between Thomas C. Shull and the Company. Incorporated by reference to the Company'sCompany’s Quarterly Report on Form 10-Q for the quarterly period ended June 29, 2002.
    10.72       
10.53
Amendment No. 1 to Employment Agreement dated as of September 1, 2002 between Thomas C. Shull and the Company. Incorporated by reference to the Company'sCompany’s Quarterly Report on Form 10-Q for the quarterly period ended September 28, 2002.
    10.73       
10.54
Amendment No. 2 to Employment Agreement dated as of June 23, 2003 between Thomas C. Shull and the Company. Incorporated by reference to the Company'sCompany’s Quarterly Report on Form 10-Q for the quarterly period ended June 28, 2003.
    10.74       
10.55
Amendment No. 3 to Employment Agreement effective as of August 3, 2003 between Thomas C. Shull and the Company. Incorporated by reference to the Company'sCompany’s Quarterly Report on Form 10-Q for the quarterly period ended June 28, 2003.
    10.75       
10.56
Final form of letter agreement between the Company and certain Level 8 executive officers. Incorporated by reference to the Company'sCompany’s Quarterly Report on Form 10-Q for the quarterly period ended September 28, 2002.
    10.76       
10.57
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       
10.58
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       
10.59
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       

10.60
Memorandum of Understanding dated November 10, 2003 by and among Hanover Direct, Inc., Chelsey Direct, LLC and Regan Partners, L.P. Incorporated by reference to the Company's Current Report on Form 8-K filed November 10, 2003.
    10.84       
10.61
Recapitalization Agreement dated as of November 18, 2003 by and between Hanover Direct, Inc. and Chelsey Direct, LLC. Incorporated by reference to the Company's Current Report on Form 8-K filed November 18, 2003.
    10.85       
10.62
Registration Rights Agreement dated as of November 30, 2003 by and among Hanover Direct, Inc., Chelsey Direct, LLC and Stuart Feldman. Incorporated by reference to the Company's Current Report on Form 8-K filed November 30, 2003.
    10.86       
10.63
Corporate Governance Agreement dated as of November 30, 2003 by and among Hanover Direct, Inc. Chelsey Direct, LLC, Stuart Feldman, Regan Partners, L.P., Regan International Fund Limited and Basil P. Regan. Incorporated by reference to the Company's Current Report on Form 8-K filed November 30, 2003.
    10.87       
10.64
Voting Agreement dated as of November 30, 2003 by and among Chelsey Direct, LLC, Stuart Feldman, Regan Partners, L.P., Regan International Fund Limited and Basil P. Regan. Incorporated by reference to the
                Company's Current Report on Form 8-K filed November 30, 2003.
    10.88       
10.65
General Release dated November 30, 2003 given by Hanover Direct, Inc. and its parents, affiliates, subsidiaries, predecessor firms, shareholders, officers, directors, members, managers, employees, agents and others to Chelsey Direct, LLC and its parents, affiliates, subsidiaries, predecessor firms, shareholders, officers, directors, members, managers, employees, attorneys, agents and others. Incorporated by reference to the Company's Current Report on Form 8-K filed November 30, 2003.
    10.89       
10.66
General Release dated November 30, 2003 given by Chelsey Direct, LLC and its parents, affiliates, subsidiaries, predecessor firms, shareholders, officers, directors, members, managers, employees, agents and others to Hanover Direct, Inc. and its parents, affiliates, subsidiaries, predecessor firms, shareholders, officers, directors, members, managers, employees, attorneys, agents and others. Incorporated by reference to the Company's Current Report on Form 8-K filed November 30, 2003.
    10.90       
10.67
Stipulation of Discontinuance of the action entitled Hanover Direct, Inc. v. Richemont Finance S.A. and Chelsey Direct, LLC in the Supreme Court of the State of New York, County of New York (Index No. 03/602269) dated November 30, 2003. Incorporated by reference to the
                Company's Current Report on Form 8-K filed November 30, 2003.
    10.91       
10.68
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       
10.69
Thirtieth Amendment to Loan and Security Agreement, dated as of March 25, 2004, among Congress, Brawn, Gump'sGump’s by Mail, Gump's,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
10.70
Employment Agreement dated as of May 5, 2004 between Wayne P. Garten and the Registrant. Company. Incorporated by reference to the Company's Annual Report onForm10-Q filed August 10, 2004.
10.71
General Release and Covenant Not to Sue, dated as of May 5, 2004, between Thomas C. Shull and the Company. Incorporated by reference to the Form10-Q filed August 10, 2004.
10.72
Loan and Security Agreement, dated as of July 8, 2004, among Chelsey Finance, LLC, a Delaware limited liability company, and the Borrowers named therein. Incorporated by reference to the Form 8-K filed July 12, 2004.
10.73
Intercreditor and Subordination Agreement, dated as of July 8,2004, between Lender and Congress Financial Corporation, as acknowledged by Borrowers and Guarantors. Incorporated by reference to the Form 8-K filed July 12, 2004.
10.74
Thirty-first Amendment to Loan and Security Agreement, dated as of July 8, 2004, among Congress Financial Corporation and the Borrowers and Guarantors named therein. Incorporated by reference to the Form 8-K filed July 12, 2004.

10.75
Series D Preferred Stock Purchase Warrant dated July 8, 2004 issued by Hanover Direct, Inc. to Chelsey Finance, LLC. Incorporated by reference to the Form 8-K filed July 12, 2004.
10.76
Thirty-Second Amendment to Loan and Security Agreement, dated as of December 30, 2004, among Congress Financial Corporation and the Borrowers and Guarantors named therein. Incorporated by reference to the Form 8-K filed October 27, 2005.
10.77
Common Stock Purchase Warrant dated September 23, 2004 issued by Hanover Direct, Inc. to Chelsey Finance, LLC.
10.78
Thirty-Third Amendment to Loan and Security Agreement, dated as of March 11, 2005, among Congress Financial Corporation and the Borrowers and Guarantors named therein. Incorporated by reference to the Form 8-K filed October 27, 2005.
10.79
Employment Agreement dated as of March 15, 2005 between John Swatek and the Company. Incorporated by reference to the Form 8-K filed March 18, 2005.
10.80
Thirty-Fourth Amendment to Loan and Security Agreement, dated as of July 29, 2005, by and among Wachovia Bank, National Association and the Borrowers and Guarantors named therein. Incorporated by reference to the Form 8-K filed October 27, 2005.
10.81
First Amendment to Loan And Security Agreement dated as of November 30, 2004, by and among Chelsey Finance, LLC and the Borrowers and Guarantors named therein. Incorporated by reference to the Form 8-K filed October 27, 2005.
10.82
Second Amendment to Loan And Security Agreement dated as of December 30, 2004, by and among Chelsey Finance, LLC and the Borrowers and Guarantors named therein. Incorporated by reference to the Form 8-K filed October 27, 2005.
10.83
Third Amendment to Loan And Security Agreement dated as of July 29, 2005, by and among Chelsey Finance, LLC and the Borrowers and Guarantors named therein. Incorporated by reference to the Form 8-K filed October 27, 2005.
10.84
Credit Card Program Agreement between Hanover Direct, Inc. and World Financial Network National Bank dated as February 22, 2005. Incorporated by reference to the Form 8-K filed October 27, 2005.
10.85
Amendment Number One to Credit Card Program Agreement between Hanover Direct, Inc. and World Financial Network National Bank dated as March 30, 2005. Incorporated by reference to the Form 8-K filed October 27, 2005.
14.1
Hanover Direct, Inc. and Subsidiaries Code of Ethics. Incorporated by reference to the Form 10-K filed April 9, 2004.
     23.1       Consentfor the year ended December 28, 2002.
21.1
Subsidiaries of Independent Public Accountants. Previously filed.
     the Registrant.
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.
     Wayne P. Garten.
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.
     John W. Swatek.
32.1
Certification required by Rule 13a-14(b) or 15d-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C. 1350) signed by Thomas C. ShullWayne P. Garten.
32.2
Certification required by Rule 13a-14(b) or 15d-14(b) and Charles E. Blue.** IncorporatedSection 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C. 1350) signed by reference to the Company's Annual Report on Form 10-K filed April 9,
                2004.
John W. Swatek.


- ---------------

 
*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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