UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

~~Washington,~~WASHINGTON, D.C. 20549

_______________

FORM 10-Q

~~QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)~~(Mark One)

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended ~~June 25, 2005~~September 30, 2006

o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from

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)

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 Xo

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

~~Yes_ No X~~

Large accelerated filer o

Accelerated filer o

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_~~Yes o No Xx

Common stock, par value $0.01 per share: 22,426,296 shares outstanding as of ~~February 21,~~November 13, 2006.

~~EXPLANATORY NOTE~~

As explained herein, we have restated the condensed consolidated financial statements for, among other periods, the period ended June 26, 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 June 26, 2004 should no longer be relied upon. Throughout this Form 10-Q all referenced amounts for the period ended June 26, 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 -

~~June 25,~~September 30, 2006, December 31, 2005 ~~December 25, 2004~~ and ~~Restated June 26, 2004~~September 24, 2005

Condensed Consolidated Statements of Income (Loss) – 13 and ~~26-~~39- weeks ended

~~June 25,~~September 30, 2006 and September 24, 2005 ~~and Restated June 26, 2004~~

Condensed Consolidated Statements of Cash Flows – ~~13 and 26-~~39- weeks ended

~~June 25,~~September 30, 2006 and September 24, 2005 ~~and Restated June 26, 2004~~

Notes to Condensed Consolidated Financial Statements

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

Results of Operations

1918

Item 3. Quantitative and Qualitative Disclosures about Market Risk

2724

Item 4. Controls and Procedures

2724

Part II - Other Information

Item 1. Legal Proceedings

3124

Item ~~3. Defaults Upon Senior Securities~~

1A. Risk Factors

3124

Item 6. Exhibits

3126

Signature Page

3227

PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

HANOVER DIRECT, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands of dollars, except share amounts)

	June 25, 2005	December 25, 2004	June 26, 2004 As Restated	September 30, 2006	December 31, 2005	September 24, 2005
	(Unaudited)		(Unaudited)	(Unaudited)		(Unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents	$ 542	$ 510	$ 392	$ 61	$ 275	$ 134
Accounts receivable, net of allowance for doubtful accounts of $1,246, $1,367 and $1,035, respectively	14,981	17,819	13,332
Accounts receivable, net of allowance for doubtful accounts of $742, $916 and $911, respectively				13,085	16,518	10,837
Inventories, principally finished goods	50,187	53,147	39,868	58,558	51,356	57,315
Prepaid catalog costs	18,717	15,644	17,673	18,997	17,567	21,017
Other current assets	3,332	4,482	3,821	3,650	2,744	2,777
Total Current Assets	87,759	91,602	75,086	94,351	88,460	92,080
PROPERTY AND EQUIPMENT, AT COST:
Land	4,361	4,361	4,361	4,418	4,378	4,361
Buildings and building improvements	18,237	18,221	18,212	18,214	18,194	18,192
Leasehold improvements	1,012	10,156	10,108	1,332	1,115	1,118
Furniture, fixtures and equipment	50,957	53,792	53,519	53,680	51,532	51,322
Construction in progress				165	--	--
	74,567	86,530	86,200	77,809	75,219	74,993
Accumulated depreciation and amortization	(53,829)	(61,906)	(60,129)	(56,447)	(55,030)	(54,337)
Property and equipment, net	20,738	24,624	26,071	21,362	20,189	20,656
Goodwill	8,649	9,278	9,278	8,649	8,649	8,649
Deferred tax assets	2,350	2,179	1,769	2,890	2,890	2,350
Other assets	2,447	2,816	1,642	606	1,989	2,232
Total Assets	$ 121,943	$ 130,499	$ 113,846	$ 127,858	$ 122,177	$ 125,967

Continued on next page.

HANOVER DIRECT, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS (Continued)

(In thousands of dollars, except share amounts)

	June 25, 2005	December 25, 2004	June 26, 2004 As Restated	September 30, 2006	December 31, 2005	September 24, 2005
	(Unaudited)		(Unaudited)	(Unaudited)		(Unaudited)
LIABILITIES AND SHAREHOLDERS’ DEFICIENCY

CURRENT LIABILITIES:
Short-term debt and capital lease obligations	$ 4,635	$ 16,690	$ 12,232
Short-term debt and capital lease obligations (including debt to a related party see note 6)				$ 32,095	$ 10,105	$ 13,749
Accounts payable	28,851	29,544	40,775	20,593	27,043	26,079
Accrued liabilities	18,596	20,535	16,048	14,029	12,341	10,235
Customer prepayments and credits	16,005	12,032	16,652	14,572	10,074	14,828
Deferred tax liability	2,350	2,179	1,769	2,890	2,890	2,350
Total Current Liabilities	70,437	80,980	87,476	84,179	62,453	67,241
NON-CURRENT LIABILITIES:
Long-term debt (including debt to a related party see note 8)	11,709	11,196	6,970
Series C Participating Preferred Stock, authorized, issued and outstanding 564,819 shares; liquidation preference of $56,482	72,689	72,689	72,689
Long-term debt (including debt to a related party see note 6)				259	12,543	12,083
Series C Participating Preferred Stock, authorized, issued and outstanding 564,819 shares; liquidation preference of $56,482 as of September 24, 2005 and December 31, 2005 and $59,499 as of September 30, 2006				72,689	72,689	72,689
Other	3	3,286	3,692	80	40	18
Total Non-current Liabilities	84,401	87,171	83,351	73,028	85,272	84,790
Total Liabilities	154,838	168,151	170,827	157,207	147,725	152,031
SHAREHOLDERS’ DEFICIENCY:
Common Stock, $0.01 par value, authorized 50,000,000 shares at June 25, 2005 and December 25, 2004 and 30,000,000 shares at June 26, 2004; 22,426,296 shares issued and outstanding at June 25, 2005 and December 25, 2004; 22,229,456 shares issued and 22,017,363 shares outstanding at June 26, 2004	225	225	222
Common Stock, $0.01 par value, authorized 50,000,000 shares at September 30, 2006, December 31, 2005 and September 24, 2005; 22,426,296 shares issued and outstanding at September 30, 2006, December 31, 2005 and September 24, 2005				225	225	225
Capital in excess of par value	460,822	460,744	450,529	460,952	460,891	460,857
Accumulated deficit	(493,942)	(498,621)	(504,386)	(490,526)	(486,664)	(487,146)
	(32,895)	(37,652)	(53,635)
Less:
Treasury stock, at cost (0 shares at June 25, 2005 and December 25, 2004 and 212,093 shares at June 26, 2004)	--	--	(2,996)
Notes receivable from sale of Common Stock	--	--	(350)
Total Shareholders’ Deficiency	(32,895)	(37,652)	(56,981)	(29,349)	(25,548)	(26,064)
Total Liabilities and Shareholders’ Deficiency	$ 121,943	$ 130,499	$ 113,846	$ 127,858	$ 122,177	$ 125,967

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		For the 26- Weeks Ended		For the 13- Weeks Ended		For the 39- Weeks Ended
	June 25, 2005	June 26, 2004	June 25, 2005	June 26, 2004	September 30, 2006	September 24, 2005	September 30, 2006	September 24, 2005
	June 25, 2005	June 26, 2004	June 25, 2005	June 26, 2004	September 30, 2006	September 24, 2005	September 30, 2006	September 24, 2005
		As Restated		As Restated
NET REVENUES	$ 100,231	$ 87,744	$ 189,913	$ 169,025	$ 93,737	$ 96,839	$ 302,759	$ 286,752

OPERATING COSTS AND EXPENSES:
Cost of sales and operating expenses	61,030	52,617	115,002	103,704	59,273	59,795	189,398	174,797
Special charges (income)	(6)	42	18	42
Special charges					--	(25)	--	(7)
Selling expenses	25,772	23,693	48,050	43,311	25,385	24,119	81,842	72,169
General and administrative expenses	9,250	9,930	19,833	19,554	8,069	3,275	26,502	23,108
Depreciation and amortization	774	838	1,527	1,681	619	681	1,708	2,208
	96,820	87,120	184,430	168,292	93,346	87,845	299,450	272,275

INCOME BEFORE INTEREST AND INCOME TAXES	3,411	624	5,483	733	391	8,994	3,309	14,477
Interest expense, net (including interest expense to a related party see note 8)	1,928	700	3,755	1,525
Interest expense, net (including interest expense to a related party see note 6)					2,586	2,208	7,165	5,963

INCOME (LOSS) BEFORE INCOME TAXES	1,483	(76)	1,728	(792)	(2,195)	6,786	(3,856)	8,514
Provision (benefit) for Federal income taxes	30	107	35	(1)	3	(16)	3	19
Provision (benefit) for state income taxes	9	3	10	(5)
Provision for state income taxes					13	6	3	16
Provision (benefit) for income taxes	39	110	45	(6)	16	(10)	6	35

INCOME (LOSS) FROM CONTINUING OPERATIONS	1,444	(186)	1,683	(786)	(2,211)	6,796	(3,862)	8,479

Gain from discontinued operations of Gump’s, net of $22 of income tax benefit, including a gain on disposal of $3,576 at June 25, 2005	8	219	2,996	23
Gain from discontinued operations of Gump’s, net of $22 of income tax benefit, including a gain including a gain on disposal of $3,576 for the 39- weeks ended September 24, 2005					--	--	--	2,996

NET INCOME (LOSS) AND COMPREHENSIVE INCOME (LOSS)	1,452	33	4,679	(763)	(2,211)	6,796	(3,862)	11,475
Earnings applicable to Preferred Stock	36	--	115	--	--	167	--	282

NET INCOME (LOSS) APPLICABLE TO COMMON SHAREHOLDERS	$ 1,416	$ 33	$ 4,564	$ (763)	$ (2,211)	$ 6,629	$ (3,862)	$ 11,193

NET INCOME (LOSS) PER COMMON SHARE:
From continuing operations – basic	$ 0.06	$ (0.01)	$ 0.07	$ (0.03)	$ (0.10)	$ 0.30	$ (0.17)	$ 0.37
From continuing operations – diluted	$ 0.04	$ (0.01)	$ 0.05	$ (0.03)	$ (0.10)	$ 0.20	$ (0.17)	$ 0.25
From discontinued operations – basic	$ 0.00	$ 0.01	$ 0.13	$ 0.00	$ 0.00	$ 0.00	$ 0.00	$ 0.13
From discontinued operations – diluted	$ 0.00	$ 0.01	$ 0.09	$ 0.00	$ 0.00	$ 0.00	$ 0.00	$ 0.09
Net income (loss) per common share – basic	$ 0.06	$ 0.00	$ 0.20	$ (0.03)	$ (0.10)	$ 0.30	$ (0.17)	$ 0.50
Net income (loss) per common share – diluted	$ 0.04	$ 0.00	$ 0.14	$ (0.03)	$ (0.10)	$ 0.20	$ (0.17)	$ 0.34
Weighted average common shares outstanding – basic (thousands)	22,426	22,017	22,426	22,017	22,426	22,426	22,426	22,426
Weighted average common shares outstanding – diluted (thousands)	32,562	22,017	32,574	22,017	22,426	32,593	22,426	32,580

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 26- Weeks Ended		For the 39- Weeks Ended
	June 25, 2005	June 26, 2004 As Restated	September 30, 2006	September 24, 2005
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)	$ 4,679	$ (763)	$ (3,862)	$ 11,475
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization, including deferred fees	2,003	2,158	2,256	2,853
Provision for doubtful accounts	356	268	357	368
Special charges	18	42	--	(7)
Gain on the sale of Gump’s	(3,576)	--	--	(3,576)
Gain on the sale of property and equipment	(71)	--	(2)	(70)
Compensation expense related to stock options	79	122	61	115
Accretion of debt discount	1,547	--	3,432	2,426
Changes in assets and liabilities:
Accounts receivable	407	735	3,076	4,539
Inventories	(3,028)	2,938	(7,202)	(10,156)
Prepaid catalog costs	(4,133)	(5,188)	(1,430)	(6,433)
Accounts payable	1,807	(1,967)	(6,450)	(965)
Accrued liabilities	(664)	(1,082)	1,688	(9,000)
Customer prepayments and credits	4,522	5,173	4,498	3,345
Other, net	1,049	(932)	(31)	1,673
Net cash provided by operating activities	4,995	1,504
Net cash used by operating activities			(3,609)	(3,413)
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisitions of property and equipment	(875)	(308)	(2,554)	(1,483)
Proceeds from disposal of property and equipment	80	--	2	79
Proceeds from the sale of Gump’s	8,921	--	--	8,921
Net cash provided (used) by investing activities	8,126	(308)	(2,552)	7,517
CASH FLOWS FROM FINANCING ACTIVITIES:
Net payments under Wachovia revolving loan facility	(11,928)	(1,050)
Net borrowings (payments) under Wachovia revolving loan facility			7,490	(2,740)
Payments under Wachovia Tranche A term loan facility	(996)	(996)	(1,493)	(1,493)
Payments under Wachovia Tranche B term loan facility	--	(900)
Payments of long-term debt and capital lease obligations	(165)	(362)
Payment of debt issuance costs	--	(125)
Refund of estimated Richemont tax obligation on Series B Participating Preferred Stock accretion	--	347
Net cash used by financing activities	(13,089)	(3,086)
Net increase (decrease) in cash and cash equivalents	32	(1,890)
Payments of capital lease obligations and vehicle loans			(50)	(247)
Net cash provided (used) by financing activities			5,947	(4,480)
Net decrease in cash and cash equivalents			(214)	(376)
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	$ 542	$ 392	$ 61	$ 134

Supplemental Disclosures of Cash Flow Information:
Cash paid for:
Interest	$ 2,016	$ 1,332	$ 3,063	$ 3,037
Income taxes	$ 133	$ 8	$ 4	$ 160
Non-cash investing activities:
Acquisitions of property and equipment by capital lease and vehicle loans			$ 327	$ --

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. The condensed consolidated financial statements include all subsidiaries of the Company, and all intercompany transactions and balances have been eliminated. Financial Accounting Standards Board (“FASB”) Interpretation No. 46(R), “Consolidation of Variable Interest Entities” (“FIN 46(R)”), requires that if an entity is the primary beneficiary of a variable interest entity, the assets, liabilities, and results of operations of the variable interest entity should be included in the consolidated financial statements of the entity. The Company has reviewed its operations and has determined there to be no significant unconsolidated variable interest entities as of September 24, 2005, December 31, 2005 or September 30, 2006. 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 June 26, 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 June 26, 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 39- Weeks Ended September 24, 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 39- Weeks Ended September 24, 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 September 30, 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 September 30, 2006, 2.9 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 September 30, 2006 and September 24, 2005, the Company recognized stock-based compensation expense of less than $0.1 million in each period. For the 39- weeks ended September 30, 2006 and September 24, 2005, the Company recognized stock-based compensation expense of $0.1 million in each period.

The weighted average Black-Scholes fair value assumptions for stock options issued during the 13 and 39- weeks ended September 30, 2006 and September 24, 2005 are as follows (no stock options were granted for the 13 and 39- weeks ended September 30, 2006 and 13- weeks ended September 24, 2005):

	For the 13- Weeks Ended		For the 39- Weeks Ended
	September 30, 2006	September 24, 2005	September 30, 2006	September 24, 2005

Expected term (in years)	—	—	—	4
Risk free interest rate	—	—	—	3.96%
Expected volatility	—	—	—	87.55%
Expected dividend yield	—	—	—	0%

A summary of option activity during the 39- weeks ended September 30, 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	$ 61,070
Granted	—	—
Exercised	—	—
Forfeited	(617,700)	5.24
Options outstanding, end of period	551,900	$ 4.00	7.0	$ 43,000
Options exercisable, end of period	488,535	$ 4.36	6.9	$ 28,666
Weighted average fair value of options granted	$ —

As of September 30, 2006, there are 8,666 outstanding options that will not vest due to the July 18, 2006 resignation of three members of the Company’s Board of Directors. These options expired on October 18, 2006, three months after the date of their resignation. All remaining stock options outstanding are either vested or expected to vest.

A summary of the status of the Company’s nonvested shares as of September 30, 2006, and changes during the 39- weeks ended September 30, 2006, is presented below:

	Shares	Weighted Average Grant-Date Fair Value
Nonvested options outstanding, beginning of period	175,507	$1.00
Granted	—	—
Vested	(112,142)	1.15
Forfeited	—	—
Nonvested options outstanding, end of period	63,365	$0.76

As of September 30, 2006, there was less than $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 13 and 26- week periods ended June 26, 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 second 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 second 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 June 25, 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 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 second 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 condensed consolidated financial statements for the 13 and 26- week periods ended June 26, 2004 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 June 26, 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

$        36,974
--
2,894
--
--
--
$       39,868
Prepaid catalog costs

$        15,780
--
1,893
--
--
--
$       17,673
Other current assets

$          3,132
--
689
--
--
--
$         3,821
Total current assets

$        69,610
--
5,476
--
--
--
$       75,086
Deferred tax asset

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

$        39,678
--
77
--
--
1,020
$       40,775
Accrued liabilities

$        12,004
--
(434)
4,488
--
(10)
$       16,048
Customer prepayments and credits

$          5,839
2,394
7,432
--
987
--
$       16,652
Deferred tax liability

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

$        71,206
2,394
7,391
4,488
987
1,010
$       87,476
Accumulated Deficit

$   (493,908)
(2,394)
(1,599)
(4,488)
(987)
(1,010)
$   (504,386)
Total Shareholders’ Deficiency

$     (46,503)
(2,394)
(1,599)
(4,488)
(987)
(1,010)
$     (56,981)
Net revenues

$        86,870
(233)
1,107
--
--
--
$       87,744
Cost of sales and operating expenses

$        52,091
--
526
--
--
--
$       52,617
Selling expenses

$        23,360
--
268
--
--
65
$       23,693
General and administrative expenses

$          9,695
--
28
134
62
11
$         9,930
Income before interest and income taxes

$             843

(233)

285

(134)

(62)

(76)

$            623
Benefit (provision) for Federal income taxes

$               62

--

--

--

--

(169)

$          (107)
Benefit (provision) for state income taxes

$               38

--

--

--

--

(41)

$              (3)
Net income (loss) and comprehensive income (loss)

$             463

(233)

285

(134)

(62)

(286)

$              33
Net income (loss) applicable to common shareholders

$             463

(233)

285

(134)

(62)

(286)

$              33
Net income (loss) per share-basic and diluted

$            0.02

(0.01)

0.01

(0.01)

--

(0.01)

$            0.00

Six months ended June 26, 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)
Net revenues

$        173,279
(497)
(3,757)
--
--
--
$ 169,025
Cost of sales and operating expenses

$        105,413
--
(1,709)
--
--
--
$ 103,704
Selling expenses

$         44,393
--
(1,216)
--
--
134
$   43,311
General and administrative expenses

$         19,361
--
(84)
134
120
23
$   19,554
Income before interest and income taxes

$            2,390

(497)

(748)

(134)

(120)

(157)

$        734
Benefit (provision) for Federal income taxes

$                (1)

--

--

--

--

2

$            1
Benefit (provision) for state income taxes

$                (4)

--

--

--

--

9

$            5
Net income (loss) and comprehensive income (loss)

$               882

(497)

(748)

(134)

(120)

(146)

$      (763)
Net income (loss) applicable to common shareholders

$               882

(497)

(748)

(134)

(120)

(146)

$      (763)
Net income (loss) per share-basic and diluted

$              0.04

(0.02)

(0.03)

(0.01)

(0.00)

(0.01)

$     (0.03)

~~The Restatement did not result in a change to the Company’s cash flows during the restated periods.~~

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”) 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 Company filed the past due periodic reports with the SEC. Since those filings, the Company has filed its periodic reports on a timely basis.

Significant Shareholder; Going Private Proposal and Related Litigation

The Company 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 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 92% of the voting rights of the Company.

The Company received a proposal from Chelsey to 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 indicated 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 stated that Chelsey or an affiliate proposed to enter into a cash merger agreement with the 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 were 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 independent counsel and engaged Houlihan Lokey Howard & Zukin (“Houlihan Lokey”) as its financial advisor.

On May 25, 2006, the Company was advised that discussions between Chelsey Direct LLC and the Special Committee concerning Chelsey's proposal to take the Company private at $1.25 per share had been terminated and as a result, the offer had been withdrawn.

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

Segment Reporting

We have one reportable segment, “Direct Marketing” but are presenting separate information on our “Other Activities.” The Direct Marketing segment contains the following catalog and product categories: The Company Store, Company Kids, Domestications, Silhouettes, International Male, Undergear and Scandia website as well as the operations of our retail outlets. Our “Other Activities” include business-to-business services which provide third

parties end to end, fulfillment, logistics, telemarketing and information technology services. We have included in Other Activities’ income (loss) before income taxes an allocation of certain fixed expenses for the fulfillment, logistics, telemarketing and information technology areas based on the ~~results~~ratio of ~~its investigation. The Company intends~~business-to-business activities to ~~continue to cooperate with~~those of the ~~SEC in connection with its informal inquiry concerning the Company’s financial reporting.~~entire Company.

Amounts in thousands	For the 13- Weeks Ended		For the 39- Weeks Ended
	September 30, 2006	September 24, 2005	September 30, 2006	September 24, 2005
Net Revenues
Direct Marketing	$ 88,461	$ 89,606	$ 282,304	$ 265,194
Other Activities	5,276	7,233	20,455	21,558
Total Net Revenues	$ 93,737	$ 96,839	$ 302,759	$ 286,752

Income (Loss) Before Income Taxes
Direct Marketing	$ 411	$ 8,814	$ 3,924	$ 13,862
Other Activities	(20)	180	(615)	615
Unallocated Interest (Expense)	(2,586)	(2,208)	(7,165)	(5,963)
Total Income (Loss) Before Income Taxes	$ (2,195)	$ 6,786	$ (3,856)	$ 8,514

Amounts in thousands	September 30, 2006	December 31, 2005	September 24, 2005
Total Assets
Direct Marketing	$ 124,965	$ 114,956	$ 123,180
Other Activities	1,893	7,221	2,787
Total Assets	$ 127,858	$ 122,177	$ 125,967

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

For the 26- Weeks Ended

June 25,
2005

June 26,
2004
As Restated

June 25,
2005

June 26,
2004
As Restated

Net income (loss)

$      1,452

$              33

$       4,679

$        (763)
Less:

Earnings applicable to preferred stock

36

--

115

--
Net income (loss) applicable to
common shareholders

$      1,416

$              33

$       4,564

$        (763)
Basic net income (loss) per
common share

$        0.06

$           0.00

$         0.20

$        (0.03)

Weighted-average common shares
Outstanding

22,426

22,017

22,426

22,017

Diluted net income (loss)

$      1,416

$              33

$       4,564

$        (763)
Diluted net income (loss) per
common share

$        0.04

$           0.00

$         0.14

$        (0.03)

Weighted-average common shares
Outstanding

22,426

22,017

22,426

22,017
Effect of Dilution:

Stock options

--

--

--

--
Stock warrants (issued July 8, 2004)

10,136

--

10,148

--
Weighted-average common shares
Outstanding assuming dilution

32,562

22,017

32,574

22,017

	For the 13- Weeks Ended		For the 39- Weeks Ended
	September 30, 2006	September 24, 2005	September 30, 2006	September 24, 2005

Net income (loss)	$ (2,211)	$ 6,796	$ (3,862)	$ 11,475
Less:
Earnings applicable to preferred stock	--	167	--	282
Net income (loss) applicable to common Shareholders	$ (2,211)	$ 6,629	$ (3,862)	$ 11,193
Basic net income (loss) per common share	$ (0.10)	$ 0.30	$ (0.17)	$ 0.50

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

Diluted net income (loss)	$ (2,211)	$ 6,629	$ (3,862)	$ 11,193

Diluted net income (loss) per common share	$ (0.10)	$ 0.20	$ (0.17)	$ 0.34

Weighted-average common shares outstanding	22,426	22,426	22,426	22,426
Effect of Dilution:
Stock warrants (issued July 8, 2004)	--	10,167	--	10,154
Weighted-average common shares outstanding assuming dilution	22,426	32,593	22,426	32,580

Diluted net ~~loss~~income (loss) per common share excluded incremental weighted-average shares of ~~18,011~~10,207,205 and 10,220,395 for the ~~26-week period~~13 and 39- weeks ended ~~June 26, 2004.~~September 30, 2006, respectively. These incremental weighted-average shares were related to employee stock options and common stock warrants and were excluded due to their anti-dilutive effect. ~~No dilutive securities existed~~Options for which the ~~13-week period~~exercise price was greater than the average market price of common shares as of the 13 and 39- weeks ended ~~June 26, 2004.~~September 30, 2006 and September 24, 2005 were not included in the computation of diluted earnings per share, as the effect would be antidilutive. These consisted of options totaling 451,900 shares and 1,068,600 shares relating to the 13- week periods, respectively, and 403,900 shares and 1,118,600 shares relating to the 39- week periods, 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 Freedman 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. On May 25, 2006, Chelsey withdrew its going private proposal.

The Company believes that the complaints are without merit and intends to defend its interests vigorously.

On June 30, 2006, counsel to Glenn Freidman sent a letter to the Company seeking to inspect certain of the Company’s ~~failure~~books and records pursuant to ~~pay him a “tandem bonus” as well as Kaul’s alleged rights to benefits under a change in control plan and a long-term incentive plan.~~Section 220 of the Delaware General Corporation Law (“DGCL”). The Company has agreed in principal to comply with plaintiff’s counsel’s request.

On September 15, 2006 Glenn Friedman filed an action in Chancery Court to compel the Company to hold an annual shareholders’ meeting under DGCL Section 211. The Company filed an answer, and on October 30, 2006, the plaintiff filed a Motion for Summary ~~Judgment and in July 2004,~~Judgment. The Company expects to hold its annual shareholders’ meeting within the Court entered a final judgment dismissing most of Mr. Kaul’s claims with prejudice and awarded Mr. Kaul $45,946 in vacation pay and $14,910 in interest which the Company paid in July 2004. In August 2004, Kaul filed an appeal on three issues: severance and short-term bonus, tandem bonus and legal fees. On June 28, 2005 the Second Circuit Court of Appeals denied Kaul’s appeal, affirming the Summary Judgment decision in the Company’s favor. Mr. Kaul’s rights to appeal the Second Circuit’s decision expired in August 2005.

As of June 25, 2005, the Company had accrued $4.5 million related to this matter. This accrual remained on the Company’s Condensed Consolidated Balance Sheet until the third fiscal quarter of 2005 when Kaul’s rights to pursue this claim expired.

next several months.

~~Class Action Lawsuits~~SEC Informal Inquiry::

The Company was a party to four class action/ representative lawsuits that all involved allegations that the Company’s charges for insurance were invalid, unfair, deceptive and/or fraudulent. As described in greater detail below, the Company has resolved all of these class action lawsuits.

~~Jacq Wilson v. Brawn of California, Inc.~~ , Case No. CGC-02-404454 (Supp. Ct. San Francisco, CA 2002) (“Wilson Case”). On February 13, 2002, Jacq Wilson, suing on behalf of himself and other similarly situated persons, filed a representative suit in the Superior Court of the State of California, City and County of San Francisco, against the Company alleging that the Company charged an unlawful, unfair, and fraudulent insurance fee on orders, was engaged in untrue, deceptive and misleading advertising and unfair competition under the state’s Business and Professions Code. The plaintiffs sought relief including restitution and disgorgement of all monies wrongfully collected by defendants, including interest, an order enjoining defendants from imposing insurance on its order forms, and compensatory damages, attorneys’ fees, pre-judgment interest and costs of the suit. In November, 2003, the Court, after a trial the previous April, entered judgment for the plaintiffs, requiring defendants to refund insurance charges collected from consumers for the period from February 13, 1998 through January 15, 2003, with interest. In April, 2004, the Court awarded plaintiff’s counsel approximately $445,000 of attorneys’ fees.

The Company appealed the Court’s decision and the order to pay attorneys’ fees, which appeals were consolidated. Enforcement of the judgment for insurance fees and the award of attorneys’ fees was stayed pending resolution of the appeal. On September 2, 2005 the California Court of Appeals reversed both the Court’s findings on the merits and its award of attorneys’ fees and awarded the Company its cost on the appeal.

~~Teichman v. Hanover Direct, Inc. et. al.,~~ No. 3L641 (Supp. Ct. San Francisco, CA 2001). On August 15, 2001, Randi Teichman filed a summons and four-count complaint in the Superior Court for the City and County of San Francisco seeking damages and other relief for herself and a class of similarly situated persons arising out of the insurance fee charged by catalogs and Internet sites operated by Company subsidiaries. This case had been stayed since May 2002 pending resolution of the ~~Wilson~~ ~~Case.~~

~~The plaintiffs in both~~ ~~Wilson~~ ~~and~~ ~~Teichman~~ ~~were represented by the same counsel and the plaintiffs in both cases agreed to dismiss the cases with prejudice in exchange for the Company’s agreement to not seek reimbursement of costs in the~~ ~~Wilson~~ ~~case.~~

~~John Morris, individually and on behalf of all other similarly situated person and entities similarly situated v. Hanover Direct, Inc. and Hanover Brands, Inc.~~, No. L 8830-02 (Sup. Ct. Bergen Co. – Law Div., NJ) October 28, 2002, John Morris, individually and on behalf of other similarly situated persons in New Jersey filed a class 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 an appeal of the class certification. On October 25, 2005, the class certification was reversed. Martin filed an Application for Rehearing which was denied on January 3, 2006. On January 18, 2006, Martin filed a Petition for a Writ of Certiorari in the Oklahoma Supreme Court. The Company believes that it is unlikely that the Oklahoma Supreme Court will grant Martin’s petition.

~~The Company established~~See Note 1 to the consolidated financial statements for a ~~$0.5 million reserve during~~discussion of the ~~third quarter of 2004 for~~informal inquiry being conducted by the ~~class action lawsuits described above for settlements and~~SEC relating to the Company’s ~~current estimate of future legal fees to be incurred. The balance of the reserve as of June 25, 2005 was $0.1 million.~~financial results and financial reporting since 1998.

Claims for Post-Employment Benefits

The Company iswas 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~~One of these lawsuits was settled during the second fiscal quarter of 2006 and another during the fourth fiscal quarter of 2006. The remaining two cases arose from the circumstances surrounding the Restatement:

Charles Blue v. Hanover Direct, Inc., William Wachtel, Stuart Feldman, Wayne Garten and Robert Masson, ~~(Supp.~~No.: L-5153-05 (Super. Ct. N.J., Law Div. Hudson Cty, ~~Docket No.: L-5153-05)~~filed Oct. 24, 2005) 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. The parties to the lawsuit are engaging in discovery with depositions scheduled to begin in December 2006.

Frank Lengers v. Hanover Direct, Inc., Wayne Garten, William Wachtel, A. David Brown, Stuart Feldman, Paul S. Goodman, Donald Hecht and Robert Masson, ~~(Supp.~~No.: L-5795-05 (Super. Ct. N.J., Law Div. Hudson Cty, ~~Docket No.: L-5795-05)~~filed Nov. 16, 2005) 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 parties to the lawsuit are engaging in discovery.

The Company believes that it properly denied CIC benefits with respect to each of ~~the four~~these two 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.~~September 30, 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 39- weeks ended September 30, 2006 and is expected to continue for the remainder of 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 two quarters~~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~~September 30, 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 June 25, 2005, a current liability of approximately $0.4~~ 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):~~plan. This amount will be settled by December 2006.

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

18

--

18
Paid in 2005

(1,153)

(538)

(1,691)
Reductions due to sale of Gump’s

--

(2,822)

(2,822)
Balance at June 25, 2005

$          383

$             --

$           383

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 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 iswas 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~~could not secure the Company’s release within a year of the closing, an affiliate of the Purchaser ~~will~~was required to 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 agreed to accept a secured $2.5 million promissory note from one of the principal investors in the Purchaser. The note is secured by a pledge of equity which indirectly represents 5% of the Purchaser’s common stock. The Company may draw on the note if the Company incurs any liability to the landlord under the lease guarantee or as a result of a default on the other lease. As of ~~February 6,~~October 31, 2006, there are ~~$7.1~~$5.7 million (net of $0.5 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 ~~June 25, 2005.~~

September 30, 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 option to extend the term for an additional 18 months.~~This agreement expired in October 2006 and was not renewed.

~~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
June 26,
2004

Total current assets

$          10,842

$          9,430
Total non-current assets
$            3,221
$          3,547
Total assets
$          14,063
$        12,977
Total current liabilities
$            6,727
$          6,487
Total non-current liabilities
$            3,283
$          3,676
Total liabilities
$          10,010
$        10,163

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- and 26-~~39- weeks ~~ended:~~ended September 24, 2005:

In thousands (000’s)
13- Weeks Ended
June 25,
2005
26- Weeks Ended
June 25,
2005
13- Weeks Ended
June 26,
2004
26-Weeks Ended
June 26,
2004
Net revenues
$                              --
$                       7,241
$                       9,142
$                      18,045
Income before income
taxes

$                              --

$                      2,974^a

$                          219

$                              23

In thousands (000’s)

39- Weeks Ended

September 24,

2005

Net revenues

$ 7,241

Income before income taxes

$ 2,974^a

a) Includes a gain on disposal of $3,576 at ~~June 25,~~September 24, 2005

7.	~~CHANGES IN MANAGEMENT~~

~~New Officers~~

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

8.6.

DEBT

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

As of ~~June 25,~~September 30, 2006, December 31, 2005 ~~December 25, 2004~~ and ~~June 26, 2004,~~September 24, 2005, debt consisted of the following (in thousands):

June 25,
2005

December 25,
2004

June 26,
2004

Wachovia facility:

Tranche A term loans – Current portion, interest rate of 6.5% at June 25, 2005, 5.5% at December 25, 2004 and 4.75% at June 26, 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 6.5% at June 25, 2005, 5.5% at December 25, 2004 and 4.5% at June 26, 2004

2,480

14,408

7,947
Capital lease obligations – Current portion

163

290

493
Short-term debt

4,635

16,690

12,232

	September 30, 2006	December 31, 2005	September 24, 2005
	September 30, 2006	December 31, 2005	September 24, 2005

Wachovia Facility:
Tranche A term loans – Current portion, weighted average interest rate of 7.33% at September 30, 2006, 7.5% at December 31, 2005 and 7.0% at September 24, 2005	$ 1,493	$ 1,992	$ 1,992
Revolver, weighted average interest rate of 7.68% at September 30, 2006, 7.5% at December 31, 2005 and 7.0% at September 24, 2005	15,556	8,066	11,668
Chelsey Facility – stated interest rate of 13.25% (5.0% above prime rate) at September 30, 2006.	14,977	--	--
Capital lease obligations and other debt – Current portion	69	47	89
Short-term debt	32,095	10,105	13,749

Wachovia Facility:
Tranche A term loans, interest rate of 7.5% at December 31, 2005 and 7.0% at September 30, 2005	--	994	1,492
Chelsey Facility – stated interest rate of 12.0% (5.0% above prime rate) at December 31, 2005 and 11.5% (5.0% above prime rate) at September 24, 2005	--	11,545	10,585
Capital lease obligations and other debt	259	4	6
Long-term debt	259	12,543	12,083
Total debt	$ 32,354	$ 22,648	$ 25,832

Wachovia facility:

Tranche A term loans, interest rate of 6.5% at June 25, 2005, 5.5% at December 25, 2004 and 4.75% at June 26, 2004

1,989

2,985

3,482
Tranche B term loan, interest rate of 13% at June 26, 2004

--

--

3,311
Chelsey facility – stated interest rate of 11.0% (5.0% above prime rate) at June 25, 2005 and 10.0% (5.0% above prime rate) at December 25, 2004

9,706

8,159

--
Capital lease obligations

14

52

177
Long-term debt

11,709

11,196

6,970
Total debt

$   16,344

$             27,886

$   19,202

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-Sixth 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 $4.0~~$1.5 million as of ~~June 25, 2005,~~September 30, 2006, all of which ~~approximately $2.0 million~~ is classified as short ~~term and approximately $2.0 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. The interest rate on the Tranche A term loan, as provided for in the Thirty-Fifth Amendment, is the Wachovia prime rate or the Eurodollar rate plus 2% during the 13- weeks ended September 30, 2006. As of ~~June 25, 2005,~~September 30, 2006, the weighted average interest rate on the Tranche A term loan was ~~6.5%~~7.33%.

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, as provided for in the Thirty-Fifth Amendment, is ~~currently 0.5% over~~ the Wachovia prime ~~rate.~~rate or the Eurodollar rate plus 2% during the 13- weeks ended September 30, 2006. As of ~~June 25, 2005,~~September 30, 2006, the weighted average interest rate on the Revolver was ~~6.5%~~7.68%.

~~Due~~The Wachovia Loan Agreement contains affirmative and negative covenants typical for loan agreements for asset-based lending of this type including financial covenants requiring the Company to ~~among other things, the Restatement which resulted~~maintain specified levels of Consolidated Net Worth, Consolidated Working Capital and EBITDA, as those terms are defined in the ~~Company violating several financial covenants and the Company’s inability to timely file its periodic reports with the SEC, both as discussed in Note 2,~~Wachovia Loan Agreement. As of September 30, 2006, the Company was required to maintain Consolidated Working Capital of not less than $9.0 million and Consolidated Net Worth of not less than ($42.0 million) and not permit Cumulative Minimum EBITDA for the nine months ended September 30, 2006 to fall below $5.0 million.

The Company was in ~~technical default under~~compliance with its financial covenants as of September 30, 2006. Were it not in compliance with one or more of these covenants, Wachovia would have the right, among other remedies, to require immediate repayment of the Wachovia ~~and Chelsey Facilities. The Company has obtained waivers from both Wachovia and Chelsey Finance for such defaults.~~Facility.

Remaining availability under the Wachovia Facility as of ~~June 25, 2005~~September 30, 2006 was ~~$14.0~~$9.2 million.

~~2005~~2006 Amendments to Wachovia Loan Agreement

~~On March 11, 2005, Wachovia consented~~The Thirty Fifth Amendment to ~~the sale of Gump’s and Gump’s By Mail (collectively “Gump’s”). On March 11, 2005~~ the Wachovia Loan Agreement, ~~was amended~~which took effect March 28, 2006, reduced the interest rate by 0.5% on the Wachovia Facility to ~~temporarily increase~~ the ~~amount~~Wachovia prime rate plus 0% or the Eurodollar rate plus 2%, eliminated the annual Revolver fee, reduced the required minimum levels of ~~letters of credits that~~EBITDA covenant and consented to certain transactions between the ~~Company could issue from $10.0 million to $13.0 million through June 30, 2005. The Company~~Company’s subsidiaries. There were no fees paid ~~Wachovia a $25,000 fee~~ in connection with this amendment.

~~On July 29, 2005~~Effective August 10, 2006, the Company and Wachovia ~~amended~~entered into the Thirty-Sixth Amendment to the Wachovia Loan Agreement ~~to provide~~which reduced the ~~terms under which~~required minimum levels of EBITDA covenant for the third and fourth fiscal quarters of 2006. There were no fees paid in connection with this amendment.

Effective November 8, 2006, the Company ~~could enter~~and Wachovia entered into the ~~World Financial Network National Bank (“WFNNB”) Credit Card~~Thirty-Seventh Amendment to the Wachovia Loan Agreement which ~~among other things, prohibits~~reduced the ~~use~~required minimum levels of EBITDA covenant for the ~~proceeds~~fourth fiscal quarter of 2006 and the Wachovia Facility to repurchase private label accounts created under the WFNNB Credit Card Agreement should the Company become obligated to do so, prohibits the Company from terminating WFNNB Credit Card Agreement without Wachovia’s consentfirst and restricts the Company from borrowing on receivables generated under the WFNNB Credit Card Agreement. The amendment also waives enumerated defaults, resets the financial covenants, reallocates the availability that was previously allocated to ~~Gump’s~~ ~~and~~ ~~Gump’s By Mail~~ ~~among other Company subsidiaries and, retroactive to June 30, 2005, increases the amount~~second fiscal quarters of ~~letter of credits that the Company can issue to $15.0 million. The amendment also~~

~~requires that the Company enter into an amended and restated loan agreement with Wachovia by October 31, 2005. The Company~~2007. There were no fees paid ~~Wachovia a $60,000 fee~~ in connection with this amendment.

On ~~July 29, 2005~~March 28, 2006, August 10, 2006 and November 8, 2006, the Company and Chelsey Finance entered into a similar ~~amendment~~amendments of the Chelsey ~~Facility.~~Facility, which reduced the required minimum levels of the EBITDA covenant and consented to certain transactions.

Chelsey Facility

The Chelsey Facility is a $20.0 million junior secured credit facility with Chelsey Finance that was initially recorded at $7.1 million, net of an un-accreted debt discount of ~~$7.1~~$12.9 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. 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 5.0% above the prime rate publicly announced by Wachovia. The financial and non-financial covenants contained in the Chelsey Facility mirror those in the Wachovia Facility except that the quantitative measures for the consolidated working capital and EBITDA covenants are 10.0% less restrictive and the consolidated net worth covenant is 5.0% less restrictive than the comparable financial covenants in the Wachovia Facility. The Chelsey Facility is secured by a second priority lien on substantially all of the assets of the Company. The Chelsey Facility contains a cross default provision under which a default under the Wachovia Facility would also be a default under the Chelsey Facility. As part of this transaction, Chelsey Finance entered into an intercreditor and subordination agreement with Wachovia. As of September 30, 2006, the Company was required to maintain Consolidated Working Capital of not less than $8.1 million and Consolidated Net Worth of not less than ($44.1 million) and not permit its Cumulative Minimum EBITDA for the nine months ending September 30, 2006 to fall below $4.5 million under the Chelsey Facility. The Company was in compliance with its financial covenants as of September 30, 2006. Were it not in compliance with one or more of the covenants, subject to certain limitations contained in an intercreditor agreement between Wachovia and Chelsey under which Chelsey’s rights and remedies are subordinate and junior to those of Wachovia, Chelsey would have the right, among other remedies to require immediate repayment of the Chelsey Facility after the Wachovia facility was repaid in full.

At ~~June 25, 2005,~~September 30, 2006, the amount recorded as debt on the Condensed Consolidated Balance Sheet ~~is $9.7~~was $15.0 million, net of the un-accreted debt discount of ~~$10.3~~$5.0 million.

In accordance with Accounting Principles Board Opinion No. 14, “Accounting for Convertible Debt and Debt Issued with Stock Purchase Warrants” (“APB 14”), proceeds received from the sale of debt with detachable

stock purchase warrants should be allocated to both the debt and warrants, with the portion allocable to the warrants to be accounted for as Capital in excess of par value 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):

	June 25, 2005	December 25, 2004	September 30, 2006	December 31, 2005	September 24, 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)	2,645	1,098	7,916	4,484	3,524

	$ 9,706	$ 8,159	$ 14,977	$ 11,545	$ 10,585

7.	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 has adopted the provisions of SFAS 151 effective January 1, 2006 and such adoption did not have a material effect on the Company’s results of operations or financial position for the 39- weeks ended September 30, 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 employees using the fair value-based methodology under SFAS 123. The Company has adopted the provisions of SFAS 123R effective January 1, 2006 and such adoption did not have a material effect on the Company’s results of operations or financial position for the 13 and 39- weeks ended September 30, 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 required to adopt the 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 13 and 39- weeks ended September 30, 2006.

In June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes—an Interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes.” FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 is effective for fiscal years beginning after December 15, 2006. We are currently reviewing this new standard to determine its effects, if any, on our results of operations or financial position.

In September 2006, the SEC issued Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements (“SAB 108”), to address diversity in practice in quantifying financial statement misstatements. SAB 108 requires that we quantify misstatements based on their impact on each of our financial statements and related disclosures. SAB 108 is effective as of the end of our 2006 fiscal year, allowing a one-time transitional cumulative effect adjustment to retained earnings as of January 1, 2006 for errors that were not previously deemed material, but are material under

the guidance in SAB 108. We are currently evaluating the impact of adopting SAB 108 to determine its effects, if any, on our results of operations or financial position.

In September 2006, the FASB issued SFAS 157 Fair Value Measurements, which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. The provisions of SFAS 157 are effective as of the beginning of our 2008 fiscal year. We are currently evaluating the impact of adopting SFAS 157 to determine its effects, if any, on our results of operations or financial position.

8.	CHANGES IN MANAGEMENT

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 provide severance payments for 18 months of salary and other related costs. The Company has accrued an aggregate of $0.6 million during the first quarter of 2006 for severance and other related costs due to Mr. Contino’s resignation.

The employment agreements of the Chief Executive Officer and Chief Financial Officer both expired on May 5, 2006 and have been extended on a day-to-day basis. While both continue to provide employment services to the Company, there can be no assurance that they will continue to do so.

9.	~~PRIVATE LABEL~~SUBSEQUENT AND ~~COBRAND CREDIT CARD AGREEMENT~~OTHER EVENTS

United Marketing Group, LLC. On ~~February~~March 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”)~~2006 we replaced our then incumbent membership program provider with ~~World Financial Network National Bank~~Encore Marketing International (“~~WFNNB”~~Encore”) under ~~which WFNNB will provide private label (branded) and co-brand credit cards to~~an agreement where we marketed membership programs on a retail basis. Both parties were disappointed with the Company’s customers. The Company began offering the private label credit card to its customers in April 2005. The program extends credit to our customers at no credit risk to the Company and is expected to lead to increased sales and lower expenses. WFNNB will provide a fixed dollar amount of marketing funds in the first year of which 25.0% of any unused amount can be utilized in the first six monthsresults of the ~~second year~~sale of Encore membership programs and we mutually elected to terminate the agreement. On October 18, 2006, we replaced Encore and began marketing membership programs on a ~~percentage of the lesser of private label net sales or average accounts receivable balance in later years~~wholesale basis under an agreement with United Marketing Group, LLC (“UMG”). Under our Encore agreement, we were paid a commission for customers who initially agreed 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 paypurchase a ~~per card fee for each card issued under the co-brand~~membership program and a ~~percentage~~commission if a purchaser was still an active member when the customer’s membership was up for renewal at the end of a membership year. Under the ~~net finance charges on co-brand accounts.~~

~~If the Credit Card Agreement is terminated or expires other than as~~UMG agreement, we purchase membership kits and program benefits from UMG and then resell them to our customers. As a result of switching from selling memberships on a ~~default by WFNNB,~~retail basis to a wholesale basis and the ~~Company~~different economic arrangements under the two agreements, there will be ~~obligated~~lag in revenue recognition from membership programs sold and we will be amortizing the revenue from membership sales over the life of the memberships. By way of contrast, under our agreement with Encore, we recognized commissions when customers agreed 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, 2005 the Company is prohibited from using the Wachovia Facility to fund the purchase of the private label and co-brand accounts. As a consequence, should the Company become obligated to purchase the 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.membership program.

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

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

13- Weeks Ended

26- Weeks Ended

June 25,
2005

June 26,
2004

June 25,
2005

June 26,
2004

As Restated

As Restated

Net revenues
100.0
%

100.0
%

100.0
%

100.0
%
Cost of sales and operating expenses
60.9

60.0

60.6

61.4

Special charges
0.0

0.0

0.0

0.0

Selling expenses
25.7

27.0

25.3

25.6

General and administrative expenses
9.2

11.3

10.4

11.6

Depreciation and amortization
0.8

1.0

0.8

1.0

Income (loss) from operations
3.4

0.7

2.9

0.4

Interest expense, net
1.9

0.8

2.0

0.9

(Benefit) provision for Federal and state income taxes
0.1

0.1

0.0

0.0

Gain (loss) from discontinued operations of Gump’s
0.0

0.2

1.6

0.0

Net income (loss) and comprehensive income (loss)
1.4

0.0

2.5

(0.5)

Earnings applicable to Preferred Stock
0.0

0.0

0.1

0.0

Net income (loss) applicable to common shareholders
1.4
%

0.0
%

2.4
%

(0.5)
%

~~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 second 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 second 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 second 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.~~

	13- Weeks Ended				39- Weeks Ended
	September 30, 2006		September 24, 2005		September 30, 2006		September 24, 2005

Net revenues	100.0	%	100.0	%	100.0	%	100.0	%
Cost of sales and operating expenses	63.2		61.7		62.6		60.9
Selling expenses	27.1		24.9		27.0		25.2
General and administrative expenses	8.6		3.4		8.8		8.0
Depreciation and amortization	0.7		0.7		0.6		0.8
Income before interest and income taxes	0.4		9.3		1.1		5.1
Interest expense, net	2.8		2.3		2.4		2.1
Provision (benefit) for Federal and state income taxes	--		--		--		--
Income (loss) from continuing operations	(2.4)		7.0		(1.3)		3.0
Gain from discontinued operations of Gump’s	--		--		--		1.0
Net income (loss) and comprehensive income (loss)	(2.4)		7.0		(1.3)		4.0
Earnings applicable to Preferred Stock	--		0.2		--		0.1
Net income (loss) applicable to common shareholders	(2.4)	%	6.8	%	(1.3)	%	3.9	%

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 that 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 ~~six~~nine months of ~~2005,~~2006, net revenues increased ~~$20.9~~$16.0 million or 12.4% to $189.9 million from $169.0 million in the first six months of 2004. The increase was primarily driven by an increase in catalog circulation levels supported by deeper inventory positions that enabled higher initial fulfillment rates for customer orders and lower overall cancellation rates. Higher demand was experienced in ~~The Company Store, Domestications~~ ~~and~~ ~~Silhouettes~~ ~~catalogs, while lower demand was experienced in the~~ ~~International Male~~ catalogs which are in the process of being repositioned to return it to its roots as a young men’s “lifestyle” fashion leader. This merchandising shift will be evident in catalogs commencing in the fourth quarter of 2005. The ~~Domestications~~ catalog experienced strong demand however lower initial fill and higher cancellation rates due to insufficient inventory positions negatively impacted its operating results. The Company is increasing inventory positions for ~~Domestications~~ ~~to support the growth and improve the operating results in this catalog.~~

We also completed the implementation of strategies to reduce the infrastructure of the Company which were developed during fiscal 2004. These strategies included the consolidation of the operations of the LaCrosse, Wisconsin fulfillment center into the Roanoke, Virginia fulfillment center, which was substantially completed by the end of June 2005; the relocation of the ~~International Male~~ ~~and~~ ~~Undergear~~ catalog operations from San Diego, California to the corporate headquarters in Weehawken, New Jersey, which was completed February 28, 2005; and the consolidation of the Edgewater facility into the Weehawken, New Jersey premises, which was completed by May 31, 2005. Since the consolidation of our fulfillment centers, our Roanoke fulfillment center has experienced lower productivity that has negatively impacted fulfillment costs and the Company’s overall performance.

~~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 Gump’s Holdings, LLC, an unrelated third party 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, 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 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.

~~Results of Operations – 13- weeks ended June 25, 2005 compared with the 13- weeks ended June 26, 2004 as restated~~

~~Net Income.~~ The Company reported net income applicable to common shareholders of $1.4 million, or $0.06 basic income per share and $0.04 diluted income per share, for the 13- weeks ended June 25, 2005 compared with net income applicable to common shareholders of $0.0 million, or $0.00 basic and diluted income per share, for the comparable period in 2004.

~~The Company primarily attributes the increase in net income to the following:~~

•	~~Improved operating results generated from a $12.5 million increase in net revenues;~~
•	~~A favorable impact of $0.9 million due to the reduction in general and administrative expenses related to severance recorded in the second quarter of 2004.~~

~~Partially offset by:~~

•	An unfavorable impact of $1.2 million on net interest expense primarily due to interest costs incurred with the $20.0 million junior secured credit facility with Chelsey Finance (“Chelsey Facility,”) which the Company closed on July 8, 2004. See Note 8 of Notes to the condensed consolidated financial statements for additional information regarding the Chelsey Facility;
•	~~An unfavorable impact of $0.2 million of discontinued operations representing income from Gump’s on-going operations for the 13- weeks ended June 26, 2004.~~

~~Net Revenues.~~ ~~Net revenues increased $12.5 million (14.2%~~(5.6%) for the ~~13-week~~39-week period ended ~~June 25, 2005~~September 30, 2006 to ~~$100.2~~$302.8 million from ~~$87.7~~$286.8 million for the ~~comparable period in 2004.~~first nine months of 2005. This increase was primarily driven by an increase in catalog circulation ~~levels supported~~levels. In addition, net revenues grew because of higher postage and handling rates, which 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 ~~deeper inventory positions that enabled~~lower average order sizes. We experienced higher ~~initial fulfillment rates for customer orders and lower overall cancellation rates. Higher~~ demand ~~was experienced~~ in our ~~The Company Store,~~ Domestications and Silhouettes catalogs, ~~while~~ lower demand ~~was experienced for~~in The Company Store catalog and flat demand in our men’s division which consists of the International Male ~~catalogs.~~and Undergear catalogs.

During the first nine months of 2006, income before interest and income taxes decreased by approximately $11.2 million to $3.3 million from $14.5 million in the first nine months of 2005. The principal factors which negatively impacted the operating results for the nine months of 2006 included:

•	the continuation of diminished productivity in our distribution center, which started in the fall of 2005 and has led to higher product fulfillment costs;
•	higher outbound merchandise shipping costs caused by the bankruptcy of a consolidator utilized by the Company to deliver packages into the USPS system in mid March 2006, which caused the Company to utilize more expensive methods of delivery within the USPS system. While we expect this bankruptcy will continue to significantly increase our merchandise shipping costs for the remainder of 2006, the incremental increase in outbound merchandise shipping costs will diminish over the second half of the year;
•	higher catalog paper and postage costs, which started in the fall of 2005; and
•	higher general and administrative expenses due to the reversal in September 2005 of a $4.5 million accrual related to Rakesh Kaul, a former CEO who pursued claims against the Company.

Results of Operations – 13- weeks ended September 30, 2006 compared with the 13- weeks ended September 24, 2005

Net Income (Loss). The Company reported a net loss applicable to common shareholders of $2.2 million, or $0.10 basic and diluted net loss per share, for the 13- weeks ended September 30, 2006 compared with net income applicable to common shareholders of $6.6 million, or $0.30 basic earnings per share and $0.20 diluted earnings per share, for the comparable period in 2005.

The decrease in net income (loss) applicable to common shareholders was primarily a result of the following:

•	a decline in operating profit primarily driven by higher outbound merchandise shipping, product fulfillment, catalog paper and postage costs which aggregated $2.4 million; and
•	higher general and administrative expenses due to the reversal in September 2005 of a $4.5 million accrual related to Rakesh Kaul, a former CEO who pursued claims against the Company;

Partially offset by:

lower product costs due to improved sourcing of merchandise of $0.7 million.

Net Revenues. Net revenues decreased $3.1 million (3.2%) for the 13-week period ended September 30, 2006 to $93.7 million from $96.8 million for the comparable period in 2005. This decrease was primarily driven by lower catalog product shipments in the month of September 2006 due to the Company performing a physical inventory count of its inventory in mid to late September 2006. In addition, the Company generated lower revenues related to its third party fulfillment operations as a result of one customer’s paying directly their outbound shipping costs instead of reimbursing the Company. Partially offsetting these declines was an increase in net revenues because of higher postage and handling rates, which we put into effect to offset an increase in USPS rates that occurred in early January 2006. We experienced higher demand in our Domestications, Silhouettes and International Male ~~catalog experienced strong~~catalogs, and lower demand ~~for its merchandise however lower initial fill and higher cancellation rates due to insufficient inventory positions negatively impacted its operating results.~~ in The Company ~~is increasing inventory positions for~~ ~~Domestications~~ Store~~to support the growth in this~~ catalog. Internet sales increased and comprised ~~37.0%~~46.3% of combined Internet and catalog revenues for the 13- weeks ended ~~June 25, 2005~~September 30, 2006 compared with ~~33.6%~~40.0% for the comparable ~~fiscal~~ period in ~~2004,~~2005, and have increased by approximately ~~$5.7~~$6.8 million, or ~~21.0%~~20.9%, to ~~$32.8~~$39.4 million for the 13-week period ended ~~June 25, 2005~~September 30, 2006 from ~~$27.1~~$32.6 million for the comparable period in ~~2004.~~2005.

Cost of Sales and Operating Expenses. Cost of sales and operating expenses ~~increased~~decreased by ~~$8.4~~$0.5 million to ~~$61.0~~$59.3 million for the 13- weeks ended ~~June 25, 2005~~September 30, 2006 as compared with ~~$52.6~~$59.8 million for the comparable period in ~~2004.~~2005. Cost of sales and operating expenses increased to ~~60.9%~~63.2% of net revenues for the 13-week period ended ~~June 25, 2005~~September 30, 2006 as compared with ~~60.0%~~61.7% of net revenues for the comparable period in ~~2004. As a percentage of net revenues, this increase~~2005. The $0.5 million decrease was primarily due to ~~increases~~approximately $1.7 million (0.7% of net revenues) in ~~product~~lower merchandise costs related to the decline in net revenues and improved sourcing of merchandise and approximately $1.9 million (1.9% of net revenues) in lower expenses related to our third party fulfillment operations as a result of one of customers paying their outbound shipping costs ~~and higher inventory obsolescence charges on slower moving merchandise. These increases were~~directly, partially offset by a ~~decline~~$1.3 million (1.7% of net revenues) increase in outbound merchandise transportation and USPS charges, a $1.4 million (1.7% of net revenues) increase in product fulfillment costs, ~~associated with the ability to source goods that have higher product margins.~~each of which is discussed below and a $0.4 million (0.6% of net revenues) increase in telemarketing expenses.

~~Special Charges.~~ We ship a 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 merchandise shipping costs. In ~~December 2000 and June 2004,~~mid March 2006, a consolidator utilized by the Company ~~implemented strategic business realignment programs~~ that enabled the Company to bypass USPS regional bulk mail centers, thereby reducing transportation and USPS charges, filed a petition in bankruptcy and ceased operation. This caused the Company to incur increased outbound merchandise transportation and USPS charges ($1.3 million in higher costs in the second quarter of 2006 and $1.0 million in higher costs in the third quarter of 2006). While we expect this bankruptcy will continue to significantly increase our merchandise shipping costs for the remainder of 2006, we expect the incremental increase in outbound merchandise shipping costs will continue to diminish in the fourth quarter.

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 ~~the recording~~higher product fulfillment costs of special charges for severance, facility exit costs and fixed asset write-offs. The actions related to the strategic business realignment programs were taken in an effort to direct the Company’s resources primarily towards a loss reduction strategy and a return to profitability. There were nominal special charges (income) recordedapproximately $1.4 million for the 13- weeks ended ~~June 25,~~September 30, 2006. The lower productivity started in the third quarter of 2005 and ~~June 26, 2004.~~has continued through the third quarter of 2006. In the spring of 2006, we installed new management in the fulfillment center to address these issues. To date, however, we have not seen an improvement in productivity or lower costs. To free up space in our distribution center, we ceased providing fulfillment services to one our third party fulfillment customers at the end of the third quarter of 2006 and

expect to stop providing these services to our two other third party customers during 2007 when their current contracts expire.

Selling Expenses. Selling expenses increased by ~~$2.1~~$1.3 million to ~~$25.8~~$25.4 million for the 13- weeks ended ~~June 25, 2005~~September 30, 2006 as compared with ~~$23.7~~$24.1 million for the comparable period in ~~2004.~~2005. Selling expenses ~~decreased~~increased to ~~25.7%~~27.1% of net revenues for the 13- weeks ended ~~June 25, 2005~~September 30, 2006 from ~~27.0%~~24.9% for the comparable period in ~~2004. As~~2005. The $1.3 million (1.4% of net revenues) increase was primarily due to increased internet marketing expenditures as well as higher catalog paper and postage costs which had a ~~percentage~~negative 0.8% of net revenues ~~this change was due primarily due to higher response rates that more than offset the cost of higher catalog circulation.~~impact.

General and Administrative Expenses. General and administrative expenses ~~decreased~~increased by ~~$0.7~~$4.8 million to ~~$9.2~~$8.1 million for the 13- weeks ended ~~June 25, 2005~~September 30, 2006 as compared with ~~$9.9~~$3.3 million for the comparable period in ~~2004. As a percentage of net revenues, general~~2005. General and administrative expenses ~~declined~~increased to ~~9.2%~~8.6% of net revenues for the ~~13-week period~~13- weeks ended ~~June 25, 2005 as compared to 11.3% of net revenues~~September 30, 2006 from 3.4% for the comparable period in ~~2004. As~~2005. The $4.8 million increase was attributable primarily to the reversal of a ~~percentage~~$4.5 million accrual established in fiscal 2000 pertaining to Rakesh Kaul, a former CEO of ~~net revenues, this decrease~~the Company. The accrual was ~~primarily~~reversed due to ~~severance and other~~the expiration of Mr. Kaul’s rights to pursue his claims against the Company. In addition, compensation costs ~~incurred during the 13- weeks ended June 26, 2004 associated with the resignation~~increased by an aggregate of ~~the Company’s former President. This decrease was~~$0.8 million due primarily to an increased number of employees.

~~partially offset by additional audit fees incurred during the 13-weeks ended June 25, 2005 associated with the Company’s restated financial statements.~~

Depreciation and Amortization. Depreciation and amortization expense decreased approximately $0.1 million ~~during~~to approximately $0.6 million for the 13- weeks ended ~~June 25, 2005~~September 30, 2006, from $0.7 million for the comparable period in ~~2004.~~2005. The decrease was primarily due to property and equipment that have become fully depreciated, partially offset by the depreciation of newly purchased property and equipment.

Income ~~from Operations.~~before interest and income taxes. The Company’s income ~~from operations increased~~before interest and income taxes decreased by approximately ~~$2.8~~$8.6 million to ~~$3.4~~$0.4 million for the 13- weeks ended ~~June 25, 2005~~September 30, 2006, from ~~$0.6~~$9.0 million for the comparable period in 2004. See “Results of Operations – 13- weeks ended June 25, 2005 compared with the 13- weeks ended June 26, 2004 as restated - Net Income (Loss)” for further details as the relationships are the same excluding the discussion on income tax and interest expense.2005.

Interest Expense, Net. Interest expense, net, increased ~~$1.2~~$0.4 million to ~~$1.9~~$2.6 million for the 13- weeks ended ~~June 25, 2005~~September 30, 2006, from ~~$0.7~~$2.2 million for the comparable period in fiscal ~~2004.~~2005. This increase in interest expense is primarily due to ~~$0.8~~$0.4 million ofin higher accretion of the debt discount ~~and $0.6 million of stated interest related to the Chelsey Facility during~~for the 13- weeks ended ~~June 25, 2005. These increases were partially offset by a decrease in interest expense due to lower average cumulative borrowings relating to the Wachovia Facility in the amount of $0.2 million.~~September 30, 2006.

Income ~~Taxe~~Taxess.: The provision for federal and state income taxes is approximately ~~2.1%~~(0.7)% of ~~income~~the loss before income taxes for the 13- week period ended ~~June 25, 2005.~~
~~Gain (loss) from discontinued operations of Gump’s.~~ On March 14, 2005, the Company sold all of the stock of to Gump’s Holdings, LLC, an unrelated third party. The Company recognized a gain of $0.2 million representing income from Gump’s on-going operations for the 13- weeks ended June 26, 2004.September 30, 2006.

Results of Operations – ~~26-~~39- weeks ended ~~June 25, 2005~~September 30, 2006 compared with the ~~26-~~39- weeks ended ~~June 26, 2004 as restated~~September 24, 2005

Net Income (Loss). The Company reported ~~net income applicable to common shareholders of $4.6 million, or $0.20 basic income per share and $0.14 diluted income per share, for the 26- weeks ended June 25, 2005 compared with~~ a net loss applicable to common shareholders of ~~$0.8~~$3.9 million, or ~~$0.03~~$0.17 basic and diluted net loss per share, for the 39- weeks ended September 30, 2006 compared with net income applicable to common shareholders of $11.2 million, or $0.50 basic earnings per share and $0.34 diluted earnings per share, for the comparable period in ~~2004.~~2005.

The ~~Company primarily attributes the increase~~decrease in net income (loss) applicable to common shareholders was primarily a result of the following:

•
~~Improved~~a decline in operating ~~results generated from a $20.9 million increase in net revenues;~~
•
~~A favorable impact of $3.0 million of discontinued operations due to the gain of $3.6 million recognized relating to the March 14, 2005 sale of stock of~~ ~~Gump’s~~;
•
~~A favorable impact of $1.5 million due to the reduction in general~~profit primarily driven by higher outbound merchandise shipping, fulfillment, catalog paper and ~~administrative expenses related to severance recorded in the second quarter of 2004.~~
~~Partially offset by:~~
•
~~An unfavorable impact of $2.2 million on net interest expense primarily due to interest~~postage costs ~~incurred with the $20.0 million junior secured credit facility with Chelsey Finance (“Chelsey Facility,”)~~ which ~~the Company closed on July 8, 2004. See Note 8 of Notes to the condensed consolidated financial statements for additional information regarding the Chelsey Facility;~~aggregated $7.8 million;
•
An unfavorable impact of ~~$1.5~~$3.0 million ~~related~~from discontinued operations due to the sale of Gump’s in the first quarter of 2005;
•
a $0.7 million increase in compensation and fringe benefits; and
•
a $0.6 million increase in general and administrative expenses ~~incurred for~~attributable to severance recorded in 2006 related to the departure of the Company’s Chief Operating Officer;
Partially offset by:
lower product costs due to improved sourcing of merchandise of $2.4 million;

•
a $1.8 million reduction in general and administrative expenses, primarily professional fees, as a result of the completion during 2005 of the independent investigation conducted by the Audit Committee of the Board of Directors ~~in connection with~~related to the restatement of the Company’s consolidated financial statements and other accounting-related ~~matters.~~matters; and
•
a $0.6 million reduction in general and administrative expenses related to reduced rent in 2006 as a result of the 2005 consolidation of the Company’s headquarters.

Net Revenues. Net revenues increased ~~$20.9~~$16.0 million ~~(12.4%~~(5.6%) for the ~~26-week~~39-week period ended ~~June 25, 2005~~September 30, 2006 to ~~$189.9~~$302.8 million from ~~$169.0~~$286.8 million for the comparable period in ~~2004.~~2005. This increase was primarily driven by an increase in catalog circulation ~~levels supported~~levels. In addition, net revenues grew because of higher postage and handling rates, which 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 ~~deeper inventory positions that enabled~~lower average order sizes. We experienced higher ~~initial fulfillment rates for customer orders and lower overall cancellation rates. Higher~~ demand ~~was experienced~~ in our ~~The Company Store,~~ Domestications and Silhouettes catalogs, ~~while~~and lower demand ~~was experienced for~~in The Company Store catalog and flat demand in the International Male ~~catalogs. The~~ ~~Domestications~~ catalog experienced strong demand for its merchandise however lower initial fill and higher cancellation rates due to insufficient inventory positions negatively impacted its operating results. The Company is increasing inventory positions for ~~Domestications~~ ~~to support the growth in this~~ catalog. Internet sales increased and comprised ~~38.0%~~44.2% of combined Internet and catalog revenues for the ~~26-~~39- weeks ended ~~June 25, 2005~~September 30, 2006 compared with ~~34.0%~~38.6% for the comparable ~~fiscal~~ period in ~~2004,~~2005, and have increased by approximately ~~$11.0~~$22.1 million, or ~~20.9%~~22.6%, to ~~$63.9~~$120.2 million for the ~~26-week~~39-week period ended ~~June 25, 2005~~September 30, 2006 from ~~$52.9~~$98.1 million for the comparable period in ~~2004.~~2005.

Cost of Sales and Operating Expenses. Cost of sales and operating expenses increased by ~~$11.3~~$14.6 million to ~~$115.0~~$189.4 million for the ~~26-~~39- weeks ended ~~June 25, 2005~~September 30, 2006 as compared with ~~$103.7~~$174.8 million for the comparable period in ~~2004.~~2005. Cost of sales and operating expenses ~~decreased~~increased to ~~60.6%~~62.6% of net revenues for the ~~26-week~~39-week period ended ~~June 25, 2005~~September 30, 2006 as compared with ~~61.4%~~60.9% of net revenues for the comparable period in ~~2004. As a percentage of net revenues, this decrease~~2005. The $14.6 million increase was primarily due to ~~declines~~approximately $3.7 million in higher merchandise costs ~~associated with~~related to the ~~ability to source goods that have~~increase in net revenues as well as approximately $2.3 million (0.8% of net revenues) in increased outbound merchandise transportation and USPS charges and approximately $4.3 million (1.4% of net revenues) in higher product ~~margins and decreases in information technology~~fulfillment costs, ~~due to declines in equipment rentals and maintenance. These decreases were partially offset by increases in product shipping costs.~~each of which is discussed below.

~~Special Charges.~~ We ship a 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 merchandise shipping costs. In ~~December 2000 and June 2004,~~mid March 2006, a consolidator utilized by the Company ~~implemented strategic business realignment programs~~ that enabled the Company to bypass USPS regional bulk mail centers, thereby reducing transportation and USPS charges, filed a petition in bankruptcy and ceased operation. This caused the Company to incur increased outbound merchandise transportation and USPS charges ($1.3 million in higher costs in the second quarter of 2006 and $1.0 million in higher costs in the third quarter of 2006). While we expect this bankruptcy will continue to significantly increase our merchandise shipping costs for the remainder of 2006, we expect the incremental increase in outbound merchandise shipping costs will continue to diminish in the fourth quarter.
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 fulfillment costs of approximately $4.3 million for the ~~recording~~39- weeks ended September 30, 2006. The lower productivity started in the third quarter of ~~special charges for severance, facility exit~~2005 and has continued through the third quarter of 2006. In the spring of 2006, we installed new management in the fulfillment center to address these issues. To date, however, we have not seen an improvement in productivity or lower costs. To free up space in our distribution center, we ceased providing fulfillment services to one our third party fulfillment customers at the end of the third quarter of 2006 and expect to stop providing these services to our two other third party customers during 2007 when their current contracts expire.
Partially offsetting these increases are approximately $2.4 million in lower merchandise costs through improved sourcing of merchandise and ~~fixed asset write-offs. The actions~~approximately $0.5 million in lower expenses related to our third party fulfillment operations consistent with the ~~strategic business realignment programs were taken~~decline in an effort to direct the Company’s resources primarily towards a loss reduction strategy and a return to profitability. There were nominal special charges recorded for the 26- weeks ended June 25, 2005 and June 26, 2004.third party fulfillment revenues.

Selling Expenses. Selling expenses increased by ~~$4.7~~$9.6 million to ~~$48.0~~$81.8 million for the ~~26-~~39- weeks ended ~~June 25, 2005~~September 30, 2006 as compared with ~~$43.3~~$72.2 million for the comparable period in ~~2004.~~2005. Selling expenses ~~decreased~~increased to ~~25.3%~~27.0% of net revenues for the ~~26-~~39- weeks ended ~~June 25, 2005~~September 30, 2006 from ~~25.6%~~25.2% for the comparable period in ~~2004. As a percentage of net revenues, this change~~2005. The $9.7 million increase was ~~due~~ primarily due to ~~higher response rates that more than offset the cost of~~approximately $4.9 million in costs related to higher catalog ~~circulation.~~

circulation, approximately $2.4 million (0.8% of net revenues) in increased internet marketing expenditures and approximately $2.4 million (0.8% of net revenues) in higher paper and postage costs.

General and Administrative Expenses. General and administrative expenses increased by ~~$0.3~~$3.4 million to ~~$19.8~~$26.5 million for the ~~26-~~39- weeks ended ~~June 25, 2005~~September 30, 2006 as compared with ~~$19.5~~$23.1 million for the comparable period in ~~2004. As a percentage of net revenues, general~~2005. General and administrative expenses ~~declined~~increased to ~~10.4%~~8.8% of net revenues for the ~~26-week period~~39- weeks ended ~~June 25, 2005 as compared to 11.6% of net revenues~~September 30, 2006 from 8.0% for the comparable period in ~~2004. As~~2005. The $3.4 million increase was attributable primarily to the reversal of a ~~percentage~~$4.5 million accrual established in fiscal 2000 pertaining to Rakesh Kaul, a former CEO of ~~net revenues, this decrease~~the Company. The accrual was ~~primarily~~reversed due to the expiration of Mr. Kaul’s rights to pursue his claims against the Company. In addition, compensation and fringe benefits expenses increased by an aggregate of $1.9 million due to an increased number of employees and higher medical costs, $0.6 million in severance ~~and other~~ costs ~~incurred during~~related to the ~~26- weeks ended June 26, 2004 associated with the resignation~~departure of ~~three executives, including~~ the Company’s ~~former President. This decrease was partially offset by additional~~Chief Operating Officer in 2006 and $0.6 million in professional fees related to the Going Private proposal in 2006. Partially offsetting these increases were $1.8 million in professional fees incurred ~~for the investigation conducted by~~in 2005 that related to the Audit Committee investigation and other accounting-related matters. In addition there is a $0.6 million reduction in general and administrative expenses related to reduced rent in 2006 as a result of the ~~Board of Directors in connection with the restatement~~2005 consolidation of the Company’s ~~consolidated financial statements~~headquarters, $0.5 million in lower insurance costs and ~~other accounting-related matters.~~$0.5 million in lower external auditing fees.

Depreciation and Amortization. Depreciation and amortization expense decreased ~~$0.2~~approximately $0.5 million to ~~$1.5~~approximately $1.7 million for the ~~26-~~39- weeks ended ~~June 25, 2005~~September 30, 2006, from ~~$1.7~~$2.2 million for the comparable period in ~~2004.~~2005. The decrease was primarily due to property and equipment that have become fully depreciated, partially offset by the depreciation of newly purchased property and equipment.

Income ~~from Operations.~~before interest and income taxes. The Company’s income ~~from operations increased~~before interest and income taxes decreased by approximately ~~$4.8~~$11.2 million to ~~$5.5~~$3.3 million for the ~~26-~~39- weeks ended ~~June 25, 2005~~September 30, 2006, from ~~$0.7~~$14.5 million for the comparable period in 2004. See “Results of Operations – 26- weeks ended June 25, 2005 compared with the 26- weeks ended June 26, 2004 as restated - Net Income (Loss)” for further details as the relationships are the same excluding the discussion on income tax and interest expense.2005.

Interest Expense, Net. Interest expense, net, increased ~~$2.3~~$1.2 million to ~~$3.8~~$7.2 million for the ~~26-~~39- weeks ended ~~June 25, 2005~~September 30, 2006, from ~~$1.5~~$6.0 million for the comparable period in fiscal ~~2004.~~2005. This increase in interest expense is

primarily due to ~~$1.5~~$1.0 million ofin higher accretion of the debt discount and ~~$1.1 million of stated~~higher interest rates related to the Wachovia and Chelsey ~~Facility~~Facilities during the ~~26-~~39- weeks ended ~~June 25, 2005.~~September 30, 2006. These increases were partially offset by a decrease in interest expense due to lower average cumulative borrowings relating to the Wachovia ~~Facility in the amount of $0.4 million.~~Facility.

Income Taxes.: The provision for federal and state income taxes is approximately ~~2.6%~~(0.2)% of ~~income~~the loss before income taxes for the ~~26-~~39- week period ended ~~June 25, 2005.~~September 30, 2006 (which represents the anticipated effective tax rate for the full year 2006).

Gain ~~(loss)~~ from discontinued operations of ~~Gump’s.~~Gump’s: On March 14, 2005, the Company sold all of the stock of Gump’s to Gump’s Holdings, LLC, an unrelated third party. The Company recognized a gain on the sale of approximately $3.6 million in the ~~26- weeks~~quarter ended ~~June 25,~~March 26, 2005, offset by losses from Gump’s on-going operations through the sale date of approximately $0.6 million.

LIQUIDITY AND CAPITAL RESOURCES

Overview

In 2005, the liquidity position of the Company continues to strengthen as a result of improved operating results, proceeds from the sale of Gump’s and as a result of securing the $20.0 million Chelsey Facility on July 8, 2004 and concurrently amending the terms of the Wachovia Facility. The additional working capital has continued to provide us the ability to restore inventory to adequate levels in order to support higher demand driven by an overall increase in catalog circulation. The funding has eliminated substantially all vendor restrictions involvingOur borrowings under our ~~credit arrangements. The $8.9 million in proceeds from the sale of Gump’s enabled the Company to pay down $8.1 million of the~~ Wachovia revolving loan facility ~~during the first quarter of 2005.~~have increased from $8.1 million at December 31, 2005 to $15.6 million at September 30, 2006.

Net cash ~~provided~~used by operating activities. During the ~~26-week~~39-week period ended ~~June 25, 2005,~~September 30, 2006, net cash ~~provided~~used by operating activities was ~~$5.0~~$3.6 million. This was due primarily to ~~an increase in customer prepayments~~higher inventory positions compared to December 31, 2005 and ~~credits, and $5.2 million of operating cash provided by net income, when adjusted for the gain on the disposition of~~ ~~Gump’s~~~~, depreciation, amortization and other non cash items, offset by~~ payments made by the Company to ~~increase inventory~~reduce accounts payable, partially offset by receipts on accounts receivable and ~~prepaid catalog costs~~increased customer prepayments and ~~reduce accrued liabilities.~~credits.

Net cash ~~provided (used)~~used by investing activities. During the ~~26-week~~39-week period ended ~~June 25, 2005,~~September 30, 2006, net cash ~~provided~~used by investing activities was ~~$8.1 million. This was due primarily to $8.9~~$2.6 million ~~in proceeds received from the sale of~~ ~~Gump’s~~~~, partially offset by~~for capital expenditures, consisting primarily of purchases and upgrades to

various information technology hardware and software, expenditures associated with our new retail store in Roanoke, Virginia and other miscellaneous equipment throughout the ~~Company and purchases of furniture and equipment for the Company’s headquarters in New Jersey.~~Company.

Net cash ~~used~~provided by financing activities. During the ~~26-week~~39-week period ended ~~June 25, 2005,~~September 30, 2006, net cash ~~used~~provided by financing activities was ~~$13.1~~$5.9 million, which was primarily due to net ~~payments~~borrowings of ~~$12.9~~$6.0 million under the Wachovia ~~Facility and payments of $0.2 million for obligations under capital leases.~~Facility.

Financing Activities

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

~~As of June 25, 2005, December 25, 2004 and June 26, 2004, debt consisted of the following (in thousands):~~

June 25,
2005

December 25,
2004

June 26,
2004

Wachovia facility:

Tranche A term loans – Current portion, interest rate of 6.5% at June 25, 2005, 5.5% at December 25, 2004 and 4.75% at June 26, 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 6.5% at June 25, 2005, 5.5% at December 25, 2004 and 4.5% at June 26, 2004

2,480

14,408

7,947
Capital lease obligations – Current portion

163

290

493
Short-term debt

4,635

16,690

12,232

Wachovia facility:

Tranche A term loans, interest rate of 6.5% at June 25, 2005, 5.5% at December 25, 2004 and 4.75% at June 26, 2004

1,989

2,985

3,482
Tranche B term loan, interest rate of 13.0% at June 26, 2004

--

--

3,311
Chelsey facility – stated interest rate of 11.0% (5.0% above prime rate) at June 25, 2005 and 10.0% (5.0% above prime rate) at December 25, 2004

9,706

8,159

--
Capital lease obligations

14

52

177
Long-term debt

11,709

11,196

6,970
Total debt

$    16,344

$             27,886

$     19,202
~~Wachovia Facility~~
~~Remaining availability under the Wachovia Facility as of June 25, 2005 was $14.0 million.~~
~~Chelsey Facility~~
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):

June 25,
2005

December 25,
2004

Amount Borrowed Under the Chelsey Facility
$             20,000

$             20,000
Fair Value of Common Stock Warrant (Recorded as Capital in excess of par value)
(12,939)

(12,939)
Accretion of Debt Discount (Recorded as Interest Expense)
2,645

1,098

$               9,706

$               8,159
See Note 86 to the condensed consolidated financial statements for ~~additional~~ information relating to the Company’s ~~debt.~~

debt and financing activities.

Other Activities

~~Consolidation of New Jersey Office Facilities.~~ The Company entered into a 10-year extension of the lease for its Weehawken, New Jersey premises and has relocated its executive offices to that facility in 2005. We consolidated all of our New Jersey operations into the Weehawken facility when the Edgewater, New Jersey facility closed upon the expiration of the lease on May 31, 2005.
~~Consolidation of Men’s Apparel Business.~~ ~~The Company decided on November 9, 2004 to relocate and consolidate all functions of~~ ~~International Male~~ ~~and~~ ~~Undergear~~ from San Diego, California to Weehawken, New Jersey by February 28, 2005. The decision was prompted by the business need to consolidate operations, reduce costs and leverage its catalog expertise in New Jersey. We accrued $0.9 million in severance and related costs during the fourth quarter of 2004 associated with the elimination of 32 California-based full-time equivalent positions. The payment of these costs began in February 2005 and continued through August 2005. During the 26- weeks ended June 25, 2005, the Company made payments of $0.7 million in severance and related costs associated with this consolidation. Since the consolidation of our fulfillment centers, our Roanoke fulfillment center has experienced lower production that has negatively impacted fulfillment costs and the Company’s overall performance.
The projected annual savings from the consolidation of the San Diego, California and the Edgewater, New Jersey facilities into the Weehawken, New Jersey facility is approximately $2.1 million, however with this relocation and consolidation, the transition has negatively impacted the performance of the Men’s Apparel catalogs in 2005.
~~Consolidation of Fulfillment Centers.~~ On June 30, 2004 the Company announced plans to consolidate the operations of the LaCrosse, Wisconsin fulfillment center and storage facility into the Roanoke, Virginia fulfillment center by June 30, 2005. The LaCrosse fulfillment center and the LaCrosse storage facility were closed in June 2005 and August 2005, upon the expiration of their respective leases. The plan to consolidate operations was prompted by excess capacity at the Roanoke facility and the lack of sufficient warehouse space in the leased Wisconsin facilities to support the growth of ~~The Company Store~~ and reduce the overall cost structure of the Company. The Company substantially completed the consolidation into the Roanoke, Virginia fulfillment center by the end of June 2005. The Company accrued $0.5 million in severance and related costs and incurred $0.2 million of facility exit costs during 2004 associated with the consolidation of the LaCrosse operations and the elimination of 149 full and part-time positions. The payment of these costs began in January 2005 and is expected to continue into the fourth quarter of 2005. During the 26- weeks ended June 25, 2005, the Company has made payments of approximately $0.3 million in severance and related costs associated with this consolidation. Since the consolidation of our fulfillment centers, our Roanoke fulfillment center has experienced lower productivity that has negatively impacted fulfillment costs and the Company’s overall performance.
~~Delisting of Common Stock.~~ The Common Stock was delisted from the American Stock Exchange (“AMEX”) on February 16, 2005 because of the Restatement which prevented us from timely filing our Form 10-Q for the fiscal quarter ended September 25, 2004, a condition of continued AMEX listing. 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.
General. At ~~June 25, 2005,~~September 30, 2006, the Company had ~~$0.5~~less than $0.1 million in cash and cash equivalents, compared with ~~$0.5~~$0.3 million at December ~~25, 2004~~31, 2005 and ~~$0.4~~$0.1 million at ~~June 26, 2004.~~September 24, 2005. Working capital and current ratio at ~~June 25, 2005~~September 30, 2006 were ~~$17.3~~$10.2 million and ~~1.25~~1.12 to 1, ~~respectively.~~respectively, compared to $26.0 million and 1.42 to 1, respectively, at December 31, 2005. Total recorded borrowings, ~~including financing under capital lease obligations,~~net of the un-accreted debt discount of $5.0 million and the Series C Preferred, as of ~~June 25, 2005,~~September 30, 2006, aggregated ~~$16.3 million.~~$32.4 million, $32.1 million of which is classified as short term and $0.3 million of which is classified as long term. Remaining availability under the Wachovia Facility as of ~~June 25, 2005~~September 30, 2006 was ~~$14.0~~$9.2 million, compared with ~~$5.1~~$7.2 million at ~~June 26, 2004.~~September 24, 2005.

~~Management~~Because both the Wachovia and the Chelsey Facilities become due in July 2007, the Company will be forced to seek extensions of these facilities or seek replacement financing from other sources before the maturity date. While management believes that it will be able to replace both of these credit facilities, no assurances can be given that the Company ~~has sufficient liquidity and availability under its~~will be able to do so. Even if the Company is able to secure a new credit ~~agreements~~facility, it is possible that the terms of any replacement facility could be less favorable than the existing credit facilities. Were that to ~~fund its planned~~occur, the Company’s results of operations ~~through at least~~in the ~~next twelve months. See “Forward-Looking Statements” below.~~future would be adversely affected.

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.

NEW ACCOUNTING PRONOUNCEMENTS

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, and Note 7 of the Condensed Consolidated Financial Statements for additional information relating to new accounting pronouncements that the Company has adopted.

FORWARD-LOOKING STATEMENTS

This Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The use of words such as “anticipates,” “estimates,” “expects,” “projects,” “intends,” “plans,” and “believes,” among others, generally identify forward-looking statements. Forward-looking statements are predictions of future trends and events and as such, there are substantial risks and uncertainties associated with forward-looking statements, many of which are beyond management’s control. Some of the more material risks and uncertainties are

identified in “Risk Factors” contained in Item 1A of the Company’s Annual Report on Form 10-K for the fiscal year ended December ~~25, 2004.~~31, 2005. We do not intend, and disclaim any obligation, to update any forward-looking statements.

ITEM 3. ~~QUANTITIVE~~QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Interest Rates: The Company’s exposure to market risk relates to interest rate fluctuations for borrowings under the Wachovia Facility, including the term loans, which bear interest at variable rates, and the Chelsey Facility, which bears interest at ~~5.0%~~5% above the prime rate publicly announced by Wachovia Bank, N.A. At ~~June 25, 2005,~~September 30, 2006, outstanding principal balances under the Wachovia Facility and Chelsey Facility subject to variable rates of interest were approximately ~~$6.5~~$17.0 million and $20.0 million, respectively. If interest rates were to increase by one percent from current levels, the resulting increase in interest expense, based upon the amount outstanding at ~~June 25, 2005,~~September 30, 2006, would be approximately ~~$0.3~~$0.4 million on an annual basis.

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

ITEM 4. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has ~~completed~~concluded, based on an evaluation performed as of September 30, 2006, that the ~~effectiveness of the design and operation of our~~Company’s disclosure controls and procedures (as defined in Rule ~~13a-15~~13a-15(e) under the Securities Exchange Act of 1934, as amended ~~(the “Exchange Act”)~~(Exchange Act)) pursuant to Item 307 of Regulation S-K for the fiscal quarter covered by this quarterly report. This evaluation has allowed management to make conclusions, as set forth below, regarding the state of the Company’s disclosure controls and procedureswere effective as of ~~June 25, 2005. While management has made significant improvements in its disclosure controls and procedures and has completed various action plans~~September 30, 2006 to ~~remedy identified weaknesses in these controls (as more fully discussed below), based on management’s evaluation, management has concluded~~ensure that ~~the Company’s disclosure controls and procedures were not effective in alerting management on a timely basis to material~~ information ~~relating to the Company~~ required to be ~~included~~disclosed by the Company in ~~the Company’s periodic filings~~reports that it files or submits under the Exchange ~~Act. In coming to this conclusion, management considered, among other things,~~Act is (i) recorded, processed, summarized and reported within the ~~control deficiency related to~~

~~periodic review of the application of generally accepted accounting principles, which resulted~~time periods specified in the ~~Restatement as disclosed in Note 2~~Securities and Exchange Commission rules and forms and (ii) accumulated and communicated to the ~~accompanying consolidated financial statements included in this Form 10-Q.~~Company’s management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

~~As background, the following occurred during 2004 and 2005:~~
•
~~During the second quarter of 2004, the Company identified a revenue recognition cut-off issue that resulted~~Changes in revenue being recorded in advance of the actual shipment of merchandise to the customer. The practice was stopped immediately. Subsequently, the Company determined that revenue should be recognized when merchandise is received by the customer rather than when shipped because the Company routinely replaces customer merchandise damaged or lost in transit as a customer service matter (even though risk of loss, as a legal matter, passes on shipment). As a consequence, the Company has restated all affected periods presented to recognize revenue when merchandise is received by the customer.
•
In the first quarter of 2004, former management identified a potential issue with the accounting treatment of discount obligations due to members of certain of the Company’s buyers’ club programs, and at that time, an inappropriate conclusion regarding the accounting treatment was reached. During the third quarter of 2004, the issue was re-evaluated and it was determined that an error in the accounting treatment had occurred. The cumulative impact of the error for which the Company restated resulted in the overstatement of revenues and the omission of the related liability to the guarantee of these discount obligations that aggregated $2.4 million as of June 26, 2004 (the end of the second quarter of 2004). The Company immediately implemented accounting policies to appropriately account for all obligations due to members of the buyers’ club programs.
•
On November 9, 2004, the Company’s Audit Committee discussed the two matters noted above with the Company’s former independent registered public accounting firm, KPMG LLP (“KPMG”) and then on November 17, 2004, the Audit Committee launched an investigation relating to the restatement of the Company’s consolidated financial statements and other accounting-related matters and engaged Wilmer Cutler as its independent outside counsel to assist with the investigation.
•
The Company was notified on January 11, 2005 by the SEC that the SEC was conducting an informal inquiry relating to the Company’s financial results and financial statements since 1998. The Audit Committee, the Board of Directors and the Company’s management have been cooperating fully with the SEC in connection with the inquiry.
•
On February 3, 2005, the Company reported that its Common Stock was being delisted by the AMEX as a consequence, among other reasons, of the Company’s inability to meet the AMEX’s continued listing requirements and its inability to timely file its Form 10-Q for the fiscal quarter ended September 25, 2004.
•
On March 14, 2005, the Audit Committee reported that it had concluded its investigation and, with the assistance of Wilmer Cutler, reported its findings to the Board of Directors. The Audit Committee, with Wilmer Cutler’s assistance, formulated recommendations to the Company and the Board of Directors concerning ways of improving the Company’s internal controls and procedures for financial reporting which the Board of Directors and the Company began to implement.
•
The Audit Committee subsequently instructed Wilmer Cutler to cooperate fully with the SEC in connection with its inquiry and share the results of its investigation with the SEC, KPMG and Goldstein Golub Kessler LLP (“GGK”), whom had been engaged by the Audit Committee on November 2, 2005 as the Company’s new auditors after the dismissal of KPMG on October 20, 2005. Wilmer Cutler has presented the results of its investigation to the SEC, KPMG and GGK.
•
During the course of preparing its 2004 consolidated financial statements, the Company evaluated a previously reversed litigation reserve relating to post employment benefits allegedly owed to its former CEO. In the course of evaluating the accounting treatment of the restoration of the reserve, the Company identified that the original reserve had been improperly established as a litigation reserve rather than an accrual for post employment benefits and that legal expenses had been improperly charged against the reserve rather than treated as period expenses. Management corrected these errors and restated all affected periods presented in accordance with the corrected treatment of the reserve.

•
During the course of preparing its 2004 consolidated financial statements, the Company determined that an accrual related to certain customer prepayments and credits had been inappropriately released and that other liabilities relating primarily to certain miscellaneous catalog costs and other miscellaneous costs had not been appropriately accrued in the appropriate periods. The Company re-established the improperly released accrual and accrued certain miscellaneous catalog costs in the appropriate periods and restated all affected periods presented in accordance with the corrected treatment of these items.
Internal Control Over ~~Financing~~Financial Reporting

~~KPMG, the Company’s former auditors, identified material weaknesses~~There has been no change in internal control over financial reporting ~~based upon its audit of~~that occurred during the ~~2004 consolidated financial statements which it did not complete. After their engagement, we informed GGK of~~13- weeks ended September 30, 2006, that has materially affected, or is reasonably likely to materially affect, the ~~identified material weaknesses in~~Company’s internal control over financial reporting and other matters relating to the Company’s internal controls based upon KPMG’s incomplete audit of the 2004 consolidated financial statements. Upon completion of their audit of fiscal 2004, GGK has not brought to our attention any material weaknesses. Our management considered the material weaknesses identified by KPMG in evaluating the adequacy of the Company’s internal controls.
A control deficiency exists when the design or operation of a control does not allow management or employees, in the normal course of performing their assigned functions, to detect or prevent misstatements on a timely basis. A deficiency in design exists when (a) a control necessary to meet the control objective is missing, or (b) an existing control is not properly designed so that even if the control operates as designed, the control objective is not always met. A deficiency in operation exists when a properly designed control does not operate as designed, or when the person performing the control does not posses the necessary authority or qualification to perform the control effectively. A material weakness is a significant deficiency, or combination of significant deficiencies, that result in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. The following material weaknesses had been identified:
•
The Company lacks a sufficient number of financial and tax personnel with the appropriate level of expertise to independently monitor, interpret and implement the application of financial accounting standards in accordance with generally accepted accounting principles,
•
~~The environment of the Company was such that members of management were not encouraged to discuss transactions and events that could impact the appropriate financial reporting of the Company, and~~
•
The Company does not have adequate policies and procedures relating to the origination and maintenance of contemporaneous documentation to support key accounting judgments or to effectively document the terms of all significant contracts and agreements and the related accounting treatment for these contracts and agreements.
The Company has strengthened and replaced its senior management commencing with the May 5, 2004 appointment of a new Chief Executive Officer. Under new management, the Company is committed to meeting and enhancing its internal control obligations as part of the Company’s overall commitment to establishing a new corporate culture that focuses on ethics, unfettered communication within the organization and compliance, and sets a new standard for corporate behavior within the Company. Toward this end during 2004, the Company has:
•
~~Appointed a new Chief Executive Officer;~~
•
~~Replaced its Corporate Controller and Director of Internal Audit;~~
•
~~Instituted a policy of open channels of communication including regularly scheduled meetings of and with senior management;~~

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

reporting.

PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

See Note 43 to the condensed consolidated financial statements for information relating to the Company’s legal proceedings.

ITEM 3. ~~DEFAULTS UPON SENIOR SECURITIES~~1A. RISK FACTORS

~~Due to, among other things,~~The following sets forth material changes from the ~~Restatement, which resulted~~risk factors previously disclosed in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2005:
We have a majority shareholder who controls the Board and is also a secured lender and has filed a proposal to take the Company ~~violating several financial covenants~~private.
Chelsey, together with its affiliates, owns approximately 69% of the Company’s issued and outstanding Common Stock (including the January 10, 2005 purchase of 3,799,735 shares) and controls approximately 92% of the voting power (after giving effect to the exercise of all outstanding options and warrants to purchase Common

Stock beneficially owned by Chelsey and the Series C Preferred voting rights). Chelsey has appointed a majority of our Board of Directors including our Chairman, and Chelsey Finance is the Company’s ~~inability~~junior secured lender.
On February 23, 2006, Chelsey offered to ~~timely file~~purchase the remaining Common Stock that it did not already own and take the Company private. Shortly after receipt of the offer, 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 were 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 ~~periodic reports with the SEC, both~~independent counsel and engaged Houlihan Lokey Howard & Zukin as ~~discussed in Notes 2 and 8 to the Consolidated Financial Statements,~~its financial advisor.
On May 25, 2006, the Company was advised that discussions between Chelsey and the Special Committee concerning Chelsey's proposal to take the Company private at $1.25 per share had been terminated and as a result, the offer had been withdrawn.
As a result of Chelsey’s proposal, the Company, Chelsey and the Board members were sued in ~~technical default~~both Delaware Chancery Court and Superior Court of New Jersey Chancery Division. On July 18, 2006, the three independent members of the Board of Directors who were also the members of the Special Committee resigned with the result that none of the members of the Board are independent. In September, one of the plaintiffs also commenced an action to compel the Company to hold an annual meeting of stockholders.
It should also be noted that Chelsey has sufficient voting power to approve extraordinary transactions such as a sale of the Company or its assets or a going private transaction without the vote of the other Company’s shareholders. In certain transactions, these shareholders would have statutory appraisal rights under the ~~Wachovia~~Delaware General Corporation Law.
Our management team is critical to our success.
Our success depends to a significant extent upon our ability to attract and ~~Chelsey Facilities. The~~retain key personnel. Moreover, virtually all of our senior management team has been with the Company ~~has obtained waivers from~~for less than three years. Our current employment agreements with our CEO and CFO each expired in May 2006 and have been extended on a day-to-day basis. While both ~~Wachovia and Chelsey Finance for such defaults pursuant~~continue to ~~amendments~~provide employment services to the ~~Wachovia~~Company, there can be no assurance that they will continue to do so. Our success is dependent on the ability of our senior management to manage successfully our business and ~~Chelsey Facilities dated July 29, 2005.~~the individual catalogs. The loss of the services of one or more of our current members of senior management, or our failure to attract talented new employees, could have a material adverse effect on our business.
We receive a material portion of our operating profits from our sale of third party membership services and derive a material portion of our revenues by providing fulfillment services to third parties.
In 2005, we received approximately $10.7 million in revenues from our sale of Vertrue membership programs, which generates a material portion of our operating profit. We replaced our agreement with Vertrue in March 2006 with an agreement with Encore Marketing International (“Encore”) under which we sold Encore membership programs on a retail basis and were paid a commission. Both parties were disappointed with the results of the sale of Encore membership programs and we mutually elected to terminate the agreement. On October 18, 2006, we entered into an agreement with United Marketing Group, LLC (“UMG”) under which we sell UMG supplied membership programs on a wholesale basis. We expect that because of the different accounting treatment accorded revenues from the sale of memberships as a result of the different economic arrangements under the UMG and Encore agreements, that our membership income will be lower than would be the case had we continued to sell memberships on a retail basis with Encore for the fourth quarter of 2006 and 2007. There can be no assurances that our revenues from sales of membership programs will not decrease as a result of the change to a new membership program provider and/or the change from selling memberships on a wholesale versus a retail basis. Were this revenue stream to diminish or were we to lose it entirely, our operating results would be adversely affected. In addition, our membership program revenues may be adversely affected as more of our business transitions to the Internet where customer response rates are lower than the response rates for customers who place phone orders.
We also derive a material portion of our revenues by providing order processing and product fulfillment services to third parties. These revenues offset some of our fixed costs associated with operating our distribution facility and our call centers. Our services agreement with Gump’s expired in October 2006, our services agreement with National Geographic Society will terminate no later than May 30, 2007 and our services agreement with Improvements will expire in August 2007. While we expect to absorb this capacity through the growth of our own direct marketing operations, our results would be adversely affected if our direct marketing operations fail to make up for the lost revenues.

ITEM 6. EXHIBITS

10.91
Thirty-Seventh Amendment to Loan and Security Agreement, dated as of November 8, 2006, by and among Wachovia Bank, National Association and the Borrowers and Guarantors named therein.
10.92
Sixth Amendment to Loan And Security Agreement dated as of November 8, 2006, by and among Chelsey Finance, LLC and the Borrowers and Guarantors named therein.
10.93
Agreement between Hanover Direct, Inc. and United Marketing Group, LLC dated September 26, 2006.
31.1
Rule 13a-14(a) Certification signed by Wayne P. Garten.

31.2
Rule 13a-14(a) Certification signed by John W. Swatek.

32.1
Certification signed by Wayne P. Garten and John W. ~~Swatek.~~
Swatek pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

HANOVER DIRECT, INC.

(Registrant)

By:
/s/ 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,~~November 13, 2006

3127

	Quarter ended June 26, 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	$ 36,974	--	2,894	--	--	--	$ 39,868
Prepaid catalog costs	$ 15,780	--	1,893	--	--	--	$ 17,673
Other current assets	$ 3,132	--	689	--	--	--	$ 3,821
Total current assets	$ 69,610	--	5,476	--	--	--	$ 75,086
Deferred tax asset	$ 1,453	--	316	--	--	--	$ 1,769
Accounts payable	$ 39,678	--	77	--	--	1,020	$ 40,775
Accrued liabilities	$ 12,004	--	(434)	4,488	--	(10)	$ 16,048
Customer prepayments and credits	$ 5,839	2,394	7,432	--	987	--	$ 16,652
Deferred tax liability	$ 1,453	--	316	--	--	--	$ 1,769
Total current liabilities	$ 71,206	2,394	7,391	4,488	987	1,010	$ 87,476
Accumulated Deficit	$ (493,908)	(2,394)	(1,599)	(4,488)	(987)	(1,010)	$ (504,386)
Total Shareholders’ Deficiency	$ (46,503)	(2,394)	(1,599)	(4,488)	(987)	(1,010)	$ (56,981)
Net revenues	$ 86,870	(233)	1,107	--	--	--	$ 87,744
Cost of sales and operating expenses	$ 52,091	--	526	--	--	--	$ 52,617
Selling expenses	$ 23,360	--	268	--	--	65	$ 23,693
General and administrative expenses	$ 9,695	--	28	134	62	11	$ 9,930
Income before interest and income taxes	$ 843	(233)	285	(134)	(62)	(76)	$ 623
Benefit (provision) for Federal income taxes	$ 62	--	--	--	--	(169)	$ (107)
Benefit (provision) for state income taxes	$ 38	--	--	--	--	(41)	$ (3)
Net income (loss) and comprehensive income (loss)	$ 463	(233)	285	(134)	(62)	(286)	$ 33
Net income (loss) applicable to common shareholders	$ 463	(233)	285	(134)	(62)	(286)	$ 33
Net income (loss) per share-basic and diluted	$ 0.02	(0.01)	0.01	(0.01)	--	(0.01)	$ 0.00

	Six months ended June 26, 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)
Net revenues	$ 173,279	(497)	(3,757)	--	--	--	$ 169,025
Cost of sales and operating expenses	$ 105,413	--	(1,709)	--	--	--	$ 103,704
Selling expenses	$ 44,393	--	(1,216)	--	--	134	$ 43,311
General and administrative expenses	$ 19,361	--	(84)	134	120	23	$ 19,554
Income before interest and income taxes	$ 2,390	(497)	(748)	(134)	(120)	(157)	$ 734
Benefit (provision) for Federal income taxes	$ (1)	--	--	--	--	2	$ 1
Benefit (provision) for state income taxes	$ (4)	--	--	--	--	9	$ 5
Net income (loss) and comprehensive income (loss)	$ 882	(497)	(748)	(134)	(120)	(146)	$ (763)
Net income (loss) applicable to common shareholders	$ 882	(497)	(748)	(134)	(120)	(146)	$ (763)
Net income (loss) per share-basic and diluted	$ 0.04	(0.02)	(0.03)	(0.01)	(0.00)	(0.01)	$ (0.03)

	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	18	--	18
Paid in 2005	(1,153)	(538)	(1,691)
Reductions due to sale of Gump’s	--	(2,822)	(2,822)
Balance at June 25, 2005	$ 383	$ --	$ 383


Wachovia facility:
Tranche A term loans, interest rate of 6.5% at June 25, 2005, 5.5% at December 25, 2004 and 4.75% at June 26, 2004	1,989	2,985	3,482
Tranche B term loan, interest rate of 13% at June 26, 2004	--	--	3,311
Chelsey facility – stated interest rate of 11.0% (5.0% above prime rate) at June 25, 2005 and 10.0% (5.0% above prime rate) at December 25, 2004	9,706	8,159	--
Capital lease obligations	14	52	177
Long-term debt	11,709	11,196	6,970
Total debt	$ 16,344	$ 27,886	$ 19,202

	13- Weeks Ended				26- Weeks Ended
	June 25, 2005		June 26, 2004		June 25, 2005		June 26, 2004
			As Restated				As Restated

Net revenues	100.0	%	100.0	%	100.0	%	100.0	%
Cost of sales and operating expenses	60.9		60.0		60.6		61.4
Special charges	0.0		0.0		0.0		0.0
Selling expenses	25.7		27.0		25.3		25.6
General and administrative expenses	9.2		11.3		10.4		11.6
Depreciation and amortization	0.8		1.0		0.8		1.0
Income (loss) from operations	3.4		0.7		2.9		0.4
Interest expense, net	1.9		0.8		2.0		0.9
(Benefit) provision for Federal and state income taxes	0.1		0.1		0.0		0.0
Gain (loss) from discontinued operations of Gump’s	0.0		0.2		1.6		0.0
Net income (loss) and comprehensive income (loss)	1.4		0.0		2.5		(0.5)
Earnings applicable to Preferred Stock	0.0		0.0		0.1		0.0
Net income (loss) applicable to common shareholders	1.4	%	0.0	%	2.4	%	(0.5)	%

•	~~Improved~~a decline in operating ~~results generated from a $20.9 million increase in net revenues;~~
•	~~A favorable impact of $3.0 million of discontinued operations due to the gain of $3.6 million recognized relating to the March 14, 2005 sale of stock of~~ ~~Gump’s~~;
•	~~A favorable impact of $1.5 million due to the reduction in general~~profit primarily driven by higher outbound merchandise shipping, fulfillment, catalog paper and ~~administrative expenses related to severance recorded in the second quarter of 2004.~~

•	~~An unfavorable impact of $2.2 million on net interest expense primarily due to interest~~postage costs ~~incurred with the $20.0 million junior secured credit facility with Chelsey Finance (“Chelsey Facility,”)~~ which ~~the Company closed on July 8, 2004. See Note 8 of Notes to the condensed consolidated financial statements for additional information regarding the Chelsey Facility;~~aggregated $7.8 million;
•	An unfavorable impact of ~~$1.5~~$3.0 million ~~related~~from discontinued operations due to the sale of Gump’s in the first quarter of 2005;
•	a $0.7 million increase in compensation and fringe benefits; and
•	a $0.6 million increase in general and administrative expenses ~~incurred for~~attributable to severance recorded in 2006 related to the departure of the Company’s Chief Operating Officer;

•	a $1.8 million reduction in general and administrative expenses, primarily professional fees, as a result of the completion during 2005 of the independent investigation conducted by the Audit Committee of the Board of Directors ~~in connection with~~related to the restatement of the Company’s consolidated financial statements and other accounting-related ~~matters.~~matters; and
•	a $0.6 million reduction in general and administrative expenses related to reduced rent in 2006 as a result of the 2005 consolidation of the Company’s headquarters.

•	~~During the second quarter of 2004, the Company identified a revenue recognition cut-off issue that resulted~~Changes 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.

•	The Company lacks a sufficient number of financial and tax personnel with the appropriate level of expertise to independently monitor, interpret and implement the application of financial accounting standards in accordance with generally accepted accounting principles,
•	~~The environment of the Company was such that members of management were not encouraged to discuss transactions and events that could impact the appropriate financial reporting of the Company, and~~
•	The Company does not have adequate policies and procedures relating to the origination and maintenance of contemporaneous documentation to support key accounting judgments or to effectively document the terms of all significant contracts and agreements and the related accounting treatment for these contracts and agreements.

•	~~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.~~

•	~~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.

10.91	Thirty-Seventh Amendment to Loan and Security Agreement, dated as of November 8, 2006, by and among Wachovia Bank, National Association and the Borrowers and Guarantors named therein.

10.92	Sixth Amendment to Loan And Security Agreement dated as of November 8, 2006, by and among Chelsey Finance, LLC and the Borrowers and Guarantors named therein.

10.93	Agreement between Hanover Direct, Inc. and United Marketing Group, LLC dated September 26, 2006.

31.1	Rule 13a-14(a) Certification signed by Wayne P. Garten.

31.2	Rule 13a-14(a) Certification signed by John W. Swatek.

32.1	Certification signed by Wayne P. Garten and John W. ~~Swatek.~~ Swatek pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

	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,~~November 13, 2006