SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended MARCH 27,JUNE 26, 2004
Commission file number 1-08056
HANOVER DIRECT, INC.
-------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
DELAWARE 13-0853260
------------------------ ----------------------------------------- ----------
(State of incorporation) (IRS Employer Identification No.)
115 RIVER ROAD, BUILDING 10, EDGEWATER, NEW JERSEY 07020
- -------------------------------------------------- -----------------------
(Address of principal executive offices) (Zip Code)
(201) 863-7300
--------------
(Telephone number)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES [X] NO [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). YES [ ] NO [X]
Common stock, par value $.66 2/3 per share: 220,173,633224,518,395 shares outstanding (net
of treasury shares) as of May 3,August 4, 2004.
HANOVER DIRECT, INC.
TABLE OF CONTENTS
Page
----
Part I - Financial Information
Item 1. Financial Statements
Condensed Consolidated Balance Sheets -
March 27,June 26, 2004 and Restated December 27, 2003 ............................................................................................. 2
Condensed Consolidated Statements of Income (Loss) - 13-13 and 26- weeks ended
March 27,June 26, 2004 and March 29,Restated June 28, 2003 .................................................. 4
Condensed Consolidated Statements of Cash Flows - 13-13 and 26- weeks ended
March 27,June 26, 2004 and March 29,Restated June 28, 2003................................................... 5
Notes to Condensed Consolidated Financial Statements..................................Statements......................................... 6
Item 2. Management's Discussion and Analysis of Consolidated Financial Condition and
Results of Operations............................................................... 18Operations...................................................................... 23
Item 3. Quantitative and Qualitative Disclosures about Market Risk...................... 27Risk............................. 35
Item 4. Controls and Procedures......................................................... 27Procedures................................................................ 35
Part II - Other Information
Item 1. Legal Proceedings............................................................... 28Proceedings...................................................................... 37
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds............................ 40
Item 5. Other Information............................................................... 32Information...................................................................... 40
Item 6. Exhibits and Reports on Form 8-K................................................ 33
Signatures............................................................................... 348-K....................................................... 42
Signatures...................................................................................... 44
1
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
HANOVER DIRECT, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS OF DOLLARS, EXCEPT SHARE AMOUNTS)
(UNAUDITED)
MARCH 27,JUNE 26, DECEMBER 27,
2004 2003
----------- ------------
(UNAUDITED)---- ----
(AS RESTATED)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 2,434392 $ 2,282
Accounts receivable, net of allowance for doubtful accounts of
$1,069$1,035 and $1,105, respectively 12,614 14,33513,332 13,802
Inventories 37,646 41,57636,974 41,794
Prepaid catalog costs 15,305 11,80815,780 11,945
Other current assets 3,2943,132 3,951
--------- ---------
Total Current Assets 71,293 73,95269,610 73,774
--------- ---------
PROPERTY AND EQUIPMENT, AT COST:
Land 4,361 4,361
Buildings and building improvements 18,21018,212 18,210
Leasehold improvements 10,108 10,108
Furniture, fixtures and equipment 53,33153,519 53,212
--------- ---------
86,01086,200 85,891
Accumulated depreciation and amortization (59,125)(60,129) (58,113)
--------- ---------
Property and equipment, net 26,88526,071 27,778
--------- ---------
Goodwill 9,278 9,278
Deferred tax assets 2,213 2,213
Other assets 1,7421,642 1,575
--------- ---------
Total Assets $ 111,411108,814 $ 114,796114,618
========= =========
Continued on next page.
2
HANOVER DIRECT, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (CONTINUED)
(IN THOUSANDS OF DOLLARS, EXCEPT SHARE AMOUNTS)
(UNAUDITED)
MARCH 27,JUNE 26, DECEMBER 27,
2004 2003
----------- ------------
(UNAUDITED)---- ----
(AS RESTATED)
LIABILITIES AND SHAREHOLDERS' DEFICIENCY
CURRENT LIABILITIES:
Short-term debt and capital lease obligations $ 15,13512,232 $ 13,468
Accounts payable 38,499 41,88039,678 41,834
Accrued liabilities 11,997 12,91812,004 12,907
Customer prepayments and credits 5,8665,839 5,485
Deferred tax liability 2,213 2,213
--------- -------------------- ----------
Total Current Liabilities 73,710 75,964
--------- ---------71,966 75,907
----------- ----------
NON-CURRENT LIABILITIES:
Long-term debt 8,0016,970 9,042
Series C Participating Preferred Stock, authorized, issued and
outstanding 564,819 shares; liquidation preference of $56,482 72,689 72,689
Other 4,0973,692 4,609
--------- -------------------- ----------
Total Non-current Liabilities 84,78783,351 86,340
--------- -------------------- ----------
Total Liabilities 158,497 162,304
--------- ---------155,317 162,247
----------- ----------
SHAREHOLDERS' DEFICIENCY:
Common Stock, $0.66 2/3 par value, authorized 300,000,000
shares; 222,294,562 shares issued and 220,173,633 shares outstanding 148,197 148,197
Capital in excess of par value 302,436302,554 302,432
Accumulated deficit (494,373) (494,791)
--------- ---------
(43,740) (44,162)
--------- ---------(493,908) (494,912)
----------- ----------
(43,157) (44,283)
----------- ----------
Less:
Treasury stock, at cost (2,120,929 shares) (2,996) (2,996)
Notes receivable from sale of Common Stock (350) (350)
--------- -------------------- ----------
Total Shareholders' Deficiency (47,086) (47,508)
--------- ---------(46,503) (47,629)
----------- ----------
Total Liabilities and Shareholders' Deficiency $ 111,411108,814 $ 114,796
========= =========114,618
=========== ==========
See notesNotes to Condensed Consolidated Financial Statements.
3
HANOVER DIRECT, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (LOSS)
(IN THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
FOR THE 13- WEEKS ENDED ---------------------------
MARCH 27, MARCH 29,FOR THE 26- WEEKS ENDED
----------------------- -----------------------
JUNE 28, JUNE 28,
JUNE 26, 2003 JUNE 26, 2003
2004 2003
---------- ----------AS RESTATED 2004 AS RESTATED
---- ---- ---- ----
NET REVENUES $ 95,31296,482 $ 102,474
---------- ----------105,883 $ 191,857 $ 207,412
--------- --------- --------- ---------
OPERATING COSTS AND EXPENSES:
Cost of sales and operating expenses 59,243 65,53958,009 66,291 117,294 131,398
Special charges (income) (31) 27743 211 11 488
Selling expenses 23,276 24,45325,754 26,922 49,029 51,100
General and administrative expenses 10,367 11,27810,419 9,491 20,786 20,746
Depreciation and amortization 1,012 1,183
---------- ----------
93,867 102,730
---------- ----------1,004 1,138 2,016 2,321
--------- --------- --------- ---------
95,229 104,053 189,136 206,053
--------- --------- --------- ---------
INCOME (LOSS) FROM OPERATIONS 1,445 (256)1,253 1,830 2,721 1,359
Gain on sale of Improvements -- -- -- 1,911
---------- ------------------- --------- --------- ---------
INCOME BEFORE INTEREST AND INCOME TAXES 1,445 1,6551,253 1,830 2,721 3,270
Interest expense, net 922 1,448
---------- ----------790 1,120 1,712 2,568
--------- --------- --------- ---------
INCOME BEFORE INCOME TAXES 523 207
Provision463 710 1,009 702
(Benefit) provision for Federal income taxes 63(62) -- Provision1 --
(Benefit) provision for state income taxes 42 15
---------- ----------(38) (5) 4 10
--------- --------- --------- ---------
NET INCOME AND COMPREHENSIVE INCOME 418 192563 715 1,004 692
Preferred stock dividends -- 3,6324,290 -- 7,922
Earnings Applicableapplicable to Preferred Stock (1)1 -- ---------- ----------2 --
--------- --------- --------- ---------
NET INCOME (LOSS) APPLICABLE TO COMMON SHAREHOLDERS $ 417562 $ (3,440)
========== ==========(3,575) $ 1,002 $ (7,230)
--------- --------- --------- ---------
NET INCOME (LOSS) PER COMMON SHARE:
Net income (loss) per common share - basic and diluted $ .000.00 $ (.02)
========== ==========(0.02) $ 0.00 $ (0.05)
--------- --------- --------- ---------
Weighted average common shares outstanding -
basic (thousands) 220,174 138,316 ========== ==========220,174 138,316
--------- --------- --------- ---------
Weighted average common shares outstanding -
diluted (thousands) 220,666220,174 138,316 ========== ==========220,455 138,316
--------- --------- --------- ---------
See notesNotes to Condensed Consolidated Financial Statements.
4
HANOVER DIRECT, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS OF DOLLARS)
(UNAUDITED)
FOR THE 13-26- WEEKS ENDED
---------------------------
MARCH 27, MARCH 29,-----------------------
JUNE 26, JUNE 28,
2004 2003
---------- ----------AS RESTATED
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 4181,004 $ 192692
Adjustments to reconcile net income to net cash usedprovided (used) by operating activities:
Depreciation and amortization, including deferred fees 1,077 1,6802,158 2,966
Provision for doubtful accounts 87 179268 298
Special charges (income) (31) 27711 488
Gain on the sale of Improvements -- (1,911)
Gain on the sale of property and equipment -- (2)
Compensation expense related to stock options 4 177122 341
Changes in assets and liabilities:
Accounts receivable 1,634 3,186202 2,114
Inventories 3,930 (294)4,820 3,418
Prepaid catalog costs (3,497) (3,763)(3,835) (1,844)
Accounts payable (3,381) 1,708(2,156) (1,703)
Accrued liabilities (890) (6,648)(914) (11,082)
Customer prepayments and credits 381 2,178354 2,396
Other, net (309) (455)
---------- ----------(530) (1,087)
-------- --------
Net cash usedprovided (used) by operating activities (577) (3,496)
---------- ----------1,504 (4,916)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisitions of property and equipment (119) (546)(308) (1,202)
Proceeds from the sale of Improvements -- 2,000
Costs related to the early release of escrow funds -- (89)
Proceeds from disposal of property and equipment -- 2
---------- ------------------ --------
Net cash (used) provided by investing activities (119) 1,367
---------- ----------(308) 711
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net (payments) borrowings under Congress revolving loan facility 1,759 5,270(1,050) 6,453
Payments under Congress Tranche A term loan facility (498) (497)(996) (994)
Payments under Congress Tranche B term loan facility (450) (450)(900) (900)
Payments of long-term debt and capital lease obligations (185) (4)(362) (6)
Payment of debt issuance costs (125) (34)(78)
Refund (payment) of estimated Richemont tax obligation on Series B Participating Preferred
Stock accretion 347 (347)
---------- ------------------ --------
Net cash (used) provided by financing activities 848 3,938
---------- ----------(3,086) 4,128
-------- --------
Net increasedecrease in cash and cash equivalents 152 1,809(1,890) (77)
Cash and cash equivalents at the beginning of the year 2,282 785
---------- ------------------ --------
Cash and cash equivalents at the end of the period $ 2,434392 $ 2,594
========== ==========708
======== ========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid for:
Interest $ 7331,332 $ 8061,642
Income taxes $ 68 $ 196663
Non-cash investing and financing activities:
Series B Participating Preferred Stock redemption price increase $ -- $ 3,2857,575
See notesNotes to Condensed Consolidated Financial Statements.
5
HANOVER DIRECT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited interim condensed consolidated financial
statements have been prepared in accordance with the instructions for Form 10-Q
and, therefore, do not include all information and footnotes necessary for a
fair presentation of financial condition, results of operations and cash flows
in conformity with generally accepted accounting principles. Reference should be
made to the annual financial statements, including the footnotes thereto,
included in the Hanover Direct, Inc. (the "Company") Annual Report on Form 10-K
for the fiscal year ended December 27, 2003.2003, as amended. In the opinion of
management, the accompanying unaudited interim condensed consolidated financial
statements contain all material adjustments, consisting of normal recurring
accruals, necessary to present fairly the financial condition, results of
operations and cash flows of the Company and its consolidated subsidiaries for
the interim periods. Operating results for interim periods are not necessarily
indicative of the results that may be expected for the entire year. Pursuant to
Statement of Financial Accounting Standards ("SFAS") No. 131, "Disclosures about
Segments of an Enterprise and Related Information," the consolidated operations
of the Company are reported as one segment.
Uses of Estimates and Other Critical Accounting Policies
The condensed consolidated financial statements include all subsidiaries
of the Company and all intercompany transactions and balances have been
eliminated. The preparation of financial statements, in conformity with
generally accepted accounting principles, requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities, the
disclosure of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
See "Management's Discussion and Analysis of Consolidated Financial
Condition and Results of Operations," found in the Company's Annual Report on
Form 10-K for the fiscal year ended December 27, 2003, as amended, for
additional information relating to the Company's use of estimates and other
critical accounting policies.
2. RESTATEMENTS OF PRIOR PERIOD FINANCIAL STATEMENTS
During the second quarter of 2004, the Company identified a revenue
recognition cut-off issue that resulted in revenue being recorded in advance of
the actual shipment of merchandise to the customer. The practice was stopped
immediately. The impact of the restatement on the years ended December 30, 2000,
December 29, 2001 and December 28, 2002 as well as the quarterly and
year-to-date financial statements for each of the periods ended March 29, 2003,
June 28, 2003, September 27, 2003 and December 27, 2003 is not material. The
affected prior quarters' and annual periods' results have been restated as set
forth below.
6
YEAR ENDED DECEMBER 30, 2000
----------------------------
AS
PREVIOUSLY
REPORTED AS RESTATED
-------- -----------
(IN THOUSANDS)
Accounts receivable, net $ 27,703 $ 27,357
Inventory $ 69,612 $ 69,731
Total Current Assets $ 128,446 $ 128,313
Accumulated Deficiency $(471,651) $(471,753)
Total Shareholders' Deficiency $ (24,452) $ (24,554)
Net revenues $ 603,014 $ 602,668
Loss before interest and income taxes $ (70,552) $ (70,652)
Net loss and comprehensive income loss $ (80,800) $ (80,900)
Net loss applicable to common shareholders $ (84,815) $ (84,915)
Net loss per share-basic and diluted $ (0.40) $ (0.40)
YEAR ENDED DECEMBER 29, 2001
----------------------------
AS
PREVIOUSLY
REPORTED AS RESTATED
-------- -----------
(IN THOUSANDS)
Net revenues $ 532,165 $ 532,519
Income before interest and income taxes $ 804 $ 906
Net loss and comprehensive income loss $ (5,845) $ (5,743)
Net loss applicable to common shareholders $ (16,590) $ (16,488)
Net loss per share-basic and diluted $ (0.08) $ (0.08)
YEAR ENDED DECEMBER 28, 2002
----------------------------
AS
PREVIOUSLY
REPORTED AS RESTATED
-------- -----------
(IN THOUSANDS)
Accounts receivable, net $ 16,945 $ 16,938
Inventory $ 53,131 $ 53,134
Total Current Assets $ 88,287 $ 88,285
Accumulated Deficiency $(486,627) $(486,628)
Total Shareholders' Deficiency $ (58,841) $ (58,842)
Net revenues $ 457,644 $ 457,638
Net loss per share-basic and diluted $ (0.18) $ (0.18)
7
QUARTER ENDED MARCH 29, 2003
----------------------------
AS
PREVIOUSLY
REPORTED AS RESTATED
-------- -----------
(IN THOUSANDS)
Accounts receivable, net $ 13,580 $ 12,652
Inventory $ 53,425 $ 53,787
Total Current Assets $ 90,837 $ 90,548
Accumulated Deficiency $(486,435) $(486,650)
Total Shareholders' Deficiency $ (62,103) $ (62,318)
Net revenues $ 102,474 $ 101,529
Income before interest and income taxes $ 1,655 $ 1,440
Net income (loss) and comprehensive income (loss) $ 192 $ (23)
Net loss applicable to common shareholders $ (3,440) $ (3,655)
Net loss per share-basic and diluted $ (0.02) $ (0.03)
QUARTER ENDED JUNE 28, 2003
---------------------------
AS
PREVIOUSLY
REPORTED AS RESTATED
-------- -----------
(IN THOUSANDS)
Accounts receivable, net $ 15,360 $ 14,526
Inventory $ 49,382 $ 49,716
Total Current Assets $ 84,667 $ 84,381
Accumulated Deficiency $(485,745) $(485,935)
Total Shareholders' Deficiency $ (65,540) $ (65,730)
Net revenues $ 105,765 $ 105,883
Income before interest and income taxes $ 1,805 $ 1,830
Net income and comprehensive income $ 690 $ 715
Net loss applicable to common shareholders $ (3,600) $ (3,575)
Net loss per share-basic and diluted $ (0.02) $ (0.02)
SIX MONTHS ENDED JUNE 28, 2003
------------------------------
AS
PREVIOUSLY
REPORTED AS RESTATED
-------- -----------
(IN THOUSANDS)
Net revenues $ 208,239 $ 207,412
Income before interest and income taxes $ 3,460 $ 3,270
Net income and comprehensive income $ 882 $ 692
Net loss applicable to common shareholders $ (7,040) $ (7,230)
Net loss per share-basic and diluted $ (0.05) $ (0.05)
8
QUARTER ENDED SEPTEMBER 27, 2003
--------------------------------
AS
PREVIOUSLY
REPORTED AS RESTATED
-------- -----------
(IN THOUSANDS)
Net revenues $ 96,633 $ 97,466
Income (loss) before interest and income taxes $ (64) $ 126
Net loss and comprehensive loss $ (16,645) $ (16,455)
Net loss applicable to common shareholders $ (16,645) $ (16,455)
Net loss per share-basic and diluted $ (0.12) $ (0.12)
NINE MONTHS ENDED SEPTEMBER 27, 2003
------------------------------------
AS
PREVIOUSLY
REPORTED AS RESTATED
-------- -----------
(IN THOUSANDS)
Net revenues $ 304,872 $ 304,878
Net loss per share-basic and diluted $ (0.17) $ (0.17)
QUARTER ENDED DECEMBER 27, 2003
-------------------------------
AS
PREVIOUSLY
REPORTED AS RESTATED
-------- -----------
(IN THOUSANDS)
Accounts receivable, net $ 14,335 $ 13,802
Inventory $ 41,576 $ 41,794
Total Current Assets $ 73,952 $ 73,774
Accumulated Deficiency $(494,791) $(494,912)
Total Shareholders' Deficiency $ (47,508) $ (47,629)
Net revenues $ 110,002 $ 109,469
Income before interest and income taxes $ 4,621 $ 4,500
Net income and comprehensive income $ 364 $ 243
Net income applicable to common shareholders $ 364 $ 243
Net income per share-basic and diluted $ 0.00 $ 0.00
9
YEAR ENDED DECEMBER 27, 2003
----------------------------
AS
PREVIOUSLY
REPORTED AS RESTATED
-------- -----------
(IN THOUSANDS)
Net revenues $ 414,874 $ 414,347
Income before interest and income taxes $ 8,017 $ 7,896
Net loss and comprehensive loss $ (15,399) $ (15,520)
Net loss applicable to common shareholders $ (23,321) $ (23,442)
Net loss per share-basic and diluted $ (0.16) $ (0.16)
QUARTER ENDED MARCH 27,2004
----------------------------
AS
PREVIOUSLY
REPORTED AS RESTATED
-------- -----------
(IN THOUSANDS)
Accounts receivable, net $ 12,614 $ 12,145
Inventory $ 37,646 $ 37,835
Total Current Assets $ 71,293 $ 71,152
Accumulated Deficiency $(494,373) $(494,470)
Total Shareholders' Deficiency $ (47,086) $ (47,183)
Net revenues $ 95,312 $ 95,375
Income before interest and income taxes $ 1,445 $ 1,468
Net income and comprehensive income $ 418 $ 441
Net income applicable to common shareholders $ 417 $ 440
Net income per share-basic and diluted $ 0.00 $ 0.00
The restatements did not result in a change to the Company's cash flows
during the restated periods; however it did result in technical defaults by the
Company with its covenants under the Congress Credit Facility and the Term Loan
Facility. Congress and Chelsey Finance have waived such defaults.
3. DIVIDEND RESTRICTIONS
The Company is restricted from paying dividends at any time on its Common
Stock or from acquiring its capital stockCommon Stock by certain debt covenants contained in
agreements to which the Company is a party.
3.4. NET INCOME (LOSS) PER COMMON SHARE
Net income (loss) per common share is computed using the weighted average
number of common shares outstanding in accordance with the provisions of
Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per
Share" ("FAS 128"). Basic net income (loss) per common share is calculated by
dividing net income (loss) available to common shareholders, reduced for
participatory interests, by the weighted average number of common shares
outstanding during the period. Diluted net income (loss) per common share is
calculated using the weighted average number of common shares outstanding
adjusted to include the potentially dilutive effect of convertible stock or
stock options. The computations of basic and diluted net income (loss) per
common share are as follows (in thousands)thousands except per share amounts):
610
MARCH 27,FOR THE 13- WEEKS ENDED FOR THE 26- WEEKS ENDED
----------------------- -----------------------
JUNE 26, JUNE 28, JUNE 26, JUNE 28,
2004 MARCH 29, 2003 -------------- --------------2004 2003
AS RESTATED AS RESTATED
---- ---- ---- ----
Net income $ 418563 $ 192715 $ 1,004 $ 692
Less:
Preferred stock dividends -- (3,632)4,290 -- 7,922
Earnings Applicableapplicable to preferred stock (1)1 -- 2 --
--------- --------- --------- ---------
Net income (loss) applicable to common shareholders $ 417562 $ (3,440)(3,575) $ 1,002 $ (7,230)
========= ========= ========= =========
Basic net income (loss) per common share $ 0.00 $ (0.02) $ 0.00 $ (0.05)
========= ========= ========= =========
Weighted-average common shares outstanding 220,174 138,316 220,174 138,316
========= ========= Net income (loss) applicable to common shareholders $ 417 $ (3,440)
Dilutive securities:
Stock options -- --
--------- ---------========= =========
Diluted net income (loss) $ 417562 $ (3,440)(3,575) $ 1,002 $ (7,230)
========= ========= ========= =========
Diluted net income (loss) per common share $ 0.00 $ (0.02) $ 0.00 $ (0.05)
========= ========= ========= =========
Weighted-average common shares outstanding 220,174 138,316 220,174 138,316
Effect of Dilution:
Stock options 492 10-- -- 281 --
--------- --------- --------- ---------
Weighted-average common shares outstanding
assuming dilution 220,666 138,326220,174 138,316 220,455 138,316
========= ========= ========= =========
Diluted net income (loss) per common share excluded incremental shares of
3.914.6 million and 14.4 million for the 13-week periods ended March 27,June 26, 2004 and
March 29,June 28, 2003, respectively, and 12.3 million and 14.4 million incremental
shares for the 26-week periods ended June 26, 2004 and June 28, 2003,
respectively. These incremental shares were related to employee stock options
and were excluded due to their antidilutive effect.
4.5. COMMITMENTS AND CONTINGENCIES
A class action lawsuit was commenced on March 3, 2000 in the District
Court in Sequoyah County, Oklahoma entitled Edwin L. Martin v. Hanover Direct,
Inc. and John Does 1 through 10 bearing case no.
CJ2000-177 in the State Court of Oklahoma (District Court in and for Sequoyah
County). Plaintiff commenced the action on behalf of himself and a class of
persons who have at any time purchased a product from the Company and paid for
an "insurance charge." The complaint("Martin"), which sets forth claims for breach
of contract, unjust enrichment, recovery of money paid absent consideration,
fraud and a claim under the New Jersey Consumer Fraud Act.Act as a result of
"insurance charges" paid to the Company by participants in the class action
suit. The complaint alleges that the Company charges its customers for delivery
insurance even though, among other things, the Company's common carriers already
provide insurance and the insurance charge provides no benefit to the Company's
customers. Plaintiff also seeks a declaratory judgment as to the validity of the
delivery insurance. The
damages sought are (i)Plaintiff seeks an order (i) directing the Company to return
to the plaintiff and class members the "unlawful revenue" derived from the
insurance charges, (ii) declaring the rights of the parties, (iii) permanently enjoining the
Company from imposing thean insurance charge, (iv) awarding threefold damages of
less than $75,000 per plaintiff and per class member, and (v) awarding
attorneys' fees and costs. On April 12,July 23, 2001, the Court heldcertified a hearing on plaintiff's class
certification motion. Subsequent to the April 12, 2001 hearing on plaintiff's
class certification motion, plaintiff filed a motion to amend the definitioncomprised of the class. On July 23, 2001, plaintiff's class certification motion was granted,
defining the class as "Allall persons in the United States who are customers of any catalog
or catalog company owned by Hanover Direct, Inc.the Company and who have at any time purchased a product
from any such company and paid money thatwhich was designated to be an insurance`insurance
charge." On August 21, 2001, the' The Company filed an appeal of the order with the Oklahoma Supreme Court and subsequently moved to stay proceedings
in the district court pending resolution of the appeal. The appeal has been
fully briefed. At a subsequent status hearing, the parties agreed that issues
pertaining to notice to the class would be stayed pending resolution of the
appeal, that certain other issues would be subject to limited discovery, and
that the issue of a stay for any remaining issues would be resolved if and when
such issues arise.certification. On January 20,
2004, the plaintiff filed a motion for oral argument withon the Court.appeal of the class
certification. The Company believes it has defenses against the claims and plans
to conduct a vigorous defense of this action. The Company believes that a loss
is not probable; therefore, no accrual for potential losses was deemed
necessary.
On August 15, 2001, the Company was served with a summons and four-count
complaint filed in Superior Court for the City and County of San
Francisco, California, entitled Teichman v. Hanover Direct, Inc., Hanover Brands, Inc.,
Hanover Direct Virginia, Inc., and Does 1-100.1-100 ("Teichman"), which was
subsequently expanded to include other Hanover Direct, Inc. subsidiaries as
defendants. The complaint was filed by a California resident in the Superior
Court for the City and County of San Francisco seeking damages and other relief
for herself and a class of all others similarly situated arising out of the
insurance fee charged by catalogs and Internet sites operated by subsidiaries of
the Company. Defendants, includingOn May 14, 2002, as a result of the Company have filed motions to dismiss based on a lack
of personal jurisdiction over them. In January 2002, plaintiff sought leave to
name six additional entities: International Male, Domestications Kitchen &
Garden, Silhouettes, Hanover Company Store, Kitchen & Home, and Domestications
as co-defendants. On March 12, 2002, the Company was served with the First
Amended Complaint in which plaintiff named as defendants the Company, Hanover
Brands, Hanover Direct Virginia, LWI Holdings, Hanover Company Store, Kitchen
and Home, and Silhouettes. On April 15, 2002, the Companyhaving filed a Motion
to Stay the Teichman action in favor of the previously filedpreviously-filed Martin action and also
filed a
Motion to quash service of summons
7
for lack of personal jurisdiction on behalf of defendantsDismiss the case against Hanover Direct, Inc., Hanover Brands, Inc.,
and Hanover Direct Virginia, Inc. On May 14, 2002,for lack of personal jurisdiction, the Court
(1)
11
granted the Company's Motion to quashStay the action in favor of the previously-filed
Martin action, and (2) granted the Company's Motion to Quash service, on behalf of Hanover
Direct, Hanover Brands, and Hanover Direct Virginia, leaving
only LWI Holdings, Hanover Company Store, Kitchen & Home, and Silhouettes as
defendants, and (2)
granted the Company's Motion to Stay the action in favor of the previously filed
Oklahoma action, so nothing will proceed on this case against the remaining
entities until the Oklahoma case is decided.defendants. The Company believes it has defenses against the claims. The Companyclaims and plans to
conduct a vigorous defense of this action. The Company believes that a loss is
not probable; therefore, no accrual for potential losses was deemed necessary.
A class action lawsuit was commenced on February 13, 2002 in the Superior
Court of the State of California, City and County of San Francisco entitled Jacq
Wilson, suing on behalf of himself, all others similarly situated, and the
general public v. Brawn of California, Inc. dba International Male and
Undergear, and Does 1-100 ("Brawn") in the Superior Court of the State of
California, City and County of San Francisco.. Does 1-100 are Internet and catalog direct
marketers offering a selection of men's clothing, sundries, and shoes who
advertise within California and nationwide. The complaint allegesalleged that, for at
least four years, members of the class havehad been charged an unlawful, unfair, and
fraudulent insurance fee and tax on orders sent to them by Brawn; that Brawn was
engaged in untrue, deceptive and misleading advertising in that it was not
lawfully required or permitted to collect insurance, tax and sales tax from
customers in California; and that Brawn has engaged in acts of unfair
competition under the state's Business and Professions Code. Plaintiff and the
class seek (i) restitution and disgorgement of all monies wrongfully collected and
earned by Brawn, including interest and other gains, made on account of these
practices, including reimbursement in the amount of the
insurance tax and sales
tax collected unlawfully, togethercharge with interest, (ii) an order enjoining Brawn from charging customersimposing insurance and tax
on its order forms and/or from
charging tax on the delivery, shippingforms; and insurance charges, (iii) an order
directing Brawn to notify the California State Board of Equalization of the
failure to pay the correct amount of tax to the state and to take appropriate
steps to provide the state with the information needed for audit, and (iv) compensatory damages, attorney'sattorneys' fees, pre-judgment
interest and costs of the suit. The claims of(Plaintiff lost at trial on the individually named plaintifftax issue and
for each member ofhas not appealed it so it is no longer among the class amount to less than $75,000. On April 15, 2002, the Company filed a Motion
to Stay the Wilson actionissues being litigated in favor of the previously filed Martin action. On May
14, 2002, the Court denied the Motion to Stay. The Wilson case proceeded to
trial before the Honorable Diane Elan Wick of the Superior Court of California
for the County of San Francisco, and the Judge, sitting without a jury, heard
evidence from April 15-17, 2003.this
case.) On November 25, 2003, the Court, after hearing
evidence and considering post-trial submissions from the parties,a trial, entered judgment in plaintiff's favor,for the
plaintiff and the class, requiring Brawn, by June 30, 2004, to refund insurance
feescharges collected from consumers for the period from February 13, 1998 through
January 15, 2003 with interest from the date paid by June 30, 2004. Plaintiff did not
prevail onpaid. On April 14, 2004, the tax issues.Court
awarded plaintiff's counsel approximately $445,000 of attorneys' fees. On January 12, 2004, plaintiff filed a motion
requesting approximately $740,000 in attorneys' fees and costs. On February 27,April
23, 2004, the Company filed its responsea Motion to that motion. PlaintiffStay the enforcement of the insurance
fees judgment pending resolution of the appeal, including a request to
extinguish a lien filed a reply
brief on March 13, 2004. A hearing was held on plaintiff's motion on March 18,
2004. The judge ruled on that motion on April 14,2, 2004, awarding plaintiff's
counsel approximately $445,000.and including a request for a
determination that an appellate bond will not be required by the Company. This
motion was heard on May 11, 2004 and granted, the Court finding that enforcement
of the judgment entered was stayed on January 23, 2004 when Brawn filed its
Notice of Appeal. The Company has appealed the trial court's decision on the
merits of the insurance fees issue as well as the decision on the attorneys'
fees issue. TheOn May 18, 2004, the Court of Appeals issued an Order consolidating
the two appeals will likely be consolidated with
briefing expected to begin in late May 2004. The Company will be required to
post a bond in the amount of approximately $750,000 while the appeal of the
attorneys' fees award is proceeding but its counsel does not believe the Company
will be required to do so while the appeal on the insurance fees decision is
proceeding.appeals. The Company plans to conduct a vigorous defense of this action.
The potential estimated exposure is in the range of $0 to $4.0 million. Based
upon the Company's policy of evaluating accruals for legal liabilities, the
Company has not established a reserve due toas a result of management determining that
it is not probable that an unfavorable outcome will result.
A class action lawsuit was commenced on October 28, 2002 in the Superior
Court of New Jersey, Bergen County - Law Division entitled John Morris,
individually and on behalf of all other persons & entities similarly situated v.
Hanover Direct, Inc., and Hanover Brands, Inc. (referred to herein this paragraph as
"Hanover"), No. L 8830-02 in the Superior Court of New Jersey, Bergen County --
Law Division.. The plaintiff bringsbrought the action individually and on behalf of a
class of all persons and entities in New Jersey who purchased merchandise from
Hanover within six years prior to filing of the lawsuit and continuing to the
date of judgment. On the basis of a purchase made by plaintiff in August 2002 of
certain clothing from a Hanover (which was from a men's division catalog, the only
ones which retained the insurance line item in 2002), Plaintiff claimsplaintiff alleged that for
at least six years, Hanover
maintainedhad a policy and practice of improperly adding a charge for "insurance" to the
orders it received, and concealed and failed to disclose its policy with respect to all class members.the charge. Plaintiff
claims that Hanover's conduct was (i) in violation of the New Jersey Consumer Fraud
Act as otherwise deceptive, misleading and unconscionable; (ii)unconscionable such as to constitute
Unjust
Enrichmentunjust enrichment of Hanover at the expense and to the detriment of plaintiff
and the class;class and (iii) unconscionable per se under the Uniform Commercial Code for
contracts related to the sale of goods. Plaintiff and the class seek damages
equal to the amount of all insurance charges, interest thereon, treble and
punitive damages, injunctive relief, costs and reasonable attorneys' fees, and
such other relief as may be just, necessary and appropriate. On December 13,
2002, the Company filed a Motion to Stay the Morrisaction pending resolution of the
previously-filed Martin action in favor of the
previously filed Martin action. Plaintiff then filed an Amended Complaint adding
International Male as a defendant. Hearing on the Motion to Stay took place on
June 5, 2003.Oklahoma. The Court granted the Company's
Motion to Stay the action and the case was stayed, first until December 31, 2003 and subsequentlyextended once, until March 31, 2004. The2004,
at which time the stay was lifted on March 31, 2004.lifted. On April 30, 2004, the Company responded to
plaintiff'sPlaintiff's Amended Complaint by filing a Motion for Summary
Judgment thatComplaint. The case is currently scheduled to be heard byin the Court on June 11, 2004.discovery phase. The Company
plans to conduct a vigorous defense of this action. 8
The Company believes that a
loss is not probable; therefore, no accrual for potential losses was deemed
necessary.
On June 28, 2001, Rakesh K. Kaul, the former President and Chief Executive
Officer of the Company, filed a five-count complaint (the "Complaint") in New York State Court against the Company, seeking
damages and other relief arising out of his separation of employment
12
from the Company. On or about July 13, 2004, a final judgment was entered
whereby the Court ordered and adjudged that certain claims in the case are
dismissed with prejudice and that Mr. Kaul is to recover from the Company
including
severance payments of $2,531,352 plus the cost of employee benefits, attorneys'
fees and costs incurred in connection with the enforcement of his rights under
his employment agreement with the Company, payment of $298,650 for 13$45,946, representing four weeks of accrued and unused vacation damagespay, together with interest thereon
from December 5, 2000. The parties have agreed to a final payment, including
interest, in the amount of $3,583,800, or, in the
alternative, a declaratory judgment from the court that he is entitled to all
change of control benefits under the "Hanover Direct, Inc. Thirty-Six Month
Salary Continuation Plan," and damages in the amount of $1,396,066 or $850,000
due to the Company's purported breach of the terms of the "Long-Term Incentive
Plan for Rakesh K. Kaul" by failing to pay him a "tandem bonus" he alleges was
due and payable to him within the 30 days following his resignation. The Company
removed the case to the U.S. District Court for the Southern District of New
York on July 25, 2001. Mr. Kaul filed an Amended Complaint ("Amended Complaint")
in the U.S. District Court for the Southern District of New York on September
18, 2001. The Amended Complaint repeats many of the claims made in the original
Complaint and adds ERISA claims.
On October 11, 2001, the Company filed its Answer, Defenses and
Counterclaims to the Amended Complaint, denying liability under each and every
of Mr. Kaul's causes of action, challenging all substantive assertions, raising
several defenses and stating nine counterclaims against Mr. Kaul. The
counterclaims include (1) breach of contract; (2) breach of the Non-Competition
and Confidentiality Agreement with the Company; (3) breach of fiduciary duty;
(4) unfair competition; and (5) unjust enrichment. The Company seeks damages,
including, without limitation, the $341,803 in severance pay and car allowance
Mr. Kaul received following his resignation, $412,336 for amounts paid to Mr.
Kaul for car allowance and related benefits, the cost of a long-term disability
policy, and certain payments made to personal attorneys and consultants retained
by Mr. Kaul during his employment, $43,847 for certain services the Company
provided and certain expenses the Company incurred, relating to the renovation
and leasing of office space occupied by Mr. Kaul's spouse at 115 River Road,
Edgewater, New Jersey, the Company's current headquarters, $211,729 on a tax
loan to Mr. Kaul outstanding since 1997 and interest, compensatory and punitive
damages and attorneys' fees. The Company moved to amend its counterclaims, and
the parties each moved for summary judgment.
The Company sought summary judgment: dismissing Mr. Kaul's claim for
severance under his employment agreement on the ground that he failed to provide
the Company with a general release of, among other things, claims for change of
control benefits; dismissing Mr. Kaul's claim for attorneys' fees on the grounds
that they are not authorized under his employment agreement; dismissing Mr.
Kaul's claims related to change in control benefits based on an administrative
decision that he is not entitled to continued participation in the plan or to
future benefits thereunder; dismissing Mr. Kaul's claim for a tandem bonus
payment on the ground that no payment is owing; dismissing Mr. Kaul's claim for
vacation payments based on Company policy regarding carry over vacation; and
seeking judgment on the Company's counterclaim for unjust enrichment based on
Mr. Kaul's failure to pay under a tax note. Mr. Kaul sought summary judgment:
dismissing the Company's defenses and counterclaims relating to a release on the
grounds that he tendered a release or that the Company is estopped from
requiring him to do so; dismissing the Company's defenses and counterclaims
relating to his alleged violations of his non-compete and confidentiality
obligations on the grounds that he did not breach the obligations as defined in
the agreement; and dismissing the Company's claims based on his alleged breach
of fiduciary duty, including those based on his monthly car allowance payments
and the leased space to his wife, on the grounds that he was entitled to the car
payments and did not involve himself in or make misrepresentations in connection
with the leased space. The Company concurrently moved to amend its Answer and
Counterclaims to state a claim that it had cause for terminating Mr. Kaul's
employment based on, among other things, after acquired evidence that Mr. Kaul
received a monthly car allowance and other benefits totaling $412,336 that had
not been authorized by the Company's Board of Directors and that his wife's
lease and related expense was not properly authorized by the Company's Board of
Directors, and to clarify or amend the scope of the Company's counterclaims for
reimbursement.
On January 7, 2004, the Court granted summary judgment in favor of the
Company dismissing Mr. Kaul's claim for severance under his employment agreement
on the grounds that he failed to provide the Company with a general release;
granted in part the Company's motion for summary judgment on Mr. Kaul's claim
for attorneys' fees, finding as a matter of law that Mr. Kaul is not entitled to
fees incurred in prosecuting this lawsuit but finding an issue of fact as to the
amount of reasonable fees he may have incurred in seeking advice and
representation in connection with the termination of his employment; granted
summary judgment in favor of the Company dismissing Mr. Kaul's claims related to
change in control benefits on the grounds that Mr. Kaul's participation in the
plan was properly terminated when his employment was terminated, the plan was
properly terminated, and the administrator and appeals committee properly denied
Mr. Kaul's claim; granted summary judgment in favor of the Company dismissing
Mr. Kaul's claim for a tandem bonus payment on the ground that payment is not
owed to him; granted summary judgment in part and denied summary judgment in
part on Mr. Kaul's claims for vacation pay, deeming Mr. Kaul to have abandoned
claims for vacation pay in excess of five weeks but finding him
9
entitled to four weeks vacation pay based on the Company's policy and finding an
issue of fact as to Mr. Kaul's claim for an additional week of vacation pay in
dispute for 2000; and denied summary judgment on the Company's counterclaim for
payment under a tax note based on disputed issues of fact.$60,856. The Court dismissed the Company's affirmative defenses as largely moot
and the Court granted summary judgment in favor of Mr. Kaul dismissing the
Company's counterclaims relatingis expected to his non-compete and confidentiality
obligations on the grounds that there is no evidence of actual damage to the
Company resulting from Mr. Kaul's alleged violations of those obligations;
granted summary judgment in favor of Mr. Kaul on the Company's breach of
contract and breach of fiduciary duty claims, including those based on his
monthly car allowance payments and the leased space to his wife, on the grounds
that he did not breach his fiduciary duties in accepting the car payments and
would not be unjustly enriched if he kept them, and on the grounds that the
Company would not be able to prove fraud in connection with the leased space
based on the circumstances, including Mr. Kaul's disclosures.
The Court denied in part and granted in part the Company's motion to
amend its Answer and Counterclaims. The Court denied the Company's motion for
leave to state a claim that it had acquired evidence of cause for terminating
Mr. Kaul's employment based on certain reimbursements on the grounds that the
payments were authorized, but granted the Company's motion with respect to its
claim for reimbursement of amounts paid to the Internal Revenue Service ("IRS")
on Mr. Kaul's behalf.
The Opinion identifies three remaining issues in the case: (i) Mr.
Kaul's claim for attorneys' fees pursuant to Section 12 of the employment
agreement; (ii) Mr. Kaul's claim for an additional week of vacation pay in the
amount of approximately $11,500; and (iii) the Company's counterclaim for
$211,729 plus interest paid to the IRS on Mr. Kaul's behalf.
In an attempt to resolve the outstanding issues prior to the entry ofshortly issue a
final judgment conferences were held with the Court on two separate occasions.
As a result of these conferences, the parties have tentatively reached a
settlement whereby the parties agree to dismiss the following claims: (1) Mr.
Kaul agrees to withdraw and release his claims concerning reimbursement of
certain attorneys' fees under Section 12 of the employment agreement (but
preserves and does not waive, release or limit his claim for attorneys' fees and
costs under Section 12 of the employment agreement incurred in connection with
the preparation for and litigation of this lawsuit) and reimbursement for an
additional week of vacation pay; and (2) the Company agrees to withdraw and
releaseimplementing its claims concerning reimbursement of certain attorneys' fees and costs
under ERISA, reimbursement of the $211,729 paid to the IRS on Mr. Kaul's behalf,
and reimbursement of the $341,803 of severance payments made to Mr. Kaul. The
parties also agree that Mr. Kaul shall not appeal that portion of the Opinion
concerning the dismissal of certain of Mr. Kaul's ERISA-based claims with
respect to the Plan and the Company shall not appeal that portion of the Opinion
concerning the dismissal of its claims relating to the leasing and build-out of
property or office space located in Edgewood, New Jersey to Mr. Kaul's wife. Mr.
Kaul has expressed his intent to now tender a general release to the Company. If
he does, in fact, do so, the Companysummary judgment Opinion. Each party will reject the tender on the grounds,
inter alia, that the time to do so has long passed and that the purpose for the
general release has been extinguished. After final judgment issues, each party
shall have
the right to appeal any aspect of that judgment. The Company has reserved
$65,435 for payments due Mr. Kaul and the judgment.associated employer payroll taxes.
Payment was made to Mr. Kaul on July 15, 2004 for the interest portion of the
agreement and on July 16, 2004 for the four weeks vacation.
The Company was named as one of 88 defendants in a patent infringement
complaint filed on November 23, 2001 in the U.S. District Court in Arizona by
the Lemelson Medical, Education & Research Foundation, Limited Partnership (the
"Lemelson Foundation"). The complaint filed in the U.S. District Court in Arizona, was not served on the Company until March
2002. In the complaint, the Lemelson Foundation accuses the named defendants of
infringing seven U.S. patents, which allegedly cover "automatic identification"
technology through the defendants' use of methods for scanning production
markings such as bar codes. The Company received a letter
dated November 27, 2001 from attorneys for the Lemelson Foundation notifying the
Company of the complaint and offering a license. The Court entered a stay of the case on March 20,
2002, requested by the Lemelson Foundation, pending the outcome of a related
case in Nevada being fought by bar code manufacturers. The
order for the stay in the case involving the Company provides that the Company
need not answer the complaint, although it has the option to do so. The Company
was invited to join a common interest/joint-defense group consisting of
defendants named in the complaint as well as in other actions brought by the
Lemelson Foundation. The trial in the Nevada case began on November 18, 2002 and
ended on January 17, 2003. On January 23, 2004, following extensive briefing by
the parties, the
Nevada Court entered judgment declaring that the claims of each of the patents
at issue in the Nevada case, including all seven patents asserted by the
Lemelson
10
Foundation against the Company in the Arizona case, are unenforceable
under the doctrine of prosecution laches, are invalid for lack of written
description and enablement, and are not infringed by the bar code equipment
manufacturers. Subject toThe Lemelson Foundation filed a notice of appeal before the
resultsdeadline of any appealMay 28, 2004. The Arizona court confirmed that may be filed by the parties tostay of the
Arizona case will extend until the entry of a final, non-appealable judgment in
the Nevada litigation, the judgment of the Nevada court should preclude assertion of
each of the affected patents against all parties, including the Company in the
Arizona case. Counsel is now monitoring the Nevada and Arizona cases in order to
determine a suitable moment for moving for dismissal of the Lemelson
Foundation's claims.litigation. The Company has analyzed the merits of the issues raised
by the complaint, notified vendors of its receipt of the complaint and letter,
evaluated the merits of joining thea joint-defense group, and had discussions with
attorneys for the Lemelson Foundation regarding thetheir license offer. The Company
will not agree to a settlement at this time and thus has not established a
reserve. A preliminary estimate of the royalties and attorneys' fees, which the
Company may pay if it decides to accept the license offer from the Lemelson
Foundation, range from about $125,000 to $400,000. The Company believes it has
defenses against the claims and plans to conduct a vigorous defense of this
action. The Company believes that a loss is not probable; therefore, no accrual
for potential losses was deemed necessary.
In early March 2003, the Company learned that one of its business units
had engaged in certain travel transactions that may have constituted violations
under the provisions of U.S. government regulations promulgated pursuant to 50
U.S.C. App. 1-44, which proscribe certain transactions related to travel to
certain countries. The Company immediately commenced an inquiry into the matter,
incurred resulting charges, made an initial voluntary disclosure to the
appropriate U.S. government agency under its program for such disclosures and
will submit to that agency a detailed report on the results of the inquiry. In
addition, the Company has taken steps to ensure that all of its business units
are acting in compliance with the travel and transaction restrictions and other
requirements of all applicable U.S. government programs. Although the Company is
uncertain of the extent of the penalties, if any, that may be imposed on it by
virtue of the transactions being voluntarily disclosed, it does not currently
believe that any such penalties will have a material effect on its business or
financial condition. The Company believes that a loss is not probable;
therefore, no accrual for potential losses was deemed necessary.
In addition, the Company is involved in various routine lawsuits of a
nature whichthat is deemed customary and incidental to its businesses. In the opinion
of management, the ultimate disposition of these actions will not have a
material adverse effect on the Company's financial position or results of
operations.
5.6. SPECIAL CHARGES (INCOME)
In December 2000, the Company began a strategic business realignment
program that resulted in the recording of special charges for severance,
facility exit costs and fixed asset write-offs. The actions related to the
strategic business realignment program were taken in an effort to direct the
Company's resources primarily towards a loss reduction strategy and return to
profitability.
As of the end of the first quarter ofJune 26, 2004, a liability of approximately $2.1$2.0 million was
included within Accrued Liabilities and a liability of approximately $3.0$2.6
million was included within Other Non-current Liabilities. These liabilities relateLiabilities relating to future
payments in
13
connection with the Company's strategic business realignment program. They are
expected to be satisfied no later than February 2010 and consist of the
following (in thousands):
SEVERANCE & REAL ESTATE
PERSONNEL LEASE &
COSTS EXIT COSTS TOTAL
----- ---------- -----
Balance at December 27, 2003 $ 205 $ 5,589 $ 5,794
2004 revisionrevisions of previous estimate (31) -- (31)42 11
Paid in 2004 (174) (469) (643)
----------- ----------- -----------(1,013) (1,187)
------- ------- -------
Balance at March 27,June 26, 2004 $ -- $ 5,1204,618 $ 5,120
=========== =========== ===========4,618
======= ======= =======
A summary of the liability related to real estate lease and exit costs, by
location, as of March 27,June 26, 2004 and December 27, 2003, is as follows (in
thousands):
11
MARCH 27,JUNE 26, DECEMBER 27,
2004 2003
--------- ---------------- ----
Gump's facility, San Francisco, CA $ 3,634 $ 3,788$3,422 $3,788
Corporate facility, Weehawken, NJ 1,194943 1,447
Corporate facility, Edgewater, NJ 214166 261
Administrative and telemarketing facility, San Diego, CA 7887 93
--------- ------------------ ------
Total Real Estate Lease and Exit Costs $ 5,120 $ 5,589
========= ============$4,618 $5,589
------ ------
6.7. SALE OF IMPROVEMENTS BUSINESS
On June 29, 2001, the Company sold certain assets and liabilities of its
Improvements business to HSN, a division of USA Networks, Inc.'s Interactive
Group, for approximately $33.0 million. In conjunction with the sale, the
Company's Keystone Internet Services, Inc. subsidiary (now Keystone Internet
Services, LLC)LLC, or "Keystone") agreed to provide telemarketing and fulfillment
services for the Improvements business under a services agreement with HSN for a
period of three years. Effective June 28, 2004, the services agreement was
extended an additional two years through June 27, 2006.
The asset purchase agreement between the Company and HSN provided that if
Keystone Internet Services, Inc. failed to perform its obligations during the first two years of the
services contract, HSN could receive a reduction in the original purchase price
of up to $2.0 million. An escrow fund of $3.0 million, which was withheld from
the original proceeds of the sale, had been established for a period of two
years under the terms of an escrow agreement between LWI Holdings, Inc. (a
wholly-owned subsidiary of the Company), HSN and The Chase Manhattan Bank as a
result of these contingencies.
On March 27, 2003, the Company and HSN amended the asset purchase
agreement to provide for the release of the remaining $2.0 million balance of
the escrow fund and to terminate the related escrow agreement. By agreeing to
the terms of the amendment, HSN forfeited its ability to receive a reduction in
the original purchase price of up to $2.0 million if Keystone failed to perform
its obligations during the first two years of the services contract. In
consideration for the release, Keystone issued a credit to HSN for $100,000,
which could be applied by HSN against any invoices of Keystone to HSN. This
credit was utilized by HSN during the March 2003 billing period. On March 28,
2003, the remaining $2.0 million escrow balance was received by the Company,
thus terminating the escrow agreement.
The Company recognized a net gain on the sale of approximately $23.2
million, net of a non-cash goodwill charge of $6.1 million, in the second
quarter of 2001. During fiscal 2002, the Company recognized approximately $0.6
million of the deferred gain consistent with the terms of the escrow agreement.
The Company recognized the remaining net deferred gain of $1.9 million upon the
receipt of the escrow balance on March 28, 2003. This gain was reported net of
the costs incurred to provide the credit to HSN of approximately $0.1 million.
7.14
8. CHANGES IN MANAGEMENT AND BOARD OF DIRECTORS
BrianPRESIDENT AND CHIEF EXECUTIVE OFFICER
Thomas C. Harriss. BrianShull. Thomas C. Harriss was appointedShull resigned as Chairman of the Board,
President and Chief Executive Vice
President, Human Resources and Legal and SecretaryOfficer of the Company effective
December 2, 2002 and as Executive Vice President, Finance and Administration
effective November 11, 2003. Prior to January 2002, Mr. Harriss had served the
Company as Executive Vice President and Chief Financial Officer until his
resignation.on May 5, 2004. In
connection with the December 2002 appointment, Mr. Harriss and
the Company terminated a severance agreement entered into during January 2002 at
the time ofShull's resignation, effective May 5, 2004, Mr. Harriss' resignation from the Company during January 2002, and
Mr. Harriss waived his rights to certain payments under such severance
agreement. Effective February 15, 2004, the position of Executive Vice
President, Finance and Administration was eliminated in connection with the
Company's ongoing strategic business realignment program. In connection with
such change, Mr. HarrissShull and
the Company entered into a severance agreement
dated February 15,General Release and Covenant Not to Sue (the "Shull
Severance Agreement") in conjunction with Mr. Shull's resignation from all
positions with the Company pursuant to which the Company agreed to pay to Mr.
Shull $900,000 ("Severance") in multiple installments of which the first
installment of $300,000 was paid on May 18, 2004 providingand the remaining $600,000 is
to be payable in 16 installments of $35,625 payable every two weeks commencing
May 21, 2004 with a final payment in the amount of $30,000 to be payable on or
about December 31, 2004. In addition, the Company agreed to pay the cost of
continuing Mr. Shull's group health and dental benefits under COBRA and
Exec-U-Care plan coverage ("Benefits Continuation" and together with Severance,
"Termination Benefits") for $545,500a period of cash payments,eighteen months. Under the Shull
Severance Agreement, the Company and Mr. Shull agreed that, except for the
Termination Benefits and the reimbursement of previously submitted out-of-pocket
expenses, no other monies or benefits will be due, become due or be paid to Mr.
Shull by the Company; provided that Mr. Shull's options remain vested and
exercisable in accordance with their terms. The Shull Severance Agreement
contained a general release by Mr. Shull in favor of the Company, and a limited
release by the Company of certain claims against Mr. Shull, and covenants not to
sue. The Company accrued the $900,000 severance, as well as $55,500$26,795 of other
benefits, all of which were expensed in the firstsecond quarter of 2004.
Wayne P. Garten. Wayne P. Garten was elected as President and Chief
Executive Officer of the Company effective May 5, 2004. In connection with Mr.
Garten's election, effective May 5, 2004, within GeneralMr. Garten and Administrative Expenses.the Company entered
into an Employment Agreement (the "Garten Employment Agreement") pursuant to
which Mr. HarrissGarten is employed by the Company as its President and Chief Executive
Officer, as described below. The term of the Garten Employment Agreement began
on May 5, 2004 and will terminate on May 5, 2006 (the "Garten Employment
Agreement Term"). Under the Garten Employment Agreement, Mr. Garten is to
receive from the Company base compensation equal to $600,000 per annum, payable
in accordance with the Company's normal payroll procedures ("Base
Compensation"). Mr. Garten is to be provided with the employee benefits the
Company provides to its other senior executives, including but not limited to
four weeks of paid vacation per year and participation in such bonus plans with
such targets as the Compensation Committee of the Board of Directors may approve
in its sole discretion, determined in a manner consistent with bonus
opportunities afforded to other senior executives under such plans. The Company
is to reimburse Mr. Garten for his reasonable out-of-pocket expenses incurred in
connection with his employment by the Company. In addition, the Company is also
to reimburse Mr. Garten for up to $12,500 of attorneys' fees incurred by him in
connection with legal advice relating to, and the negotiation of, the Garten
Employment Agreement.
Under the Garten Employment Agreement, upon the closing of any transaction
within the Garten Employment Agreement Term that constitutes a "change of
control" thereunder (as defined in the Garten Employment Agreement), the Company
will be required to make a lump sum cash payment to Mr. Garten in the amount of
200% of his Base Compensation (a "Change of Control Payment") within 30 days of
the closing of the transaction resulting in the "change of control."
Under the Garten Employment Agreement, additional amounts are payable to
Mr. Garten by the Company under certain circumstances upon the termination of
the Garten Employment Agreement. If the termination is on account of the
expiration of the Garten Employment Agreement Term and no "change of control"
has occurred thereunder, Mr. Garten shall be entitled to receive, subject to his
continued compliance with his confidentiality and nonsolicitation obligations
under the Garten Employment Agreement, monthly severance payments at the rate of
Mr. Garten's Base Compensation for a period of 18 months, payable in accordance
with the Company's normal payroll practices and policies and continued coverage
under the Company's health, life insurance and long-term disability benefit
plans for the 18-month period immediately following the end of the Garten
Employment Agreement Term. If the termination is on account of the Company's
termination of Mr. Garten's employment "For Cause," Mr. Garten's resignation
other than "For Good Reason," or on account of Mr. Garten's death or
"Disability" (all as defined in the Garten Employment Agreement), no additional
amount (other than payment of Base Compensation through the end of the month in
which the termination occurred) shall be payable to Mr. Garten. If the
termination is on account of Mr.
15
Garten's resignation For Good Reason, or the Company's termination of Mr.
Garten's employment other than For Cause, and in either such case Mr. Garten has
not received or become entitled to receive a paymentChange of Control Payment, Mr.
Garten shall receive, subject to his continued compliance with his
confidentiality and nonsolicitation obligations under the Garten Employment
Agreement, continued payments of his monthly Base Compensation for a period
equal to 18 months, payable in accordance with the Company's normal payroll
practices and policies, the pro rated portion of bonuses earned for the fiscal
year in which the effective date of termination occurs pursuant to the Company's
bonus plans, accrued vacation and continued coverage under the Company's 2003 Management Incentive Plan.
Boardhealth,
life insurance and long-term disability benefit plans for the 18-month period
immediately following Mr. Garten's resignation or termination, as applicable.
Under the Garten Employment Agreement, the Company is required to maintain
directors' and officers' liability insurance for Mr. Garten during the Garten
Employment Agreement Term. The Company is also required to indemnify Mr. Garten
in certain circumstances.
Under the Garten Employment Agreement, on May 5, 2004, the Company granted
Mr. Garten an option to purchase 1,000,000 shares of Directors. Effective February 15, 2004, Martin L. Edelman
resigned fromCommon Stock under the
Company's Board2000 Management Stock Option Plan at a price of Directors.$0.195 per share, and,
subject to approval by the shareholders at the 2004 Annual Meeting of
Shareholders, an additional option to purchase an additional 1,000,000 shares of
Common Stock at a price of $0.195 per share, which option was granted under a
Stock Option Agreement between the Company and Mr. Garten outside the Company's
2000 Management Stock Option Plan. All such options vest over a two-year period;
one-third of such options vested on the execution of the Garten Employment
Agreement, one-third will vest on May 5, 2005 and the final one-third will vest
on May 5, 2006; provided that all such options will vest in their entirety and
become fully exercisable upon the earliest to occur of Mr. Garten's resignation
"For Good Reason," the Company's termination of Mr. Garten's services under the
Garten Employment Agreement other than "For Cause," or a "change of control"
under the Garten Employment Agreement. The Company expensed $113,337 during the
second quarter of 2004 related to Mr. Garten's stock option grants.
BOARD OF DIRECTORS
Effective April 12, 2004, Paul S. Goodman joined the Company's Board of
Directors as a designee of Chelsey Direct, LLC filling the vacancy created by
the resignation of Martin L. Edelman.
On April 29,effective February 15, 2004 the Board of Directors elected (1) Wayne P. Garten to serve
as a member and as the Chairman of the Transactions Committee of the Board of
Directors to fill the vacancy created by the resignation of Martin L. Edelman from such positions, (2) William B. Wachtel to serve as a member of the
Executive Committee of the Board
of Directors to fill the vacancy created by the
resignation of Martin L. Edelman from such position, (3) Paul S. Goodman to
serve as a member of the Corporate Governance Committee of the Board of
Directors to fill the vacancy created by the resignation of Martin L. Edelman
from such position, and (4) Donald Hecht to serve as a member of the
Compensation Committee to fill the vacancy created by the contemporaneous
resignation of Wayne P. Garten from such position.
12
President and Chief Executive Officer.Directors. Thomas C. Shull resigned as Chairman of the Board, President and
Chief Executive Officer of the Company on May 5, 2004. William B. Wachtel was
elected as Chairman of the Board and Wayne P. Garten was elected as President
and Chief Executive Officer of the Company effective the same date.
On April 12, 2004, the Company issued options to purchase 50,000 shares of
the Company's Common Stock to Mr. Goodman, the newly-appointed Board member, at
a price of $0.23 per share and services rendered.
On July 30, 2004, Basil P. Regan resigned as a member of the Company's
Board of Directors. As a result, Mr. Regan has advised the Company that he will
not be standing for reelection at the Company's August 12, 2004 Annual Meeting
of Shareholders. Mr. Regan continues to have the right, which is required to be
exercised as promptly as practicable, to appoint a designee to the Company's
Board of Directors until November 30, 2005 pursuant to the Company's Corporate
Governance Agreement dated as of November 30, 2003 among the Company, Chelsey
Direct, LLC, Stuart Feldman, Regan Partners L.P., Regan International Fund
Limited and Basil P. Regan so long as the Regan group collectively owns at least
29,128,762 shares of Common Stock of the Company (as adjusted for stock splits
and the like).
9. RECENTLY ISSUED ACCOUNTING STANDARDS
The Company accounts for goodwill in accordance with SFAS No. 142,
"Goodwill and Other Intangible Assets," which requires that goodwill no longer
be amortized but reviewed for impairment if impairment indicators arise and, at
a minimum, annually. During the second quarters of 2004 and 2003, the Company
completed its annual reviews of goodwill, which did not result in an impairment
charge.
In connectionMay 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Mr. Shull's resignation, Mr. ShullCharacteristics of both Liabilities and Equity"
("SFAS 150"). SFAS 150 establishes standards for how an issuer
16
classifies and measures certain financial instruments with characteristics of
both liabilities and equity. It requires that an issuer classify a financial
instrument that is within its scope as a liability, many of which had been
previously classified as equity or between the liabilities and equity sections
of the Condensed Consolidated Balance Sheet. The provisions of SFAS 150 are
effective for financial instruments entered into or modified after May 31, 2003,
and otherwise are effective at the beginning of the first interim period
beginning after June 15, 2003. The standard is to be implemented by reporting
the cumulative effect of a change in accounting principle for financial
instruments created before the issuance of SFAS 150 and still existing at the
beginning of the interim period of adoption. The Company adopted the provisions
of SFAS 150, which resulted in the reclassification of its Series B
Participating Preferred Stock to a liability rather than between the liabilities
and equity sections of the Condensed Consolidated Balance Sheet. Based upon the
requirements set forth by SFAS 150, this reclassification was subject to
implementation beginning on June 29, 2003. Upon implementation of SFAS 150, the
Company reflected subsequent increases in liquidation preference as an increase
in Total Liabilities with a corresponding reduction in capital in excess of par
value because the Company has an accumulated deficit. Accretion was recorded as
interest expense.
On March 31, 2004, the Financial Accounting Standards Board ("FASB")
issued Emerging Issues Task Force Issue No. 03-6, "Participating Securities and
the Two-Class Method under FASB Statement No. 128" ("EITF 03-6"). SFAS 128
defines earnings per share ("EPS") as "the amount of earnings attributable to
each share of common stock" and indicates that the objective of EPS is to
measure the performance of an entity over the reporting period. SFAS 128
addresses conditions under which a participating security requires the use of
the two-class method of computing EPS. The two-class method is an earnings
allocation formula that treats a participating security as having rights to
earnings that otherwise would have been available to common shareholders, but
does not require the presentation of basic and diluted EPS for securities other
than common stock. The Company's Series C Participating Preferred Stock is a
participating security and, therefore, the Company calculates EPS utilizing the
two-class method, however, it has chosen not to present basic and diluted EPS
for its preferred stock.
10. AMENDMENTS TO CONGRESS LOAN AND SECURITY AGREEMENT
Concurrent with the closing of the Term Loan Facility on July 8, 2004 with
Chelsey Finance (see Note 14), the Company amended its existing senior credit
facility (the "Congress Credit Facility") with Congress Financial Corporation
("Congress") to (1) release certain existing availability reserves and remove
the excess loan availability covenant, increasing availability to the Company by
approximately $10 million, (2) reduce the amount of the maximum credit, the
revolving loan limit and the inventory and accounts sublimits of the borrowers,
(3) defer for three months the payment of principal with respect to the Tranche
A Term Loan, (4) permit the secured indebtedness to Chelsey Finance arising
under the Term Loan Facility, (5) modify certain provisions of the Congress
Credit Facility with respect to asset sales and the application of proceeds
thereof by borrowers, (6) extend the term of the Congress Credit Facility until
July 8, 2007, and (7) amend certain other provisions of the Congress Credit
Facility. In addition, Congress consented to (a) the issuance by the Company of
the Common Stock Warrant, the Series D Preferred Stock Warrant, the Common Stock
pursuant to the Common Stock Warrant and the Series D Preferred Stock pursuant
to the Series D Preferred Stock Warrant (see note 14), (b) the filing of the
Certificate of Designation of the Series D Preferred Stock, (c) the proposed
reverse split and the Company agreedmaking payments in principalcash to holders of Common Stock
to repurchase fractional shares of such Common Stock from such shareholders as
contemplated by the proposed reverse split (pending shareholder approval at the
August 2004 shareholder meeting), (d) certain amendments to the Company's
Certificate of Incorporation, and (e) the issuance by the Company of Common
Stock to Chelsey Finance as payment of a waiver fee. The amendment required the
payment of fees to Congress in the amount of $400,000.
As of June 26, 2004, the Company had $18.5 million of cumulative
borrowings outstanding under the Congress Credit Facility, comprising $7.9
million of short-term borrowings under the Revolving Loan Facility, bearing an
interest rate of 4.50%, $5.5 million under the Tranche A Term Loan, bearing an
interest rate of 4.75%, and $5.1 million under the Tranche B Term Loan, bearing
an interest rate of 13.0%. The Tranche B Term Loan, originally scheduled to be
repaid in January 2007, was repaid in full on July 9, 2004. Of the total
borrowings on June 26, 2004, $11.7 million is classified as short-term, and $6.8
million classified as long-term, on the Company's Condensed Consolidated Balance
Sheet. As of December 27, 2003, the Company had $21.5 million of borrowings
outstanding under the Congress Credit Facility comprising $9.0 million of
short-term borrowings under the revolving loan facility, bearing an interest
rate of 4.50%, $6.5 million under the Tranche A Term Loan, bearing an interest
rate of 4.75%, and $6.0 million under the Tranche B Term Loan, bearing an
interest rate of 13.0%. Of the aggregate borrowings at December 27, 2003, $12.8
17
million is classified as short-term, and $8.7 million classified as long-term,
on the Company's Condensed Consolidated Balance Sheet. Remaining availability
under the Congress Credit Facility as of June 26, 2004 was $5.1 million. On or
before August 15, 2004, the Company is required to enter into a severancerestatement of
the loan agreement with Congress requiring no changes to the terms of the
current agreement.
On April 14, 2004, the judge in the Wilson case (See Note 5) ruled on a
motion filed by the plaintiff requesting attorneys' fees and costs, awarding
plaintiff's counsel approximately $445,000. Prior thereto, on November 25, 2003,
the Court entered judgment in the Wilson case in plaintiff's favor requiring the
Company's Brawn of California subsidiary, which operates the International Male
catalog business, to refund insurance fees collected from consumers for the
period from February 13, 1998 through January 15, 2003 with interest from the
date paid by June 30, 2004. The Company is appealing both of these decisions. On
or about April 2, 2004, plaintiff's counsel filed a lien against Brawn of
California's real property assets in the State of California with respect to the
insurance fees judgment, which has subsequently been extinguished. Both the
award of attorneys' fees and costs of $445,000 and the filing of a lien by
plaintiff's counsel against Brawn of California's assets for the insurance fees
judgment constituted defaults by the Company under the Congress Credit Facility.
Congress agreed to conditionally waive such defaults so long as (1) the Company
is diligently defending the Wilson action by all appropriate proceedings and
sets aside adequate reserves in accordance with GAAP, (2) no action shall be
taken by the plaintiff in the Wilson action against any collateral of Brawn of
California or any other borrower or guarantor under the Congress Credit
Facility, (3) Brawn shall not enter into any settlement agreement with the
plaintiff in the Wilson action without prior written consent of Congress, (4)
Congress' security interests remain senior to any interest of the plaintiff in
the Wilson action, and (5) no other event of default exists or occurs. The
Company believes that it may be a number of years before all appeals in the
Wilson action are exhausted and continues to believe that an unfavorable outcome
to the Company is not probable.
11. SERIES B PARTICIPATING PREFERRED STOCK
On December 19, 2001, as part of the Company's transaction (the "Richemont
Transaction") with Richemont Finance S.A. ("Richemont"), the Company issued to
Richemont 1,622,111 shares of Series B Participating Preferred Stock. The Series
B Participating Preferred Stock had a par value of $0.01 per share.
In the event of the liquidation, dissolution or winding up of the Company,
the holders of the Series B Participating Preferred Stock were entitled to a
liquidation preference, which was initially $47.36 per share, increasing
thereafter to a maximum of $86.85 per share in 2005.
The Company was required to redeem the Series B Participating Preferred
Stock on August 23, 2005 consistent with Delaware General Corporation Law. The
Company could redeem all or less than all of the then outstanding shares of
Series B Participating Preferred Stock at any time prior to that date.
As a result of filings made by Richemont and certain related parties with
the Securities and Exchange Commission on May 21, 2003, the Company learned that
Richemont sold to Chelsey, on May 19, 2003, all of Richemont's securities in the
Company consisting of 29,446,888 shares of Common Stock and 1,622,111 shares of
18
Series B Participating Preferred Stock for $40 million. The Company was not a
party to such transaction and did not provide Chelsey with any material,
non-public information in connection with such transaction, nor did the
Company's Board of Directors endorse the transaction. As a result of the
transaction, Chelsey succeeded to Richemont's rights in the Common Stock and the
Series B Participating Preferred Stock, including the right of the holder of the
Series B Participating Preferred Stock to a liquidation preference with respect
to such shares which was equal to $98,202,600 on May 19, 2003, the date of the
sale of the shares, and which could have increased to and capped at $146,168,422
on August 23, 2005, the final redemption date of the Series B Participating
Preferred Stock.
On November 30, 2003, the Company consummated the transactions
contemplated by the Recapitalization Agreement, dated as of November 18, 2003,
with Chelsey and recapitalized the Company, completed the reconstitution of the
Board of Directors of the Company and settled outstanding litigation between the
Company and Chelsey (the "Recapitalization").
In the transaction, the Company exchanged all of the 1,622,111 outstanding
shares of the Series B Participating Preferred Stock held by Chelsey for the
issuance to Chelsey of 564,819 shares of newly created Series C Participating
Preferred Stock and 81,857,833 additional shares of Common Stock of the Company.
Effective upon the closing of the transactions contemplated by the
Recapitalization Agreement, the size of the Board of Directors was increased to
nine (9) members. For a period of two (2) years from the closing of the
Recapitalization, five (5) of the nine (9) directors of the Company will at all
times be directors of the Company designated by Chelsey and one (1) of the nine
(9) directors of the Company will at all times be a director of the Company
designated by Regan Partners.
Because its Series B Participating Preferred Stock was mandatorily
redeemable and thus accounted for as a liability, the Company accounted for the
exchange of the 1,622,111 outstanding shares of its Series B Participating
Preferred Stock held by Chelsey for the issuance of the 564,819 shares of
newly-created Series C Participating Preferred Stock and the 81,857,833
additional shares of Common Stock of the Company to Chelsey in accordance with
SFAS No. 15, "Accounting by Debtors and Creditors for Troubled Debt
Restructurings." As such, the $107.5 million carrying value of the Series B
Participating Preferred Stock as of the consummation date of the exchange was
compared with the fair value of the Common Stock of approximately $19.6 million
issued to Chelsey as of the consummation date and the total maximum potential
cash payments of approximately $72.7 million that could be made pursuant to the
terms of the Series C Participating Preferred Stock. Since the carrying value,
net of issuance costs of approximately $1.3 million, exceeded these amounts by
approximately $13.9 million, pursuant to SFAS No. 15, such excess was determined
to be a "gain" and the Series C Participating Preferred Stock was recorded at
the amount of total potential cash payments (including dividends and other
contingent amounts) that could be required pursuant to its terms. Since Chelsey
was a significant stockholder at the time of the exchange and, as a result, a
related party, the "gain" was recorded to "Capital in Excess of Par Value"
within "Shareholders' Deficiency" on the accompanying Condensed Consolidated
Balance Sheets.
12. SERIES C CUMULATIVE PARTICIPATING PREFERRED STOCK
On November 30, 2003, as part of the Recapitalization, the Company issued
to Chelsey 564,819 shares of Series C Participating Preferred Stock. The Series
C Participating Preferred Stock has a par value of $.01 per share. The holders
of the Series C Participating Preferred Stock are entitled to one hundred votes
per share on any matter on which the Common Stock votes and are entitled to one
hundred votes per share plus that number of votes as shall equal the dollar
value of any accrued, unpaid and compounded dividends with respect to such
share. The holders of the Series C Participating Preferred Stock are also
entitled to vote as a class on any matter that would adversely affect the Series
C Participating Preferred Stock. In addition, in the event that the Company
defaults on its obligations under the Certificate of Designations, the
Recapitalization Agreement or the Congress Credit Facility, then the holders of
the Series C Participating Preferred Stock, voting as a class, shall be entitled
to elect twice the number of directors as comprised the Board of Directors on
the default date, and such additional directors shall be elected by the holders
of record of Series C Participating Preferred Stock as set forth in the
Certificate of Designations.
In the event of the liquidation, dissolution or winding up of the Company,
effective through December 31, 2005, the holders of the Series C Participating
Preferred Stock are entitled to a liquidation preference of $100 per share, or
an aggregate amount of $56,481,900. Effective October 1, 2008, the maximum
aggregate amount of the liquidation preference is $72,689,337, which would occur
if the Company elects to accrue unpaid dividends as mentioned below.
19
Commencing January 1, 2006, dividends will be payable quarterly on the
Series C Participating Preferred Stock at the rate of 6% per annum, with the
preferred dividend rate increasing by 1 1/2% per annum on each subsequent
January 1 until redeemed. At the Company's option, in lieu of cash dividends,
the Company may instead elect to cause accrued and unpaid dividends to compound
at a rate equal to 1% higher than the applicable cash dividend rate. The Series
C Participating Preferred Stock is entitled to participate ratably with the
Common Stock on a share for share basis in any dividends or distributions paid
to or with respect to the Common Stock. The right to participate has
anti-dilution protection. The Congress Credit Facility and the Term Loan
Facility currently prohibit the payment of dividends.
The Series C Participating Preferred Stock may be redeemed in whole and
not in part, except as set forth below, at the option of the Company at any time
for the liquidation preference and any accrued and unpaid dividends (the
"Redemption Price"). The Series C Participating Preferred Stock, if not redeemed
earlier, must be redeemed by the Company on January 1, 2009 (the "Mandatory
Redemption Date") for the Redemption Price. If the Series C Participating
Preferred Stock is not redeemed on or before the Mandatory Redemption Date, or
if other mandatory redemptions are not made, holders of the Series C
Participating Preferred Stock will be entitled to elect one-half (1/2) of the
Company's Board of Directors. Notwithstanding the foregoing, the Company will
redeem the maximum number of shares of Series C Participating Preferred Stock as
possible with the net proceeds of certain asset and equity sales not required to
be used to repay Congress pursuant to the terms of the 19th Amendment to the
Loan and Security Agreement with Congress (as modified by the 29th Amendment to
the Loan and Security Agreement), and Chelsey will be required to accept such
redemptions, as set forth in Section 5 of the Certificate of Designations of the
Series C Participating Preferred Stock.
Pursuant to the terms of the Certificate of Designations of the Series C
Participating Preferred Stock, the Company's obligation to pay dividends on or
redeem the Series C Participating Preferred Stock is subject to its compliance
with its agreements with Congress and Chelsey Finance.
13. AMERICAN STOCK EXCHANGE NOTIFICATION
The Company received a letter dated May 21, 2004 (the "Letter") from the
American Stock Exchange (the "Exchange") advising that a review of the Company's
Form 10-K for the period ended December 27, 2003 indicates that the Company does
not meet certain of the Exchange's continued listing standards as set forth in
Part 10 of the Exchange's Company Guide. Specifically, the Company is not in
compliance with Section 1003(a)(i) of the Company Guide with shareholders'
equity of less than $2,000,000 and losses from continuing operations and/or net
losses in two out of its three most recent fiscal years; and Section 1003(a)(ii)
of the Company Guide with shareholders' equity of less than $4,000,000 and
losses from continuing operations and/or net losses in three out of its four
most recent fiscal years; and Section 1003(a)(iii) of the Company Guide with
shareholders' equity of less than $6,000,000 and losses from continuing
operations and/or net losses in its five most recent fiscal years. The Exchange
requested that the Company contact the Exchange by June 4, 2004 to confirm
receipt of the Letter, discuss any possible financial data of which the
Exchange's staff may be unaware, and indicate whether or not the Company intends
to submit a plan of compliance. In order to maintain its listing on the
Exchange, the Company had to submit a plan to the American Stock Exchange by
June 22, 2004, advising the Exchange of action it has taken, or will take, that
would bring it into compliance with the continued listing standards of the
Exchange by November 21, 2005 (18 months of receipt of the Letter). The Company
submitted a plan to the Exchange on June 22, 2004 and on August 3, 2004 the
Exchange notified the Company that it accepted the Company's plan of compliance
and granted the Company an extension of time until November 21, 2005 to regain
compliance with the continued listing standards. The Company will be subject to
periodic review by Exchange staff during the extension period. Failure to make
progress consistent with the plan or to regain compliance with the continued
listing standards by the end of the extension period on November 21, 2005 could
result in the Company being delisted from the Exchange. There can be no
assurance that the Company will be able to maintain the listing of its Common
Stock on the Exchange.
14. SUBSEQUENT EVENTS
TERM LOAN FACILITY WITH CHELSEY FINANCE
On July 8, 2004, the Company completed a $20 million junior secured term
loan facility (the "Term Loan
20
Facility") with Chelsey Finance, LLC ("Chelsey Finance"), an affiliate of its
controlling shareholder, Chelsey Direct LLC ("Chelsey"). The Term Loan Facility
is for a three-year term, subject to earlier maturity upon the occurrence of a
change in control or sale of the Company (as defined), and carries an interest
rate of 5% above the prime rate publicly announced by Wachovia Bank, N.A., which
is calculated and payable monthly. The Term Loan Facility is secured by a second
priority lien on the assets of the Company. In connection therewith, Chelsey
Finance concurrently entered into an intercreditor and subordination agreement
with the Company's senior secured lender, Congress.
In consideration for providing the Term Loan Facility to the Company,
Chelsey Finance received a closing fee of $200,000, which was paid in cash, and
will receive a warrant (the "Common Stock Warrant") to purchase 30% of the fully
diluted shares of Common Stock of the Company, which the Company believes would
be equivalent to the issuance of an additional 10,247,210 shares of Common Stock
(adjusted for the proposed one-for-ten reverse split of the Company's Common
Stock) at an exercise price of $.01 per share. Pending shareholder approval of
such issuance at the Company's Annual Meeting of Shareholders scheduled for
August 12, 2004, Chelsey Finance received a warrant (the "Series D Preferred
Warrant") to purchase a newly-issued series of nonvoting preferred stock of the
Company, called Series D Participating Preferred Stock (the "Series D Preferred
Stock"), that will be automatically exchanged for the Common Stock Warrant upon
the receipt of shareholder approval of the issuance thereof at the Company's
Annual Meeting of Shareholders. See the Series D Participating Preferred Stock
discussion below for a description of the terms of the Series D Preferred Stock.
In connection with the closing of the Term Loan Facility, Chelsey received a
waiver fee equal to 1% of the liquidation preference of the Company's
outstanding Series C Participating Preferred Stock, payable in Common Stock of
the Company, or 4,344,762 additional shares of Common Stock (calculated based
upon the fair market value thereof two business days prior to the closing date),
in consideration for the waiver by Chelsey of its blockage rights over the
issuance of senior securities.
As part of the Term Loan Facility, the Company and its subsidiaries agreed
to indemnify Chelsey Finance and its affiliates and each of its and their
respective directors, officers, partners, attorneys and advisors from any losses
suffered arising out of, in any way related to or resulting from the Term Loan
Facility and the related agreements and the transactions contemplated thereby
other than liabilities resulting from such parties' gross negligence or willful
misconduct. The indemnification agreement is not limited as to term and does not
include any limitations on maximum future payments thereunder.
The terms of the Term Loan Facility with Chelsey Finance were approved by
the Company's Audit Committee, all of whose members are independent, and the
Company's Board of Directors.
On July 8, 2004, proceeds from the Term Loan Facility with Chelsey Finance
were used to repay, in full, the Tranche B Term Loan of approximately $4.9
million under the Congress Credit Facility (see Note 10) and the balance will be
used to pay fees and expenses in connection with the transactions and will
provide ongoing working capital for the Company which will be used to reduce
outstanding payables. The Term Loan Facility, together with the concurrent
amendment of the Congress Credit Facility discussed in Note 10, has increased
the Company's liquidity by approximately $25 million.
SERIES D PARTICIPATING PREFERRED STOCK
On the closing of the Term Loan Facility, Chelsey Finance received the
Series D Preferred Warrant, which entitles Chelsey Finance to purchase 100
shares of a newly issued series of non-voting preferred stock, the Series D
Preferred Stock, as part of the consideration for providing the Term Loan
Facility. The Series D Preferred Warrant will be automatically exchanged for
the Common Stock Warrant (see discussion above) upon receipt of shareholder
approval thereof at the 2004 Annual Meeting of Shareholders. The Common Stock
Warrant will entitle Chelsey Finance to purchase 30% of the fully diluted
shares of Common Stock of the Company at an exercise price of $.01 per share,
which the Company believes would be equivalent to the issuance of an additional
10,247,210 shares of Common Stock (adjusted for the proposed one-for-ten
reverse split of the Company's Common Stock). The Series D Preferred Warrant
may not be exercised prior to September 30, 2004.
The Series D Preferred Stock has a par value of $.01 per share. The
holders of the Series D Preferred Stock have no voting rights except the right
to vote as a class on certain matters that would adversely affect the rights of
the Series D Preferred Stock.
21
In the event of the liquidation, dissolution or winding up of the Company,
the holders of the Series D Preferred Stock are entitled to a liquidation
preference equal to the fair market value of the Common Stock Warrant on July 8,
2004, or $81,868.40 per share ($8.2 million in the aggregate), plus declared
but unpaid dividends thereon. The holders of the Series D Preferred Stock will
be entitled to participate in dividends equal to the liquidation preference
plus the amount of any declared but unpaid dividends thereon as of the record
date, multiplied by the dividend yield of a share of Common Stock as of the
close of the business day immediately preceding the record date for the
dividend on the Common Stock.
At the election of the holders of a majority of the shares of Series D
Preferred Stock, in the event of the approval by the shareholders of the Company
of a sale of the Company or substantially all of its assets or certain mergers,
or upon the election of any holder following a Change of Control (as defined),
such transaction will be treated as a liquidation and entitle such holders to
have their shares of Series D Preferred Stock redeemed for an amount equal to
the liquidation preference plus declared but unpaid dividends thereon.
The Series D Preferred Stock is entitled to participate with the Common
Stock in any dividends or distributions paid to or with respect to the Common
Stock based upon the liquidation preference per share of Series D Preferred
Stock times a fraction, the numerator of which is the dividend per share of
Common Stock and the denominator is the fair market value of the Common Stock
immediately prior to the record date for the dividend. The Company's credit
agreements with Congress and Chelsey Finance currently prohibit the payment of
dividends.
The Series D Preferred Stock may be redeemed in whole and not in part,
except as set forth below, at the option of the Company at any time for the
liquidation preference plus any declared but unpaid dividends (the "Redemption
Price"). The Series D Preferred Stock, if not redeemed earlier, must be redeemed
by the Company out of the proceeds of certain equity sales, and any remaining
outstanding shares shall be redeemed on January 1, 2009 (the "Mandatory
Redemption Date") for the Redemption Price.
Pursuant to the terms of the Certificate of Designations of the Series D
Preferred Stock, the Company's obligation to pay dividends on or redeem the
Series D Preferred Stock is subject to compliance with its credit agreements
with Congress and Chelsey Finance.
22
------------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following table sets forth, for the fiscal periods indicated, the
percentage relationship to net revenues of certain items in the Company's
Condensed Consolidated Statements of Income (Loss):
13- WEEKS ENDED 26- WEEKS ENDED
--------------- --------- ------
June 28, June 28,
June 26, 2003 June 26, 2003
2004 As Restated 2004 As Restated
---- ----------- ---- -----------
Net revenues 100.0% 100.0% 100.0% 100.0%
Cost of sales and operating expenses 60.1 62.6 61.1 63.4
Special charges 0.0 0.2 0.0 0.2
Selling expenses 26.7 25.4 25.6 24.6
General and administrative expenses 10.9 9.0 10.8 10.0
Depreciation and amortization 1.0 1.1 1.1 1.1
Income from operations 1.3 1.7 1.4 0.7
Gain on sale of Improvements 0.0 0.0 0.0 0.9
Interest expense, net 0.8 1.1 0.9 1.3
(Benefit) provision for Federal and state income taxes (0.1) 0.0 0.0 0.0
Net income and comprehensive income 0.6% 0.6% 0.5% 0.3%
EXECUTIVE SUMMARY
The Company's second quarter results were negatively impacted by low
inventory levels which resulted in substantially increased backorder levels,
lower initial customer order fill rates and higher customer order cancellations.
The low inventory levels were caused by the Company's reduced borrowing
availability under the Congress Credit Facility and tighter vendor credit. In
order to alleviate these situations, the Company entered into a new $20 million
Term Loan Facility with Chelsey Finance on July 8, 2004 and concurrently amended
the terms of the Congress Credit Facility. The additional working capital will
provide the Company with the ability to restore inventory to adequate levels in
order to fulfill demand, reduce existing backorder levels and increase initial
customer order fill rates to more normal levels. In addition, the increased
working capital will allow the Company to circulate more catalogs in order to
grow the business.
On May 5, 2004, providingWayne P. Garten was appointed President and Chief
Executive Officer ("CEO") of the Company succeeding Thomas C. Shull. The Company
accrued $0.9 million in severance and other benefit costs during the second
quarter associated with the resignation of Mr. Shull.
During the second quarter of 2004, the Company identified a revenue
recognition cut-off issue that resulted in revenue being recorded in advance of
the actual shipment of merchandise to the customer. The practice was stopped
immediately and the Company implemented procedures to ensure that this issue
does not recur. See Note 2 of the Notes to the Condensed Consolidated Financial
Statements for $900,000the required restatements.
The Company announced on June 30, 2004, its intention to consolidate the
operations of the LaCrosse, Wisconsin fulfillment centers into the Roanoke,
Virginia fulfillment center over the next twelve months. The consolidation of
operations was prompted by the lack of sufficient warehouse space in the leased
Wisconsin facilities to support the growth of The Company Store and to reduce
the overall cost structure of the Company.
A review of the management structure leading the operations of both the
Domestications and The Company Store brands determined the need for a separate
management team to guide each brand. The size and diversity of the brands were
the primary factors influencing the decision. The Company hired an individual to
fill the brand president level position for Domestications in mid-July. While
the new president assembles a management team and implements changes throughout
the business, circulation will be decreased in the short-term to stabilize the
brand;
23
therefore, it is expected that sales for Domestications will be lower than the
prior year comparable periods for the remainder of the year.
RESULTS OF OPERATIONS - 13- WEEKS ENDED JUNE 26, 2004 COMPARED WITH THE 13-
WEEKS ENDED JUNE 28, 2003 AS RESTATED
Net Income (Loss). The Company reported net income applicable to common
shareholders of $0.5 million or $0.00 per share for the 13- weeks ended June 26,
2004 compared with a net loss of $3.6 million, or $0.02 per share, for the
comparable fiscal period in 2003.
The $4.1 million increase in net income applicable to common shareholders
was primarily due to:
- A favorable impact of $4.3 million due to the Recapitalization and
exchange of the Series B Participating Preferred Stock for the
Series C Participating Preferred Stock with Chelsey. During the 13-
weeks ended June 28, 2003 Preferred Stock dividends and accretion
were recorded relating to the Series B Participating Preferred
Stock. The Series C Participating Preferred Stock has been recorded
at the maximum amount of future cash payments, $300,000 payablepayments; thus, the Company is
currently not required to record interest expense relating to the
Series C Participating Preferred Stock;
- A favorable impact of $1.2 million due to continued reductions in
Maycost of sales and operating expenses primarily associated with
reductions in product postage costs and inventory write-downs;
- A favorable impact of $1.1 million due to an increase in product
sales margins primarily associated with the shift from domestic to
foreign-sourced goods;
- A favorable impact of $0.3 million due to reductions in interest
resulting from lower average borrowings and deferred amendment fees
which have been fully amortized relating to the Congress Credit
Facility;
- A favorable impact of $0.2 million due to the reduction of special
charges recorded;
- A favorable impact of $0.1 million due to a reduction in the
estimated effective tax rate for fiscal 2004; and
- A favorable impact of $0.1 million due to a decrease in depreciation
and amortization.
Partially offset by:
- An unfavorable impact of $1.2 million due to increases in selling
expenses primarily associated with increases in third-party Web site
fees, catalog preparation costs and postage costs for mailing
catalogs;
- An unfavorable impact of $1.0 million due to increases in general
and administrative expenses resulting from severance related to the
resignation of the former President and Chief Executive Officer and
compensation costs incurred on the appointment of his successor;
- An unfavorable impact of $0.8 million due to a benefit recognized
during the second quarter of 2003 from the revision of the Company's
vacation and sick policy; and
- An unfavorable impact of $0.2 million due to a reduction in variable
contribution associated with the decline in net revenues.
Net Revenues. Net revenues decreased $9.4 million (8.9%) for the 13-week
period ended June 26, 2004 to $96.5 million from $105.9 million for the
comparable fiscal period in 2003. Due to lower inventory levels across all
brands resulting from the Company's reduced borrowing availability and tighter
vendor credit, the Company experienced a decline in product fill rates caused by
increases in backorders and cancellations. In addition, the decrease was due to
a continued reduction in circulation for Domestications in order to limit the
investment in catalog production costs and working capital necessary to maintain
its inventory. For the balance of 2004, Domestications' circulation will be
decreased while changes are implemented to stabilize the brand. Internet sales
continued to grow, not withstanding the negative impact of low inventory levels,
and comprised 31.1% of combined Internet and catalog revenues for the 13- weeks
ended June 26, 2004 compared with 27.5% for the comparable fiscal period in
2003, and have increased by approximately $0.8 million, or 2.9%, to $28.3
million for the 13-week period ended June 26, 2004 from $27.5 million for the
comparable fiscal period in 2003.
24
Cost of Sales and Operating Expenses. Cost of sales and operating expenses
decreased by $8.3 million to $58.0 million for the 13- weeks ended June 26, 2004
as compared with $66.3 million for the comparable period in 2003. Cost of sales
and operating expenses decreased to 60.1% of net revenues for the 13-week period
ended June 26, 2004 as compared with 62.6% of net revenues for the comparable
period in 2003. As a percentage of net revenues, this decrease was primarily due
to a decline in merchandise costs associated with a shift from domestic to
foreign-sourced goods that have higher product margins for The Company Store and
Domestications (1.1%), a decrease in product postage costs resulting from
utilizing more economical shipping sources and methods (1.0%), a decrease in
inventory write-downs due to less slow moving inventory that would be required
to be discounted and increasing sales of clearance merchandise through the
Internet, which has less variable costs than utilizing catalogs as the clearance
avenue (0.7%), and a decrease in information technology costs due to declines in
equipment rentals and maintenance (0.1%). These reductions were partially offset
by an increase in fixed distribution and telemarketing costs (0.4%).
Special Charges. In December 2000, the Company began a strategic business
realignment program that resulted in the recording of special charges for
severance, facility exit costs and fixed asset write-offs. The actions related
to the strategic business realignment program were taken in an effort to direct
the Company's resources primarily towards a loss reduction strategy and a return
to profitability. Special charges decreased by $0.2 million for the 13- weeks
ended June 26, 2004 as compared with the comparable period in fiscal 2003.
During the 13- weeks ended June 28, 2003, $0.2 million of costs were incurred to
revise estimated losses related to sublease arrangements in connection with the
office facilities in San Francisco, California. For the 13- weeks ended June 26,
2004, additional costs of less than $0.1 million were incurred relating to real
estate lease and exit costs associated with the Weehawken, New Jersey and San
Diego, California facilities.
Selling Expenses. Selling expenses decreased by $1.1 million to $25.8
million for the 13- weeks ended June 26, 2004 as compared with $26.9 million for
the comparable period in 2003. Selling expenses increased to 26.7% of net
revenues for the 13- weeks ended June 26, 2004 from 25.4% for the comparable
period in 2003. As a percentage of net revenues, this change was due primarily
to an increase in fees paid to third-party Web sites for every click that leads
to the Company's sites (0.5%), an increase in catalog preparation costs (0.4%),
an increase in postage costs for mailing catalogs (0.3%) and an increase in
costs associated with utilizing rented name lists from other mailers and
compilers as a primary source of new customers (0.2%). These increases were
partially offset by a reduction in paper and printing costs (0.1%).
General and Administrative Expenses. General and administrative expenses
increased by $0.9 million to $10.4 million for the 13- weeks ended June 26, 2004
as compared with $9.5 million for the comparable period in 2003. As a percentage
of net revenues, general and administrative expenses increased to 10.9% of net
revenues for the 13- weeks ended June 26, 2004 compared with 9.0% of net
revenues for the comparable period in 2003. This increase was primarily due to
severance and other benefit costs associated with the resignation of the former
Company President and for compensation of his replacement.
Depreciation and Amortization. Depreciation and amortization decreased
approximately $0.1 million to $1.0 million for the 13- weeks ended June 26, 2004
from $1.1 million for the comparable period in 2003. The decrease was primarily
due to fixed assets that have become fully amortized.
Income from Operations. The Company's income from operations decreased by
$0.6 million to $1.2 million for the 13- weeks ended June 26, 2004 from income
from operations of $1.8 million for the comparable period in 2003. See "Results
of Operations - 13- weeks ended June 26, 2004 compared with the 13- weeks ended
June 28, 2003 as restated - Net Income (Loss)" for further details.
Interest Expense, Net. Interest expense, net, decreased $0.3 million to
$0.8 million for the 13- weeks ended June 26, 2004 from $1.1 million for the
comparable period in fiscal 2003. The decrease in interest expense is due to
lower average cumulative borrowings relating to the Congress Credit Facility and
decreases in amortization from deferred financing costs relating to the
Company's amendments to the Congress Credit Facility that have become fully
amortized.
25
RESULTS OF OPERATIONS - 26- WEEKS ENDED JUNE 26, 2004 COMPARED WITH THE 26-
WEEKS ENDED JUNE 28, 2003 AS RESTATED
Net Income (Loss). The Company reported net income applicable to common
shareholders of $1.0 million, or $0.00 per share, for the 26- weeks ended June
26, 2004 compared with a net loss of $7.2 million, or $0.05 per share, for the
comparable period in fiscal 2003.
The $8.2 million increase in net income applicable to common shareholders
was primarily due to:
- A favorable impact of $7.9 million due to the Recapitalization and
exchange of the Series B Participating Preferred Stock for the
Series C Participating Preferred Stock with Chelsey. During the 26-
weeks ended June 28, 2003 Preferred Stock dividends and accretion
were recorded relating to the Series B Participating Preferred
Stock. The Series C Participating Preferred Stock has been recorded
at the maximum amount of future cash payments; thus, the Company is
currently not required to record interest expense relating to the
Series C Participating Preferred Stock;
- A favorable impact of $1.7 million comprising continued reductions
in cost of sales and operating expenses primarily associated with
reductions in product postage costs and inventory write-downs and a
decrease in depreciation and amortization;
- A favorable impact of $1.5 million due to an increase in product
sales margins primarily associated with the shift from domestic to
foreign-sourced goods;
- A favorable impact of $0.9 million due to reductions in interest
resulting from lower average borrowings and deferred amendment fees
relating to the Congress Credit Facility, which have been fully
amortized; and
- A favorable impact of $0.5 million resulting from a reduction of
special charges recorded.
Partially offset by:
- An unfavorable impact of $1.9 million due to the non-recurring
deferred gain related to the June 29, 2001 sale of the Company's
Improvements business recognized during the 26- weeks ended June 28,
2003;
- An unfavorable impact of $1.0 million due to increases in general
and administrative expenses resulting from severance related to the
resignation of the former President and Chief Executive Officer and
compensation costs incurred on the appointment of his successor;
- An unfavorable impact of $0.8 million due to a benefit recognized
during the second quarter of 2003 from the revision of the Company's
vacation and sick policy; and
- An unfavorable impact of $0.6 million due to a reduction in variable
contribution associated with the decline in net revenues.
Net Revenues. Net revenues decreased $15.5 million (7.5%) for the 26-week
period ended June 26, 2004 to $191.9 million from $207.4 million for the
comparable fiscal period in 2003. Due to lower inventory levels across all
brands resulting from the Company's reduced borrowing availability and tighter
vendor credit, the Company experienced a decline in product fill rates caused by
increases in backorders and cancellations. In addition, the decrease was due to
a reduction in circulation for Domestications in order to limit the investment
in catalog production costs and working capital necessary to maintain its
inventory. For the balance of 2004, Domestications' circulation will be
decreased while changes are implemented to stabilize the brand. Internet sales
continued to grow, not withstanding the negative impact of low inventory levels,
and comprised 31.6% of combined Internet and catalog revenues for the 26- weeks
ended June 26, 2004 compared with 27.1% for the comparable fiscal period in
2003, and have increased by approximately $3.9 million, or 7.3%, to $57.0
million for the 26-week period ended June 26, 2004 from $53.1 million for the
comparable fiscal period in 2003.
Cost of Sales and Operating Expenses. Cost of sales and operating expenses
decreased by $14.1 million to $117.3 million for the 26- weeks ended June 26,
2004 as compared with $131.4 million for the comparable fiscal period in 2003.
Cost of sales and operating expenses decreased to 61.1% of net revenues for the
26-week period ended June 26, 2004 as compared with 63.4% of net revenues for
the comparable fiscal period in 2003. As a percentage of net revenues, this
decrease was primarily due to a decline in merchandise costs associated with a
shift from domestic
26
to foreign-sourced goods that have higher product margins for The Company
Store and Domestications (0.8%), a decrease in product postage costs resulting
from utilizing more economical shipping sources and methods (0.8%), a decrease
in inventory write-downs due to less slow moving inventory that would be
required to be discounted and increasing sales of clearance merchandise through
the Internet, which has less variable costs than utilizing catalogs as the
clearance avenue (0.7%), and a decrease in information technology costs due to
declines in equipment rentals and maintenance (0.2%). These reductions were
partially offset by an increase in fixed distribution and telemarketing costs
(0.2%).
Special Charges. In December 2000, the Company began a strategic business
realignment program that resulted in the recording of special charges for
severance, facility exit costs and fixed asset write-offs. The actions related
to the strategic business realignment program were taken in an effort to direct
the Company's resources primarily towards a loss reduction strategy and a return
to profitability. Special charges decreased by $0.5 million for the 26- weeks
ended June 26, 2004 as compared with the comparable period in fiscal 2003.
During the 26- weeks ended June 28, 2003, the Company recorded $0.5 million of
additional severance costs and charges incurred to revise estimated losses
related to sublease arrangements for office facilities in San Francisco,
California. Increased anticipated losses on sublease arrangements for the San
Francisco office space resulted from the loss of a subtenant, coupled with
declining market values in that area of the country. For the 26- weeks ended
June 26, 2004, additional costs of less than $0.1 million were incurred relating
to real estate lease and exit costs associated with the Weekhawken, New Jersey
and San Diego, California facilities.
Selling Expenses. Selling expenses decreased by $2.1 million to $49.0
million for the 26- weeks ended June 26, 2004 as compared with $51.1 million for
the comparable period in 2003. Selling expenses increased to 25.6% of net
revenues for the 26- weeks ended June 26, 2004 from 24.6% for the comparable
period in 2003. As a percentage of net revenues, this change was due primarily
to an increase in fees paid to third-party Web sites for every click that leads
to the Company's sites (0.4%), an increase in costs associated with utilizing
rented name lists from other mailers and compilers as a primary source of new
customers (0.3%), an increase in postage costs for mailing catalogs (0.1%) and
an increase in catalog preparation costs (0.2%).
General and Administrative Expenses. General and administrative expenses
remained constant at $20.8 million for the 26- weeks ended June 26, 2004 and
June 28, 2003, respectively. As a percentage of net revenues, general and
administrative expenses increased to 10.8% of net revenues for the 26- weeks
ended June 26, 2004 compared with 10.0% of net revenues for the comparable
period in 2003. This increase was primarily due to severance and other benefit
costs associated with the resignation of three executives, including the former
Company President and costs incurred in compensating his replacement.
Depreciation and Amortization. Depreciation and amortization decreased
approximately $0.3 million to $2.0 million for the 26- weeks ended June 26, 2004
from $2.3 million for the comparable period in 2003. The decrease was primarily
due to fixed assets that have become fully amortized.
Income from Operations. The Company's income from operations increased by
$1.3 million to $2.7 million for the 26- weeks ended June 26, 2004 from income
from operations of $1.4 million for the comparable period in 2003. See "Results
of Operations - 26- weeks ended June 26, 2004 compared with the 26- weeks ended
June 28, 2003 as restated - Net Income (Loss)" for further details.
Gain on Sale of the Improvements Business. During the 26- weeks ended June
28, 2003, the Company recognized the remaining deferred gain of $1.9 million
consistent with the terms of the March 27, 2003 amendment made to the asset
purchase agreement relating to the sale of the Improvements business. Effective
March 28, 2003, the remaining $2.0 million escrow balance was received by the
Company, thus terminating the escrow agreement. See Note 7 of Notes to be payablethe
Condensed Consolidated Financial Statements.
Interest Expense, Net. Interest expense, net, decreased $0.9 million to
$1.7 million for the 26- weeks ended June 26, 2004 from $2.6 million for the
comparable period in 16 installmentsfiscal 2003. The decrease in interest expense is due to
lower average cumulative borrowings relating to the Congress Credit Facility and
decreases in amortization from deferred financing costs relating to the
Company's amendments to the Congress Credit Facility that have become fully
amortized.
27
LIQUIDITY AND CAPITAL RESOURCES
OVERVIEW
As a result of $35,625 payable every
two weeks commencing May 21,lower than expected inventory levels in the fourth quarter
of 2003 and the interruptions in the flow of merchandise, which prevented
inventories from reaching adequate levels in the first quarter of 2004, the
Company experienced a significant negative impact on second quarter revenues and
cash flow. These lower inventory levels resulted in large part from tighter
vendor credit and a more restrictive senior debt facility. This had a
compounding effect on the business as a whole; lower levels of inventory reduced
the amount of the financing available under the Congress Credit Facility as well
as the ability to meet customer demand, which resulted in a significant increase
in the Company's backorder position and cancellation of customer orders. During
the second quarter of 2004, management determined that this inventory position
was not sustainable for the long-term, as the Company was experiencing a
significant negative impact on second quarter net revenues due to the decreased
inventory levels. Management's primary objective became the formulation and
execution of a plan to address the liquidity issue facing the Company and after
reviewing alternatives available, the Company entered into the Chelsey Finance
Loan and Security Agreement, dated July 8, 2004 and concurrently amended the
terms of the Congress Credit Facility. The additional availability of working
capital resulting from these transactions will provide for the purchase and
receipt of inventory to fulfill current demand, reduce existing backorder levels
and increase initial customer order fill rates to more normal levels. Finally,
the funding also alleviates the difficulties with certain vendors who were
suggesting the need for more restrictive credit arrangements.
Net cash provided by operating activities. During the 26-week period ended
June 26, 2004, net cash provided by operating activities was $1.5 million. Cash
provided by operations, net of non-cash items, and receipts resulting from a
decrease in accounts receivable were only partially offset by payments made to
increase investment in working capital items such as prepaid catalog costs and a
reduction in accrued liabilities and accounts payable.
Net cash used by investing activities. During the 26-week period ended
June 26, 2004, net cash used by investing activities was $0.3 million. This
entire amount comprised capital expenditures, consisting primarily of purchases
and upgrades to various information technology hardware and software throughout
the Company and purchases of equipment for the Company's Lacrosse, Wisconsin and
Roanoke, Virginia locations.
Net cash used by financing activities. During the 26-week period ended
June 26, 2004, net cash used by financing activities was $3.1 million, which was
primarily due to net payments of $2.9 million under the Congress Credit
Facility, payments of $0.4 million made to lessors relating to obligations under
capital leases and a payment of $0.1 million to the Company's lender for fees
relating to an amendment of the Congress Credit Facility. These payments were
partially offset by a $0.3 million refund relating to withholding taxes remitted
on behalf of Richemont Finance S.A. for estimated taxes due related to the
Series B Participating Preferred Stock.
Amendments to the Congress Credit Facility. In the fourth quarter of 2003,
the Company re-examined the provisions of the Congress Credit Facility and,
based on EITF Issue No. 95-22, "Balance Sheet Classification of Borrowings
Outstanding under Revolving Credit Agreements that Include Both a Subjective
Acceleration Clause and a Lock-Box Arrangement" ("EITF 95-22") and certain
provisions in the credit agreement, the Company has classified its revolving
loan facility as short-term debt at June 26, 2004 and December 27, 2003.
Concurrent with the closing of the Term Loan Facility on July 8, 2004 with
Chelsey Finance (see Note 14 of Notes to the Condensed Consolidated Financial
Statements), the Company amended the Congress Credit Facility to (1) release
certain existing availability reserves and remove the excess loan availability
covenant, increasing availability to the Company by approximately $10 million,
(2) reduce the amount of the maximum credit, the revolving loan limit and the
inventory and accounts sublimits of the borrowers, (3) defer for three months
the payment of principal with respect to the Tranche A Term Loan, (4) permit the
secured indebtedness to Chelsey Finance arising under the Term Loan Facility,
(5) modify certain provisions of the Congress Credit Facility with respect to
asset sales and the application of proceeds thereof by borrowers, (6) extend the
term of the Congress Credit Facility until July 8, 2007, and (7) amend certain
other provisions of the Congress Credit Facility. In addition, Congress
consented to (a) the issuance by the Company of the Common Stock Warrant, the
Series D Preferred Stock Warrant, the Common Stock pursuant to the Common Stock
Warrant and the Series D Preferred Stock pursuant to the Series D Preferred
Stock Warrant, (b) the
28
filing of the Certificate of Designation of the Series D Preferred Stock, (c)
the proposed reverse split and the Company making payments in cash to holders of
Common Stock to repurchase fractional shares of such Common Stock from such
shareholders as contemplated by the proposed reverse split (pending shareholder
approval at the August 2004 shareholder meeting), (d) certain amendments to the
Company's Certificate of Incorporation, and (e) the issuance by the Company of
Common Stock to Chelsey Finance as payment of a finalwaiver fee. The amendment
required the payment of fees to Congress in the amount of $30,000$400,000. See Note 10
of Notes to the Condensed Consolidated Financial Statements.
Under the Congress Credit Facility, the Company is required to maintain
minimum net worth, working capital and EBITDA as defined throughout the term of
the agreement, which it was in compliance with as of June 26, 2004. However, the
Company's restatements resulted in technical defaults by the Company with its
covenants under the Congress Credit Facility and the Term Loan Facility.
Congress and Chelsey Finance have waived such defaults.
As of June 26, 2004, the Company had $18.5 million of cumulative
borrowings outstanding under the Congress Credit Facility, comprising $7.9
million of short-term borrowings under the Revolving Loan Facility, bearing an
interest rate of 4.50%, $5.5 million under the Tranche A Term Loan, bearing an
interest rate of 4.75%, and $5.1 million under the Tranche B Term Loan, bearing
an interest rate of 13.0%. The Tranche B Term Loan, originally scheduled to be
payablerepaid in January 2007, was repaid in full on July 9, 2004. Of the total
borrowings on June 26, 2004, $11.7 million is classified as short-term, and $6.8
million classified as long-term, on the Company's Condensed Consolidated Balance
Sheet. As of December 27, 2003, the Company had $21.5 million of borrowings
outstanding under the Congress Credit Facility comprising $9.0 million of
short-term borrowings under the revolving loan facility, bearing an interest
rate of 4.50%, $6.5 million under the Tranche A Term Loan, bearing an interest
rate of 4.75%, and $6.0 million under the Tranche B Term Loan, bearing an
interest rate of 13.0%. Of the aggregate borrowings on December 27, 2003, $12.8
million is classified as short-term, and $8.7 million classified as long-term,
on the Company's Condensed Consolidated Balance Sheet. Remaining availability
under the Congress Credit Facility as of June 26, 2004 was $5.1 million. On or
about December 31, 2004.before August 15, 2004, the Company is required to enter into a restatement of
the loan agreement with Congress requiring no changes to the terms of the
current agreement.
Sale of Improvements Business. On June 29, 2001, the Company sold certain
assets and liabilities of its Improvements business to HSN, a division of USA
Networks, Inc.'s Interactive Group, for approximately $33.0 million. In
conjunction with the sale, the Company's Keystone Internet Services, Inc.
subsidiary (now Keystone Internet Services, LLC, or "Keystone") agreed to
provide telemarketing and fulfillment services for the Improvements business
under a services agreement with HSN for a period of three years. Effective June
28, 2004, the services agreement was extended an additional two years through
June 27, 2006.
The asset purchase agreement between the Company and HSN provided that if
Keystone failed to perform its obligations during the first two years of the
services contract, HSN could receive a reduction in the original purchase price
of up to $2.0 million. An escrow fund of $3.0 million, which was withheld from
the original proceeds of the sale, had been established for a period of two
years under the terms of an escrow agreement between LWI Holdings, Inc. (a
wholly-owned subsidiary of the Company), HSN and The Chase Manhattan Bank as a
result of these contingencies.
On March 27, 2003, the Company and HSN amended the asset purchase
agreement to provide for the release of the remaining $2.0 million balance of
the escrow fund and to terminate the related escrow agreement. By agreeing to
the terms of the amendment, HSN forfeited its ability to receive a reduction in
the original purchase price of up to $2.0 million if Keystone failed to perform
its obligations during the first two years of the services contract. In
consideration for the release, Keystone issued a credit to HSN for $100,000,
which could be applied by HSN against any invoices of Keystone to HSN. This
credit was utilized by HSN during the March 2003 billing period. On March 28,
2003, the remaining $2.0 million escrow balance was received by the Company,
thus terminating the escrow agreement.
The Company will accruerecognized a net gain on the $900,000sale of severanceapproximately $23.2
million, net of a non-cash goodwill charge of $6.1 million, in the second
quarter of 2001. During fiscal 2002, the Company recognized approximately $0.6
million of the deferred gain consistent with the terms of the escrow agreement.
The Company recognized the remaining net deferred gain of $1.9 million upon the
receipt of the escrow balance on March 28, 2003. This gain was reported net of
the costs incurred to provide the credit to HSN of approximately $0.1 million.
American Stock Exchange Notification. The Company received a letter dated
May 21, 2004 (the "Letter") from
29
the American Stock Exchange (the "Exchange") advising that a review of the
Company's Form 10-K for the period ended December 27, 2003 indicates that the
Company does not meet certain of the Exchange's continued listing standards as
set forth in Part 10 of the Exchange's Company Guide. Specifically, the Company
is not in compliance with Section 1003(a)(i) of the Company Guide with
shareholders' equity of less than $2,000,000 and losses from continuing
operations and/or net losses in two out of its three most recent fiscal years;
and Section 1003(a)(ii) of the Company Guide with shareholders' equity of less
than $4,000,000 and losses from continuing operations and/or net losses in three
out of its four most recent fiscal years; and Section 1003(a)(iii) of the
Company Guide with shareholders' equity of less than $6,000,000 and losses from
continuing operations and/or net losses in its five most recent fiscal years.
The Exchange requested that the Company contact the Exchange by June 4, 2004 to
confirm receipt of the Letter, discuss any possible financial data of which the
Exchange's staff may be unaware, and indicate whether or not the Company intends
to submit a plan of compliance. In order to maintain its listing on the
Exchange, the Company had to submit a plan to the American Stock Exchange by
June 22, 2004, advising the Exchange of action it has taken, or will take, that
would bring it into compliance with the continued listing standards of the
Exchange by November 24, 2005 (18 months of receipt of the Letter). The Company
submitted a plan to the Exchange on June 22, 2004 and on August 3, 2004 the
Exchange notified the Company that it accepted the Company's plan of compliance
and granted the Company an extension of time until November 21, 2005 to regain
compliance with the continued listing standards. The Company will be subject to
periodic review by Exchange staff during the extension period. Failure to make
progress consistent with the plan or to regain compliance with the continued
listing standards by the end of the extension period on November 21, 2005 could
result in the Company being delisted from the Exchange. There can be no
assurance that the Company will be able to maintain the listing of its Common
Stock on the Exchange.
General. At June 26, 2004, the Company had $0.4 million in cash and cash
equivalents, compared with $2.3 million at December 27, 2003. Total cumulative
borrowings, including financing under capital lease obligations, as of June 26,
2004, aggregated $19.2 million. Remaining availability under the Congress Credit
Facility as of June 26, 2004 was $5.1 million. There were nominal short-term
capital commitments (less than $0.1 million) at June 26, 2004.
In connectionManagement continues to focus on enhancing shareholder value through the
exploration of various avenues that will strengthen the Company's financial
position and results of operations. The Company continues to pursue
opportunistic sales of certain assets and other financing alternatives. This
would provide additional liquidity for operational requirements and potentially
enable the Company to retire a portion of the Series C Participating
Preferred Stock obligation.
Management believes that the Company has sufficient liquidity and
availability under its credit agreements to fund its planned operations through
at least the next twelve months. See "Cautionary Statements" below. Continued
flexibility among the Company's major vendors is critical to the maintenance of
adequate liquidity as is compliance with Mr.
Garten's election, Mr. Gartenthe terms and provisions of the
Congress Credit Facility and the Term Loan Facility as mentioned in Notes 10 and
14 of the Condensed Consolidated Financial Statements.
USES OF ESTIMATES AND OTHER CRITICAL ACCOUNTING POLICIES
The condensed consolidated financial statements include all subsidiaries
of the Company, and all intercompany transactions and balances have negotiatedbeen
eliminated. The preparation of financial statements, in conformity with
generally accepted accounting principles, requires management to make estimates
and assumptions that affect the principle
termsreported amounts of an employment agreementassets 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 Mr. Garten which will be presentedthe fiscal year ended December 27, 2003, as amended, for
additional information relating to the Compensation CommitteeCompany's use of estimates and other
critical accounting policies.
NEW ACCOUNTING PRONOUNCEMENTS
The Company accounts for goodwill in accordance with SFAS No. 142,
"Goodwill and Other Intangible Assets," which requires that goodwill no longer
be amortized but reviewed for impairment if impairment indicators arise
30
and, at a minimum, annually. During the Boardsecond quarters of Directors for approval shortly.
8. RECENTLY ISSUED ACCOUNTING STANDARDS2004 and 2003, the
Company completed its annual reviews of goodwill, which did not result in an
impairment charge.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity"
("SFAS 150"). SFAS 150 establishes standards for how an issuer classifies and
measures certain financial instruments with characteristics of both liabilities
and equity. It requires that an issuer classify a financial instrument that is
within its scope as a liability, many of which had been previously classified as
equity or between the liabilities and equity sections of the Condensed
Consolidated Balance Sheet. The provisions of SFAS 150 are effective for
financial instruments entered into or modified after May 31, 2003, and otherwise
are effective at the beginning of the first interim period beginning after June
15, 2003. The standard is to be implemented by reporting the cumulative effect
of a change in accounting principle for financial instruments created before the
issuance of SFAS 150 and still existing at the beginning of the interim period
of adoption. The Company adopted the provisions of SFAS 150, which resulted in
the reclassification of its Series B Participating Preferred Stock to a
liability rather than between the liabilities and equity sections of the
Condensed Consolidated Balance Sheet. Based upon the requirements set forth by
SFAS 150, this reclassification was subject to implementation beginning on June
29, 2003. Upon implementation of SFAS 150, the Company reflected subsequent
increases in liquidation preference as an increase in Total Liabilities with a
corresponding reduction in capital in excess of par value because the Company
has an accumulated deficit. Accretion was recorded as interest expense.
No such
accretion has been recorded as interest expense during the 13-week period ended
March 27, 2004. The Series C Participating Preferred Stock has been recorded at
the maximum amount of future cash payments, thus the Company is currently not
required to record interest expense relating to the Series C Participating
Preferred Stock.
On March 31,2004, the Financial Accounting Standards Board ("FASB")
issued Emerging Issues Task Force Issue No. 03-6 "Participating Securities and
the Two-Class Method under FASB Statement No. 128" ("EITF 03-6"). SFAS 128
defines earnings per share ("EPS") as "the amount of earnings attributable to
each share of common stock" and indicates that the objective of EPS is to
measure the performance of an entity over the reporting period. SFAS 128
addresses conditions under which a participating security requires the use of
the two-class method of computing EPS. The two-class method is an earnings
allocation formula that treats a participating security as having rights to
earnings that otherwise would have been available to common shareholders, but
does not require the presentation of basic and diluted EPS for securities other
than common stock. The Company's Series C Participating Preferred Stock is a
participating security and, therefore, the Company calculates EPS utilizing the
two-class method, however, it has chosen not to present basic and diluted EPS
for preferred stock.
9. AMENDMENTS TO CONGRESS LOAN AND SECURITY AGREEMENT
On March 25, 2004, the Company amended the Congress Credit Facility to
change the definition of Consolidated Net Worth, to amend the Consolidated
Working Capital and Consolidated Net Worth covenants to specify minimum levels
of Consolidated Working Capital and Consolidated Net Worth that must be
maintained during each month commencing January 2004, and to amend the EBITDA
covenant to specify minimum levels of EBITDA that must be achieved during the
Company's 2004, 2005 and 2006 fiscal years. The Company expects to maintain the
minimum levels of these covenants in future periods. In addition, the definition
of "Event of Default" was amended by replacing the Event of Default, which would
have occurred on the occurrence of a material adverse change in the business,
assets, liabilities or condition of the Company and its subsidiaries, with an
Event of Default that would occur if certain specific events such as a decrease
in consolidated revenues beyond certain specified levels or aging of inventory
or accounts payable beyond certain specified levels, were to occur.
During the fourth quarter of 2003, the Company re-examined the
provisions of the Congress Credit Facility and, based on EITF Issue No. 95-22,
"Balance Sheet Classification of Borrowings Outstanding under Revolving Credit
Agreements that Include Both a Subjective Acceleration Clause and a Lock-Box
Arrangement" ("EITF 95-22") and certain provisions in
13
the credit agreement, the Company has classified its revolving loan facility as
short-term debt for the periods ended March 27, 2004 and December 27, 2003.
As of March 27, 2004, the Company had $22.3 million of cumulative
borrowings outstanding under the Congress Credit Facility, comprising $10.7
million of short-term borrowings under the Revolving Loan Facility, bearing an
interest rate of 4.50%, $6.0 million under the Tranche A Term Loan, bearing an
interest rate of 4.75%, and $5.6 million under the Tranche B Term Loan, bearing
an interest rate of 13.0%. Of the aggregate borrowings, $14.6 million is
classified as short-term with $7.7 million classified as long-term on the
Company's Condensed Consolidated Balance Sheet. As of December 27, 2003, the
Company had $21.5 million of borrowings outstanding under the Congress Credit
Facility comprising $9.0 million of short-term borrowings under the revolving
loan facility, bearing an interest rate of 4.50%, $6.5 million under the Tranche
A Term Loan, bearing an interest rate of 4.75%, and $6.0 million under the
Tranche B Term Loan, bearing an interest rate of 13.0%. Of the aggregate
borrowings, $12.8 million is classified as short-term with $8.7 million
classified as long-term on the Company's Condensed Consolidated Balance Sheet.
On or before June 30, 2004, the Company is required to enter into a restatement
of the loan agreement with Congress, requiring no changes to the terms of the
current agreement.
On April 14, 2004, the judge in the Wilson case ruled on a motion filed
by the plaintiff requesting attorneys' fees and costs, awarding plaintiff's
counsel approximately $445,000. Prior thereto, on November 25, 2003, the Court
entered judgment in the Wilson case in plaintiff's favor requiring the Company's
Brawn of California subsidiary which conducts the International Male catalog
business to refund insurance fees collected from consumers for the period from
February 13, 1998 through January 15, 2003 with interest from the date paid by
June 30, 2004. The Company is appealing both of these decisions. On or about
April 2, 2004, plaintiff's counsel filed a lien against Brawn of California's
real property assets in the State of California with respect to the insurance
fees judgment. Both the award of attorneys' fees and costs in the amount of
$445,000 and the filing of a lien by plaintiff's counsel against Brawn of
California's assets for the insurance fees judgment constitute defaults by the
Company under the Congress Credit Facility. Congress has agreed to conditionally
waive such defaults so long as (1) the Company is diligently defending the
Wilson action by all appropriate proceedings and sets aside adequate reserves
in accordance with GAAP, (2) no action shall be taken by the plaintiff in the
Wilson action against any collateral of Brawn of California or any other
borrower or guarantor under the Congress Credit Facility, (3) Brawn shall not
enter into any settlement agreement with the plaintiff in the Wilson action
without the prior written consent of Congress, (4) Congress' security interests
remain senior to any interest of the plaintiff in the Wilson action, and (5) no
other event of default exists or occurs. The Company believes that it may be a
number of years before all appeals in the Wilson action are exhausted and
continues to believe that an unfavorable outcome to the Company is not probable.
Although certain of the conditions are outside its control, management
of the Company believes, based on discussions with its attorneys, that it can
maintain compliance with such conditions through at least December 25, 2004. If
the Company were to fail to meet any one of these conditions, Congress would
have the ability to exercise all rights and remedies available to it under the
Congress Credit Facility including the right to call a default and accelerate
the indebtedness due thereunder although Congress, in the past, has shown a
willingness to waive its rights rather than call the facility. However, there
can be no assurance that Congress will continue to do so in the future. In the
event that there is an adverse decision in the future in the Wilson action or
the Company does not comply with any of the requirements of the conditional
waiver, an event of default would occur under the Congress Credit Facility.
Congress would have the right to accelerate the indebtedness under the Congress
Credit Facility, and could exercise the rights and remedies available to it
under the Congress Credit Facility. Although management of the Company believes
that it will be able to comply with the conditional waiver requirements, in the
event it were unable to do so, it would be required to seek alternative
solutions, including possible settlement of the Wilson action or satisfaction of
any liens or renegotiation of the Congress Credit Facility. All indebtedness
under the Congress Credit Facility is currently classified as short-term. For
more information on the Wilson action, see Note 4 of the Condensed Consolidated
Financial Statements.
10. SERIES B PARTICIPATING PREFERRED STOCK
On December 19, 2001, as part of the Richemont Transaction, the Company
issued to Richemont Finance S.A. ("Richemont") 1,622,111 shares of Series B
Participating Preferred Stock. The Series B Participating Preferred Stock had a
par value of $0.01 per share. The holders of the Series B Participating
Preferred Stock were entitled to ten votes per share on any matter on which the
Common Stock voted. In addition, in the event that the Company defaulted on its
obligations arising in connection with the Richemont Transaction, the
Certificate of Designations of the Series B Participating Preferred Stock or its
agreements with Congress, or in the event that the Company failed to redeem at
least 811,056 shares of Series B Participating Preferred Stock by August 31,
2003, then the holders of the Series B Participating Preferred Stock, voting as
a class, were entitled to elect two members to the Board of Directors of the
Company.
In the event of the liquidation, dissolution or winding up of the
Company, the holders of the Series B Participating Preferred Stock were entitled
to a liquidation preference, which was initially $47.36 per share, increasing
thereafter to a maximum of $86.85 per share in 2005.
For Federal income tax purposes, the increases in the liquidation
preference of the Series B Participating Preferred Stock were considered
distributions, by the Company to Richemont, deemed made on the commencement
dates of the quarterly increases, as discussed above. These distributions may
have been taxable dividends to Richemont, provided the Company had accumulated
or current earnings and profits ("E&P") for each year in which the distributions
were deemed to be made. Under the terms of the Richemont Transaction, the
Company was obligated to reimburse Richemont for any U.S. income tax incurred
pursuant to the Richemont Transaction. Based on the Company's past income tax
filings and its current income tax position, the Company had an E&P deficit as
of December 28, 2002 and December 27, 2003. Accordingly, the Company has not
incurred a tax reimbursement obligation for fiscal 2002 and 2003.
The Company was required to redeem the Series B Participating Preferred
Stock on August 23, 2005 consistent
14
with Delaware General Corporation Law. The Company could redeem all or less than
all of the then outstanding shares of Series B Participating Preferred Stock at
any time prior to that date. At the option of the holders, the Company was
required to redeem the Series B Participating Preferred Stock upon a Change of
Control or upon the consummation of an Asset Disposition or Equity Sale (all as
defined in the Certificate of Designations of the Series B Participating
Preferred Stock). The redemption price for the Series B Participating Preferred
Stock upon a Change of Control or upon the consummation of an Asset Disposition
or Equity Sale was the then applicable liquidation preference of the Series B
Participating Preferred Stock plus the amount of any declared but unpaid
dividends on the Series B Participating Preferred Stock.
As a result of filings made by Richemont and certain related parties
with the SEC on May 21, 2003, the Company learned that Richemont sold to
Chelsey, on May 19, 2003, all of Richemont's securities in the Company
consisting of 29,446,888 shares of Common Stock and 1,622,111 shares of Series B
Participating Preferred Stock for a purchase price equal to $40 million. The
Company was not a party to such transaction and did not provide Chelsey with any
material, non-public information in connection with such transaction, nor did
the Company's Board of Directors endorse the transaction. As a result of the
transaction, Chelsey purportedly succeeded to Richemont's rights in the Common
Shares and the Series B Participating Preferred Stock, including the right of
the holder of the Series B Participating Preferred Stock to a liquidation
preference with respect to such shares which was equal to $98,202,600 on May 19,
2003, the date of the sale of the Shares, and which could have increased to and
capped at $146,168,422 on August 23, 2005, the final redemption date of the
Series B Participating Preferred Stock.
On November 30, 2003, the Company consummated the transactions
contemplated by the Recapitalization Agreement, dated as of November 18, 2003,
with Chelsey and recapitalized the Company, completed the reconstitution of the
Board of Directors of the Company and settled outstanding litigation between the
Company and Chelsey (the "Recapitalization").
In the transaction, the Company exchanged all of the 1,622,111
outstanding shares of the Series B Participating Preferred Stock held by Chelsey
for the issuance to Chelsey of 564,819 shares of newly-created Series C
Participating Preferred Stock and 81,857,833 additional shares of Common Stock
of the Company.
Effective upon the closing of the transactions contemplated by the
Recapitalization Agreement, the size of the Board of Directors was increased to
nine (9) members, and Mr. Donald Hecht was elected to the Company's Board of
Directors and the Audit Committee thereof. For a period of two (2) years from
the closing of the Recapitalization, five (5) of the nine (9) directors of the
Company will at all times be directors of the Company designated by Chelsey and
one (1) of the nine (9) directors of the Company will at all times be a director
of the Company designated by Regan Partners.
Because its Series B Participating Preferred Stock was mandatorily
redeemable and thus accounted for as a liability, the Company accounted for the
exchange of 1,622,111 outstanding shares of its Series B Participating Preferred
Stock held by Chelsey for the issuance of 564,819 shares of newly-created Series
C Participating Preferred Stock and 81,857,833 additional shares of Common Stock
of the Company to Chelsey in accordance with SFAS No. 15 "Accounting by Debtors
and Creditors for Troubled Debt Restructuring." As such, the $107.5 million
carrying value of the Series B Participating Preferred Stock as of the
consummation date of the exchange was compared with the fair value of the Common
Stock of approximately $19.6 million issued to Chelsey as of the consummation
date and the total maximum potential cash payments of approximately $72.7
million that could be made pursuant to the terms of the Series C Participating
Preferred Stock. Since the carrying value, net of issuance costs of
approximately $1.3 million, exceeded these amounts by approximately $13.9
million, pursuant to SFAS No. 15, such excess was determined to be a "gain" and
the Series C Participating Preferred Stock was recorded at the amount of total
potential cash payments (including dividends and other contingent amounts) that
could be required pursuant to its terms. Since Chelsey was a significant
stockholder at the time of the exchange and, as a result, a related party, the
"gain" was recorded in equity.
11. SERIES C CUMULATIVE PARTICIPATING PREFERRED STOCK
On November 30, 2003, as part of the Recapitalization, the Company
issued to Chelsey 564,819 shares of Series C Participating Preferred Stock. The
Series C Participating Preferred Stock has a par value of $.01 per share. The
holders of the Series C Participating Preferred Stock are entitled to one
hundred votes per share on any matter on which the Common Stock votes and are
entitled to one hundred votes per share plus that number of votes as shall equal
15
the dollar value of any accrued, unpaid and compounded dividends with respect to
such share. The holders of the Series C Participating Preferred Stock are also
entitled to vote as a class on any matter that would adversely affect such
Series C Participating Preferred Stock. In addition, in the event that the
Company defaults on its obligations under the Certificate of Designations, the
Recapitalization Agreement or the Congress Credit Facility, then the holders of
the Series C Participating Preferred Stock, voting as a class, shall be entitled
to elect twice the number of directors as comprised the Board of Directors on
the default date, and such additional directors shall be elected by the holders
of record of Series C Participating Preferred Stock as set forth in the
Certificate of Designations.
In the event of the liquidation, dissolution or winding up of the
Company, effective through December 31, 2005, the holders of the Series C
Participating Preferred Stock are entitled to a liquidation preference of $100
per share or an aggregate amount of $56,481,900. Effective October 1, 2008, the
maximum aggregate amount of the liquidation preference is $72,689,337, which
would occur if the Company elects to accrue unpaid dividends as mentioned below.
Commencing January 1, 2006, dividends will be payable quarterly on the
Series C Participating Preferred Stock at the rate of 6% per annum, with the
preferred dividend rate increasing by 1 1/2% per annum on each subsequent
January 1 until redeemed. At the Company's option, in lieu of cash dividends,
the Company may instead elect to cause accrued and unpaid dividends to compound
at a rate equal to 1% higher than the applicable cash dividend rate. The Series
C Participating Preferred Stock is entitled to participate ratably with the
Common Stock on a share for share basis in any dividends or distributions paid
to or with respect to the Common Stock. The right to participate has
anti-dilution protection. The Congress Credit Facility currently prohibits the
payment of dividends.
The Series C Participating Preferred Stock may be redeemed in whole and
not in part, except as set forth below, at the option of the Company at any time
for the liquidation preference and any accrued and unpaid dividends (the
"Redemption Price"). The Series C Participating Preferred Stock, if not redeemed
earlier, must be redeemed by the Company on January 1, 2009 (the "Mandatory
Redemption Date") for the Redemption Price. If the Series C Participating
Preferred Stock is not redeemed on or before the Mandatory Redemption Date, or
if other mandatory redemptions are not made, the Series C Participating
Preferred Stock will be entitled to elect one-half (1/2) of the Company's Board
of Directors. Notwithstanding the foregoing, the Company will redeem the maximum
number of shares of Series C Participating Preferred Stock as possible with the
net proceeds of certain asset and equity sales not required to be used to repay
Congress pursuant to the terms of the 19th Amendment to the Loan and Security
Agreement with Congress (as modified by the 29th Amendment to the Loan and
Security Agreement), and Chelsey will be required to accept such redemptions,
as set forth in Section 5 of the Certificate of Designations of the Series C
Participating Preferred Stock.
Pursuant to the terms of the Certificate of Designations of the Series
C Participating Preferred Stock, the Company's obligation to pay dividends on or
redeem the Series C Participating Preferred Stock is subject to its compliance
with its agreements with Congress.
12. AMERICAN STOCK EXCHANGE NOTIFICATION
On May 2, 2001, the American Stock Exchange (the "Exchange") notified
the Company that it was below certain of the Exchange's continued listing
guidelines set forth in the Exchange's Company Guide. The Exchange instituted a
review of the Company's eligibility for continuing listing of the Company's
common stock on the Exchange. The Company received a letter dated January 9,
2002 from the Exchange confirming that the American Stock Exchange determined to
continue the Company's listing on the Exchange pending quarterly reviews of the
Company's compliance with the steps of its strategic business realignment
program. This determination was made subject to the Company's favorable progress
in satisfying the Exchange's guidelines for continued listing and to the
Exchange's periodic review of the Company's Securities and Exchange Commission
and other filings.
The Company received a letter dated November 8, 2002 from the Exchange
updating its position regarding the Company's compliance with certain of the
Exchange's continued listing standards as set forth in Part 10 of the Exchange's
Company Guide. Although the Company had been making favorable progress in
satisfying the Exchange's guidelines for continued listing based on its
compliance with the steps of its strategic business realignment program shared
with the Exchange in 2001 and updated in 2002, the Exchange informed the Company
that it had now become strictly subject to the procedures and requirements of
Part 10 of the Company Guide. Specifically, the Company must not fall below the
requirements of: (i) Section 1003(a)(i) with shareholders' equity of less than
16
$2,000,000 and losses from continuing operations and/or net losses in two out of
its three most recent fiscal years; (ii) Section 1003(a)(ii) with shareholders'
equity of less than $4,000,000 and losses from continuing operations and/or net
losses in three out of its four most recent fiscal years; and (iii) Section
1003(a)(iii) with shareholders' equity of less than $6,000,000 and losses from
continuing operations and/or net losses in its five most recent fiscal years.
The Exchange requested that the Company submit a plan to the Exchange by
December 11, 2002, advising the Exchange of action it has taken, or will take,
that would bring it into compliance with the continued listing standards by
December 28, 2003. The Company submitted a plan to the Exchange on December 11,
2002, in an effort to maintain the listing of the Company's common stock on the
Exchange.
On January 28, 2003, the Company received a letter from the Exchange
confirming that, as of the date of the letter, the Company had evidenced
compliance with the requirements necessary for continued listing on the
Exchange. Such compliance resulted from a rule change by the Exchange approved
by the Securities and Exchange Commission related to continued listing on the
basis of compliance with total market capitalization or total assets and
revenues standards as alternatives to shareholders' equity standards including
the requirement that each listed company maintain $15.0 million of public float.
The letter is subject to changes in the Exchange Rules that might supersede the
letter or require the Exchange to re-evaluate its position. The Company's common
stock has traded below the minimum level of public float since April 14, 2004.
To date, the Company has not received any communication from the Exchange on
this issue.
17
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
--------------------------
March 27, March 29,
2004 2003
--------- ---------
Net revenues 100.0% 100.0%
Cost of sales and operating expenses 62.1 64.0
Special charges 0.0 0.3
Selling expenses 24.4 23.9
General and administrative expenses 10.9 11.0
Depreciation and amortization 1.1 1.1
Income (loss) from operations 1.5 (0.3)
Gain on sale of Improvements 0.0 1.9
Interest expense, net 1.0 1.4
Provision for Federal and state income taxes 0.1 0.0
Net income and comprehensive income 0.4% 0.2%
EXECUTIVE SUMMARY
Management continues to focus on enhancing shareholder value through
the exploration of various avenues that will strengthen the Company's financial
position. The Company continues to pursue options to increase liquidity and
reduce debt through a review of its senior credit facility with Congress,
opportunistic sales of non-core assets and other financing alternatives. These
options would enable the Company to retire a portion of the Series C
Participating Preferred Stock obligation in addition to providing additional
liquidity for operational requirements.
RESULTS OF OPERATIONS - 13- WEEKS ENDED MARCH 27, 2004 COMPARED WITH THE 13-
WEEKS ENDED MARCH 29, 2003
Net Income. The Company reported net income applicable to common
shareholders of $0.4 million or $0.00 per share for the 13- weeks ended March
27, 2004 compared with a net loss of $3.4 million, or $0.02 per share, for the
comparable period in fiscal 2003. These amounts were calculated after deducting
Series B Participating Preferred Stock dividends and accretion of $3.6 million
for the 13- weeks ended March 29, 2003. The weighted average number of shares
used in the calculation for basic and diluted net income per common share was
220,173,633 and 220,665,781, respectively, for the 13-week period ended March
27, 2004. The weighted average number of shares used in the calculation for both
basic and diluted net loss per common share was 138,315,800 for the 13-week
period ended March 29, 2003. The increase in weighted average shares was
primarily a result of the Recapitalization consummated on November 30, 2003 (see
Notes 10 and 11 to the Company's Condensed Consolidated Financial Statements).
The $3.9 million increase in net income was primarily due to:
- A favorable impact of $3.6 million due to the Recapitalization
and exchange of the Series B for the Series C Participating
Preferred Stock with Chelsey. During the 13- weeks ended March
29, 2003 Preferred Stock dividends and accretion were recorded
relating to the Series B Participating Preferred Stock. The
Series C Participating Preferred Stock has been recorded at
the maximum amount of future cash payments; thus the Company
is currently not required to record interest expense relating
to the Series C Participating Preferred Stock;
- A favorable impact of $1.8 million comprising continued
reductions in cost of sales and operating expenses and general
and administrative expenses and a decrease in depreciation and
amortization;
- A favorable impact of $0.5 million due to reductions in
interest resulting from lower average borrowings and deferred
amendment fees which have become fully amortized relating to
the Congress Credit Facility; and
18
- A favorable impact of $0.3 million due to the reduction of
special charges recorded.
partially offset by:
- An unfavorable impact of $1.9 million due to the non-recurring
deferred gain related to the June 29, 2001 sale of the
Company's Improvements business recognized during the 13-
weeks ended March 29, 2003; and
- An unfavorable impact of $0.4 million due to reduction in
variable contribution associated with the decline in net
revenues.
Net Revenues. Net revenues decreased $7.2 million (7.0%) for the
13-week period ended March 27, 2004 to $95.3 million from $102.5 million for the
comparable period in 2003. The decline was primarily attributable to a reduction
in circulation for one of the Company's brands in order to limit the investment
in catalog production costs and working capital necessary to maintain inventory
for this brand. The majority of this reduction occurred in the first quarter of
2004, however, there will be a continuation of this trend, albeit at a lower
rate of decline in sales, for the balance of 2004. Internet sales continued to
grow, and comprised 32.2% of combined Internet and catalog revenues for the 13-
weeks ended March 27, 2004 compared with 26.5% for the comparable fiscal period
in 2003, and have increased by approximately $3.1 million, or 12.1%, to $28.6
million for the 13-week period ended March 27, 2004 from $25.5 million for the
comparable fiscal period in 2003.
Cost of Sales and Operating Expenses. Cost of sales and operating
expenses decreased by $6.3 million to $59.2 million for the 13- weeks ended
March 27, 2004 as compared with $65.5 million for the comparable period in 2003.
Cost of sales and operating expenses decreased to 62.1% of net revenues for the
13-week period ended March 27, 2004 as compared with 64.0% of net revenues for
the comparable period in 2003. This decrease was primarily due to a 0.6% decline
in merchandise costs associated with a shift from "branded" goods to proprietary
goods that have higher product margins for one of the Company's brands, a 0.6%
decrease in the inventory obsolescence provision and other inventory write-downs
due to maintaining lower inventory levels and an increase in sales of clearance
merchandise through the Internet at discounted prices, a 0.5% decrease in
product postage costs resulting from utilizing more economical shipping sources
and methods, and a 0.2% decrease relating to information technology costs due to
declines in equipment rentals and maintenance. Fixed distribution and
telemarketing costs as a percentage of net revenues continued to remain constant
with the comparable period in 2003.
Special Charges (Income). In December 2000, the Company began a
strategic business realignment program that resulted in the recording of special
charges for severance, facility exit costs and fixed asset write-offs. The
actions related to the strategic business realignment program were taken in an
effort to direct the Company's resources primarily towards a loss reduction
strategy and a return to profitability. Special charges (income) decreased by
$0.3 million for the 13- weeks ended March 27, 2004 as compared with the
comparable period in fiscal 2003. During the 13- weeks ended March 29, 2003,
$0.3 million of additional severance costs were recorded. No additional special
charges were recorded during the 13- weeks ended March 27, 2004, although an
adjustment was recorded relating to a revision of an estimate of benefit costs
previously recorded.
Selling Expenses. Selling expenses decreased by $1.2 million to $23.3
million for the 13- weeks ended March 27, 2004 as compared with $24.5 million
for the comparable period in 2003. As a percentage of net revenues, selling
expenses increased to 24.4% for the 13- weeks ended March 27, 2004 from 23.9%
for the comparable period in 2003. This change was due primarily to a 0.4%
increase in costs associated with utilizing rented name lists from other mailers
and compilers as a primary source of new customers, a 0.2% increase in catalog
preparation costs and a 0.1% increase in postage costs. These increases were
partially offset by a 0.2% reduction in paper and printing costs.
General and Administrative Expenses. General and administrative
expenses decreased by $0.9 million to $10.4 million for the 13- weeks ended
March 27, 2004 as compared with $11.3 million for the comparable period in 2003.
As a percentage of net revenues, general and administrative expenses declined
slightly to 10.9% of net revenues for the 13- weeks ended March 27, 2004
compared with 11.0% of revenues for the 13- weeks ended March 29, 2003.
Decreases were recognized with a reduction of 0.3% in incentive compensation and
legal costs, which were partially offset by a 0.2% increase in the area of
merchandising and product development.
19
Depreciation and Amortization. Depreciation and amortization decreased
approximately $0.2 million to $1.0 million for the 13- weeks ended March 27,
2004 from $1.2 million for the comparable period in 2003. The decrease was
primarily due to capital expenditures that have been fully amortized.
Income (Loss) from Operations. The Company's income from operations
increased by $1.7 million to $1.4 million for the 13- weeks ended March 27, 2004
from a loss of $0.3 million for the comparable period in 2003. See "Results of
Operations - 13- weeks ended March 27, 2004 compared with the 13- weeks ended
March 29, 2003 - Net Income and Comprehensive Income" above for further details.
Gain on Sale of the Improvements Business. During the 13- weeks ended
March 29, 2003, the Company recognized the remaining deferred gain of $1.9
million consistent with the terms of the March 27, 2003 amendment made to the
asset purchase agreement relating to the sale of the Improvements business.
Effective March 28, 2003, the remaining $2.0 million escrow balance was received
by the Company, thus terminating the agreement. See Note 6 of Notes to the
Condensed Consolidated Financial Statements.
Interest Expense, Net. Interest expense, net, decreased $0.5 million to
$0.9 million for the 13- weeks ended March 27, 2004 from $1.4 million for the
comparable period in fiscal 2003. The decrease in interest expense is due to
lower average cumulative borrowings relating to the Congress Credit Facility and
decreases in amortization from deferred financing costs relating to the
Company's amendments to the Congress Credit Facility that have become fully
amortized.
LIQUIDITY AND CAPITAL RESOURCES
Net cash used by operating activities. During the 13-week period ended
March 27, 2004, net cash used by operating activities was $0.6 million. Cash
provided by operations, net of non-cash items, and receipts resulting from a
decrease in accounts receivable were more than offset by payments made to
increase investment in working capital items such as increased prepaid catalog
costs and decreased accrued liabilities and accounts payable.
Net cash used by investing activities. During the 13-week period ended
March 27, 2004, net cash used by investing activities was $0.1 million. This
entire amount comprised capital expenditures, consisting primarily of purchases
and upgrades to various information technology hardware and software throughout
the Company and purchases of equipment for the Company's Lacrosse, Wisconsin
location.
Net cash provided by financing activities. During the 13-week period
ended March 27, 2004, net cash provided by financing activities was $0.8
million, which was primarily due to net borrowings of $1.8 million under the
Congress Credit Facility and a $0.3 million refund relating to withholding taxes
remitted on behalf of Richemont for estimated taxes due related to the Series B
Participating Preferred Stock. These borrowings were partially offset by $1.0
million in payments made to the Company's lender relating to the Congress
Tranche A and Tranche B term loan facilities as well as a payment of $0.1
million to the Company's lender for fees relating to the amendment of the
Congress Credit Facility. In addition, payments of $0.2 million were made to
lessors relating to obligations under capital leases.
Amendments to the Congress Credit Facility. On March 25, 2004, the
Company amended the Congress Credit Facility to change the definition of
Consolidated Net Worth, to amend the Consolidated Working Capital and
Consolidated Net Worth covenants to specify minimum levels of Consolidated
Working Capital and Consolidated Net Worth that must be maintained during each
month commencing January 2004, and to amend the EBITDA covenant to specify
minimum levels of EBITDA that must be achieved during the Company's 2004, 2005
and 2006 fiscal years. The Company expects to maintain the minimum levels of
these covenants in future periods. In addition, the definition of "Event of
Default" was amended by replacing the Event of Default, which would have
occurred on the occurrence of a material adverse change in the business, assets,
liabilities or condition of the Company and its subsidiaries, with an Event of
Default that would occur if certain specific events such as a decrease in
consolidated revenues beyond certain specified levels or aging of inventory or
accounts payable beyond certain specified levels, were to occur.
In 2003, the Company re-examined the provisions of the Congress Credit
Facility and, based on EITF Issue No. 95-22, "Balance Sheet Classification of
Borrowings Outstanding under Revolving Credit Agreements that Include Both
20
a Subjective Acceleration Clause and a Lock-Box Arrangement" ("EITF 95-22") and
certain provisions in the credit agreement, the Company has classified its
revolving loan facility as short-term debt for the periods ended March 27, 2004
and December 27, 2003.
Under the Congress Credit Facility, the Company is required to maintain
minimum net worth, working capital and EBITDA as defined throughout the term of
the agreement. As of March 27, 2004, the Company was in compliance with all
covenants set forth under the Congress Credit Facility.
As of March 27, 2004, the Company had $22.3 million of cumulative
borrowings outstanding under the Congress Credit Facility, comprising $10.7
million of short-term borrowings under the Revolving Loan Facility, bearing an
interest rate of 4.50%, $6.0 million under the Tranche A Term Loan, bearing an
interest rate of 4.75%, and $5.6 million under the Tranche B Term Loan, bearing
an interest rate of 13.0%. Of the aggregate borrowings, $14.6 million is
classified as short-term with $7.7 million classified as long-term on the
Company's Condensed Consolidated Balance Sheet. As of December 27, 2003, the
Company had $21.5 million of borrowings outstanding under the Congress Credit
Facility comprising $9.0 million of short-term borrowings under the revolving
loan facility, bearing an interest rate of 4.50%, $6.5 million under the Tranche
A Term Loan, bearing an interest rate of 4.75%, and $6.0 million under the
Tranche B Term Loan, bearing an interest rate of 13.0%. Of the aggregate
borrowings, $12.8 million is classified as short-term with $8.7 million
classified as long-term on the Company's Condensed Consolidated Balance Sheet.
On or before June 30, 2004, the Company is required to enter into a restatement
of the loan agreement with Congress, requiring no changes to the terms of the
current agreement.
Sale of Improvements Business. On June 29, 2001, the Company sold
certain assets and liabilities of its Improvements business to HSN, a division
of USA Networks, Inc.'s Interactive Group, for approximately $33.0 million. In
conjunction with the sale, the Company's Keystone Internet Services, Inc.
subsidiary agreed to provide telemarketing and fulfillment services for the
Improvements business under a service agreement with HSN for a period of three
years.
The asset purchase agreement between the Company and HSN provided that
if Keystone Internet Services failed to perform its obligations during the first
two years of the services contract, the purchaser could receive a reduction in
the original purchase price of up to $2.0 million. An escrow fund of $3.0
million, which was withheld from the original proceeds of the sale of
approximately $33.0 million, had been established for a period of two years
under the terms of an escrow agreement between LWI Holdings, Inc. (a
wholly-owned subsidiary of the Company), HSN and The Chase Manhattan Bank as a
result of these contingencies.
The Company recognized a net gain on the sale of approximately $23.2
million, net of a non-cash goodwill charge of $6.1 million, in fiscal year 2001.
During fiscal 2002, the Company recognized approximately $0.6 million of the
deferred gain consistent with the terms of the escrow agreement. The Company
recognized the remaining net deferred gain of $1.9 million from the receipt of
the escrow balance on March 28, 2003. This gain was reported net of the costs
incurred to provide the credit to HSN of approximately $0.1 million.
American Stock Exchange Notification. On May 2, 2001, the American
Stock Exchange (the "Exchange") notified the Company that it was below certain
of the Exchange's continued listing guidelines set forth in the Exchange's
Company Guide. The Exchange instituted a review of the Company's eligibility for
continuing listing of the Company's common stock on the Exchange. The Company
received a letter dated January 9,
21
2002 from the Exchange confirming that the American Stock Exchange determined to
continue the Company's listing on the Exchange pending quarterly reviews of the
Company's compliance with the steps of its strategic business realignment
program. This determination was made subject to the Company's favorable progress
in satisfying the Exchange's guidelines for continued listing and to the
Exchange's periodic review of the Company's Securities and Exchange Commission
and other filings.
The Company received a letter dated November 8, 2002 from the Exchange
updating its position regarding the Company's compliance with certain of the
Exchange's continued listing standards as set forth in Part 10 of the Exchange's
Company Guide. Although the Company had been making favorable progress in
satisfying the Exchange's guidelines for continued listing based on its
compliance with the steps of its strategic business realignment program shared
with the Exchange in 2001 and updated in 2002, the Exchange informed the Company
that it had now become strictly subject to the procedures and requirements of
Part 10 of the Company Guide. Specifically, the Company must not fall below the
requirements of: (i) Section 1003(a)(i) with shareholders' equity of less than
$2,000,000 and losses from continuing operations and/or net losses in two out of
its three most recent fiscal years; (ii) Section 1003(a)(ii) with shareholders'
equity of less than $4,000,000 and losses from continuing operations and/or net
losses in three out of its four most recent fiscal years; and (iii) Section
1003(a)(iii) with shareholders' equity of less than $6,000,000 and losses from
continuing operations and/or net losses in its five most recent fiscal years.
The Exchange requested that the Company submit a plan to the Exchange by
December 11, 2002, advising the Exchange of action it has taken, or will take,
that would bring it into compliance with the continued listing standards by
December 28, 2003. The Company submitted a plan to the Exchange on December 11,
2002, in an effort to maintain the listing of the Company's common stock on the
Exchange.
On January 28, 2003, the Company received a letter from the Exchange
confirming that, as of the date of the letter, the Company had evidenced
compliance with the requirements necessary for continued listing on the
Exchange. Such compliance resulted from a rule change by the Exchange
approved by the Securities and Exchange Commission related to continued listing
on the basis of compliance with total market capitalization or total assets and
revenues standards as alternatives to shareholders' equity standards including
the requirement that each listed company maintain $15 million of public float.
The letter is subject to changes in the Exchange Rules that might
supersede the letter or require the Exchange to re-evaluate its position. The
Company's common stock has traded below the minimum level of public float since
April 14, 2004. To date, the Company has not received any communication from
the Exchange on this issue.
General. At March 27, 2004, the Company had $2.4 million in cash and
cash equivalents, compared with $2.6 million at March 29, 2003. Total cumulative
borrowings, including financing under capital lease obligations, as of March 27,
2004, aggregated $23.1 million. Remaining availability under the Congress Credit
Facility as of March 27, 2004 was $4.0 million. There were nominal short-term
capital commitments (less than $0.2 million) at March 27, 2004.
On April 14, 2004, the judge in the Wilson case ruled on a motion filed
by the plaintiff requesting attorneys' fees and costs, awarding plaintiff's
counsel approximately $445,000. Prior thereto, on November 25, 2003, the Court
entered judgment in the Wilson case in plaintiff's favor requiring the Company's
Brawn of California subsidiary which conducts the International Male catalog
business to refund insurance fees collected from consumers for the period from
February 13, 1998 through January 15, 2003 with interest from the date paid by
June 30, 2004. The Company is appealing both of these decisions. On or about
April 2, 2004, plaintiff's counsel filed a lien against Brawn of California's
real property assets in the State of California with respect to the insurance
fees judgment. Both the award of attorneys' fees and costs in the amount of
$445,000 and the filing of a lien by plaintiff's counsel against Brawn of
California's assets for the insurance fees judgment constitute defaults by the
Company under the Congress Credit Facility. Congress has agreed to conditionally
waive such defaults so long as (1) the Company is diligently defending the
Wilson action by all appropriate proceedings and sets aside adequate reserves in
accordance with GAAP, (2) no action shall be taken by the plaintiff in the
Wilson action against any collateral of Brawn of California or any other
borrower or guarantor under the Congress Credit Facility, (3) Brawn shall not
enter into any settlement agreement with the plaintiff in the Wilson action
without the prior written consent of Congress, (4) Congress' security interests
remain senior to any interest of the plaintiff in the Wilson action, and (5) no
other event of default exists or occurs. The Company believes that it may be a
number of years before all appeals in the Wilson action are exhausted and
continues to believe that an unfavorable outcome to the Company is not probable.
Although certain of the conditions are outside its control, management
of the Company believes, based on discussions with its attorneys, that it can
maintain compliance with such conditions through at least December 25, 2004. If
the Company were to fail to meet any one of these conditions, Congress would
have the ability to exercise all rights and remedies available to it under the
Congress Credit Facility including the right to call a default and accelerate
the indebtedness due thereunder although Congress, in the past, has shown a
willingness to waive its rights rather than call the facility. However, there
can be no assurance that Congress will continue to do so in the future. In the
event that there is an adverse decision in the future in the Wilson action or
the Company does not comply with any of the requirements of the conditional
waiver, an event of default would occur under the Congress Credit Facility,
Congress would have the right to accelerate the indebtedness under the Congress
Credit Facility, and could exercise the rights and remedies available to it
under the Congress Credit Facility. Although management of the Company believes
that it will be able to comply with the conditional waiver requirements, in the
event it were unable to do so, it would be required to seek alternative
solutions, including possible settlement of the Wilson action or satisfaction of
any liens or renegotiation of the Congress Credit Facility. All indebtedness
under the Congress Credit Facility is currently classified as short-term. For
more information on the Wilson action, see Note 4 of the Condensed Consolidated
Financial Statements.
Management continues to focus on enhancing shareholder value through
the exploration of various avenues that will strengthen the Company's financial
position. The Company continues to pursue options to increase liquidity and
reduce debt through a review of its senior credit facility with Congress,
opportunistic sales of non-core assets and other financing alternatives. These
options would enable the Company to retire a portion of the Series C
Participating Preferred Stock obligation in addition to providing additional
liquidity for operational requirements.
Management believes that the Company has sufficient liquidity and
availability under its credit agreement to fund its planned operations through
at least December 25, 2004. See "Cautionary Statements," below. Continued
flexibility among the Company's major vendors is critical to the maintenance of
adequate liquidity as is compliance with the terms and provisions of the
Congress Credit Facility as mentioned in Note 9 of the Condensed Consolidated
Financial Statements.
USES OF ESTIMATES AND OTHER CRITICAL ACCOUNTING POLICIES
The condensed consolidated financial statements include all
subsidiaries of the Company, and all intercompany transactions and balances have
been eliminated. The preparation of financial statements, in conformity with
generally accepted accounting principles, requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities, the
disclosure of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
See "Management's Discussion and Analysis of Consolidated Financial
Condition and Results of Operations," found in the Company's Annual Report on
Form 10-K for the fiscal year ended December 27, 2003, for additional
information relating to the Company's use of estimates and other critical
accounting policies.
22
NEW ACCOUNTING PRONOUNCEMENTS
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity"
("SFAS 150"). SFAS 150 establishes standards for how an issuer classifies and
measures certain financial instruments with characteristics of both liabilities
and equity. It requires that an issuer classify a financial instrument that is
within its scope as a liability, many of which had been previously classified as
equity or between the liabilities and equity sections of the Condensed
Consolidated Balance Sheet. The provisions of SFAS 150 are effective for
financial instruments entered into or modified after May 31, 2003, and otherwise
are effective at the beginning of the first interim period beginning after June
15, 2003. The standard is to be implemented by reporting the cumulative effect
of a change in accounting principle for financial instruments created before the
issuance of SFAS 150 and still existing at the beginning of the interim period
of adoption. The Company adopted the provisions of SFAS 150, which resulted in
the reclassification of its Series B Participating Preferred Stock to a
liability rather than between the liabilities and equity sections of the
Condensed Consolidated Balance Sheet. Based upon the requirements set forth by
SFAS 150, this reclassification was subject to implementation beginning on June
29, 2003. Upon implementation of SFAS 150, the Company reflected subsequent
increases in liquidation preference as an increase in Total Liabilities with a
corresponding reduction in capital in excess of par value, because the Company
has an accumulated deficit. Accretion was recorded as interest expense.
During March 2004, the Financial Accounting Standards Board ("FASB")
issued Emerging Issues Task Force Issue No. 03-6, "Participating Securities and
the Two-Class Method under FASB Statement No. 128" ("EITF 03-6"). SFAS 128
defines earnings per share ("EPS") as "the amount of earnings attributable to
each share of common stock" and indicates that the objective of EPS is to
measure the performance of an entity over the reporting period. SFAS 128
addresses conditions under which a participating security requires the use of
the two-class method of computing EPS. The two-class method is an earnings
allocation formula that treats a participating security as having rights to
earnings that otherwise would have been available to common shareholders, but
does not require the presentation of basic and diluted EPS for securities other
than common stock. The Company's Series C Participating Preferred Stock is a
participating security and, therefore, the Company calculates EPS utilizing the
two-class method, however, it has chosen not to present basic and diluted EPS
for its preferred stock.
See "Management's Discussion and Analysis of Consolidated Financial
Condition and Results of Operations," found in the Company's Annual Report on
Form 10-K for the fiscal year ended December 27, 2003, as amended, and Note 89 of
the Condensed Consolidated Financial Statements for additional information
relating to new accounting pronouncements that the Company has adopted.
OFF-BALANCE SHEET ARRANGEMENTS AND CONTRACTUAL OBLIGATIONS
The Company has entered into no "off-balance sheet arrangements" within
the meaning of the Securities Exchange Act of 1934, as amended, and the rules
thereunder other than operating leases, which are in the normal course of
business.
Provided below is a tabular disclosure of contractual obligations as of
March 27,June 26, 2004, as required by Item 303(a)(5) of SEC Regulation S-K. In addition
to obligations recorded on the Company's Condensed Consolidated Balance Sheets
as of March 27,June 26, 2004, the schedule includes purchase obligations, which are
defined as legally binding and enforceable agreements to purchase goods or
services that specify all significant terms (quantity, price and timing of
transaction).
2331
PAYMENT DUE BY PERIOD (IN THOUSANDS)
LESS THAN MORE THAN
CONTRACTUAL OBLIGATIONS TOTAL 1 YEAR 1-3 YEARS 3-5 YEARS 5 YEARS
----------------------- ----- ------ --------- --------- -------
Long-term Debt Obligations, excluding the Series C
Participating Preferred Stock $ 2,28918,532 $ 14,54811,739 $ 7,7416,793 $ -- $ --
Total Minimum Lease Payments Under
Capital Lease Obligations 899 629 268 2707 524 182 1 --
Operating Lease Obligations 15,487 5,421 4,632 3,751 1,68314,363 4,945 4,462 3,732 1,224
Operating Lease Obligations -
Restructuring/Discontinued Operations 8,774 3,393 2,4577,950 3,056 2,221 2,005 919668
Purchase Obligations (a) 2,992 1,776 1,2162,908 2,010 898 -- --
Other Long-Term Liabilities Reflected on the
Registrant's Balance Sheet under GAAP (b) 72,689 -- -- 72,689 --
72,689
---------- ---------- ---------- ---------- ------------------ -------- -------- ------ --------
Total $117,149 $ 123,13022,274 $ 25,76714,556 $78,427 $ 16,314 $ 5,758 $ 75,291
========== ========== ========== ========== ==========1,892
======== ======== ======== ======= ========
(a) The Company's purchase obligations consist primarily of a total
commitment of $2,000,000 to purchase telecommunication services during the
period from May 1, 2004 through April 30, 2006, of which approximately
$1,166,667 should be fulfilled during the next 12 months and the remaining
$833,333 fulfilled by April 30, 2006; a total commitment of approximately
$487,000 to purchase catalog photography services during the period from
September 11, 2003 through September 10, 2005, of which approximately
$96,000$172,000 had been fulfilled as of March 27,June 26, 2004, and of which
approximately $258,000$250,000 should be fulfilled during the next fiscal yeartwelve months
and the remaining $133,000$65,000 fulfilled by September 10, 2005; a total
commitment of $375,000 for list processing services representing the
maximum exposure for a service contract which requires a three-month
notice of termination for services costing $125,000 per month; a total
commitment of $201,000$199,000 to purchase various packaging materials from
several vendors during the next 12 months, under contracts wherein the
vendors warehouse varying minimum and maximum levels of materials to
ensure immediate availability; and several commitments totaling
approximately $151,000$75,000 for various consulting services to be provided
during the period AprilAugust 2003 through July 2004, of which approximately
$126,000$56,000 had been fulfilled as of March 27,June 26, 2004.
(b) Represents Series C Participating Preferred Stock as disclosed in Note 1112
to the Company's Condensed Consolidated Financial Statements.
SEASONALITY
The Company does not consider its business seasonal. The revenues for the
Company are proportionally consistent for each quarter during a fiscal year. The
percentage of annual revenues for the first, second, third and fourth quarters
recognized by the Company, respectively, were as follows: 2003 - 24.7%24.5%, 25.5%25.6%,
23.3%23.5% and 26.5%26.4%; and 2002 - 23.9%, 24.9%, 23.2%23.1% and 28.0%28.2%.
FORWARD-LOOKING STATEMENTS
The following statements from above constitute forward-looking statements
within the meaning of the Private Securities Litigation Reform Act of 1995:
"Subject to an adverse outcome in the Wilson matter discussed above,
management"Management believes that the Company has sufficient liquidity and
availability under its credit agreementagreements to fund its planned operations through
at least December 25, 2004.the next twelve months."
32
CAUTIONARY STATEMENTS
The following material identifies important factors that could cause
actual results to differ materially from those expressed in the forward-looking
statements identified above and in any other forward-looking statements
contained elsewhere herein:
24
-
- A general deterioration in economic conditions in the United States
leading to reduced consumer confidence, reduced disposable income and increased
competitive activity and the business failure of companies in the retail,
catalog and direct marketing industries. Such economic conditions leading to a
reduction in consumer spending generally and in-home fashions specifically, and
leading to a reduction in consumer spending specifically with reference to other
types of merchandise the Company offers in its catalogs or over the Internet, or
which are offered by the Company's third party fulfillment clients.
- - Customer response to the Company's merchandise offerings and circulation
changes; effects of shifting patterns of e-commerce versus catalog purchases;
costs associated with printing and mailing catalogs and fulfilling orders;
effects of potential slowdowns or other disruptions in postal service;
dependence on customers' seasonal buying patterns; and fluctuations in foreign
currency exchange rates. The ability of the Company to reduce unprofitable
circulation and to effectively manage its customer lists.
- - The ability of the Company to achieve projected levels of sales and the
ability of the Company to reduce costs commensurate with sales projections.
Increases in postage, printing and paper prices and/or the inability of the
Company to reduce expenses generally as required for profitability and/or
increase prices of the Company's merchandise to offset expense increases.
- - The failure of the Internet generally to achieve the projections for it
with respect to growth of e-commerce or otherwise, and the failure of the
Company to increase Internet sales. The success of the Amazon.com
venture. The imposition of regulatory, tax or other
requirements with respect to Internet sales. Actual or perceived technological
difficulties or security issues with respect to conducting e-commerce over the
Internet generally or through the Company's Web sites or those of its third
party fulfillment clients specifically.
-
- The ability of the Company to attract and retain management and
employees generally and specifically with the requisite experience in
e-commerce, Internet and direct marketing businesses. The ability of employees
of the Company who have been promoted as a result of the Company's strategic
business realignment program to perform the responsibilities of their new
positions.
-
- A general deterioration in economic conditions in the United States
leading to key vendors and suppliers reducing or withdrawing trade credit to
companies in the retail, catalog and direct marketing industries. The risk that
key vendors or suppliers may reduce or withdraw trade credit to the Company,
convert the Company to a cash basis or otherwise change credit terms, or require
the Company to provide letters of credit or cash deposits to support its
purchase of inventory, increasing the Company's cost of capital and impacting
the Company's ability to obtain merchandise in a timely manner. The ability of
the Company to find alternative vendors and suppliers on competitive terms if
vendors or suppliers who exist cease doing business with the Company.
- - The inability of the Company to timely obtain and distribute
merchandise, leading to an increase in backorders and cancellations.
-
- Defaults under the Congress Credit Facility, or inadequacy of available
borrowings thereunder, reducing or impairing the Company's ability to obtain
letters of credit or other credit to support its purchase of inventory and
support normal operations, impacting the Company's ability to obtain, market and
sell merchandise in a timely manner.
- - The inadequacy of available borrowings under the Congress Credit
Facility preventing the Company from paying vendors or suppliers in a timely
fashion.
- Defaults under the Term Loan Facility impacting the Company's ability to
obtain, market and sell merchandise in a timely manner or preventing the Company
from paying vendors or suppliers in a timely fashion.
33
- Continued compliance by the Company with and the enforcement by Congress
of financial and other covenants and limitations contained in the Congress
Credit Facility, including net worth, net working capital, capital expenditure
and EBITDA covenants, and limitations based upon specified percentages of
eligible receivables and eligible inventory, and the requirement that the Company maintain $3.0 million of excess
credit availability at all times, affecting the ability of the
Company to continue to make borrowings under the Congress Credit Facility.
-
- Continuation of the Company's history of operating losses, and the
incidence of costs associated with the Company's strategic business realignment
program, resulting in the Company failing to comply with certain financial and
other covenants contained in the Congress Credit Facility and/or the Term Loan
Facility, including net worth, net working capital, capital expenditure and
EBITDA covenants and the ability of the Company to obtain waivers from Congress
and/or Chelsey Finance in the event that
25
future internal and/or external events
result in performance that results in noncompliance by the Company with the
terms of the Congress Credit Facility and/or the Term Loan Facility requiring
remediation.
-
- The ability of the Company to realize the aggregate cost savings and
other objectives anticipated in connection with the strategic business
realignment program, or within the time periods anticipated therefor. The
aggregate costs of effecting the strategic business realignment program may be
greater than the amounts anticipated by the Company.
- The ability of the Company to achieve its business plan.
- The ability of the Company to maintain advance rates under the Congress
Credit Facility that are at least as favorable as those obtained in the past due
to market conditions affecting the value of the inventory which is periodically
re-appraised in order to re-set such advance rates.
- - The ability of the Company to dispose of assets related to its third
party fulfillment business, to the extent not transferred to other facilities.
-
- The initiation by the Company of additional cost cutting and
restructuring initiatives, the costs associated therewith, and the ability of
the Company to timely realize any savings anticipated in connection therewith.
-
- The ability of the Company to maintain insurance coverage required in
order to operate its businesses and as required by the Congress Credit Facility.
The ability of the Company to obtain certain types of insurance, including
directors' and officers' liability insurance, or to accept reduced policy limits
or coverage, or to incur substantially increased costs to obtain the same or
similar coverage, due to recently enacted and proposed changes to laws and
regulations affecting public companies, including the provisions of the
Sarbanes-Oxley Act of 2002 and rules of the Securities and Exchange Commission
thereunder.
- - The inability of the Company to access the capital markets due to market
conditions generally, including a lowering of the market valuation of companies
in the direct marketing and retail businesses, and the Company's business
situation specifically.
- - The inability of the Company to sell non-core or other assets due to
market conditions or otherwise.
- - The inability of the Company to redeem the Series C Participating
Preferred Stock.
-
- The ability of the Company to maintain the listing of its Common Stock
on the American Stock Exchange due to a failure to maintain $15 million of
public float or otherwise.
- - The continued willingness of customers to place and receive mail orders
in light of worries about bio-terrorism.
-
- The ability of the Company to sublease, terminate or renegotiate the
leases of its vacant facilities in Weehawken, New Jersey and other locations.
- The ability of the Company to smoothly transition its operations at its
leased fulfillment facility in LaCrosse, WI to its owned facility in Roanoke,
VA.
34
- The ability of the Company to achieve a satisfactory resolution of the
various class action lawsuits that are pending against it, including the Wilson
case. The possibility that the Company may be required to post a significant
bond or bonds in the Wilson case or the other class action lawsuits when
appealing an adverse decision of the courts.
- - The ability of the Company to evaluate and implement the requirements of
the Sarbanes-Oxley Act of 2002 and the rules of the Securities and Exchange
Commission thereunder, as well as recent changes to listing standards by the
American Stock Exchange, in a cost effective manner.
- - The ability of the Company to achieve cross channel synergies, create
successful affiliate programs, effect profitable brand extensions or establish
popular loyalty and buyers' club programs.
-
- Uncertainty in the U.S. economy and decreases in consumer confidence
leading to a slowdown in economic growth and spending resulting from the
invasion of, war with and occupation of Iraq, which may result in future acts of
terror. Such activities, either domestically or internationally, may affect the
economy and consumer confidence and spending within the United States and
adversely affect the Company's business.
26
- - Softness in demand for the Company's products.
-
- The inability of the Company to continue to source goods from foreign
sources, particularly India and Pakistan, leading to increased costs of sales.
-
- The possibility that all or part of the summary judgment decision in the
matter of Rakesh K. Kaul v. Hanover Direct, Inc. will be overturned on appeal.
- - Reductions in unprofitable circulation leading to loss of revenue, which
is not offset by a reduction in expenses.
-
- Any significant increase in the Company's return rate experience as a
result of the recent change in its return policy or otherwise.
- The inability of the Company to achieve its targeted annual conversion
rate of buyers' club customers leading to a loss of the agreed-upon year-end
bonus.
- Any significant increase in the cost of down as a result of the Asian
bird virus or otherwise.
ITEM 3. QUANTITIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
INTEREST RATES: The Company's exposure to market risk relates to interest
rate fluctuations for borrowings under the Congress revolving credit facility
and its term financing facilities, which bear interest at variable rates.rates, and
the Term Loan Facility with Chelsey Finance, which bears interest at 5% above
the prime rate publicly announced by Wachovia Bank, N.A. At March 27,June 26, 2004,
outstanding principal balances under these facilitiesthe Congress Credit Facility subject to
variable rates of interest were approximately $16.7$13.4 million. If interest rates
were to increase by one percent from current levels, the resulting increase in
interest expense, based upon the amount outstanding at March 27,June 26, 2004, would be
approximately $0.17$0.13 million on an annual basis.
In addition, the Company's exposure to market risk relates to customer
response to the Company's merchandise offerings and circulation changes, effects
of shifting patterns of e-commerce versus catalog purchases, costs associated
with printing and mailing catalogs and fulfilling orders, effects of potential
slowdowns or other disruptions in postal service, dependence on customers'
seasonal buying patterns, fluctuations in foreign currency exchange rates, and
the ability of the Company to reduce unprofitable circulation and effectively
manage its customer lists.
ITEM 4. CONTROLS AND PROCEDURES
DISCLOSURE CONTROLS AND PROCEDURES. The Company's management, with the
participation of the
35
Company's Chief Executive Officer and Chief Financial Officer, has evaluated the
effectiveness of the Company's disclosure controls and procedures (as such term
is detailed in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act
of 1934, as amended (the "Exchange Act")) as of the end of the period covered by
this report. Based on such evaluation, the Company's Chief Executive Officer and
Chief Financial Officer have concluded that, as of the end of such period, the
Company's disclosure controls and procedures are effective in recording,
processing, summarizing and reporting, on a timely basis, information required
to be disclosed by the Company in the reportreports it files or submits under the
Exchange Act.
INTERNAL CONTROL OVER FINANCIAL REPORTING. There have not been any changes
in the Company's internal control over financial reporting (as such term is
defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the
fiscal quarter to which this report relates that have materially affected, or
are reasonably likely to materially affect, the Company's internal control over
financial reporting.
2736
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
A class action lawsuit was commenced on March 3, 2000 in the District
Court in Sequoyah County, Oklahoma entitled Edwin L. Martin v. Hanover Direct,
Inc. and John Does 1 through 10 bearing case no.
CJ2000-177 in the State Court of Oklahoma (District Court in and for Sequoyah
County). Plaintiff commenced the action on behalf of himself and a class of
persons who have at any time purchased a product from the Company and paid for
an "insurance charge." The complaint("Martin"), which sets forth claims for breach
of contract, unjust enrichment, recovery of money paid absent consideration,
fraud and a claim under the New Jersey Consumer Fraud Act.Act as a result of
"insurance charges" paid to the Company by participants in the class action
suit. The complaint alleges that the Company charges its customers for delivery
insurance even though, among other things, the Company's common carriers already
provide insurance and the insurance charge provides no benefit to the Company's
customers. Plaintiff also seeks a declaratory judgment as to the validity of the
delivery insurance. The
damages sought are (i)Plaintiff seeks an order (i) directing the Company to return
to the plaintiff and class members the "unlawful revenue" derived from the
insurance charges, (ii) declaring the rights of the parties, (iii) permanently enjoining the
Company from imposing thean insurance charge, (iv) awarding threefold damages of
less than $75,000 per plaintiff and per class member, and (v) awarding
attorneys' fees and costs. On April 12,July 23, 2001, the Court heldcertified a hearing on plaintiff's class
certification motion. Subsequent to the April 12, 2001 hearing on plaintiff's
class certification motion, plaintiff filed a motion to amend the definitioncomprised of the class. On July 23, 2001, plaintiff's class certification motion was granted,
defining the class as "Allall persons in the United States who are customers of any catalog
or catalog company owned by Hanover Direct, Inc.the Company and who have at any time purchased a product
from any such company and paid money thatwhich was designated to be an insurance`insurance
charge." On August 21, 2001, the' The Company filed an appeal of the order with the Oklahoma Supreme Court and subsequently moved to stay proceedings
in the district court pending resolution of the appeal. The appeal has been
fully briefed. At a subsequent status hearing, the parties agreed that issues
pertaining to notice to the class would be stayed pending resolution of the
appeal, that certain other issues would be subject to limited discovery, and
that the issue of a stay for any remaining issues would be resolved if and when
such issues arise.certification. On January 20,
2004, the plaintiff filed a motion for oral argument withon the Court.appeal of the class
certification. The Company believes it has defenses against the claims and plans
to conduct a vigorous defense of this action. The Company believes that a loss
is not probable; therefore, no accrual for potential losses was deemed
necessary.
On August 15, 2001, the Company was served with a summons and four-count
complaint filed in Superior Court for the City and County of San
Francisco, California, entitled Teichman v. Hanover Direct, Inc., Hanover Brands, Inc.,
Hanover Direct Virginia, Inc., and Does 1-100.1-100 ("Teichman"), which was
subsequently expanded to include other Hanover Direct, Inc. subsidiaries as
defendants. The complaint was filed by a California resident in the Superior
Court for the City and County of San Francisco seeking damages and other relief
for herself and a class of all others similarly situated arising out of the
insurance fee charged by catalogs and Internet sites operated by subsidiaries of
the Company. Defendants, includingOn May 14, 2002, as a result of the Company have filed motions to dismiss based on a lack
of personal jurisdiction over them. In January 2002, plaintiff sought leave to
name six additional entities: International Male, Domestications Kitchen &
Garden, Silhouettes, Hanover Company Store, Kitchen & Home, and Domestications
as co-defendants. On March 12, 2002, the Company was served with the First
Amended Complaint in which plaintiff named as defendants the Company, Hanover
Brands, Hanover Direct Virginia, LWI Holdings, Hanover Company Store, Kitchen
and Home, and Silhouettes. On April 15, 2002, the Companyhaving filed a Motion
to Stay the Teichman action in favor of the previously filedpreviously-filed Martin action and also
filed a
Motion to quash service of summons for lack of personal jurisdiction on
behalf of defendantsDismiss the case against Hanover Direct, Inc., Hanover Brands, Inc.,
and Hanover Direct Virginia, Inc. On May 14, 2002,for lack of personal jurisdiction, the Court
(1) granted the Company's Motion to quashStay the action in favor of the
previously-filed Martin action, and (2) granted the Company's Motion to Quash
service, on behalf of Hanover Direct, Hanover Brands, and Hanover
Direct Virginia, leaving only LWI Holdings, Hanover Company Store, Kitchen & Home, and
Silhouettes as defendants, and (2) granted the Company's Motion to
Stay the action in favor of the previously filed Oklahoma action, so nothing
will proceed on this case against the remaining entities until the Oklahoma case
is decided.defendants. The Company believes it has defenses against the
claims. The Companyclaims and plans to conduct a vigorous defense of this action. The Company
believes that a loss is not probable; therefore, no accrual for potential losses
was deemed necessary.
A class action lawsuit was commenced on February 13, 2002 in the Superior
Court of the State of California, City and County of San Francisco entitled Jacq
Wilson, suing on behalf of himself, all others similarly situated, and the
general public v. Brawn of California, Inc. dba International Male and
Undergear, and Does 1-100 ("Brawn") in the Superior Court of the State of
California, City and County of San Francisco.. Does 1-100 are Internet and catalog direct
marketers offering a selection of men's clothing, sundries, and shoes who
advertise within California and nationwide. The complaint allegesalleged that, for at
least four years, members of the class havehad been charged an unlawful, unfair, and
fraudulent insurance fee and tax on orders sent to them by Brawn; that Brawn was
engaged in untrue, deceptive and misleading advertising in that it was not
lawfully required or permitted to collect insurance, tax and sales tax from
customers in California; and that Brawn has engaged in acts of unfair
competition under the state's Business and Professions Code. Plaintiff and the
class seek (i) restitution and disgorgement of all monies wrongfully collected and
earned by Brawn, including interest and other gains, made on account of these
practices, including reimbursement in the amount of the
insurance tax and sales
tax collected unlawfully, togethercharge with interest, (ii) an order enjoining Brawn from charging customersimposing insurance and tax
on its order forms and/or from
charging tax on the delivery, shippingforms; and insurance charges, (iii) an order
directing Brawn to notify
28
the California State Board of Equalization of the failure to pay the correct
amount of tax to the state and to take appropriate steps to provide the state
with the information needed for audit, and (iv) compensatory damages, attorneys' fees, pre-judgment
interest and costs of the suit. The claims of(Plaintiff lost at trial on the individually named plaintifftax issue and
for each member ofhas not appealed it so it is no longer among the class amount to less
than $75,000. On April 15, 2002, the Company filed a Motion to Stay the Wilson
actionissues being litigated in favor of the previously filed Martin action. On May 14, 2002, the
Court denied the Motion to Stay. The Wilson case proceeded to trial before the
Honorable Diane Elan Wick of the Superior Court of California for the County of
San Francisco, and the Judge, sitting without a jury, heard evidence from April
15-17, 2003.this
case.) On November 25, 2003, the Court, after hearing evidence and
considering post-trial submissions from the parties,a trial, entered judgment in
plaintiff's favor,for the
plaintiff and the class, requiring Brawn, by June 30, 2004, to refund insurance
feescharges collected from consumers for the period from February 13, 1998 through
January 15, 2003 with interest from the date paid by June 30, 2004. Plaintiff did not prevail onpaid. On April 14, 2004, the tax issues.Court
awarded plaintiff's counsel approximately $445,000 of attorneys' fees. On January 12, 2004, plaintiff filed a motion requesting
approximately $740,000 in attorneys' fees and costs. On February 27,April
23, 2004, the Company filed its responsea Motion to that motion. PlaintiffStay the enforcement of the insurance
fees judgment pending resolution of the appeal, including a request to
extinguish a lien filed a reply brief on
March 13, 2004. A hearing was held on plaintiff's motion on March 18, 2004. The
judge ruled on that motion on April 14,2, 2004, awarding plaintiff's counsel
approximately $445,000.and including a request for a
determination that an appellate bond will not be required by the Company. This
motion was heard on May 11, 2004 and granted, the Court
37
finding that enforcement of the judgment entered was stayed on January 23, 2004
when Brawn filed its Notice of Appeal. The Company has appealed the trial
court's decision on the merits of the insurance fees issue as well as the
decision on the attorney'sattorneys' fees issue. TheOn May 18, 2004, the Court of Appeals
issued an Order consolidating the two appeals will likely be consolidated with briefing expected
to begin in late May 2004. The Company will be required to post a bond in the
amount of approximately $750,000 while the appeal of the attorneys' fees award
is proceeding but its counsel does not believe the Company will be required to
do so while the appeal on the insurance fees decision is proceeding.appeals. The Company plans to conduct a
vigorous defense of this action. The potential estimated exposure is in the
range of $0 to $4.0 million. Based upon the Company's policy of evaluating
accruals for legal liabilities, the Company has not established a reserve due toas a
result of management determining that it is not probable that an unfavorable
outcome will result.
A class action lawsuit was commenced on October 28, 2002 in the Superior
Court of New Jersey, Bergen County - Law Division entitled John Morris,
individually and on behalf of all other persons & entities similarly situated v.
Hanover Direct, Inc., and Hanover Brands, Inc. (referred to herein this paragraph as
"Hanover"), No. L 8830-02 in the Superior Court of New Jersey, Bergen County --
Law Division.. The plaintiff bringsbrought the action individually and on behalf of a
class of all persons and entities in New Jersey who purchased merchandise from
Hanover within six years prior to filing of the lawsuit and continuing to the
date of judgment. On the basis of a purchase made by plaintiff in August 2002 of
certain clothing from a Hanover (which was from a men's division catalog, the only
ones which retained the insurance line item in 2002), Plaintiff claimsplaintiff alleged that for
at least six years, Hanover
maintainedhad a policy and practice of improperly adding a charge for "insurance" to the
orders it received, and concealed and failed to disclose its policy with respect to all class members.the charge. Plaintiff
claims that Hanover's conduct was (i) in violation of the New Jersey Consumer Fraud
Act as otherwise deceptive, misleading and unconscionable; (ii)unconscionable such as to constitute
Unjust
Enrichmentunjust enrichment of Hanover at the expense and to the detriment of plaintiff
and the class;class and (iii) unconscionable per se under the Uniform Commercial Code for
contracts related to the sale of goods. Plaintiff and the class seek damages
equal to the amount of all insurance charges, interest thereon, treble and
punitive damages, injunctive relief, costs and reasonable attorneys' fees, and
such other relief as may be just, necessary and appropriate. On December 13,
2002, the Company filed a Motion to Stay the Morrisaction pending resolution of the
previously-filed Martin action in favor of the
previously filed Martin action. Plaintiff then filed an Amended Complaint adding
International Male as a defendant. Hearing on the Motion to Stay took place on
June 5, 2003.Oklahoma. The Court granted the Company's
Motion to Stay the action and the case was stayed, first until December 31, 2003 and subsequentlyextended once, until March 31, 2004. The2004,
at which time the stay was lifted on March 31, 2004.lifted. On April 30, 2004, the Company responded to
plaintiff'sPlaintiff's Amended Complaint by filing a Motion for Summary
Judgment thatComplaint. The case is currently scheduled to be heard byin the Court on June 11, 2004.discovery phase. The Company
plans to conduct a vigorous defense of this action. The Company believes that a
loss is not probable; therefore, no accrual for potential losses was deemed
necessary.
On June 28, 2001, Rakesh K. Kaul, thea former President and Chief Executive
Officer of the Company, filed a five-count complaint (the "Complaint") in New York State Court against the
Company seeking damages and other relief arising out of his separation of
employment from the Company including, among other things, severance payments of
$2,531,352 plus the cost of employee benefits,and attorneys' fees and costs incurred in connection with the
enforcementprosecution and defense of his rights under
his employment agreement with the Company, payment of $298,650 for 13 weeks of
accrued and unused vacation, damages in the amount of $3,583,800, or, in the
alternative, a declaratory judgment from the court that he is entitled to all
change of control benefits under the "Hanover Direct, Inc. Thirty-Six Month
Salary Continuation Plan,"lawsuit, and damages in the amount of $1,396,066 or $850,000 due to the Company's
purported breach of the terms of the "Long-Term Incentive Plan for Rakesh K.
Kaul" by failing to pay him a "tandem bonus" he alleges was due and payable to
him withinon the 30 days30th day following his resignation.termination of employment. The Companycase was
removed the case to the U.S.United States District Court for the Southern District of New
York on July 25, 2001.whereupon Mr. Kaul filed an Amended Complaint ("Amended Complaint")
in the U.S. District Court for the Southern District of New York on September
18, 2001. The Amended Complaint repeats many of the claims made in the original
Complaint and addsamended his complaint to add ERISA claims.
On October 11, 2001, the Company filed its Answer, Defenses and
CounterclaimsCounterclaim to the Amended Complaint,amended complaint, denying liability under each and every
of Mr.
Kaul's eight causes of action, challenging all substantive assertions, raising several defenses and stating nine
counterclaims of its own against Mr. Kaul. The
counterclaims includeKaul including, among other things, (1)
breach of contract; (2) breach of the Non-Competition
and Confidentiality Agreement with the Company; (3) breach of fiduciary duty; (3) unjust enrichment; and (4)
unfair competition; and (5) unjust enrichment. The Company seeks damages,
including, without limitation, the $341,803 in severance pay and car allowance
Mr. Kaul received following his resignation, $412,336 for amounts paid
29
to Mr. Kaul for car allowance and related benefits, the cost of a long-term
disability policy, and certain payments made to personal attorneys and
consultants retained by Mr. Kaul during his employment, $43,847 for certain
services the Company provided and certain expenses the Company incurred,
relating to the renovation and leasing of office space occupied by Mr. Kaul's
spouse at 115 River Road, Edgewater, New Jersey, the Company's current
headquarters, $211,729 on a tax loan to Mr. Kaul outstanding since 1997 and
interest, compensatory and punitive damages and attorneys' fees.competition. The Company moved to amend its counterclaims, and the
parties each moved for summary judgment. The Company sought summary judgment: dismissing Mr. Kaul's claim for
severance under his employment agreement on the ground that he failed to provide
the Company with a general release of, among other things, claims for change of
control benefits; dismissing Mr. Kaul's claim for attorneys' fees on the grounds
that they are not authorized under his employment agreement;requested judgment
dismissing Mr. Kaul's claims related to change in control benefits based on an administrative
decision that he is not entitled to continued participation in the plan or to
future benefits thereunder; dismissing Mr. Kaul's claim for a tandem bonus
payment on the ground that no payment is owing; dismissing Mr. Kaul's claim for
vacation payments based on Company policy regarding carry over vacation; and seeking judgment awarding damages on the Company's
counterclaimclaim for unjust enrichment based on
Mr. Kaul's failure to pay underreimbursement of a tax note.loan. Mr. Kaul sought summary judgment:requested judgment dismissing
the Company's defenses and counterclaims relating to a release on the
grounds that he tendered a release or that the Company is estopped from
requiring him to do so; dismissing the Company's defenses and counterclaims
relating to his alleged violations of his non-compete and confidentiality
obligations on the grounds that he did not breach the obligations as defined in
the agreement; and dismissing the Company's claims based on his alleged breach
of fiduciary duty, including those based on his monthly car allowance payments
and the leased space to his wife, on the grounds that he was entitled to the car
payments and did not involve himself in or make misrepresentations in connection
with the leased space. The Company concurrently moved to amend its Answer and
Counterclaims to state a claim that it had cause for terminating Mr. Kaul's
employment based on, among other things, after acquired evidence that Mr. Kaul
received a monthly car allowance and other benefits totaling $412,336 that had
not been authorized by the Company's Board of Directors and that his wife's
lease and related expense was not properly authorized by the Company's Board of
Directors, and to clarify or amend the scopecertain of the Company's counterclaims for
reimbursement.and defenses.
On January 7, 2004, the Court rendered an Opinion and Order dismissing in
part and granting in part the motions on summary judgment. The Court: granted
summary judgment in favor of the Company dismissing Mr. Kaul's claim for
severance under his employment agreement on the groundsground that he failed to provide
the Company with a general release; granted in part the Company's motion for
summary judgment on Mr. Kaul's claim for attorneys' fees, finding as a matter of
law that Mr. Kaul is not entitled to fees incurred in prosecuting this lawsuit
but finding an issue of fact as to the amount of reasonable fees he may have
incurred in seeking advice and representation in connection with the termination
of his employment; granted summary judgment in favor of the Company dismissing
Mr. Kaul's claims related to change in control benefits on the grounds that Mr.
Kaul's participation in the plan was properly terminated when his employment was
terminated, the plan was properly terminated, and the administrator and appeals
committee properly denied Mr. Kaul's claim; granted summary judgment in favor of
the Company dismissing Mr. Kaul's claim for a tandem bonus payment on the ground
that payment is not owed to him; granted summary judgment in part and denied
38
summary judgment in part on Mr. Kaul's claims for vacation pay, deeming Mr. Kaul
to have abandoned claims for vacation pay in excess of five weeks but finding
him entitled to four weeks vacation pay based on the Company's policy and
finding an issue of fact as to Mr. Kaul's claim for an additional week of
vacation pay in dispute for 2000; and denied summary judgment on the Company's
counterclaim for payment under a tax note based on disputed issues of fact.
The Court dismissed the Company's affirmative defenses as largely moot and
the CourtCourt: granted summary judgment in favor of Mr. Kaul dismissing certain of
the Company's counterclaims relating to his non-compete and confidentiality
obligations on the grounds that there is no evidence of actual damage to the
Company resulting from Mr. Kaul's alleged violations of those obligations;
granted summary judgment in favor of Mr. Kaul on the Company's breach of
contract and breach of fiduciary duty claims, including those based on his
monthly car allowance payments and the leased space to his wife, on the grounds
that he did not breach his fiduciary duties in accepting the car payments and
would not be unjustly enriched if he kept them, and on the ground that the
Company would not be able to prove fraud in connection with the leased space
based on the circumstances, including Mr. Kaul's disclosures.counterclaims. The Court denied in part and granted in part the
Company's motion to amend its Answer and Counterclaims. The Court denied the Company's motion for
leave to state a claim that it had acquired evidence of cause for terminating
Mr. Kaul's employment based on certain reimbursements on the grounds that the
payments were authorized, but granted the
Company's motion with respect to its claim for reimbursement of amounts paid to
the Internal Revenue Service ("IRS") on Mr. Kaul's behalf. The Opinion identifiesOnly three remaining issuesclaims
remained in the case: (i) Mr. Kaul's claim for attorneys' fees pursuant to
Section 12 of the employment agreement; (ii) Mr. Kaul's claim for an additional
week of vacation pay in the amount of 30
approximately $11,500; and (iii) the
Company's counterclaim for $211,729 plus interest it paid to the IRS on Mr.
Kaul's behalf.
In an attempt to resolve the outstanding issues prior to the entry ofOn or about July 13, 2004 a final judgment conferences were held withwas entered whereby the Court
on two separate occasions.
Asdismissed the remaining claims (except for Mr. Kaul's claim to attorney's fees
incurred in prosecuting and defending the law suit) and ordered a resultpayment to Mr.
Kaul in the amount of these conferences, the$45,946, representing four weeks of vacation pay, together
with interest thereon from December 5, 2000. The parties have tentatively reachedagreed to a settlement wherebyfinal
payment, including interest, in the parties agreeamount of $60,856. The Court is expected to
dismiss the following claims: (1) Mr.
Kaul agrees to withdraw and release his claims concerning reimbursement of
certain attorneys' fees under Section 12 of the employment agreement (but
preserves and does not waive, release or limit his claim for attorneys' fees and
costs under Section 12 of the employment agreement incurred in connection with
the preparation for and litigation of this lawsuit) and reimbursement for an
additional week of vacation pay; and (2) the Company agrees to withdraw and
release its claims concerning reimbursement of certain attorneys' fees and costs
under ERISA, reimbursement of the $211,729 paid to the IRS on Mr. Kaul's behalf,
and reimbursement of the $341,803 of severance payments made to Mr. Kaul. The
parties also agree that Mr. Kaul shall not appeal that portion of the Opinion
concerning the dismissal of certain of Mr. Kaul's ERISA-based claims with
respect to the Plan and the Company shall not appeal that portion of the Opinion
concerning the dismissal of its claims relating to the leasing and build-out of
property or office space located in Edgewood, New Jersey to Mr. Kaul's wife. Mr.
Kaul has expressed his intent to now tendershortly issue a general release to the Company. If
he does, in fact, do so, the Company will reject the tender on the grounds,
inter alia, that the time to do so has long passed and that the purpose for the
general release has been extinguished. After final judgment issues, eachimplementing its summary judgment Opinion. Each
party shall have the right to appeal any aspect of that judgment. The Company
has reserved $65,435 for payments due Mr. Kaul including the judgment.associated employer
payroll taxes. Payment was made to Mr. Kaul on July 15, 2004 for the interest
portion of the agreement and on July 16, 2004 for the four weeks vacation.
The Company was named as one of 88 defendants in a patent infringement
complaint filed on November 23, 2001 in the U.S. District Court in Arizona by
the Lemelson Medical, Education & Research Foundation, Limited Partnership (the
"Lemelson Foundation"). The complaint filed in the U.S. District Court in Arizona, was not served on the Company until March
2002. In the complaint, the Lemelson Foundation accuses the named defendants of
infringing seven U.S. patents, which allegedly cover "automatic identification"
technology through the defendants' use of methods for scanning production
markings such as bar codes. The Company received a letter
dated November 27, 2001 from attorneys for the Lemelson Foundation notifying the
Company of the complaint and offering a license. The Court entered a stay of the case on March 20,
2002, requested by the Lemelson Foundation, pending the outcome of a related
case in Nevada being fought by bar code manufacturers. The
order for the stay in the case involving the Company provides that the Company
need not answer the complaint, although it has the option to do so. The Company
was invited to join a common interest/joint-defense group consisting of
defendants named in the complaint as well as in other actions brought by the
Lemelson Foundation. The trial in the Nevada case began on November 18, 2002 and
ended on January 17, 2003. On January 23, 2004, following extensive briefing by
the parties, the
Nevada Court entered judgment declaring that the claims of each of the patents
at issue in the Nevada case, including all seven patents asserted by the
Lemelson Foundation against the Company in the Arizona case, are unenforceable
under the doctrine of prosecution laches, are invalid for lack of written
description and enablement, and are not infringed by the bar code equipment
manufacturers. Subject toThe Lemelson Foundation filed a notice of appeal before the
resultsdeadline of any appealMay 28, 2004. The Arizona court confirmed that may be filed
by the parties tostay of the
Arizona case will extend until the entry of a final, non-appealable judgment in
the Nevada litigation, the judgment of the Nevada court should
preclude assertion of each of the affected patents against all parties,
including the Company in the Arizona case. Counsel is now monitoring the Nevada
and Arizona cases in order to determine a suitable moment for moving for
dismissal of the Lemelson Foundation's claims.litigation. The Company has analyzed the merits of the issues raised
by the complaint, notified vendors of its receipt of the complaint and letter,
evaluated the merits of joining thea joint-defense group, and had discussions with
attorneys for the Lemelson Foundation regarding thetheir license offer. The Company
will not agree to a settlement at this time and thus has not established a
reserve. A preliminary estimate of the royalties and attorneys' fees which the
Company may pay if it decides to accept the license offer from the Lemelson
Foundation range from about $125,000 to $400,000. The Company believes it has
defenses against the claims and plans to conduct a vigorous defense of this
action. The Company believes that a loss is not probable; therefore, no accrual
for potential losses was deemed necessary.
In early March 2003, the Company learned that one of its business units
had engaged in certain travel transactions that may have constituted violations
under the provisions of U.S. government regulations promulgated pursuant to 50
U.S.C. App. 1-44, which proscribe certain transactions related to travel to
certain countries. The Company immediately commenced an inquiry into the matter,
incurred resulting charges, made an initial voluntary disclosure to the
appropriate U.S. government agency under its program for such disclosures and
will submit to that agency a detailed report on the results of the inquiry. In
addition, the Company has taken steps to ensure that all of its business units
are acting in compliance with the travel and transaction restrictions and other
requirements of all applicable U.S. government programs. Although the Company is
uncertain of the extent of the penalties, if any, that may be imposed on it by
virtue of the transactions being voluntarily disclosed, it does not currently
believe that any such penalties will have a material effect on its business or
financial condition. 31The Company believes that a loss is not probable;
therefore, no accrual for potential losses was deemed necessary.
39
In addition, the Company is involved in various routine lawsuits of a
nature whichthat is deemed customary and incidental to its businesses. In the opinion
of management, the ultimate disposition of these actions will not have a
material adverse effect on the Company's financial position or results of
operations.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
In consideration for providing the $20 million Term Loan Facility to the
Company, the Company will issue to Chelsey Finance a warrant (the "Common Stock
Warrant") to purchase 30% of the fully diluted shares of Common Stock of the
Company, which the Company believes would be approximately 10,247,210 shares of
Common Stock (adjusted for the proposed one-for-ten reverse split of the
Company's Common Stock) at an exercise price of $.01 per share. Pending
shareholder approval of such issuance at the Company's Annual Meeting of
Shareholders scheduled for August 12, 2004, on July 8, 2004, the Company issued
to Chelsey Finance a warrant (the "Series D Preferred Warrant") to purchase 100
shares of a newly-issued series of nonvoting preferred stock of the Company,
called Series D Participating Preferred Stock (the "Series D Preferred Stock"),
that will be automatically exchanged for such Common Stock Warrant upon the
receipt of shareholder approval of the issuance thereof at the Company's Annual
Meeting of Shareholders scheduled for August 12, 2004. See Note 14 of Notes to
Consolidated Financial Statements for a description of the terms of the Term
Loan Facility and the Series D Preferred Stock.
In connection with the closing of the Term Loan Facility, on July 8, 2004,
the Company paid Chelsey a waiver fee equal to 1% of the liquidation preference
of the Company's outstanding Series C Participating Preferred Stock, in Common
Stock of the Company, issuing to Chelsey 4,344,762 additional shares of Common
Stock (calculated based upon the fair market value of the Common Stock two
business days prior to the closing date), in consideration for the waiver by
Chelsey of its blockage rights over the issuance of senior securities. The Board
of Directors of the Company determined that the value of the waiver was at least
equal to the aggregate par value of the 4,344,762 shares of Common Stock issued
to Chelsey.
The Series D Preferred Stock Warrant issued to Chelsey Finance and the
shares of Common Stock paid as a waiver fee to Chelsey were not publicly offered
and there were no underwriters involved in their offering. The Company issued
the Series D Preferred Stock Warrant to Chelsey Finance and the 4,344,762 shares
of Common Stock to Chelsey pursuant to Section 4(2) of the Securities Act of
1933, as amended, and Regulation D promulgated thereunder as a transaction by
the Company not involving a public offering.
ITEM 5. OTHER INFORMATION
BoardAMERICAN STOCK EXCHANGE NOTIFICATION
The Company received a letter dated May 21, 2004 (the "Letter") from the
American Stock Exchange (the "Exchange") advising that a review of Directors. Effective February 15,the Company's
Form 10-K for the period ended December 27, 2003 indicates that the Company does
not meet certain of the Exchange's continued listing standards as set forth in
Part 10 of the Exchange's Company Guide. Specifically, the Company is not in
compliance with Section 1003(a)(i) of the Company Guide with shareholders'
equity of less than $2,000,000 and losses from continuing operations and/or net
losses in two out of its three most recent fiscal years; and Section 1003(a)(ii)
of the Company Guide with shareholders' equity of less than $4,000,000 and
losses from continuing operations and/or net losses in three out of its four
most recent fiscal years; and Section 1003(a)(iii) of the Company Guide with
shareholders' equity of less than $6,000,000 and losses from continuing
operations and/or net losses in its five most recent fiscal years. The Exchange
requested that the Company contact the Exchange by June 4, 2004 Martin L. Edelmanto confirm
receipt of the Letter, discuss any possible financial data of which the
Exchange's staff may be unaware, and indicate whether or not the Company intends
to submit a plan of compliance. In order to maintain its listing on the
Exchange, the Company had to submit a plan to the American Stock Exchange by
June 22, 2004, advising the Exchange of action it has taken, or will take, that
would bring it into compliance with the continued listing standards of the
Exchange by November 24, 2005 (18 months of receipt of the Letter). The Company
submitted a plan to the Exchange on June 22, 2004 and on August 3, 2004 the
Exchange notified the Company that it accepted the Company's plan of compliance
and granted the Company an extension of time until November 21, 2005 to regain
compliance with the continued listing standards. The Company will be subject to
periodic review by Exchange staff during the extension period. Failure to make
progress consistent with the plan or to regain compliance with the
40
continued listing standards by the end of the extension period on November 21,
2005 could result in the Company being delisted from the Exchange. There can be
no assurance that the Company will be able to maintain the listing of its Common
Stock on the Exchange.
BOARD RESIGNATION
On July 30, 2004, Basil P. Regan resigned fromas a member of the Company's
Board of Directors. Effective AprilAs a result, Mr. Regan has advised the Company that he will
not be standing for reelection at the Company's August 12, 2004 Paul
S. Goodman joinedAnnual Meeting
of Shareholders. Mr. Regan continues to have the right, which is required to be
exercised as promptly as practicable, to appoint a designee to the Company's
Board of Directors as a designee of Chelsey
Direct, LLC filling the vacancy created by the resignation of Martin L. Edelman.
On April 29, 2004, the Board of Directors elected (1) Wayne P. Garten to serve
as a member and as the Chairman of the Transactions Committee of the Board of
Directors to fill the vacancy created by the resignation of Martin L. Edelman
from such positions, (2) William B. Wachtel to serve as a member of the
Executive Committee of the Board of Directors to fill the vacancy created by the
resignation of Martin L. Edelman from such position, (3) Paul S. Goodman to
serve as a member of the Corporate Governance Committee of the Board of
Directors to fill the vacancy created by the resignation of Martin L. Edelman
from such position, and (4) Donald Hecht to serve as a member of the
Compensation Committee to fill the vacancy created by the contemporaneous
resignation of Wayne P. Garten from such position.
President and Chief Executive Officer. Thomas C. Shull resigned as
Chairman of the Board, President and Chief Executive Officer of the Company on
May 5, 2004. William B. Wachtel was elected as Chairman of the Board and Wayne
P. Garten was elected as President and Chief Executive Officer of the Company
effective the same date. In connection with Mr. Shull's resignation, Mr. Shull
and the Company agreed in principle to enter into a severance agreement dated as
of May 5, 2004 providing for $900,000 of cash payments, $300,000 payable in May
2004 and the balance to be payable in 16 installments of $35,625 payable every
two weeks commencing May 21, 2004 with a final payment in the amount of $30,000
to be payable on or about December 31, 2004. The Company will accrue the
$900,000 of severance in the second quarter of 2004. In connection with Mr.
Garten's election, Mr. Garten and the Company have negotiated the principle
terms of an employment agreement for Mr. Garten which will be presented to the
Compensation Committee of the Board of Directors for approval shortly.
Due to the recent changes in management, the Company intends to
postpone its 2004 Annual Meeting of Stockholders now scheduled for June 3, 2004
until later in the summer of 2004. At the rescheduled meeting, the Company
intends to submit proposals to stockholders to approve (1) an amendmentNovember 30, 2005 pursuant to the Company's Certificate of Incorporation that would reduce the par value of each
share of common stock from $0.66 2/3 per share to $0.01 per share and (2) an
amendment to the Company's Certificate of Incorporation that would increase the
number of shares of Additional Preferred Stock which the Company would have
authority to issue and make a corresponding change in the number of shares of
all classes of stock which the Company would have authority to issue as well as
(3) an amendment to the Company's Certificate of Incorporation that would effect
a one-for-ten reverse stock split of the Company's common stock, all as called
for by the RecapitalizationCorporate
Governance Agreement dated as of November 18,30, 2003 betweenamong the Company, Chelsey
Direct, LLC, Stuart Feldman, Regan Partners L.P., Regan International Fund
Limited and Chelsey.
32Basil P. Regan so long as the Regan group collectively owns at least
29,128,762 shares of Common Stock of the Company (as adjusted for stock splits
and the like).
41
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
3.1 Amendment to By-laws of the Company
10.1 Employment Agreement, dated as of May 5, 2004, between Wayne P. Garten and
the Company
10.2 General Release and Covenant Not to Sue, dated as of May 5, 2004, between
Thomas C. Shull and the Company
31.1 Certification signed by Wayne P. Garten.Garten
31.2 Certification signed by Charles E. Blue.
32.1 Certification signed by Wayne P. Garten and Charles E. Blue.
(b) Reports on Form 8-K:
1.1 Form 8-K, filed March 29, 2004 -- reporting pursuant to Item 5 of such
Form the filing of a Form 12b-25 Notification of Late Filing for its
Annual Report on Form 10-K for the fiscal year ended December 27, 2003.
1.2 Form 8-K, filed April 2, 2004 -- reporting pursuant to Item 5 of such Form
certain letters sent to Chelsey Direct, LLC.
1.3 Form 8-K, filed April 12, 2004 -- reporting pursuant to Item 7 of such
Form (information furnished pursuant to Item 12 of such Form) the issuance
of a press release announcing operating results for the fiscal year ended
December 27, 2003.
1.4 Form 8-K, filed April 12, 2004 -- reporting pursuant to Item 5 of such
Form the appointment of Paul S. Goodman as a director.
1.5 Form 8-K, filed April 13, 2004 --- reporting pursuant to Item 9 of such
Form a statement of guidance as to where the Company sees fiscal year
2004.
1.6 Form 8-K, filed April 16, 2004 --- reporting pursuant to Item 9 of such
Form an unofficial transcript of its conference call with management to
review the operating results for the fiscal year ended December 27, 2003.
1.7 Form 8-K, filed May 6, 2004 --- reporting pursuant to Item 5 of such Form
the resignation of Thomas C. Shull as Chairman of the Board, President and
Chief Executive Officer of the Company and the election of William B.
Wachtel as Chairman of the Board and Wayne P. Garten as President and
Chief Executive Officer effective immediately.
331.8 Form 8-K, filed May 12, 2004 -- reporting pursuant to Items 7 and 9 of
such Form (information furnished pursuant to Item 12 of such Form) the
issuance of a press release announcing operating results for the thirteen
weeks ended March 27, 2004.
1.9 Form 8-K, filed May 25, 2004 -- reporting pursuant to Item 5 of such Form
the receipt of a letter dated May 21, 2004 from the American Stock
Exchange as to the Company's compliance with the Exchange's continued
listing standards.
2.0 Form 8-K, filed June 17, 2004 -- reporting pursuant to Items 5 and 7 of
such Form the Company's signing of a commitment letter with Chelsey Direct
LLC for a $20 million junior secured loan facility and an agreement in
principle to amend its existing senior credit facility with Congress
Financial Corporation and that it had notified the American Stock Exchange
that it intends to submit a plan to the Exchange by June 22, 2004 to
address its compliance with the Exchange's continued listing standards.
42
2.1 Form 8-K, filed July 12, 2004 -- reporting pursuant to Items 5 and 7 of
such Form the closing and funding of the $20 million junior secured term
loan facility with Chelsey Finance, LLC and the amendment to the Company's
existing senior credit facility with Congress Financial Corporation.
2.2 Form 8-K, filed August 3, 2004 -- reporting pursuant to Items 5 and 7 of
such Form the resignation of Basil P. Regan from the Company's Board of
Directors effective July 30, 2004.
43
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HANOVER DIRECT, INC.
Registrant
By: /s/ Charles E. Blue
-------------------------------------------------------------------------------------
Charles E. Blue
Senior Vice President and
Chief Financial Officer
(On behalf of the Registrant and as
principal financial officer)
Date: May 11,August 10, 2004
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