SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended ~~March 26, 2005~~April 1, 2006

Commission file number 1-08056

HANOVER DIRECT, INC.

(Exact name of registrant as specified in its charter)

	Delaware	13-0853260
(State of incorporation)	(IRS Employer Identification No.)


1500 Harbor Boulevard, Weehawken, New Jersey	07086
	(Address of principal executive offices)	(Zip Code)

(201) 863-7300
		(Telephone number)

~~(201) 863-7300~~

~~(Telephone number)~~

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. ~~YES~~

Yes X No _ NO X

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer __

Accelerated filer __

Non-accelerated filer X

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)~~. YES~~ NO

Yes_ No X

Common stock, par value $0.01 per share: 22,426,296 shares outstanding as of ~~February 21,~~May 16, 2006.

~~EXPLANATORY NOTE~~

As explained herein, we have restated the condensed consolidated financial statements for, among other periods, the period ended March 27, 2004 which is included in this Form 10-Q (collectively, the “Restatement”). By way of summary, 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 and corrects the premature reversal of a reserve for post employment benefits. 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 federal and state tax provision and the deferred tax asset and liabilities to reflect the effect of the Restatement adjustments. For a more complete description of the Restatement, refer to Note 2 to the attached condensed consolidated financial statements. As previously disclosed in our Current Report on Form 8-K filed with the Securities and Exchange Commission (“SEC”) on November 10, 2004, the financial statements and related financial information contained in, among other reports, the Form 10-Q for the fiscal quarter ended March 27, 2004 should no longer be relied upon. Throughout this Form 10-Q all referenced amounts for the period ended March 27, 2004 and comparisons thereto reflect the balances and amounts after giving effect to the Restatement.

HANOVER DIRECT, INC.

TABLE OF CONTENTS

Page

Part I - Financial Information

Item 1. Financial Statements

Condensed Consolidated Balance Sheets -

April 1, 2006, December 31, 2005 and March 26, 2005 ~~December 25, 2004 and Restated March 27, 2004~~

Condensed Consolidated Statements of Income (Loss) – 13- weeks ended

April 1, 2006 and March 26, 2005 ~~and Restated March 27, 2004~~

Condensed Consolidated Statements of Cash Flows – 13- weeks ended

April 1, 2006 and March 26, 2005 ~~and Restated March 27, 2004~~

Notes to Condensed Consolidated Financial Statements

Item 2. Management’s Discussion and Analysis of Consolidated Financial Condition and

Results of Operations

Item 3. Quantitative and Qualitative Disclosures about Market Risk

2719

Item 4. Controls and Procedures

2720

Part II - Other Information

Item 1. Legal Proceedings

~~Item 3. Defaults Upon Senior Securities~~

3220

Item 6. Exhibits

3220

~~Signatures~~

Signature Page

PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

HANOVER DIRECT, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands of dollars, except share amounts)

March 26,
2005

December 25, 2004

March 27,
2004
As Restated

(Unaudited)

(Unaudited)

ASSETS

CURRENT ASSETS:

Cash and cash equivalents
$             515

$            510

$          2,434
Accounts receivable, net of allowance for doubtful accounts of $1,189, $1,367 and $1,069, respectively

15,342

17,819

12,615
Inventories, principally finished goods
47,325

53,147

41,088
Prepaid catalog costs
18,647

15,644

17,466
Other current assets
5,143

4,482

4,169
Total Current Assets
86,972

91,602

77,772

PROPERTY AND EQUIPMENT, AT COST:

Land
4,361

4,361

4,361

Buildings and building improvements
18,221

18,221

18,210

Leasehold improvements
1,078

10,156

10,108

Furniture, fixtures and equipment
51,716

53,792

53,331

75,376

86,530

86,010

Accumulated depreciation and amortization
(54,320)

(61,906)

(59,125)

Property and equipment, net
21,056

24,624

26,885
Goodwill
8,649

9,278

9,278

Deferred tax assets
2,350

2,179

1,769

Other assets
2,645

2,816

1,742
Total Assets
$    121,672

$    130,499

$      117,446

	April 1, 2006	December 31, 2005	March 26, 2005
	(Unaudited)		(Unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents	$ 127	$ ��275	$ 515
Accounts receivable, net of allowance for doubtful accounts of $873, $916 and $1,189, respectively	13,310	16,518	15,342
Inventories, principally finished goods	54,882	51,356	47,325
Prepaid catalog costs	18,121	17,567	18,647
Other current assets	3,055	2,744	5,143
Total Current Assets	89,495	88,460	86,972
PROPERTY AND EQUIPMENT, AT COST:
Land	4,378	4,378	4,361
Buildings and building improvements	18,200	18,194	18,221
Leasehold improvements	1,052	1,115	1,078
Furniture, fixtures and equipment	51,582	51,532	51,716
	75,212	75,219	75,376
Accumulated depreciation and amortization	(55,277)	(55,030)	(54,320)
Property and equipment, net	19,935	20,189	21,056
Goodwill	8,649	8,649	8,649
Deferred tax assets	2,890	2,890	2,350
Other assets	1,792	1,989	2,645
Total Assets	$ 122,761	$ 122,177	$ 121,672

Continued on next page.

HANOVER DIRECT, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS (Continued)

(In thousands of dollars, except share amounts)

March 26,
2005

December 25, 2004

March 27,
2004
As Restated

(Unaudited)

(Unaudited)
LIABILITIES AND SHAREHOLDERS’ DEFICIENCY

CURRENT LIABILITIES:

Short-term debt and capital lease obligations
$ 8,545

$ 16,690

$ 15,135
Accounts payable
25,850

29,544

39,441
Accrued liabilities
17,622

20,535

15,666
Customer prepayments and credits
17,587

12,032

17,778
Deferred tax liability
2,350

2,179

1,769
Total Current Liabilities
71,954

80,980

89,789
NON-CURRENT LIABILITIES:

Long-term debt (including debt to a related party see note 9)
11,419

11,196

8,001
Series C Participating Preferred Stock, authorized, issued and outstanding 564,819 shares; liquidation preference of $56,482
72,689

72,689

72,689
Other
--

3,286

4,097
Total Non-current Liabilities
84,108

87,171

84,787
Total Liabilities
156,062

168,151

174,576
SHAREHOLDERS’ DEFICIENCY:

Common Stock, $0.01 par value, authorized 50,000,000 shares at March 26, 2005 and December 25, 2004 and 30,000,000 shares at March 27, 2004; 22,426,296 shares issued and outstanding at March 26, 2005 and December 25, 2004; 22,229,456 shares issued and 22,017,363 shares outstanding at March 27, 2004
225

225

222
Capital in excess of par value
460,779

460,744

450,411
Accumulated deficit
(495,394)

(498,621)

(504,417)

(34,390)

(37,652)

(53,784)
Less:

Treasury stock, at cost (0 shares at March 26, 2005 and December 25, 2004 and 212,093 shares at March 27, 2004)
--

--

(2,996)
Notes receivable from sale of Common Stock
--

--

(350)
Total Shareholders’ Deficiency
(34,390)

(37,652)

(57,130)
Total Liabilities and Shareholders’ Deficiency
$ 121,672

$ 130,499

$ 117,446

	April 1, 2006	December 31, 2005	March 26, 2005
	(Unaudited)		(Unaudited)
LIABILITIES AND SHAREHOLDERS’ DEFICIENCY

CURRENT LIABILITIES:
Short-term debt and capital lease obligations	$ 11,403	$ 10,105	$ 8,545
Accounts payable	22,234	27,043	25,850
Accrued liabilities	12,739	12,341	17,622
Customer prepayments and credits	13,972	10,074	17,587
Deferred tax liability	2,890	2,890	2,350
Total Current Liabilities	63,238	62,453	71,954
NON-CURRENT LIABILITIES:
Long-term debt (including debt to a related party see note 6)	13,090	12,543	11,419
Series C Participating Preferred Stock, authorized, issued and outstanding 564,819 shares; liquidation preference of $56,482	72,689	72,689	72,689
Other	1,053	40	--
Total Non-current Liabilities	86,832	85,272	84,108
Total Liabilities	150,070	147,725	156,062
SHAREHOLDERS’ DEFICIENCY:
Common Stock, $0.01 par value, authorized 50,000,000 shares at April 1, 2006, December 31, 2005 and March 26, 2005; 22,426,296 shares issued and outstanding at April 1, 2006, December 31, 2005 and March 26, 2005	225	225	225
Capital in excess of par value	460,925	460,891	460,779
Accumulated deficit	(488,459)	(486,664)	(495,394)
Total Shareholders’ Deficiency	(27,309)	(25,548)	(34,390)
Total Liabilities and Shareholders’ Deficiency	$ 122,761	$ 122,177	$ 121,672

See Notes to Condensed Consolidated Financial Statements.

HANOVER DIRECT, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME (LOSS)

(In thousands of dollars, except per share amounts)

(Unaudited)

For the 13- Weeks Ended

March 26,
2005

March 27,
2004
As Restated

NET REVENUES
$ 89,682

$ 81,281

OPERATING COSTS AND EXPENSES:

Cost of sales and operating expenses
53,972

51,087

Special charges
24

--

Selling expenses
22,278

19,618

General and administrative expenses
10,583

9,624

Depreciation and amortization
753

843

87,610

81,172

INCOME BEFORE INTEREST AND INCOME TAXES
2,072

109

Interest expense, net (including interest expense to a related party see note 9)
1,827

825

INCOME (LOSS) BEFORE INCOME TAXES
245

(716)

Provision (benefit) for Federal income taxes
5

(108)

Provision (benefit) for state income taxes
1

(8)

Provision (benefit) for income taxes
6

(116)

INCOME (LOSS) FROM CONTINUING OPERATIONS
239

(600)

Gain (loss) from discontinued operations of Gump’s net of income tax benefit of $14, including a gain on disposal of $3,576 at March 26, 2005
2,988

(196)

NET INCOME (LOSS) AND COMPREHENSIVE INCOME (LOSS)
3,227

(796)

Earnings applicable to Preferred Stock
79

--

NET INCOME (LOSS) APPLICABLE TO COMMON SHAREHOLDERS
$ 3,148

$ (796)

NET INCOME (LOSS) PER COMMON SHARE:

From continuing operations – basic
$ 0.01

$ (0.03)

From continuing operations – diluted
$ 0.01

$ (0.03)

From discontinued operations – basic
$ 0.13

$ (0.01)

From discontinued operations – diluted
$ 0.09

$ (0.01)

Net income (loss) per common share – basic
$ 0.14

$ (0.04)

Net income (loss) per common share – diluted
$ 0.10

$ (0.04)

Weighted average common shares outstanding –
basic (thousands)
22,426

22,017

Weighted average common shares outstanding –
diluted (thousands)
32,585

22,017

	For the 13- Weeks Ended
	April 1, 2006	March 26, 2005
	April 1, 2006	March 26, 2005

NET REVENUES	$ 100,283	$ 89,682

OPERATING COSTS AND EXPENSES:
Cost of sales and operating expenses	63,265	53,972
Special charges	--	24
Selling expenses	26,183	22,278
General and administrative expenses	9,855	10,583
Depreciation and amortization	537	753
	99,840	87,610

INCOME BEFORE INTEREST AND INCOME TAXES	443	2,072
Interest expense, net (including interest expense to a related party see note 6)	2,246	1,827

INCOME (LOSS) BEFORE INCOME TAXES	(1,803)	245
Provision (benefit) for Federal income taxes	(7)	5
Provision (benefit) for state income taxes	(1)	1
Provision (benefit) for income taxes	(8)	6

INCOME (LOSS) FROM CONTINUING OPERATIONS	(1,795)	239

Gain from discontinued operations of Gump’s, net of $14 of income tax benefit, including a gain including a gain on disposal of $3,576 at March 26, 2005	--	2,988

NET INCOME (LOSS) AND COMPREHENSIVE INCOME (LOSS)	(1,795)	3,227
Earnings applicable to Preferred Stock	--	79

NET INCOME (LOSS) APPLICABLE TO COMMON SHAREHOLDERS	$ (1,795)	$ 3,148

NET INCOME (LOSS) PER COMMON SHARE:
From continuing operations – basic	$ (0.08)	$ 0.01
From continuing operations – diluted	$ (0.08)	$ 0.01
From discontinued operations – basic	$ 0.00	$ 0.13
From discontinued operations – diluted	$ 0.00	$ 0.09
Net income (loss) per common share – basic	$ (0.08)	$ 0.14
Net income (loss) per common share – diluted	$ (0.08)	$ 0.10
Weighted average common shares outstanding – basic (thousands)	22,426	22,426
Weighted average common shares outstanding – diluted (thousands)	22,426	32,585

See Notes to Condensed Consolidated Financial Statements.

HANOVER DIRECT, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands of dollars)

(Unaudited)

	For the 13- Weeks Ended		For the 13- Weeks Ended
	March 26, 2005	March 27, 2004 As Restated	April 1, 2006	March 26, 2005
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)	$ 3,227	$ (796)	$ (1,795)	$ 3,227
Adjustments to reconcile net income (loss) to net cash provided (used) by operating activities:
Depreciation and amortization, including deferred fees	1,065	1,077	714	1,065
Provision for doubtful accounts	213	87	264	213
Special charges	24	--	--	24
Gain on the sale of Gump’s			--	(3,576)
Gain on the sale of property and equipment	(2)	--	(1)	(2)
Gain on the sale of Gump’s	(3,576)	--
Compensation expense related to stock options	37	4	34	37
Accretion of debt discount	740	--	1,047	740
Changes in assets and liabilities:
Accounts receivable	189	1,634	2,944	189
Inventories	(166)	1,718	(3,526)	(166)
Prepaid catalog costs	(4,063)	(4,981)	(554)	(4,063)
Accounts payable	(1,194)	(3,301)	(4,809)	(1,194)
Accrued liabilities	(1,644)	(1,422)	398	(1,644)
Customer prepayments and credits	6,104	6,299	3,898	6,104
Other, net	(801)	(896)	722	(801)
Net cash provided (used) by operating activities	153	(577)	(664)	153
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisitions of property and equipment	(412)	(119)	(283)	(412)
Proceeds from the sale of property and equipment	5	--
Proceeds from disposal of property and equipment			1	5
Proceeds from the sale of Gump’s	8,921	--	--	8,921
Net cash provided (used) by investing activities	8,514	(119)	(282)	8,514
CASH FLOWS FROM FINANCING ACTIVITIES:
Net (payments) borrowings under Wachovia revolving loan facility	(8,082)	1,759
Net borrowings (payments) under Wachovia revolving loan facility			1,314	(8,082)
Payments under Wachovia Tranche A term loan facility	(498)	(498)	(498)	(498)
Payments under Wachovia Tranche B term loan facility	--	(450)
Payments of long-term debt and capital lease obligations	(82)	(185)	(18)	(82)
Payment of debt issuance costs	--	(125)
Refund of estimated Richemont tax obligation on Series B Participating Preferred Stock accretion	--	347
Net cash (used) provided by financing activities	(8,662)	848
Net increase in cash and cash equivalents	5	152
Net cash provided (used) by financing activities			798	(8,662)
Net increase (decrease) in cash and cash equivalents			(148)	5
Cash and cash equivalents at the beginning of the period	510	2,282	275	510
Cash and cash equivalents at the end of the period	$ 515	$ 2,434	$ 127	$ 515

Supplemental Disclosures of Cash Flow Information:
Cash paid for:
Interest	$ 1,015	$ 733	$ 1,013	$ 1,015
Income taxes	$ 132	$ 6	$ 2	$ 132

See Notes to Condensed Consolidated Financial Statements.

HANOVER DIRECT, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1.	BASIS OF PRESENTATION

The accompanying unaudited interim condensed consolidated financial statements have been prepared in accordance with the instructions for Form 10-Q and, therefore, do not include all information and footnotes necessary for a fair presentation of financial condition, results of operations and cash flows in conformity with generally accepted accounting principles. Reference should be made to the annual financial statements, including the footnotes thereto, included in the Hanover Direct, Inc. (the “Company”) Annual Report on Form 10-K for the fiscal year ended December ~~25, 2004.~~31, 2005. The condensed consolidated balance sheet at December 31, 2005 has been derived from the audited financial statements. In the opinion of management, the accompanying unaudited interim condensed consolidated financial statements contain all material adjustments, consisting of normal recurring accruals, necessary to present fairly the financial condition, results of operations and cash flows of the Company and its consolidated subsidiaries for the interim periods. Operating results for interim periods are not necessarily indicative of the results that may be expected for the entire year. All references in these unaudited condensed 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 effect of the one-for-ten reverse stock split occurring at the close of business on September 22, 2004.

~~The Company has adjusted the calculation~~Sale of its deferred tax assets and liabilities as of March 27, 2004 to also consider the effect of deferred state income taxes as of that date, as well as the Company has calculated deferred taxes on only those Net Operating Loss 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 March 27, 2004. 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.Gump’s Business

On March 14, 2005, the Company sold all of the stock of Gump’s Corp. and Gump’s By Mail,, Inc. (collectively, “Gump’s”) ~~to an unrelated third party~~ (See Note 6)5). The Condensed Consolidated Statements of Income ~~(Loss)~~for the 13- Weeks Ended March 26, 2005 reflects the Gump’s operating results and gain on sale as discontinued operations. In addition, in the Condensed Consolidated Statement of Cash Flows for the 13- Weeks Ended March 26, 2005, the change in assets and liabilities reflects Gump’s as discontinued operations.

Stock-Based Compensation

On January 1, 2006, the Company adopted Statement of Financial Accounting Standards (SFAS) 123R, “Share-Based Payment” (“SFAS 123R”), under the modified prospective method. Since the Company had previously accounted for stock-based compensation plans under the fair value provisions of SFAS 123 “Accounting for Stock-Based Compensation” (“SFAS 123”), adoption did not significantly impact the Company’s financial position or results of operations. Under SFAS 123R, actual tax benefits recognized in excess of tax benefits previously established upon grant are reported as a financing cash inflow. Prior to adoption, such excess tax benefits were reported as an increase to operating cash flows. As of April 1, 2006, there were no tax benefits recognized in excess of tax benefits previously established upon grant.

The Company accounts for its stock options issued under its stock compensation plans under the fair value method of accounting using a Black-Scholes valuation model to measure stock option expense at the date of grant. All stock option grants have an exercise price equal to the fair market value of the Company’s common stock on the date of grant and generally have a 10-year term. The fair value of stock option grants is amortized to expense over the vesting period, generally 24 to 48 months. As of April 1, 2006, 2.8 million shares were available for future stock-based compensation grants. The Company issues new shares on the open market upon the exercise of stock options. For the 13- weeks ended April 1, 2006 and March 26, 2005, the Company recognized stock-based compensation expense of less than $0.1 million in each period.

The weighted average Black-Scholes fair value assumptions for stock options issued during the 13- weeks ended April 1, 2006 and March 26, 2005 are as follows (no stock options were granted for the 13- weeks ended April 1, 2006):

	For the 13- Weeks Ended
	April 1, 2006	March 26, 2005

Expected term (in years)	—	4
Risk free interest rate	—	3.78%
Expected volatility	—	88.61%
Expected dividend yield	—	0%

A summary of option activity during the 13- weeks ended April 1, 2006 is presented below:

	Shares	Weighted Average Exercise Price	Weighted Average Remaining Contractual Life	Aggregate Intrinsic Value
Options outstanding, beginning of period	1,169,600	$ 4.65	4.9	$ 61,095
Granted	—	—
Exercised	—	—
Forfeited	(469,500)	4.56
Options outstanding, end of period	700,100	$ 4.72	7.1	$ 41,000
Options exercisable, end of period	541,259	$ 5.66	6.8	$ 18,667
Weighted average fair value of options granted	$ —

As of April 1, 2006, all stock options outstanding are either vested or expected to vest.

A summary of the status of the Company’s nonvested shares as of April 1, 2006, and changes during the 13- weeks ended April 1, 2006, is presented below:

	Shares	Weighted Average Grant-Date Fair Value
Nonvested options outstanding, beginning of period	175,507	$1.00
Granted	—	—
Vested	(16,666)	0.48
Forfeited	—	—
Nonvested options outstanding, end of period	158,841	$1.06

As of April 1, 2006, there was $0.1 million of total unrecognized compensation cost related to nonvested share-based compensation stock option plans of the Company. That cost is expected to be recognized over a weighted-average period of 0.8 years.

Uses of Estimates and Other Critical Accounting Policies

The condensed consolidated financial statements include all subsidiaries of the Company and all intercompany transactions and balances have been eliminated. The preparation of financial statements, in conformity with generally accepted accounting principles, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

See “Management’s Discussion and Analysis of Consolidated Financial Condition and Results of Operations,” found in the Company’s Annual Report on Form 10-K for the fiscal year ended December ~~25, 2004~~31, 2005 for additional information relating to the Company’s use of estimates and other critical accounting policies.

2.	~~RESTATEMENTS OF FINANCIAL STATEMENTS~~

~~We have restated the condensed consolidated financial statements for the first quarter of 2004 included in this Form 10-Q (the “Restatement”).~~

~~Buyers’ Club Program.~~ In the first quarter of 2004, we 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 the condensed consolidated financial statements for the first quarter of 2004.

~~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 the first quarter of 2004 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 condensed consolidated financial statements contain a restatement related to the Kaul reserve that corrects an error 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 a summary judgment decision in January 2004. 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 inappropriately recorded certain of these fees against the reserve as opposed to recording them as an expense in the income statement. As of March 26, 2005, 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 premature 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 the condensed consolidated financial statements for the first quarter of 2004.

~~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 first quarter of 2004 condensed consolidated financial statements is stated below. The amounts presented below “As Previously Reported” reflect the Gump’s operating results and gain on sale as discontinued operations.

Quarter ended March 27, 2004

As
Previously Reported

Buyers’ Club Adjustment

Revenue Recognition Adjustments

Kaul
Accrual Adjustment
Customer
Prepayments And Credits Adjustment

Other
Accrual Adjustments

As Restated

(In thousands, except per share amounts)
Inventories

$          37,646
--
3,442
--
--
--
$       41,088
Prepaid catalog costs

$          15,305
--
2,161
--
--
--
$       17,466
Other current assets

$            3,294
--
721
--
--
154
$         4,169
Total current assets

$          71,293
--
6,324
--
--
155
$       77,772
Deferred tax asset

$            1,453
--
316
--
--
--
$         1,769
Accounts payable

$          38,499
--
--
--
--
942
$       39,441
Accrued liabilities

$          11,997
--
(618)
4,354
--
(67)
$       15,666
Customer prepayments and credits

$            5,866
2,161
8,826
--
925
--
$       17,778
Deferred tax liability

$            1,453
--
316
--
--
--
$         1,769
Total current liabilities

$          72,950
2,161
8,524
4,354
925
875
$       89,789
Accumulated deficit

$      (494,373)
(2,161)
(1,884)
(4,354)
(925)
(720)
$   (504,417)
Total shareholders’ deficiency

$        (47,086)
(2,161)
(1,884)
(4,354)
(925)
(720)
$     (57,130)
Net revenues

$          86,409
(264)
(4,864)
--
--
--
$       81,281
Cost of sales and operating expenses

$          53,322
--
(2,235)
--
--
--
$       51,087
Selling expenses

$          21,034
--
(1,484)
--
--
68
$       19,618
General and administrative expenses

$            9,666
--
(112)
--
58
12
$         9,624
Income before interest and income taxes

$            1,546
(264)
(1,033)
--
(58)
(80)
$           111
Benefit (provision) for Federal income taxes

$              (63)
--
--
--
--
171
$           108
Benefit (provision) for state income taxes

$              (42)
--
--
--
--
50
$               8
Net income (loss) and comprehensive income (loss)

$              418

(264)

(1,033)

--

(58)

141

$         (796)
Net income (loss) applicable to common shareholders

$              417

(264)

(1,032)

--

(58)

141

$         (796)
Net income (loss) per share-basic and diluted

$             0.02
(0.01)
(0.05)
--
--
--
$        (0.04)

~~The Restatement did not result in a change to the Company’s cash flows during the first quarter of 2004.~~

Audit Committee Investigation; SEC Inquiry

~~On November 17,~~In response to the discovery during the second half of 2004 of errors in the Company’s accounting treatment of certain items, it was determined in the third quarter of 2004 that the Company needed to restate previously filed financial statements (“Restatement”). Shortly thereafter, the Audit Committee of the Board of Directors ~~began~~launched an independent investigation ~~of matters~~ relating to ~~restatements of~~ the ~~Company’s financial statements~~Restatement and other accounting-related matters ~~with the assistance of independent outside counsel,~~and engaged Wilmer Cutler Pickering Hale ~~and~~& Dorr LLP (“Wilmer ~~Cutler”~~Hale”).

~~On March 14, 2005,~~ to conduct 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, 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.

investigation. The Company was notified onin January ~~11,~~ 2005 by the ~~Securities and Exchange Commission (“SEC”)~~SEC that it was conducting an informal inquiry ~~relating to~~into the Company’s financial results and financial reporting since 1998. ~~The SEC indicated~~At this point in ~~its letter to the Company that the inquiry should not be construed as an indication by~~time, the SEC ~~that there has been any violation of~~informal inquiry is ongoing. On October 20, 2005, 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~~Audit Committee dismissed KPMG LLP (“KPMG”) as the Company’s independent ~~registered public accounting firm,~~auditors and thereafter engaged Goldstein Golub Kessler LLP (“GGK”),. GGK completed its audit of the Company’s 2004, 2003 and 2002 fiscal year end financial statements and its review of the Company’s quarterly financial statements for the third fiscal quarter of 2004 and the first three quarters of 2005 on February 8, 2006. On February 21, 2006, the ~~results of its investigation.~~ Company filed the past due periodic reports with the SEC.

Significant Shareholder; Going Private Proposal and Related Litigation

The Company ~~intends~~has a significant shareholder, Chelsey Direct, LLC. Chelsey and its related affiliates (“Chelsey”) beneficially own approximately 69% of the Company’s issued and outstanding common stock (“Common Stock”) and approximately 77% of the Common Stock after giving effect to ~~continue~~the exercise of all of Chelsey’s outstanding options and warrants. In addition, Chelsey holds all 564,819 shares of the Company’s Series C Participating Preferred Stock (“Series C Preferred”) which has 100 votes per share. Including the Series C Preferred and the outstanding options and warrants beneficially owned by Chelsey, Chelsey holds approximately 91% of the voting rights of the Company.

The Company received a proposal from Chelsey to ~~cooperate~~acquire the shares of Common Stock that Chelsey does not already own for a cash purchase price of $1.25 per share in a letter dated February 23, 2006. The letter indicates Chelsey's belief that the Company should become privately owned due to the financial drain imposed by remaining public as well as the limited benefits of remaining public. The letter states that Chelsey or an affiliate proposes to enter into a cash merger agreement with the ~~SEC in connection~~Company and to commence a cash tender promptly after the execution of that agreement.

Shortly after receipt of the letter, the Board of Directors met and formed a special committee (“Special Committee”) comprised of A. David Brown, Robert H. Masson and Donald Hecht, the three directors who are not Company employees or affiliated with Chelsey; Mr. Masson was appointed as the Special Committee’s Chairman. The Special Committee appointed Wilmer Hale as its ~~informal inquiry concerning~~independent counsel and engaged Houlihan Lokey Howard & Zukin (“Houlihan Lokey”) as its financial advisor. The Special Committee is continuing its deliberations regarding the proposed going private transaction. There can be no assurances that any transaction will occur, or if any transaction does occur, on what terms such transaction might be consummated.

As a result of the going private proposal, three substantially identical complaints have been filed against the Company, Chelsey and each of the Company’s ~~financial reporting.~~directors (see Note 3 below).

3.2.

NET INCOME (LOSS) PER COMMON SHARE

Net income (loss) per common share is computed using the weighted average number of common shares outstanding in accordance with the provisions of SFAS No. 128, “Earnings Per Share” (“SFAS 128”). Basic net income (loss) per common share is calculated by dividing net income (loss) available to common shareholders, reduced for participatory interests, by the weighted average number of common shares outstanding during the period. Diluted net income (loss) per common share is calculated using the weighted average number of common shares outstanding adjusted to include the potentially dilutive effect of 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):

For the 13- Weeks Ended

March 26, 2005

March 27, 2004
As Restated

Net income (loss)

$              3,227

$              (796)
Less:

Earnings applicable to preferred stock

79

--
Net income (loss) applicable to
common shareholders

$              3,148

$              (796)
Basic net income (loss) per common
share

$                0.14

$             (0.04)

Weighted-average common shares outstanding

22,426

22,017

Diluted net income (loss)

$              3,148

$              (796)
Diluted net income (loss) per common
share

$                0.10

$             (0.04)

Weighted-average common shares
outstanding

22,426

22,017
Effect of Dilution:

Stock warrants (issued July 8, 2004)

10,159

--
Weighted-average common shares
outstanding assuming dilution

32,585

22,017

	For the 13- Weeks Ended
	April 1, 2006	March 26, 2005

Net income (loss)	$ (1,795)	$ 3,227
Less:
Earnings applicable to preferred stock	--	79
Net income (loss) applicable to common Shareholders	$ (1,795)	$ 3,148
Basic net income (loss) per common share	$ (0.08)	$ 0.14

Weighted-average common shares outstanding	22,426	22,426

Diluted net income (loss)	$ (1,795)	$ 3,148
Diluted net income (loss) per common share	$ (0.08)	$ 0.10

Weighted-average common shares outstanding	22,426	22,426
Effect of Dilution:
Stock warrants (issued July 8, 2004)	--	10,159
Weighted-average common shares outstanding assuming dilution	22,426	32,585

Diluted net ~~loss~~income (loss) per common share excluded incremental weighted-average shares of ~~36,021~~10,248,806 for the ~~13-week period~~13- weeks ended ~~March 27, 2004.~~April 1, 2006. These incremental weighted-average shares were related to employee stock options and common stock warrants and were excluded due to their anti-dilutive effect. Options for which the exercise price was greater than the average market price of common shares as of the 13- weeks ended April 1, 2006 and March 26, 2005 were not included in the computation of diluted earnings per share as the effect would be antidilutive. These consisted of options totaling 552,100 shares and 1,331,100 shares, respectively.

4.3.

CONTINGENCIES

~~Rakesh K. Kaul v. Hanover Direct, Inc.~~Litigation Related to Going Private Proposal:

As a result of the going private proposal (see Note 1 above), ~~No. 04-4410(L)-CV, 2nd Cir.S.D.N.Y.~~three substantially identical complaints have been filed against the Company, Chelsey and each of the Company’s directors: the first complaint was filed in Delaware Chancery Court by Glenn Friedman and L.I.S.T., Inc. as plaintiffs on ~~appeal from 296 F. Supp.2d (S.D. NY 2004). On June 28, 2001, Rakesh K. Kaul,~~March 1, 2006; the ~~former President~~second complaint was filed in Delaware Chancery Court by Howard Lasker as plaintiff on March 7, 2006; and ~~Chief Executive Officer~~the third complaint was filed in Superior Court of New Jersey Chancery Division by Feivel Gottlieb as plaintiff on March 3, 2006. In each complaint, the plaintiffs challenge Chelsey’s going private proposal and allege, among other things, that the consideration to be paid in the going private proposal is unfair and grossly inadequate, that the Special Committee cannot be expected to act independently, that Chelsey has manipulated the financial statements of the Company ~~filed a five-count complaint~~and its public statements in order to depress the ~~Federal District Court in New York seeking relief stemming from his separation~~stock price of ~~employment from~~ the Company ~~including short-term bonus~~ and ~~severance payments~~that the proposal would freeze out the purported class members and capture the true value of ~~$2,531,352, attorneys’ fees~~the Company for Chelsey. In each complaint, plaintiffs seek class action certification, preliminary and ~~costs,~~permanent injunctive relief, rescission of the transaction if the offer is consummated and ~~damages due~~unspecified damages.

The plaintiffs in each of the cases agreed to extend the time by which the defendants were required to respond pending the recommendation of the Special Committee regarding the fairness of the transaction from a financial perspective.

Based upon a preliminary analysis of the complaints, the Company believes that the complaints are without merit and intends to defend its interests vigorously.

~~Company’s failure~~

SEC Informal Inquiry:

See Note 1 to ~~pay him~~the consolidated financial statements for a ~~“tandem bonus” as well as Kaul’s alleged rights~~discussion of the informal inquiry being conducted by the SEC relating 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. The Company paid Mr. Kaul the $60,856 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 opinion expired in August 2005.~~

As of March 26, 2005, the Company had accrued $4.5 million related to this matter, which remained on the Company’s Condensed Consolidated Balance Sheet until the final resolution of Kaul’s claims against the Company, which occurred in August 2005 when all of his rights to pursue this claim expired. During the third quarter ended September 24, 2005, the Company reversed an accrual established in fiscal 2000 of $4.5 million due to the expiration of Kaul’s rights to further pursue the claim.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,~~During the third quarter of 2005, the Company ~~has,~~favorably resolved three of the cases: one was settled for an aggregate payment of $39,500, the Company prevailed in ~~large part, resolved all of these 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 class action lawsuitanother case which led to the plaintiff in the ~~Superior Court of~~third case voluntarily dismissing his case. In 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 engaged in untrue, deceptive and misleading advertising and unfair competition under the state’s Business and Professions Code. Wilson and the class 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 trial the previous April, entered judgment for the plaintiff and the class, 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 issue, which appeals were consolidated. The enforcement of the judgment for insurance fees and the award of attorneys’ fees were stayed pending resolution of the appeal. On September 2, 2005, the California Court of Appeals reversed both the trial court’s findings on the merits and its award of attorneys’ fees. The plaintiffs have 30 days to appeal the decision.

~~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. Thisremaining case, ~~has been stayed since May 2002 pending resolution of the Martin 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 (Supp. Ct. Bergen Co. – Law Div., NJ) October 28, 2002, John Morris, individually and on behalf of other similarly situated persons in New Jersey filed an action 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 insurance 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 allegations stem from “insurance charges” paid to the Company by consumers who had placed orders from catalogs published by indirect subsidiaries of the Company over a number of years. Martin sought relief including (i) a declaratory judgment as to the validity of the delivery insurance, (ii) an order directing the Company to return to the plaintiff and class members the “unlawful revenue” derived from the insurance charges, (iii) threefold damages for each class member, and (iv) attorneys’ fees and costs. In July 2001, the Court certified the class and the Company filed anprevailed in its appeal of ~~the~~ class ~~certification. On~~certification in an October 25, 2005 ~~the class certification was reversed.~~decision. Martin filed an Application for Rehearing ~~which was denied on January 3, 2006. On January 18, 2006, Martin filed~~and 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~~both of which were denied during the ~~third~~first quarter of 2004 for the class action lawsuits described above for settlements and the Company’s current estimate of future legal fees to be incurred. The balance of the reserve as of March 26, 2005 was approximately $0.3 million.2006.

Claims for Post-Employment ~~Benefits:~~ Benefits

The Company is involved in four lawsuits instituted by former employees arising from the Company’s denial of change in control (“CIC”) benefits under compensation continuation plans following the termination of employment.

Two of these cases arose from the circumstances surrounding the Restatement:

Charles Blue v. Hanover Direct, Inc., William Wachtel, Stuart Feldman, Wayne Garten and Robert Masson, (Supp. Ct. N.J., 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 seeks compensatory and punitive damages and attorney’s fees and alleges retaliation, mental anguish and reputational damage, loss of earnings and employment and racial discrimination. The Company is mounting a vigorous defense in the action, which is in the discovery phase, and believes that Mr. Blue was properly terminated for cause and that his claims are groundless.

Frank Lengers v. Hanover Direct, Inc., Wayne Garten, William Wachtel, A. David Brown, Stuart Feldman, Paul S. Goodman, Donald Hecht and Robert Masson, (Supp. Ct. N.J., Law Div. Hudson Cty, Docket No.: L-5795-05) was brought as a result of the Company terminating the employment of its former Vice President, Treasury Operations & Risk Management, on March 8, 2005 for cause. The complaint seeks compensatory and punitive damages and attorney’s fees and alleges improper denial of CIC benefits, age and disability discrimination, handicap discrimination, aiding and abetting and breach

of contract. The Company is mounting a vigorous defense in the action, which is in the discovery phase, and believes that Mr. Lengers was properly terminated for cause and that his claims are groundless.

The Company believes that it properly denied CIC benefits with respect to each of the four former employees and that it has meritorious defenses in all of the cases and plans a vigorous defense.

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

5.4.

SPECIAL CHARGES

2004 Plan

On June 30, 2004 the Company announced its 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. The Company substantially completed the consolidation into the Roanoke, Virginia fulfillment center by the end of June 2005. The Company has incurred approximately $0.8 million in facility exit costs from the date of the announcement through ~~June 25, 2005.~~April 1, 2006. 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~~have been or are being provided severance benefits by the Company. Since the consolidation of ~~our~~the fulfillment centers, ~~our~~the Company’s Roanoke fulfillment center has experienced high levels of employee turnover and lower productivity that has negatively impacted fulfillment costs and the Company’s overall performance. This trend of high levels of employee turnover and lower productivity has continued through the 13- weeks ended April 1, 2006 and is expected to continue further into 2006.

On November 9, 2004, the Company decided to relocate its International Male and Undergear catalog operations to its offices in New Jersey. The Company completed the relocation on February 28, 2005. The relocation was done primarily to consolidate operations, reduce costs, and leverage its catalog expertise in New Jersey. The Company accrued a total of $0.9 million in severance and related costs during the fourth quarter 2004 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.~~

~~During the first quarter~~As of ~~2005, the reserve activity represents the utilization of the severance reserves established in 2004 for the Lacrosse fulfillment center and storage facility and the~~ ~~International Male~~ ~~and~~ ~~Undergear~~ ~~catalog operations as well as additional severance charges~~April 1, 2006, a current liability of less than $0.1 ~~million.~~

~~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. The actions related to the strategic business realignment program were taken in an effort to direct the Company’s resources primarily towards a loss reduction strategy and return to profitability.

~~Plan Summary~~

~~At March 26, 2005, a current liability of approximately $1.0~~ million was included within Accrued Liabilities relating to future payments of severance and personnel costs in connection with the Company’s ~~2000 and~~ 2004 ~~plans and consists of the following (in thousands):~~

Severance
&
Personnel
Costs

Real
Estate
Lease &
Exit Costs

2004 Plan

2000 Plan

Total

Balance at December 25, 2004

$        1,518

$       3,360

$        4,878
2005 expenses

24

--

24
Paid in 2005

(667)

(423)

(1,090)
Reductions due to sale of Gump’s

--

(2,822)

(2,822)
Balance at March 26, 2005

$          875

$         115

$           990

~~The following is a summary of the liability related to real estate lease and exit costs,~~plan. This amount will be settled by ~~location, as of March 26, 2005,~~ December ~~25, 2004 and March 27, 2004. The liability as of December 25, 2004 and March 27, 2004 includes lease and exit costs related to the~~ ~~Gump’s~~ ~~operations that were extinguished upon the sale of~~ ~~Gump’s~~ ~~on March 14, 2005 (in thousands):~~2006.

March 26,
2005

December 25,
2004

March 27,
2004

Gump’s facility, San Francisco, CA

$                 -

$           2,885

$         3,634
Corporate facility, Weehawken, NJ

115

386

1,194
Corporate facility, Edgewater, NJ

-

68

214
Administrative and telemarketing facility,
San Diego, CA

-

21

78

Total Real Estate Lease and Exit Costs

$            115

$           3,360

$         5,120

6.5.

SALE OF 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 recognized a gain ~~on the sale~~ of approximately $3.6 million in the quarter ended March 26, 2005. Chelsey Direct, LLC (“Chelsey”), as the holder of all of the Series C Participating Preferred Stock (“Series C Preferred”), consented to the application of the sales proceeds to reduce the outstanding balance of the credit facility provided by Wachovia ~~Facility~~National Bank (“Wachovia”) 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 of the Series C Preferred subject to Wachovia’s approval.

After the sale, the Company ~~continues~~continued 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. The Purchaser did not secure the Company’s release of the guarantee. The Company and the Purchaser are in negotiations with regard to the Purchaser’s obligations with regard to the lease guarantee. As of ~~February 6,~~April 29, 2006, there are ~~$7.1~~$6.5 million (net of ~~$0.5~~$0.6 million in 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, thus has not established a guarantee liability as of the March 14, 2005 sale date or as of ~~March 25, 2005.~~April 1, 2006.

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 18 months. ~~We have~~The Company has the option to extend the term for an additional 18 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
March 27,
2004

Total current assets

$         10,842

$       10,406
Total non-current assets
$           3,221
$         3,638
Total assets
$         14,063
$       14,044
Total current liabilities
$           6,727
$         7,139
Total non-current liabilities
$           3,283
$         3,886
Total liabilities
$         10,010
$       11,025

~~Listed below are the~~ revenues and income before income taxes included in the Condensed 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) for the 13- weeks ~~ended:~~ended March 26, 2005:

In thousands (000’s)
March 26,
2005
March 27,
2004

Net revenues
$             7,241
$          8,903
Income (Loss) before income taxes
$            2,974^a
$          (196)

In thousands (000’s)

13- Weeks Ended

March 26,

2005

Net revenues

$ 7,241

Income before income taxes

$ 2,974^a

a) Includes a gain on disposal of $3,576 at March 26, 2005

7.	~~CHANGES IN MANAGEMENT~~

~~New Officers~~

~~On January 31, 2005, the Company appointed Daniel J. Barsky as its Senior Vice President and General Counsel. Mr. Barsky was appointed as Secretary effective March 8, 2005.~~

On March 8, 2005, the Company terminated the employment of Charles E. Blue, the Company’s former Chief Financial Officer. Wayne Garten, the Company’s Chief Executive Officer, served as interim Chief Financial Officer until April 4, 2005 when John Swatek was appointed as the Company’s Senior Vice President, Chief Financial Officer and Treasurer.

8.	~~RECENTLY ISSUED ACCOUNTING STANDARDS~~

In November 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 permitted. We are currently in the process of determining the impact of the adoption of this Statement on our financial statements.

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 principle. We are required to adopt the provisions of SFAS 154 effective January 1, 2006; however, early adoption is permitted. We are currently assessing the impact of the adoption of this Statement.

9.6.

DEBT

The Company has two credit facilities: a senior secured credit facility (the “Wachovia Facility”) provided by Wachovia ~~National Bank (“Wachovia”)~~ and a ~~$20~~$20.0 million junior secured facility (the “Chelsey Facility”), provided by Chelsey Finance, LLC (“Chelsey Finance”), of which the entire ~~$20~~$20.0 million was borrowed by the Company. Chelsey Finance is an affiliate of Chelsey, the Company’s principal shareholder.

As of April 1, 2006, December 31, 2005 and March 26, 2005, ~~December 25, 2004 and March 27, 2004,~~ debt consisted of the following (in thousands):

	March 26, 2005	December 25, 2004	March 27, 2004	April 1, 2006	December 31, 2005	March 26, 2005
	March 26, 2005			April 1, 2006	December 31, 2005	March 26, 2005
		December 25, 2004	March 27, 2004
Wachovia Facility:
Tranche A term loans – Current portion, interest rate of 6% at March 26, 2005, 5.5% at December 25, 2004 and 4.75% at March 27, 2004	$ 1,992	$ 1,992	$ 1,992
Tranche B term loan – Current portion, interest rate of 13.0% in 2004	--	--	1,800
Revolver, interest rate of 6% at March 26, 2005, 5.5% at December 25, 2004 and 4.5% at March 27, 2004	6,326	14,408	10,756
Tranche A term loans – Current portion, interest rate of 7.75% at April 1, 2006, 7.5% at December 31, 2005 and 6.0% at March 26, 2005				$ 1,992	$ 1,992	$ 1,992
Revolver, interest rate of 7.75% at April 1, 2006, 7.5% at December 31, 2005 and 6.0% at March 26, 2005				9,380	8,066	6,326
Capital lease obligations – Current portion	227	290	587	31	47	227
Short-term debt	8,545	16,690	15,135	11,403	10,105	8,545

Wachovia Facility:
Tranche A term loans, interest rate of 6% at March 26, 2005, 5.5% at December 25, 2004 and 4.75% at March 27, 2004	2,487	2,985	3,980
Tranche B term loan, interest rate of 13.0% in 2004	--	--	3,761
Chelsey Facility – stated interest rate of 10.5% (5% above prime rate) in 2005 and 10.0% (5% above prime rate) in 2004	8,899	8,159	--
Tranche A term loans, interest rate of 7.75% at April 1, 2006, 7.5% at December 31, 2005 and 6.0% at March 26, 2005				496	994	2,487
Chelsey Facility – stated interest rate of 12.75% (5.0% above prime rate) at April 1, 2006, 12.0% (5.0% above prime rate) at December 31, 2005 and 10.5% (5.0% above prime rate) at March 26, 2005				12,592	11,545	8,899
Capital lease obligations	33	52	260	2	4	33
Long-term debt	11,419	11,196	8,001	13,090	12,543	11,419
Total debt	$ 19,964	$ 27,886	$ 23,136	$ 24,493	$ 22,648	$ 19,964

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~~Thirty-Fifth 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.

Currently, the Wachovia facility has a Tranche A term loan outstanding which has a principal balance of approximately ~~$4.5~~$2.5 million as of ~~March 26, 2005,~~April 1, 2006, of which approximately $2.0 million is classified as short term and approximately ~~$2.5~~$0.5 million is classified as long term on the Condensed Consolidated Balance Sheet. ~~The~~Prior to the reduction in interest rates provided for in the Thirty-Fifth Amendment the Tranche A term loan ~~bears~~bore interest at 0.5% over the Wachovia prime rate and ~~requires~~required monthly principal payments of approximately $166,000. As of April 1, 2006, the interest rate on the Tranche A term loan was 7.75% after taking into account the reduction in interest rates in the Thirty-Fifth Amendment, which reduced the interest rate to the Wachovia prime rate plus 0%.

The Revolver has a maximum loan limit of $34.5 million, subject to inventory and accounts receivable sublimits that limit the credit available to the Company’s subsidiaries, which are borrowers under the Revolver. The interest rate on the Revolver ~~is currently~~was 0.5% over the Wachovia prime ~~rate.~~rate during the 13- weeks ended April 1, 2006. As of ~~March 26, 2005,~~April 1, 2006, the interest rate on the Revolver was ~~6%.~~

~~Due to, among other things,~~7.75% after taking into account the ~~Restatement which resulted in~~rate change from the ~~Company violating several financial covenants and the Company’s inability to timely file its periodic reports with the SEC the Company was in technical default under the~~Thirty-Fifth Amendment (the Wachovia ~~and Chelsey Facilities. The Company has obtained waivers from both Wachovia and Chelsey Finance for such defaults.~~prime rate plus 0%).

Remaining availability under the Wachovia Facility as of ~~March 26, 2005~~April 1, 2006 was ~~$10.2~~$15.0 million.

~~2005~~First Quarter 2006 Amendments to Wachovia Loan Agreement

OnEffective March 11, 2005, Wachovia consented to the sale of 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 million to $13 million through June 30, 2005. The Company paid Wachovia a $25,000 fee in connection with this amendment.

~~On July 29, 2005~~28, 2006 the Company and Wachovia amended the Wachovia Loan Agreement ~~to provide~~(“Thirty-Fifth Amendment”) which reduced the ~~terms under which~~interest rate by 0.5% on the ~~Company could enter into the World Financial Network National Bank (“WFNNB”) Credit Card Agreement (see note 12) which, among other things, prohibits the use of the proceeds of~~Revolver to the Wachovia ~~Facility to repurchase private label accounts created under~~prime rate plus 0% or the ~~WFNNB Credit Card Agreement should~~Eurodollar rate plus 2%, eliminated 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 theannual Revolver fee, reset certain financial covenants ~~reallocates~~and consented to certain transactions between 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 million. The amendment also requires that the Company enter into an amended and restated loan agreement with Wachovia by October 31, 2005. The CompanyCompany’s subsidiaries. There were no fees paid ~~Wachovia a $60,000 fee~~ in connection with this amendment.

On ~~July 29, 2005~~March 28, 2006 the Company and Chelsey Finance entered into a similar amendment of the Chelsey ~~Facility.~~Facility which reset certain financial covenants and consents to certain transactions.

Chelsey Facility

The Chelsey Facility is a ~~$20~~$20.0 million junior secured credit facility with Chelsey Finance that was recorded at net of an un-accreted debt discount atof $7.1 ~~million at issuance.~~million. 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 a stated interest rate of 5% above the prime rate publicly announced by Wachovia. The Company is not obligated to make principal payments until July 8, 2007, except if there is a change in control or sale of the Company. At ~~March 26, 2005,~~April 1, 2006, the amount recorded as debt on the

Condensed Consolidated Balance Sheet is ~~$8.9~~$12.6 million, net of the un-accreted debt discount of ~~$11.1~~$7.4 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 with the remaining portion, or $7.1 million, 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 volatility 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):

	March 26, 2005	December 25, 2004	April 1, 2006	December 31, 2005	March 26, 2005

Amount Borrowed Under the Chelsey Facility	$ 20,000	$ 20,000	$ 20,000	$ 20,000	$ 20,000
Fair Value of Common Stock Warrant (Recorded as Capital in excess of par value)	(12,939)	(12,939)	(12,939)	(12,939)	(12,939)
Accretion of Debt Discount (Recorded as Interest Expense)	1,838	1,098	5,530	4,484	1,838

	$ 8,899	$ 8,159	$ 12,591	$ 11,545	$ 8,899

~~10.~~7.

~~DELISTING OF COMMON STOCK~~NEW ACCOUNTING PRONOUNCEMENTS

In November 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. The ~~Company’s Common Stock was delisted from~~Company has adopted the ~~American Stock Exchange (the “AMEX”)~~provisions of SFAS 151 effective January 1, 2006 and such adoption did not have a material effect on ~~February 16, 2005 as a result of~~ the Company’s ~~inability~~results of operations or financial position for the first quarter of 2006.

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 ~~comply with~~employees using the ~~AMEX’s continued listing standards~~fair value-based methodology under SFAS 123. The Company has adopted the provisions of SFAS 123R effective January 1, 2006 and ~~because the Company~~such adoption did not ~~file~~have a material effect on ~~a timely basis its Form 10-Q for the fiscal quarter ended September 25, 2004 as a result of the Restatement. 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.~~

~~11.~~

~~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 “Credit Card Agreement”) with World Financial Network National Bank (“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 amountresults of ~~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~~operations 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 upfront 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 34^th ~~Amendment to the Loan & Security Agreement executed by the~~

~~Company and Wachovia on July 29,~~financial position for the first quarter of 2006. See Note 1 to the condensed consolidated financial statements for additional disclosures for SFAS 123R.

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 principle. The Company is ~~prohibited from using~~required to adopt the ~~Wachovia Facility~~provisions of SFAS 154 effective January 1, 2006. The Company has adopted the provisions of SFAS 154 and such adoption did not have a material effect on the Company’s results of operations or financial position for the first quarter of 2006.

8.	SUBSEQUENT EVENTS

Management and Compensation

Effective April 14, 2006, Michael D. Contino resigned as the Company’s Executive Vice President and Chief Operating Officer. The Company has entered into a severance agreement with Mr. Contino to ~~fund~~provide severance payments for 18 months of salary and other related costs. The Company has accrued an aggregate of $0.6 million during the ~~purchase~~13- weeks ended April 1, 2006 for severance and other related costs due to Mr. Contino’s resignation.

The employment agreements of the ~~private label~~Chief Executive Officer and ~~co-brand accounts. As~~Chief Financial Officer were both set to expire on May 5, 2006 and have been extended on a ~~consequence, should~~day-to-day basis. While both continue to provide employment services to the Company, ~~become obligated~~there can be no assurance that they will continue to purchase the private label 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.do so.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following table sets forth, for the fiscal periods indicated, the percentage relationship to net revenues of certain items in the Company’s Condensed Consolidated Statements of Income (Loss):

	13- Weeks Ended				13- Weeks Ended
	March 26, 2005		March 27, 2004 As Restated		April 1, 2006		March 26, 2005

Net revenues	100.0	%	100.0	%	100.0	%	100.0	%
Cost of sales and operating expenses	60.2		62.9		63.1		60.2
Selling expenses	24.9		24.1		26.1		24.9
General and administrative expenses	11.8		11.8		9.8		11.8
Depreciation and amortization	0.8		1.0		0.6		0.8
Income before interest and income taxes	2.3		0.2		0.4		2.3
Interest expense, net	2.1		1.0		2.2		2.1
Provision (benefit) for Federal and state income taxes	--		(0.1)		--		--
Income (loss) from continuing operations	0.2		(0.7)		(1.8)		0.2
Gain (loss) from discontinued operations of Gump’s	3.4		(0.3)
Gain from discontinued operations of Gump’s					--		3.4
Net income (loss) and comprehensive income (loss)	3.6		(1.0)		(1.8)		3.6
Earnings applicable to Preferred Stock	0.1		--		--		0.1
Net income applicable to common shareholders	3.5	%	(1.0)	%
Net income (loss) applicable to common shareholders					(1.8)	%	3.5	%

~~Restatement of Prior Year Financial Information and Related Matters~~

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 the condensed consolidated financial statements for the first quarter of 2004 to recognize revenue when merchandise is received by the customer.

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 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 impact of the error resulted in an overstatement of revenues and the omission of the related liability for guarantee obligations. The proper accounting treatment has been applied to the condensed consolidated financial statements for the first quarter of 2004.

~~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 the condensed consolidated financial statements for the first quarter of 2004.

~~The Company also corrected its accounting for an accrual related to a claim for post-employment benefits by a former CEO. See Note 4, Rakesh Kaul v. Hanover Direct, Inc.~~

In addition, the Company has 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 federal and state tax provision and deferred tax asset and liabilities to reflect the effect of 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 American Stock Exchange (“AMEX”) listing criteria caused the Company’s common stock to no longer be traded on the AMEX as of February 16, 2005. In addition, the SEC is currently conducting an informal inquiry of the Company. We intend to continue our cooperation with the SEC with its informal inquiry concerning our financial reporting.

~~See Note 2 to the condensed consolidated financial statements for additional information regarding the Restatement.~~

Executive Summary

During the first quarter of ~~2005,~~2006, net revenues increased ~~$8.4~~$10.6 million, or ~~10.3%~~11.8%, to ~~$89.7~~$100.3 million from ~~$81.3~~$89.7 million in the first quarter of ~~2004.~~2005. This increase was primarily ~~due a 10.7%~~driven by an increase in ~~overall~~ catalog circulation levels and higher response rates. In addition, net revenues grew because of higher postage and handling rates, which ~~was supported~~we put into effect to offset an increase in United States Postal Service (“USPS”) rates that occurred in early January 2006. These increases were partially offset by lower average order sizes. We experienced higher ~~inventory positions~~demand in our Domestications and Silhouettes catalogs, and lower demand in The Company Store and the International Male catalogs.

During the first quarter of ~~$47.3~~2006, income before interest and income taxes decreased by approximately $1.7 million ~~in 2005 compared with $41.1~~to $0.4 million for the 13- weeks ended April 1, 2006, from $2.1 million in the first quarter of ~~2004.~~

~~We also completed~~2005. The principal factors which negatively impacted the ~~implementation~~operating results for the first quarter of ~~strategies to reduce the infrastructure of the Company, which were developed during fiscal 2004. These strategies~~2006 included the ~~consolidation~~lower demand in The Company Store, the continuation of ~~the operations of the LaCrosse, Wisconsin fulfillment center and storage facility into the Roanoke, Virginia fulfillment~~diminished productivity in our distribution center which ~~was substantially completed by~~started in the ~~end~~Fall of ~~June 2005; the relocation of the~~ ~~International Male~~2005 and ~~Undergear~~ ~~catalog operations from San Diego, California~~has led to our corporate headquarters in Weehawken, New Jersey, which was completed February 28, 2005; and the consolidation of the Edgewater, New Jersey 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 impactedhigher product fulfillment costs, higher catalog postage costs due to the USPS rate increase that occurred in early January 2006 and higher catalog paper costs which started in the ~~Company’s overall performance.~~Fall of 2005.

OnIn addition, in mid March ~~14, 2005,~~2006, a consolidator utilized by the Company ~~sold all of~~to deliver packages into the ~~stock of Gump’s Corp. and Gump’s By Mail, Inc. (collectively, “~~~~Gump’s~~~~”) to Gump’s Holdings, LLC, an unrelated third party for $8.9 million, including~~USPS system filed a ~~purchase price adjustment of $0.4 million, pursuant to the terms of a February 11, 2005 Stock Purchase Agreement. The Company recognized a gain on the sale of approximately $3.6 million~~petition in bankruptcy. While this bankruptcy did not materially impact our results in the first quarter ~~ended March 26, 2005. Chelsey, as~~of 2006, we expect it will significantly increase our merchandise shipping costs for the ~~holder~~remainder of ~~all of the Series C Participating Preferred Stock (“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 of the Series C Preferred subject to Wachovia’s approval.2006.

Results of Operations – 13- weeks ended ~~March 26, 2005~~April 1, 2006 compared with the 13- weeks ended March ~~27, 2004 as restated~~26, 2005

Net Income (Loss). The Company reported a net loss applicable to common shareholders of $1.8 million, or $0.08 basic and diluted net loss per share, for the 13- weeks ended April 1, 2006 compared with a net income applicable to common shareholders of $3.1 million, or $0.14 basic earnings per share and $0.10 diluted earnings per share, for the ~~13- weeks ended March 26, 2005 compared with a net loss applicable to common shareholders of $0.8 million, or a loss of $0.04 basic and diluted earnings per share, for the~~ comparable period in ~~2004.~~2005.

~~In addition to improved operating results, the increase~~The decrease in net income (loss) applicable to common shareholders was primarily a result of the following:

A ~~favorable impact of $3.2 million on discontinued operations due to the gain of $3.6 million recognized on the March 14, 2005 sale of Gump’s;~~decline in operating profit primarily driven by higher fulfillment, catalog paper and postage costs;

~~A favorable impact of $0.9 million due to the reduction in general and administrative expenses related to severance recorded in the first quarter 2004.~~

Net Revenues. Net revenues increased ~~$8.4~~$10.6 million ~~(10.3%~~(11.8%) for the 13-week period ended ~~March 26, 2005~~April 1, 2006 to ~~$89.7~~$100.3 million from ~~$81.3~~$89.7 million for the comparable period in ~~2004.~~2005. This increase was primarily ~~due a 10.7%~~driven by an increase in ~~overall~~ catalog circulation levels and higher response rates. In addition, net revenues grew because of higher postage and handling rates, which ~~was supported~~we put into effect to offset an increase in United States Postal Service (“USPS”) rates that occurred in early January 2006. These increases were partially offset by lower average order sizes. We experienced higher ~~inventory positions.~~demand in our Domestications and Silhouettes catalogs, and lower demand in The Company Store and the International Male catalogs. Internet sales increased and comprised ~~39.2%~~43.5% of combined Internet and catalog revenues for the 13- weeks ended ~~March 26, 2005~~April 1, 2006 compared with ~~34.5%~~39.2% for the comparable period in ~~2004,~~2005, and have increased by approximately ~~$5.7~~$7.5 million, or ~~22.2%~~24.0%, to ~~$31.2~~$38.7 million for the 13-week period ended ~~March 26, 2005~~April 1, 2006 from ~~$25.5~~$31.2 million for the comparable period in ~~2004.~~2005.

Cost of Sales and Operating Expenses. Cost of sales and operating expenses increased by ~~$2.9~~$9.3 million to ~~$54.0~~$63.3 million for the 13- weeks ended ~~March 26, 2005~~April 1, 2006 as compared with ~~$51.1~~$54.0 million for the comparable period in ~~2004.~~2005. Cost of sales and operating expenses ~~decreased~~increased to ~~60.2%~~63.1% of net revenues for the 13-week period ended ~~March 26, 2005~~April 1, 2006 as compared with ~~62.9%~~60.2% of net revenues for the comparable period in ~~2004.~~2005. As a percentage of net revenues, this ~~decrease~~increase was primarily due to increases in product shipping costs and fulfillment costs.

We ship a ~~decline~~majority of our merchandise by USPS which increased postal rates by 5.4% in January 2006. We also experienced fuel surcharges from freight consolidators that also increased our product shipping costs. In mid March 2006, a consolidator utilized by the Company to deliver packages into the USPS system, filed a petition in bankruptcy. While this bankruptcy did not materially impact our results in the first quarter of 2006, we expect it will increase our merchandise shipping costs ~~associated with~~for the ~~ability to source goods that have~~remainder of 2006.

In addition, since the consolidation of our fulfillment centers, our Roanoke fulfillment center has experienced lower productivity as a result of high levels of employee turnover and space constraints which has resulted in higher product ~~margins (1.3%), reductions in fixed~~fulfillment costs. This trend of high levels of employee turnover and ~~variable distribution and telemarketing costs (1.0%) and decreases in information technology costs due to declines in equipment rentals and maintenance (0.6%).~~

•	A $0.6 million increase in general and administrative expenses attributable to severance recorded in the first quarter 2006 related to the departure of the Company’s Chief Operating Officer; and
•	An unfavorable impact of $3.0 million from discontinued operations due to the sale of Gump’s in the first quarter of 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.

•	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~~

•	~~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.~~

	March 26, 2005	December 25, 2004	March 27, 2004 As Restated
	(Unaudited)		(Unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents	$ 515	$ 510	$ 2,434
Accounts receivable, net of allowance for doubtful accounts of $1,189, $1,367 and $1,069, respectively	15,342	17,819	12,615
Inventories, principally finished goods	47,325	53,147	41,088
Prepaid catalog costs	18,647	15,644	17,466
Other current assets	5,143	4,482	4,169
Total Current Assets	86,972	91,602	77,772
PROPERTY AND EQUIPMENT, AT COST:
Land	4,361	4,361	4,361
Buildings and building improvements	18,221	18,221	18,210
Leasehold improvements	1,078	10,156	10,108
Furniture, fixtures and equipment	51,716	53,792	53,331
	75,376	86,530	86,010
Accumulated depreciation and amortization	(54,320)	(61,906)	(59,125)
Property and equipment, net	21,056	24,624	26,885
Goodwill	8,649	9,278	9,278
Deferred tax assets	2,350	2,179	1,769
Other assets	2,645	2,816	1,742
Total Assets	$ 121,672	$ 130,499	$ 117,446

	Quarter ended March 27, 2004
	As Previously Reported	Buyers’ Club Adjustment	Revenue Recognition Adjustments	Kaul Accrual Adjustment	Customer Prepayments And Credits Adjustment		Other Accrual Adjustments		As Restated
	(In thousands, except per share amounts)
Inventories	$ 37,646	--	3,442	--	--	--		$ 41,088
Prepaid catalog costs	$ 15,305	--	2,161	--	--	--		$ 17,466
Other current assets	$ 3,294	--	721	--	--	154		$ 4,169
Total current assets	$ 71,293	--	6,324	--	--	155		$ 77,772
Deferred tax asset	$ 1,453	--	316	--	--	--		$ 1,769
Accounts payable	$ 38,499	--	--	--	--	942		$ 39,441
Accrued liabilities	$ 11,997	--	(618)	4,354	--	(67)		$ 15,666
Customer prepayments and credits	$ 5,866	2,161	8,826	--	925	--		$ 17,778
Deferred tax liability	$ 1,453	--	316	--	--	--		$ 1,769
Total current liabilities	$ 72,950	2,161	8,524	4,354	925	875		$ 89,789
Accumulated deficit	$ (494,373)	(2,161)	(1,884)	(4,354)	(925)	(720)		$ (504,417)
Total shareholders’ deficiency	$ (47,086)	(2,161)	(1,884)	(4,354)	(925)	(720)		$ (57,130)
Net revenues	$ 86,409	(264)	(4,864)	--	--	--		$ 81,281
Cost of sales and operating expenses	$ 53,322	--	(2,235)	--	--	--		$ 51,087
Selling expenses	$ 21,034	--	(1,484)	--	--	68		$ 19,618
General and administrative expenses	$ 9,666	--	(112)	--	58	12		$ 9,624
Income before interest and income taxes	$ 1,546	(264)	(1,033)	--	(58)	(80)		$ 111
Benefit (provision) for Federal income taxes	$ (63)	--	--	--	--	171		$ 108
Benefit (provision) for state income taxes	$ (42)	--	--	--	--	50		$ 8
Net income (loss) and comprehensive income (loss)	$ 418	(264)	(1,033)	--	(58)	141		$ (796)
Net income (loss) applicable to common shareholders	$ 417	(264)	(1,032)	--	(58)	141		$ (796)
Net income (loss) per share-basic and diluted	$ 0.02	(0.01)	(0.05)	--	--	--		$ (0.04)

	For the 13- Weeks Ended
	March 26, 2005	March 27, 2004 As Restated

Net income (loss)	$ 3,227	$ (796)
Less:
Earnings applicable to preferred stock	79	--
Net income (loss) applicable to common shareholders	$ 3,148	$ (796)
Basic net income (loss) per common share	$ 0.14	$ (0.04)

Weighted-average common shares outstanding	22,426	22,017

Diluted net income (loss)	$ 3,148	$ (796)
Diluted net income (loss) per common share	$ 0.10	$ (0.04)

Weighted-average common shares outstanding	22,426	22,017
Effect of Dilution:
Stock warrants (issued July 8, 2004)	10,159	--
Weighted-average common shares outstanding assuming dilution	32,585	22,017

	Severance & Personnel Costs	Real Estate Lease & Exit Costs
	2004 Plan	2000 Plan	Total

Balance at December 25, 2004	$ 1,518	$ 3,360	$ 4,878
2005 expenses	24	--	24
Paid in 2005	(667)	(423)	(1,090)
Reductions due to sale of Gump’s	--	(2,822)	(2,822)
Balance at March 26, 2005	$ 875	$ 115	$ 990

•	~~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.

	HANOVER DIRECT, INC.
	(Registrant)

	By:	/s/ John W. Swatek
		John W. Swatek
		Senior Vice President, Chief Financial Officer and Treasurer (On behalf of the Registrant and as principal financial officer)

Date: ~~February 21,~~May 16, 2006