SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q/A1
AMENDMENT NO.1 TOA
Amendment No. 1
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended JUNE 29, 2002SEPTEMBER 27, 2003
Commission file number 1-120821-08056
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[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: 138,315,800 shares outstanding
(excluding treasury shares) as of AugustNovember 7, 2003.
EXPLANATORY NOTE
This Amendment No. 1 to our Quarterly Report on Form 10-Q for the quarter
ended September 27, 2003, as originally filed on November 11, 2003, is being
filed to amend and reflect the restatement of our Consolidated Balance Sheets as
September 27, 2003 and December 28, 2002, in order to comply with EITF Issue No.
95-22, "Balance Sheet Classification of Borrowings Outstanding under Revolving
Credit Agreements that Include Both a Subjective Acceleration Clause and a
Lock-Box Arrangement" ("EITF 95-22"). We re-examined the provisions of our
revolving loan facility and, based on EITF 95-22 and certain provisions in the
credit agreement, we are required to reclassify our revolving loan facility from
long-term to short-term debt, though the existing revolving loan facility does
not mature until January 31, 2007. As a result, we reclassified $13,164 and
$8,819 (in thousands) as of September 27, 2003 and December 28, 2002,
respectively, from Long-term debt to Short-term debt and capital lease
obligations that is classified as current liabilities. See Notes 9 2002.and 12
of Notes to Consolidated Financial Statements for further discussion. Each item
of the Quarterly Report on Form 10-Q as filed on November 11, 2003 that was
affected by the restatement has been amended and restated. This Form 10-Q/A
contains no changes to the Consolidated Statements of Income (Loss), Changes in
Stockholder's Equity (Deficiency), or Cash Flows as previously reported,
although this Form 10-Q/A does include changes in the Balance Sheets and
disclosures as described below:
Part I - Item 1. Condensed Consolidated Financial Statements - Condensed
Consolidated Balance Sheets - Liabilities and Stockholders' Deficiency - Amount
for Short-term debt and capital lease obligations, total current
liabilities, long-term debt and total non-current liabilities at September 27,
2003 and December 28, 2002 have been restated from amounts originally reported
as follows:
(IN THOUSANDS) September 27, 2003 December 28, 2002
--------------------------------------------------
As Previously As As Previously As
Reported Restated Reported Restated
--------------------------------------------------
Short-term debt and
capital lease obligations $ 10,831 $ 23,995 $ 3,802 $ 12,621
Total current liabilities $ 72,424 $ 85,588 $ 78,848 $ 87,667
Long-term debt $ 22,820 $ 9,656 $ 21,327 $ 12,508
Total non-current liabilities $135,005 $121,841 $ 27,714 $ 18,895
Part I - Item 1. Condensed Consolidated Financial Statements - Notes to
Unaudited Condensed Consolidated Financial Statements - 9. Amendments to
Congress Loan and Security Agreement has been updated to provide disclosure
concerning the reclassification of the Company's revolving loan facility
pursuant to EITF 95-22.
Part I - Item 2. Management's Discussion and Analysis of Consolidated Financial
Condition and Results of Operations - Liquidity and Capital Resources - the
section titled "Congress Credit Facility" has been updated to provide disclosure
concerning the reclassification of the Company's revolving loan facility
pursuant to EITF 95-22.
HANOVER DIRECT, INC.
TABLE OF CONTENTS
Page
----
Part I - Financial Information
Item 1. Financial Statements
Condensed Consolidated Balance Sheets -
June 29, 2002September 27, 2003 and December 29, 2001 ......................................................................28, 2002 ........................................ 2
Condensed Consolidated Statements of Income (Loss) - 13- and 26-39- weeks ended
June 29,September 27, 2003 and September 28, 2002 and June 30, 2001 ................................................................................................................. 4
Condensed Consolidated Statements of Cash Flows - 26-39- weeks ended
June 29,September 27, 2003 and September 28, 2002 and June 30, 2001.................................................................................................................. 5
Notes to Condensed Consolidated Financial Statements........................................................Statements .............................. 6
Item 2. Management's Discussion and Analysis of Consolidated Financial Condition and
Results of Operations..................................................................................... 17Operations ........................................................... 20
Item 3. Quantitative and Qualitative Disclosures about Market Risk............................................ 25Risk ................... 31
Item 4. Controls and Procedures ...................................................... 31
Part II - Other Information
Item 1. Legal Proceedings ............................................................ 32
Item 5. Other Information ............................................................ 35
Item 6. Exhibits and Reports on Form 8-K...................................................................... 26
Signatures..................................................................................................... 278-K ............................................. 37
Signatures ........................................................................... 39
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)
June 29, December 29,AS RESTATED AS RESTATED
SEPTEMBER 27, DECEMBER 28,
2003 2002
2001
------------- -------------------------
(UNAUDITED)
ASSETS
CURRENT ASSETS:
$ 885 $ 1,121
Cash and cash equivalents $ 931 $ 785
Accounts receivable, net 17,860 19,45612,539 16,945
Inventories 51,266 59,22353,000 53,131
Prepaid catalog costs 17,341 14,620
Deferred tax asset, net 3,300 3,30015,770 13,459
Other current assets 3,566 3,000
--------- ---------3,834 3,967
-------- --------
Total Current Assets 94,218 100,720
--------- ---------86,074 88,287
-------- --------
PROPERTY AND EQUIPMENT, AT COST:
Land 4,509 4,5094,361 4,395
Buildings and building improvements 18,20518,210 18,205
Leasehold improvements 12,369 12,4669,895 9,915
Furniture, fixtures and equipment 59,562 59,287
--------- ---------
94,645 94,46756,240 56,094
Construction in progress 471 -
-------- --------
89,177 88,609
Accumulated depreciation and amortization (63,100) (60,235)
--------- ---------(61,705) (59,376)
-------- --------
Property and equipment, net 31,545 34,232
--------- ---------27,472 29,233
------ ------
Goodwill, net 9,278 9,278
Deferred tax asset, net 11,700 11,700assets 2,300 12,400
Other assets 1,118 1,731
--------- ---------253 902
-------- --------
Total Assets $ 147,859 $ 157,661
========= =========$125,377 $140,100
======== ========
See notes to Condensed Consolidated Financial Statements.Continued on next page.
2
HANOVER DIRECT, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (CONTINUED)
(IN THOUSANDS OF DOLLARS, EXCEPT SHARE AMOUNTS)
June 29, December 29,AS RESTATED AS RESTATED
SEPTEMBER 27, DECEMBER 28,
2003 2002
2001
------------- -----------------------------
(UNAUDITED)
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIENCY)DEFICIENCY
CURRENT LIABILITIES:
Current portion of long-termShort-term debt and capital lease obligations $ 3,06823,995 $ 3,16212,621
Accounts payable 40,510 46,34840,522 42,873
Accrued liabilities 20,171 25,13212,066 26,351
Customer prepayments and credits 7,396 5,1436,705 4,722
Deferred tax liabilities 2,300 1,100
--------- ---------
Total Current Liabilities 71,145 79,78585,588 87,667
--------- ---------
NON-CURRENT LIABILITIES:
Long-term debt 26,492 26,5489,656 12,508
Series B Participating Preferred Stock, authorized, issued
and outstanding 1,622,111 shares at September 27, 2003; liquidation
preference of $112,964 at September 27, 2003 104,437 -
Other 8,469 10,2337,748 6,387
--------- ---------
Total Non-current Liabilities 34,961 36,781121,841 18,895
--------- ---------
Total Liabilities 106,106 116,566207,429 106,562
--------- ---------
SERIES B PARTICIPATING PREFERRED STOCK, authorized, issued
and outstanding 1,622,111 shares at June 29,December 28, 2002; liquidation
preference was $92,379 at December 28, 2002 and December 29, 2001 83,230 76,823- 92,379
SHAREHOLDERS' EQUITY (DEFICIENCY):DEFICIENCY:
Common Stock, $.66 2/3 par value, authorized 300,000,000 shares authorized;shares;
140,436,729 shares issued at June 29,September 27, 2003 and December
28, 2002 and 140,336,729 shares issued at
December 29, 2001 93,625 93,55893,625
Capital in excess of par value 345,735 351,558325,923 337,507
Accumulated deficit (477,491) (477,497)(498,254) (486,627)
--------- ---------
(38,131) (32,381)(78,706) (55,495)
--------- ---------
Less:
Treasury stock, at cost (2,120,929 shares at June 29, 2002September 27, 2003 and
2,100,929 shares at December 29, 2001)28, 2002) (2,996) (2,942)(2,996)
Notes receivable from sale of Common Stock (350) (405)(350)
--------- ---------
Total Shareholders' Equity (Deficiency) (41,477) (35,728)Deficiency (82,052) (58,841)
--------- ---------
Total Liabilities and Shareholders' Equity (Deficiency)Deficiency $ 147,859125,377 $ 157,661140,100
========= =========
See notes 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 FOR THE 26-39- WEEKS ENDED
------------------------ ------------------------
JUNE 29, JUNE 30, JUNE 29, JUNE 30,-------------------------------- ---------------------------------
SEPTEMBER 27, SEPTEMBER 28, SEPTEMBER 27, SEPTEMBER 28,
2003 2002 20012003 2002
2001
--------- --------- --------- ----------------------- ------------- -------------- -------------
NET REVENUES $ 113,85296,633 $ 133,507106,030 $ 223,363304,872 $ 277,801329,393
--------- --------- --------- ---------
OPERATING COSTS AND EXPENSES:
Cost of sales and operating expenses 70,326 83,204 141,489 175,61562,557 68,890 194,361 210,379
Special charges -- 5,025 233 6,081193 1,463 681 1,696
Selling expenses 26,579 37,679 51,199 77,05722,787 25,355 74,099 76,554
General and administrative expenses 12,552 15,399 24,972 30,69510,092 11,834 30,857 36,806
Depreciation and amortization 1,481 1,940 2,983 3,8991,068 1,393 3,389 4,376
--------- --------- --------- ---------
110,938 143,247 220,876 293,34796,697 108,935 303,387 329,811
--------- --------- --------- ---------
EARNINGS (LOSS) INCOME FROM OPERATIONS 2,914 (9,740) 2,487 (15,546)(64) (2,905) 1,485 (418)
Gain on sale of Improvements - - 1,911 318 22,818 318 22,818
Gain on sale of Kindig Lane -- 1,529 -- 1,529
--------- --------- --------- ---------
EARNINGS(LOSS) INCOME BEFORE INTEREST AND
INCOME TAXES 3,232 14,607 2,805 8,801(64) (2,905) 3,396 (100)
Interest expense, net 1,386 1,845 2,739 3,6515,274 1,277 7,842 4,016
--------- --------- --------- ---------
Earnings beforeLOSS BEFORE INCOME TAXES (5,338) (4,182) (4,446) (4,116)
Provision for deferred federal income taxes 1,846 12,762 66 5,150
Income tax provision11,300 - 11,300 -
Provision for state income taxes 7 30 30 60 6017 90
--------- --------- --------- ---------
NET EARNINGSLOSS AND COMPREHENSIVE
EARNINGS 1,816 12,732 6 5,090LOSS (16,645) (4,212) (15,763) (4,206)
Preferred stock dividends and accretion 3,503 2,984 6,407 5,864- 4,185 7,922 10,593
--------- --------- --------- ---------
NET EARNINGS (LOSS) APPLICABLE TO COMMON
SHAREHOLDERS $ (1,687)(16,645) $ 9,748)(8,397) $ (6,401)(23,685) $ (774)(14,799)
========= ========= ========= ===================
NET EARNINGS (LOSS)LOSS PER COMMON SHARE:
Net earnings (loss)loss per common share - basic and diluted $ (.01)(.12) $ .05(.06) $ (.05)(.17) $ (.00)(.11)
========= ========= ========= =========
Weighted average common shares outstanding -
basic (thousands) 138,264 212,186 138,245 212,327138,316 138,316 138,316 138,268
========= ========= ========= =========
Weighted average common shares outstanding -
diluted (thousands) 138,264 212,786 138,245 212,327138,316 138,316 138,316 138,268
========= ========= ========= =========
See notes to Condensed Consolidated Financial Statements.
4
HANOVER DIRECT, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS OF DOLLARS)
(UNAUDITED)
FOR THE 26-39- WEEKS ENDED
-----------------------
JUNE 29, JUNE 30,------------------------------
SEPTEMBER 27, SEPTEMBER 28,
2003 2002
2001
-------- --------------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earningsloss $ 6(15,763) $ 5,090(4,206)
Adjustments to reconcile net earningsloss to net cash provided (used)used by operating activities:
Depreciation and amortization, including deferred fees 3,696 4,2124,206 5,483
Provision for doubtful accounts 83 283281 -
Special charges -- 2,38816 -
Deferred tax asset 11,300 -
Gain on the sale of Improvements -- (22,818)
Gain(1,911) (318)
Loss on the sale of Kindig Lane -- (1,529)property and equipment 70 -
Interest expense related to Series B Participating Preferred Stock
redemption price increase 4,482 -
Compensation expense related to stock options 627 1,379473 724
Changes in assets and liabilities, net of sale of business:liabilities:
Accounts receivable 1,513 7,9284,125 3,863
Inventories 7,957 5,382131 972
Prepaid catalog costs (2,721) (3,824)(2,311) (4,231)
Accounts payable (5,838) (2,377)(2,351) (860)
Accrued liabilities (4,961) (9,241)(14,285) (5,692)
Customer prepayments and credits 2,253 1,051
Other non-current liabilities (1,764) (1,577)1,983 2,255
Other, net (662) (248)
-------- --------1,570 (2,078)
------------ ------------
Net cash provided (used)used by operating activities 189 (13,901)
-------- --------(7,984) (4,088)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisitions of property and equipment (300) (734)(1,715) (597)
Proceeds from sale of Improvements -- 30,2352,000 318
Costs related to the early release of escrow funds (89) -
Proceeds from saledisposal of Kindig Lane -- 4,671
-------- --------property and equipment 2 -
------------ ------------
Net cash provided (used) by investing activities (300) 34,172
-------- --------198 (279)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings (payments) under Congress revolving loan facility 1,477 (15,029)11,373 3,419
Borrowings under Congress Tranche B term loan facility - 3,500
Payments under Congress Tranche A term loan facility (1,531) (4,746)(1,493) (1,493)
Payments under Congress Tranche B term loan facility (1,350) (864)
Payments of long-term debt and capital lease obligations (8) (102)
Borrowings under capital lease obligations (96) --
Other, net- 32
Payment of debt issuance costs (243) (528)
Proceeds from issuance of common stock - 25
(88)
-------- --------Series B Participating Preferred Stock Transaction Cost Adjustment - 216
Payment of estimated Richemont tax obligation on Series B Participating
Preferred Stock accretion (347) -
------------ ------------
Net cash (used)provided by financing activities (125) (19,863)
-------- --------7,932 4,205
------------ ------------
Net increase (decrease) in cash and cash equivalents (236) 408146 (162)
Cash and cash equivalents at the beginning of the year 785 1,121
1,691
-------- -------------------- ------------
Cash and cash equivalents at the end of the period $ 885931 $ 2,099
======== ========959
============ ============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid for:
Interest $ 1,7062,480 $ 2,946
======== ========2,451
Income taxes $ 137665 $ 85
======== ========193
Non-cash investing and financing activities:
Series B Participating Preferred Stock redemption price increase $ 6,4077,575 $ --
======== ========
Stock dividend and accretion of Series A Cumulative Participating Preferred Stock $ -- $ 5,864
======== ========10,593
See notes 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 29, 2001.28, 2002. 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. Certain prior year amounts
have been reclassified to conform to the current year presentation. Pursuant to
SFASStatement of Financial Accounting Standards ("SFAS") No. 131, "Disclosures about
Segments of an Enterprise and Related Information," the consolidated operations
of Hanover Direct, Inc.the Company are reported as one segment.
Uses of Estimates and Other Critical Accounting Policies
In addition to the use of estimates and other critical accounting
policies disclosed in our Annual Report on Form 10-K for the fiscal year ended
December 28, 2002, an understanding of the below use of estimates and other
critical accounting policies is necessary to analyze our financial results for
the 13 and 39-week periods ended September 27, 2003.
Revenue is recognized for catalog and internet sales when merchandise
is shipped to customers and at the time of sale for retail sales. Shipping terms
for catalog and internet sales are FOB shipping point, and title passes to the
customer at the time and place of shipment. Prices for all merchandise are
listed in the Company's catalogs and Web sites and are confirmed with the
customer upon order. The customer has no cancellation privileges other than
customary rights of return that are accounted for in accordance with SFAS No. 48
"Revenue Recognition When Right of Return Exists." The Company accrues a sales
return allowance for estimated returns of merchandise subsequent to the balance
sheet date that relate to sales prior to the balance sheet date. Amounts billed
to customers for shipping and handling fees related to catalog and internet
sales are included in other revenues at the time of shipment.
During June 2003, the Company established and issued a new Company-wide
vacation and sick policy to better administer vacation and sick benefits. For
purposes of the policy, employees were converted to a fiscal year for earning
vacation benefits. Under the new policy, vacation benefits are deemed earned and
thus accrued ratably throughout the fiscal year and employees must utilize all
vacation earned by the end of the same year. Generally, any unused vacation
benefits not utilized by the end of a fiscal year will be forfeited. In prior
periods, employees earned vacation in the twelve months prior to the year that
it would be utilized. The policy has been modified in certain locations to
comply with state and local laws or written agreements. As a result of the
transition to this new policy, the Company has recognized a benefit of
approximately $0.5 million and $1.3 million for the 13 and 39- weeks ended
September 27, 2003. Approximately $0.2 million and $0.7 million of general and
administrative expenses were reduced as a result of the recognition of this
benefit for the 13 and 39- weeks ended September 27, 2003, respectively.
Approximately $0.3 million and $0.6 million of operating expenses were reduced
as a result of the recognition of this benefit for the 13 and 39- weeks ended
September 27, 2003, respectively.
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 28, 2002, for additional
information relating to the Company's use of estimates and other critical
accounting policies.
2. RETAINED EARNINGSACCUMULATED DEFICIENCY RESTRICTIONS
The Company is restricted from paying dividends at any time on its
Common Stock or from acquiring its capital
6
stock by certain debt covenants contained in agreements to which the Company is
a party.
3. NET EARNINGS (LOSS)LOSS PER COMMON SHARE
Net earnings (loss)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."Share" ("FAS
128"). The weighted average number of shares used in the calculation for both
basic and diluted net (loss)loss per common share for the 13-week periodperiods ended
June 29,September 27, 2003 and September 28, 2002 was 138,264,152. For the 13-week period ended June 30, 2001, the weighted
average number of shares used in the calculation for basic and diluted net
earnings per share were 212,186,331 and 212,786,467 shares, respectively.138,315,800 shares. The weighted
average number of shares used in the calculation for both basic and diluted net
(loss)loss per common share for the 26-week39-week periods ended June 29,September 27, 2003 and
September 28, 2002 was 138,315,800 and June 30, 2001 was 138,244,591 and 212,327,375138,268,327 shares, respectively. Diluted
net (loss)loss per common share equals basic net (loss)loss per common share as the
inclusion of potentially dilutive securities would have an anti-dilutive impact
on the diluteddilutive calculation as a result of the net losses incurred during the 13-week
period ended June 29, 200213
and 26-week39-week periods ended June 29, 2002September 27, 2003 and June 30,
2001. The number ofSeptember 28, 2002. Currently,
all potentially dilutive securities consist of options to purchase shares of the
Company's Common Stock that have been issued and are outstanding. Outstanding
options to purchase 14.0 million shares for the 13 and 39-week periods ended
September 27, 2003 and 14.3 million shares for the 13 and 39-week periods ended
September 28, 2002 of the Company's Common Stock at prices ranging from $0.20 to
$3.50 were excluded from the calculationper share calculations of diluted net (loss)earnings per
share was 1,442,642because they would have been anti-dilutive. Options that had exercise
prices below the average price of a common share
equivalents for the 13-week periodperiods ended
June 29, 2002. The numberSeptember 27, 2003 and September 28, 2002 were 798,615 and 472,671,
respectively. Options that had exercise prices below the average price of potentially dilutive securities excluded from the calculation of diluted net
(loss) per share was 1,702,238 and 1,186,056a
common share equivalents for the 26-week39-week periods ended June 29,September 27, 2003 and September 28,
2002 were 19,651 and June 30, 2001,3,207,612, respectively.
4. COMMITMENTS AND CONTINGENCIES
A class action lawsuit was commenced on March 3, 2000 entitled Edwin L.
Martin v. Hanover Direct, Inc. and John Does 1 through 10, bearing case no.
CJ2000-177 in the State Court of Oklahoma (District Court in and for Sequoyah
County). Plaintiff commenced the action on behalf of himself and a class of
persons who have at any time purchased a product from the Company and paid for
an "insurance charge." The complaint sets forth claims for breach of contract,
unjust enrichment, recovery of money paid absent consideration, fraud and a
claim under the New Jersey Consumer Fraud Act. The complaint alleges that the
Company charges its customers for delivery insurance even though, among other
things, the Company's common carriers already provide insurance and the
insurance charge provides no benefit to the Company's customers. Plaintiff also
seeks a declaratory judgment as to the validity of the delivery insurance. The
damages sought are (i) an order directing the Company to return to the plaintiff
and class members the "unlawful revenue" derived from the insurance charges,
(ii) declaring the rights of the parties, (iii) permanently enjoining the
Company from imposing the insurance charge, (iv) awarding threefold damages of
less than $75,000 per plaintiff and per class member, and (v) attorneys' fees
and costs. The Company's motion to dismiss is pending and discovery has
commenced. The plaintiff has deposed a number of individuals. On April 12, 2001, the Court held a hearing on plaintiff's class
certification motion. Subsequent to the April 12, 2001 hearing on plaintiff's
6
class certification motion, plaintiff filed a motion to amend the definition of
the class. On July 23, 2001, plaintiff's class certification motion was granted,
defining the class as "All persons in the United States who are customers of any
catalog or catalog company owned by Hanover Direct, Inc. and who have at any
time purchased a product from such company and paid money whichthat was designated to
be an `insurance' charge." On August 21, 2001, the Company filed an appeal of
the order with the Oklahoma Supreme Court of Appeals 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. The Oklahoma Supreme Court has not yet ruled on the pending
appeal. Oral argument on the appeal, if scheduled, was expected during the first
half of 2003 but has yet to be scheduled by the Court. The Company believes it
has defenses against the claims. It
is too earlyclaims and plans to determine the outcome or rangeconduct a vigorous defense of potential settlement, which
could have a material impact on the Company's results of operations when settled
in a future period. Defense counsel to the Company will seek to have the
resolution of the five class action cases (Martin, Teichman, Wilson, and the two
Argonaut cases which are discussed below) combined, or their effects lessened,
in that there are common issues and a substantially similar class sought to be
defined in the five cases.this
action.
On August 15, 2001, the Company was served with a summons and
four-count complaint filed in Superior Court for the City and County of San
Francisco, California, entitled Teichman v. Hanover Direct, Inc., Hanover
Brands, Inc., Hanover Direct Virginia, Inc., and Does 1-100. The complaint was
filed by a California resident, seeking damages and other relief for herself and
a class of all others similarly situated, arising out of the $0.50 insurance fee
charged by catalogs and internet sites operated by subsidiaries of the Company.
Defendants, including the Company, have filed motions to dismiss based on a lack
of personal jurisdiction over them. In January 2002, plaintiff sought leave to
name six additional entities: International Male, Domestications Kitchen &
Garden, Silhouettes, Hanover Company Store,
7
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, and in which all causes of action related to state sales tax
have been removed. With the removal of sales tax issues, the Teichman case
concerns issues identical to the Martin case and may make it easier to stay the
Teichman case pending the outcome of the Martin case.Silhouettes. On April 15, 2002, the
Company filed a Motion to Stay the Teichman action in favor of the previously
filed Martin action and also filed a Motion to quash service of summons for lack
of personal jurisdiction on behalf of defendants Hanover Direct, Inc., Hanover
Brands Inc. and Hanover Direct Virginia, Inc.Virginia. On May 14, 2002, the Court (1) granted the
Company's Motion to Quashquash service on behalf of Hanover Direct, Hanover Brands,
and Hanover Direct Virginia, leaving only LWI Holdings, Hanover Company Store,
Kitchen &and 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.action. The
Company believes it has defenses against the claims. Itclaims and plans to conduct a
vigorous defense of this action.
A lawsuit was commenced as both a class action and for the benefit of
the general public on February 13, 2002 entitled Jacq Wilson, suing on behalf of
himself, all others similarly situated, and the general public v. Brawn of
California, Inc. dba International Male and Undergear, and Does 1-100 ("Brawn")
in the Superior Court of the State of California, City and County of San
Francisco. Does 1-100 are allegedly Internet and catalog direct marketers
offering a selection of men's clothing, sundries, and shoes who advertise within
California and nationwide. The complaint alleges that for at least four years,
members of the class and the general public have been charged an unlawful,
unfair and fraudulent insurance fee and tax on orders sent to them by Brawn;
that Brawn was engaged in untrue, deceptive and misleading advertising in that
it was not lawfully required or permitted to collect insurance, tax and sales
tax from customers in California; and that Brawn has engaged in acts of unfair
competition under the state's Business and Professions Code. Plaintiff seeks (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 fee, tax and sales tax
collected unlawfully, together with interest, (ii) an order enjoining Brawn from
charging customers insurance fee and tax on its order forms and/or from charging
tax on the delivery, shipping and insurance charges, (iii) an order directing
Brawn to notify the California State Board of Equalization of the failure to pay
the correct amount of tax to the state and to take appropriate steps to provide
the state with the information needed for audit, and (iv) compensatory damages,
attorneys' fees, pre-judgment interest and costs of the suit. The Plaintiff
alleged that the claims of the individually named plaintiff and for each member
of the class amount to less than $75,000. On April 15, 2002, the Company filed a
Motion to Stay the Wilson action in favor of the previously filed Martin action.
On May 14, 2002, the Court denied the Motion to Stay. The Wilson case proceeded
to trial before the Honorable Dian 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. The Court requested and received closing
arguments and Proposed Statements of Decision in July 2003. On September 18,
2003, the Court issued its Proposed Statement of Decision and Proposed Judgment
After Trial (the "Proposed Judgment"). The Proposed Judgment would find: 1) that
Jacq Wilson has abandoned his individual claims and has pursued the case only on
behalf of the general public; 2) that Brawn had violated Business and
Professions Code Section 17200 and 17500 by identifying its $1.48 charge to
customers as an `insurance' charge and that said charge was for an illusory
benefit that was likely to deceive consumers; and 3) that plaintiff had failed
to prove that Brawn had violated Business and Professions Code Section 17200 by
collecting, sales tax on delivery charges for goods shipped to its customers.
The Proposed Judgment would order Brawn to "locate, identify and pay restitution
to each of its customers for each transaction in which a $1.48 charge for
`insurance' was paid from February 13, 1998 through January 15, 2003" with
interest from the date paid. The Proposed Judgment states that such restitution
must be made on or before June 30, 2004. On October 10, 2003 Brawn filed its
Objections to the Court's Proposed Decision and its Amended [Tentative]
Statement of Decision, based on Brawn's belief that the Court failed to properly
consider certain undisputed evidence, reached other conclusions not supported by
any admissible evidence and improperly applied the law concerning the insurance
fee. (Plaintiff's co-counsel (on the tax matter) requested an opportunity to
respond and intended to file its response on or before October 24, 2003.) The
potential estimated exposure is too early to determinein the outcome or range of potential settlement,$0 to $4.0 million. If the trial
court fails to amend or modify its Proposed Judgment, the Company expects to
take an appeal and conduct a vigorous defense of this action.
A class action lawsuit was commenced on October 28, 2002 entitled John
Morris, individually and on behalf of all other persons & entities similarly
situated v. Hanover Direct, Inc., and Hanover Brands, Inc. (referred to here as
"Hanover"), No. L 8830-02 in the Superior Court of New Jersey, Bergen County --
Law Division. The plaintiff brings the action individually and on behalf of a
class of all persons and entities in New Jersey who purchased merchandise from
Hanover within six years prior to filing of the lawsuit and continuing to the
date of judgment. On the basis of a purchase made by the plaintiff in August
2002 of certain clothing from Hanover (which was from a men's division
8
catalog, the only one which could haveretained the insurance line item in 2002), the
Plaintiff claims that for at least six years, Hanover maintained a material impactpolicy and
practice of adding a charge for "insurance" to the orders it received and
concealed and failed to disclose its policy with respect to all class members.
Plaintiff claims that Hanover's conduct was (i) in violation of the New Jersey
Consumer Fraud Act, as otherwise deceptive, misleading and unconscionable; (ii)
such as to constitute Unjust Enrichment of Hanover at the expense and to the
detriment of plaintiff and the class; and (iii) unconscionable per se under the
Uniform Commercial Code for contracts related to the sale of goods. Plaintiff
and the class seek damages equal to the amount of all insurance charges,
interest thereon, treble and punitive damages, injunctive relief, costs and
reasonable attorneys' fees, and such other relief as may be just, necessary, and
appropriate. Plaintiff filed an Amended Complaint adding International Male as a
defendant. On December 13, 2002, the Company filed a Motion to Stay the Morris
action in favor of the previously filed Martin action. Hearing on the Company's
results of operations when settled in a future period. Defense counselMotion to
the
Company will seek to have the resolution of the five class action cases (Martin,
Teichman, Wilson,Stay took place on June 6, 2003 and the two Argonaut casesCourt granted the Company's motion to
stay until December 31, 2003, at which are discussed below)
combined, or their effects lessened, intime the Court will revisit the issue if
the parties request that there are common issues andit do so. The Company plans to conduct a substantially similar class sought to be defined in the five cases.vigorous
defense of this action.
On June 28, 2001, Rakesh K. Kaul, the Company's former President and
Chief Executive Officer, filed a five-count complaint (the "Complaint") in New
York State Court against the Company, seeking damages and other relief arising
out of his separation of employment from the Company, including severance
payments of $2,531,352 plus the cost of employee benefits, attorneys' fees and
costs incurred in connection with the enforcement of his rights under his
employment agreement with the Company, payment of $149,325$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 courtCourt 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 onwithin the 30th day30 days following his termination of employment.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
7
stating nine counterclaims against Mr.
Kaul. The counterclaims include (1) breach of contract; (2) breach of the
Non-Competition and Confidentiality Agreement with the Company; (3) breach of
fiduciary duty; (4) unfair competition; and (5) unjust enrichment. The Company
seeks damages, including, without limitation, the $341,803 in severance pay and
car allowance Mr. Kaul received following his resignation, $412,336 for amounts
paid to Mr. Kaul for car allowance and related benefits, the cost of a long-term
disability policy, and certain payments made to personal attorneys and
consultants retained by Mr. Kaul during his employment, $43,847 for certain
services the Company provided and certain expenses the Company incurred,
relating to the renovation and leasing of office space occupied by Mr. Kaul's
spouse at 115 River Road, Edgewater, New Jersey, the Company's current
headquarters, $211,729 on a tax loan to Mr. Kaul outstanding since 1997 and
interest, compensatory and punitive damages and attorneys' fees. The case is
pending. The discovery period has closed, the Company has moved to amend its
counterclaims, and the parties have each moved for summary judgment. The Company
requestsseeks summary judgmentjudgment: 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 including, without limitation, Mrrelated
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 damages ina tandem bonus payment on the amount of $3,583,800, or, in the alternative, a declaratoryground
that no payment is owing; dismissing Mr. Kaul's claim for vacation payments
based on Company policy regarding carry over vacation; and seeking 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
summary judgment awarding damages on
the Company's claimcounterclaim for reimbursement ofunjust enrichment based on Mr. Kaul's failure to
pay under a tax loan.note. Mr. Kaul requestsseeks summary judgmentjudgment: dismissing certainthe Company's
defenses and counterclaims relating to a release on the grounds that he tendered
a release or that the Company is estopped from requiring him to do so;
dismissing the Company's defenses and counterclaims relating to his alleged
violations of his non-compete and confidentiality obligations on the grounds
that he did not breach the obligations as defined in the agreement; and
dismissing the Company's claims based on his alleged breach of fiduciary duty,
including those based on his monthly car allowance payments and the leased space
to his wife, on the grounds that he was entitled to the car payments and did not
involve himself in or make misrepresentations in connection with the leased
space. The Company has concurrently moved to amend its Answer and Counterclaims
to state a claim that it had cause for terminating Mr. Kaul's employment based
on,
9
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 and defenses.for reimbursement. The
briefing on the motions is completed.completed and the parties are awaiting the decision
of the Court. No trial date has been set. It is too early to determine the
potential outcome, which could have a material impact on the Company's results
of operations when resolved in a future period.
In January 2000 and May 2001, the Company provided its full cooperation in
an investigation by the Federal Trade Commission ("FTC") into the marketing of
discount buying clubs to see whether any of the entities investigated engaged in
(1) unfair or deceptive acts or practices in violation of Section 5 of the FTC
Act and/or (2) deceptive or abusive telemarketing acts or practices in violation
of the FTC's Telemarketing Sales Rule. It was subsequently revealed to the
Company that the FTC was conducting an investigation into the activities of
entities owned or controlled by Ira Smolev. On October 24, 2001, the FTC made
final its "Stipulated Final Judgment And Order For Permanent Injunction And
Monetary Settlement" against Ira Smolev and named defendant companies in the
case of Federal Trade Commission v. Ira Smolev, et al. (USDC So. Dist. FL, Ft.
Lauderdale Div.) (the "Order"). The named defendants included The Shopper's
Edge, LLC (the Company's private label discount buying club which is owned by
Mr. Smolev), FAR Services, LLC (the Smolev-owned contracting party to the
Company's Marketing Agreement which was terminated in January 2001) and Consumer
Data Depot, LLC (the Smolev-owned contracting party to the Company's Paymentech
Processing Agreement). The Order will directly affect only those activities of
the Company, which are "in active concert or participation with the named
defendants [i.e., The Shopper's Edge, LLC, FAR Services, LLC and Consumer Data
Depot, LLC]." The most important implication of the Order was that the Company,
as bookkeeper to the club for sustaining members of The Shopper's Edge, may not
process payments from members of The Shopper's Edge club for membership renewals
where the purported authorization of the membership occurred prior to the
effective date of the Order, without first obtaining, within 60 days prior to
the date on which the consumer is billed, an "express verifiable authorization"
of such renewal that complies with the specifications of the Order. All choices
specified for "express verifiable authorization" contained in the Order are
effectively "positive opt-in," would have required some direct mail or
technology expenditures and would have severely hurt response rates, which could
have had a material impact on the Company's profits from discount buying club
membership revenues. The last renewals of Shopper's Edge memberships were
processed in October, 2001 by agreement between the Company and Ira Smolev.
During April 2002, the Company received an inquiry from the FTC asking for an
explanation of how the Company is complying with the Order and, if the Company
is asserting that it is not subject to the Order, to provide an explanation of
the basis for such assertion. The Company has replied in writing to the FTC that
it is not subject to the Order, and has provided an explanation of its
relationship with Mr. Smolev.
The Company was named as one of 88 defendants in a patent infringement
complaint filed on November 23, 2001 by the Lemelson Medical, Education &
Research Foundation, Limited Partnership (the "Lemelson Foundation"). The
complaint, filed in the U.S. District Court in Arizona, was not served on the
Company until March 2002. In the complaint, the Lemelson Foundation accuses the
named defendants of infringing seven U.S. patents, which allegedly cover
"automatic identification" technology through the defendants' use of methods for
scanning production markings such as bar codes. The Company received a letter
dated November 27, 2001 from attorneys for the Lemelson Foundation notifying the
Company of the complaint and offering a license. The Court entered a stay of the
case on March 20, 2002, requested by the Lemelson Foundation, pending the
outcome of a related case in Nevada being fought by bar code manufacturers. The
trial in the Nevada case began on November 18, 2002 and ended on January 17,
2003. The parties in the Nevada case submitted post trial briefs by the end of
May 2003, and a decision is scheduled to go to trialexpected in November 2002.the near future. The Order for the stay
in the Lemelson case provides that the Company need not answer the complaint,
although it has the option to do so. The Company has been invited to join a
common interest/joint-defense group consisting of defendants named in the
complaint as well as in other actions brought by the Lemelson Foundation. The
Company is currently in the process of analyzing the merits of
8
the issues raised
by the complaint, notifying vendors of its receipt of the complaint and letter,
evaluating the merits of joining the joint-defense group, and having discussions
with attorneys for the Lemelson Foundation regarding the license offer. A
preliminary estimate of the royalties and attorneys' fees, which the Company may
pay if it decides to accept the license offer from the Lemelson Foundation,
range from about $125,000 to $400,000. The Company has decided to gather further
information, but will not agree to a settlement at this time.
A classtime, and has not
established a reserve.
In early March 2003, the Company learned that one of its business units
had engaged in certain travel transactions that may have constituted violations
under the provisions of U.S. government regulations promulgated pursuant to 50
U.S.C. App. 1-44, which proscribe certain transactions related to travel to
certain countries. The Company immediately commenced an inquiry into the matter,
incurred resulting charges, made an initial voluntary disclosure to the
appropriate U.S. government agency under its program for such disclosures and
has submitted to that agency a detailed report on the results of the inquiry. In
addition, the Company has taken steps to ensure that all of its business units
are acting in compliance with the travel and transaction restrictions and other
requirements of all applicable U.S. government programs. Although the Company is
uncertain of the extent of the penalties, if any, that may be imposed on it by
virtue of the transactions voluntarily disclosed, it does not currently believe
that any such penalties will have a material effect on its business or financial
condition.
On July 17, 2003, the Company filed an action lawsuit was commenced on February 13, 2002 entitled Jacq
Wilson, suing on behalf of himself, all others similarly situated, and the
general public v. Brawn of California, Inc. dba International Male and
Undergear, and Does 1-100 ("Brawn") in the SuperiorSupreme Court of
the State of California, City andNew York, County of San Francisco. Does 1-100 are internetNew York (Index No. 03/602269) against
Richemont Finance S.A. ("Richemont"), and catalog direct marketers offeringChelsey Direct, LLC, a selectionDelaware
limited liability company ("Chelsey"), seeking a declaratory judgment as to
whether Richemont improperly transferred all of men's clothing, sundries,Richemont's securities in the
Company consisting of 29,446,888 shares of Common Stock and shoes who advertise within California1,622,111 shares of
Series B Participating Preferred Stock (collectively, the "Shares") to Chelsey
on or about May 19, 2003 and nationwide. Thewhether the Company can properly recognize the
transfer of those Shares from Richemont to Chelsey under federal and/or state
law. On July 29, 2003, Chelsey answered the Company's complaint, alleges that
for at least four years, membersalleged certain
affirmative defenses and raised three counterclaims against the Company,
including Delaware law requiring the registration of the class have been charged an unlawful,
unfair, and fraudulent insurance fee and tax on orders sent to them by Brawn;
that Brawn was engaged in untrue, deceptive and misleading advertising in that
it was not lawfully required or permitted to collect insurance, tax and sales
tax from customers in California; and that Brawn has engaged in acts of unfair
competition under the state's Business and Professions Code. Plaintiff and the
class seek (i) restitution and disgorgement of all monies wrongfully collected
and earned by Brawn,Shares, damages,
including interest and other gains made on account of these
practices, including reimbursement in the amount of the insurance, tax and sales
tax collected unlawfully, together with interest, (ii) an order enjoining Brawn
from charging customers insurance and tax on its order forms and/or from
charging tax on the delivery, shipping and insurance charges, (iii) an order
directing Brawn to notify the California State Board of Equalization ofattorney's fees, for the failure to payregister the correct amount of taxShares, and tortious
interference with contract. Chelsey also moved for a preliminary injunction
directing the Company to register 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 costsownership of the suit. The claimsShares in Chelsey's name.
Chelsey later moved for summary judgment dismissing the Company's complaint.
Subsequently, Chelsey moved to compel production of the individually named plaintiffcertain documents and for
each member ofsanctions and/or costs. On August 28, 2003, Richemont moved to dismiss the
class amount to less than $75,000. On April 15, 2002, the CompanyCompany's complaint. It subsequently filed a Motion
to Staymotion seeking sanctions and/or
costs against the Wilson action in favor of the previously filed Martin action.Company. On May
14, 2002,October 27, 2003, the Court heard the argument in the Company's Motion to Stay the
action in favor of the Oklahoma action, denying the motion. The Court decided
that the California sales tax issue should be resolved in California. Discovery
is proceeding and the Company plans to conduct a vigorous defense of this
action. The Company believes it has defenses against the claims and intends to
file agranted Chelsey's
motion for summary judgment and Richemont's motion to dismiss and ordered that
judgment be entered dismissing the case in the case. It is too earlyits entirety. The Court also denied
Chelsey's and Richemont's motions for sanctions and Chelsey's motion to determine the
outcome or range of potential settlement, which could have a material impact on
the Company's results of operations when settled in a future period. Defense
counsel to the Company will seek to have the resolution of the five class action
cases (Martin, Teichman, Wilson, and the two Argonaut cases which are discussed
below) combined, or their effects lessened, in that there are common issues and
a substantially similar class sought to be defined in the five cases.
A class action lawsuit was commenced on February 20, 2002 entitled
Argonaut Consumer Rights Advocates Inc., suing on behalf of the General Public
v. Gump's By Mail, Inc. ("Gump's"), and Does 1-100 in the Superior Court of the
State of California, City and County of San Francisco. The plaintiff is a
non-profit public benefit corporation suing under the California Business and
Profession Code. Does 1-100 would include persons whose activities include the
direct sale of tangible personal property to California consumers including the
type of merchandise that Gump's -- the store and the catalog -- sell, by
telephone, mail order, and sales through the web sites www.gumpsbymail.com and
www.gumps.com. The complaint alleges that for at least four years members of the
class have been charged an unlawful, unfair, and fraudulent tax and "sales tax"
on their orders in violation of California law and court decisions, including
the state Revenue and Taxation Code, Civil Code, and the California Board of
Equalization; that Gump's engages in unfair business practices; that Gump's
engaged in untrue and misleading advertising in that it was not lawfully
required to collect tax and sales tax from customers in California; is not
lawfully required or permitted to add tax and sales tax on separately stated
shipping or delivery charges to California consumers; and that it does not add
the appropriate or applicable or specific correct tax or sales tax to its
orders. Plaintiff and the class seek (i) restitution of all tax and sales tax
charged by Gump's on each transaction and/or restitution of tax and sales tax
charged on the shipping charges; (ii) an order enjoining Gump's from charging
customers for tax on orders or from charging tax on the shipping charges; and
(iii) attorneys' fees, pre-judgment interest on the sums refunded, and costs of
the suit. On April 15, 2002, the Company filed an Answer and Separate
Affirmative Defenses to the complaint, generally denying the allegations of the
complaint and each and every cause of action alleged, and denying that plaintiff
has been damaged or is entitled to any relief whatsoever. During June, 2002, the
Company filed its Answers and Objections to Plaintiff's First Set of
Interrogatories, Responses and Objections to Plaintiff's First Request for
Production of Documents, and a Stipulation and Protective Order. At a status
conference held on July 26, 2002, plaintiff moved to have the court strike a
January 2003 trial date, and re-set trial for a later date. Company counsel
filed no objection to the motion. No new trial date has
9
been set. Discovery is now proceeding. The Company plans to conduct a vigorous
defense of this action. The Company believes it has defenses against the claims
and intends to file a motion for summary judgment in the case. It is too early
to determine the outcome or range of potential settlement, which could have a
material impact on the Company's results of operations when settled in a future
period. Defense counsel to the Company will seek to have the resolution of the
five class action cases combined, or their effects lessened, in that there are
common issues and a substantially similar class sought to be defined in the five
cases.
A class action lawsuit was commenced on March 5, 2002 entitled Argonaut
Consumer Rights Advocates Inc., suing on behalf of the General Public v.
Domestications LLC, and Does 1-100 ("Domestications") in the Superior Court of
the State of California, City and County of San Francisco. The plaintiff is a
non-profit public benefit corporation suing under the California Business and
Profession Code. Does 1-100 would include persons responsible for the conduct
alleged in the complaint, including the direct sale of tangible personal
property to California consumers including the type of merchandise that
Domestications sells, by telephone, mail order, and sales through the web site
www.domestications.com. The plaintiff claims that for at least four years
members of the class have been charged an unlawful, unfair, and fraudulent tax
and sales tax for different rates and amounts on the catalog and internet orders
on the total amount of goods, tax and sales tax on shipping charges, which are
not subject to tax or sales tax under California law, in violation of California
law and court decisions, including the state Revenue and Taxation Code, Civil
Code, and the California Board of Equalization; that Domestications engages in
unfair business practices; and that Domestications engaged in untrue and
misleading advertising in that it was not lawfully required to collect tax and
sales tax from customers in California. Plaintiff and the class seek (i)
restitution of all sums, interest and other gains made on account of these
practices; (ii) prejudgment interest on all sums wrongfully collected; (iii) an
order enjoining Domestications from charging customers for tax on their orders
and/or from charging tax on the shipping charges; and (iv) attorneys' fees and
costs of the suit. The Company filed an Answer and Separate Affirmative Defenses
to the Complaint, generally denying the allegations of the Complaint and each
and every cause of action alleged, and denying that plaintiff has been damaged
or is entitled to any relief whatsoever. On June 20, 2002, the Company filed its
Answers and Objections to plaintiff's first set of form interrogatories and
request forcompel
production of certain documents.
The Company also submitted to plaintiff a
draft of a proposed Stipulation and Protective Order for comment. Once the
Protective Order has been agreed upon by the parties and entered by the Court,
the Company will produce the documents responsive to plaintiff's requests.
Discovery is proceeding and the Company plans to conduct a vigorous defense. The
Company believes it has defenses against the claims. It is too early to
determine the outcome or range of potential settlement, which could have a
material impact on the Company's results of operations when settled in a future
period. Defense counsel to the Company will seek to have the resolution of the
five class action cases combined, or their effects lessened, in that there are
common issues and a substantially similar class sought to be defined in the five
cases.10
In addition, the Company is involved in various routine lawsuits of a
nature, which are deemed customary and incidental to its businesses. In the
opinion of management, the ultimate disposition of these actions will not have a
material adverse effect on the Company's financial position or results of
operations.
5. SPECIAL CHARGES
In December 2000, the Company began a strategic business realignment
program that resulted in the recording of special charges for severance,
facility exit costs and fixed asset write-offs. Special charges recorded in fiscal
years 20002002, 2001 and 20012000 relating to the strategic business realignment program
were $19.1$4.4 million, $11.3 million and $11.3$19.1 million, respectively. The actions
related to the strategic business realignment program were taken in an effort to
direct the Company's resources primarily towards a loss reduction strategy and a
return to profitability.
In the first quarter of 2002,2003, special charges relating to the strategic
business realignment program were recorded in the
amount of $0.2$0.3 million. These charges consisted primarily of severance costs related to the elimination of an
additional
10 FTE positions andseverance costs associated with the Company's decision to
close a product manufacturing facility located in San Diego, California. In the
second quarter of 2002, no additional special charges relating to the strategic business realignment
programprogram. During the second and third quarters of 2003, special charges of $0.2
million were recorded.recorded during each quarter. These charges were incurred primarily
to revise estimated losses related to sublease arrangements for office
facilities in San Francisco, California. Increased anticipated losses on
sublease arrangements for the San Francisco office space resulted from the loss
of a subtenant, coupled with declining market values in that area of the
country.
As of the end of the secondthird quarter of 2002,2003, a liability isof
approximately $2.4 million was included on
the Company's balance sheet relatedwithin Accrued Liabilities and a
liability of approximately $3.5 million was included within Other Non-current
Liabilities. These liabilities relate to future costspayments in connection with the
Company's strategic business realignment program consistingprogram. They are expected to be
satisfied no later than February 2010 and consist of the following (in
thousands):
10
Severance &
Personal Lease &
Costs Exit Costs IT Leases Total
-------- ---------- --------- -----
Balance at December 30, 2000 $ 4,324 $ 7,656 $ 1,043 $ 13,023
2001 Expenses 3,828 4,135 - 7,963
Paid in 2001 (5,606) (3,654) (670) (9,930)
------- ------- ------- --------
Balance at December 29, 2001 2,546 8,137 373 11,056
2002 Expenses 122 111 - 233
Paid in 2002 (2,008) (3,540) (114) (5,662)
------- ------- ------- --------
Balance at June 29, 2002 $ 660 $ 4,708 $ 259 $ 5,627
======= ======= ======= ========
The Company entered into an agreement with the landlord and the
sublandlord to terminate its sublease
SEVERANCE & REAL ESTATE INFORMATION
PERSONNEL LEASE & TECHNOLOGY
COSTS EXIT COSTS LEASES TOTAL
----- ---------- ------ -----
Balance at December 29, 2001 $ 2,546 $ 8,137 $ 373 $ 11,056
2002 Expenses 1,817 2,952 - 4,769
Paid in 2002 (2,911) (4,672) (210) (7,793)
-------- ---------- --------- ---------
Balance at December 28, 2002 $ 1,452 $ 6,417 $ 163 $ 8,032
2003 Expenses 257 421 - 678
Paid in 2003 (1,356) (1,324) (131) (2,811)
-------- ---------- --------- ---------
Balance at September 27, 2003 $ 353 $ 5,514 $ 32 $ 5,899
======== ========== ========= =========
A summary of the Company's closed 497,200 square
foot warehouseliability related to real estate lease and telemarketing facility located in Maumelle, Arkansas. The
agreement provided for the paymentexit costs,
by the Company to the sublandlordlocation, as of $1,600,000, plus taxes through April 30,September 27, 2003 and December 28, 2002 in the amount of $198,000. The
Company made all of the payments in four weekly installments between May 2, 2002
and May 24, 2002. Upon the satisfaction by the Company of all of its obligations
under the agreement, the sublease terminated and the Company was released from
all further obligations under the sublease. The Company's previously established
reserves for Maumelle, Arkansas were adequate based upon the terms of the final
settlement agreement.is as follows (in
thousands):
SEPTEMBER 27, DECEMBER 28,
2003 2002
------------ ------------
Gump's facility, San Francisco, California $ 3,404 $ 3,349
Corporate facility, Weehawken, New Jersey 1,695 2,325
Corporate facility, Edgewater, New Jersey 306 439
Administrative and telemarketing facility, San Diego, California 107 179
Retail store facilities, Los Angeles and San Diego, California 2 125
---------- ----------
Total Lease and Exit Cost Liability $ 5,514 $ 6,417
========== ==========
11
6. 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
servicesservice agreement with the buyer for a period of three years.
The asset purchase agreement between the Company and HSN providesprovided that
if Keystone Internet Services Inc. failsfailed to perform its obligations during the first
two years of the services contract, the purchaser cancould 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 hasof
approximately $33.0 million, had been established for a period of two years
under the terms of an escrow agreement between LWI Holdings, Inc., HSN and The
Chase Manhattan Bank as a result of these contingencies.
AsOn March 27, 2003, the Company and HSN amended the asset purchase
agreement to provide for the release of June 29, 2002, the remaining $2.0 million balance inof
the escrow fund is $2.6
million.and to terminate the escrow agreement. By agreeing to the terms
of the amendment, HSN forfeited its ability to receive a reduction in the
original purchase price of up to $2.0 million if Keystone Internet Services
failed to perform its obligations during the first two years of the services
contract. In consideration for the release, Keystone Internet Services issued a
credit to HSN for $100,000, which could be applied by HSN against any invoices
of Keystone Internet Services to HSN. This credit was utilized by HSN during the
March 2003 billing period. On March 28, 2003, the remaining $2.0 million escrow
balance was received by the Company, thus terminating the escrow agreement.
The Company recognized a net gain on the sale of approximately $23.2
million, includingnet of a non-cash goodwill charge of $6.1 million, in fiscal year 2001,
which representsrepresented the excess of the net proceeds from the sale over the net
assets assumedacquired by HSN, the goodwill associated with the Improvements business
and expenses related to the transaction. In JuneDuring fiscal year 2002, the Company
recognized $0.3approximately $0.6 million of the deferred gain consistent with the
terms of the escrow agreement. Proceeds of $0.3 million relating toDuring the 13- weeks ended March 29, 2003, the
Company recognized the remaining net deferred gain were received
July 2, 2002. The recognition of an additional gain of up to approximately $2.3$1.9 million has been deferred untilfrom the
contingencies described above expire, which
will occur no later than the middlereceipt of the 2003 fiscal year.
7. SALE OF KINDIG LANE PROPERTY
On May 3, 2001, as partescrow 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. CHANGES IN MANAGEMENT AND EMPLOYMENT
On November 3, 2003, Charles E. Blue was appointed Chief Financial
Officer of the Company effective November 11, 2003, replacing Edward M. Lambert
as Chief Financial Officer, effective on such date, in connection with the
Company's ongoing strategic business realignment program,program. Mr. Blue joined the
Company sold its fulfillment warehouse in Hanover, Pennsylvania
(the "Kindig Lane Property")1999 and certain equipment located therein for $4.7
millionhad most recently served as Senior Vice President, Finance,
a position eliminated by this finance department restructuring.
Mr. Lambert will continue to an unrelated third party. Substantially all of the net proceeds of
the sale were paid to Congress Financial Corporation ("Congress"), pursuant to
the terms of the Congress Credit Facility, and applied to a partial repayment of
the Tranche A Term Loan made by Congress to Hanover Direct Pennsylvania, Inc.,
an affiliateserve as Executive Vice President of the
Company and to a partial repayment of the indebtedness
under the Congress Credit Facility. The Company realized a net gain on the sale
of approximately $1.5 million. The Company has continued to use the Kindig Lane
Property under a lease agreement
11
until January 2, 2004. In connection with the third party, and will continue to lease a portion of the Kindig Lane
Property on a month-to-month basis. The Company intends to transition the
activities of the Kindig Lane Property into the Company's fulfillment center in
Roanoke, Virginia at a future date.
8. CHANGES IN EMPLOYMENT AGREEMENTS
Shull Employment Agreement. Effective December 5, 2000, Thomas C. Shull,
Meridian Ventures, LLC, a limited liability company controlled bysuch change, Mr. Shull
("Meridian"),Lambert and
the Company have entered into a Services Agreement (the "December
2000 Services Agreement"). The December 2000 Services Agreement was replaced by
a subsequent servicesseverance agreement dated asNovember 4, 2003
providing a minimum of August 1, 2001 (the "August 2001
Services Agreement"), among Mr. Shull, Meridian and the Company,$600,000 and a Services
Agreement, datedmaximum of $640,000 of cash payments as
well as other benefits that will be accrued and paid in the fourth quarter of
December 14, 2001 (the "December 2001 Services
Agreement"), among2003. Mr. Shull, Meridian, and the Company. The December 2001
Services AgreementLambert is being replaced effective September 1, 2002 by an
Employment Agreement between Mr. Shull and the Company, dated as of September 1,
2002 (the "Shull Employment Agreement"), pursuant to which Mr. Shull is to be
employed by the Company as its President and Chief Executive Officer, as
described below.
The term of the Shull Employment Agreement will begin on September 1, 2002
and will terminate on September 30, 2004 (the "Shull Employment Agreement
Term").
Under the Shull Employment Agreement, Mr. Shull isalso entitled to receive from the
Company base compensation equal to $900,000 per annum, payable at the rate of
$75,000 per month ("Base Compensation"). Mr. Shull is to be provided with
participation ina payment under the Company's employee benefit plans, including but2003
Management Incentive Plan; however, the Company's current forecast does not
limitedproject any such payment for the 2003 Plan year.
The Company entered into Amendment No. 3 to the Company'sHanover Direct, Inc.
Key Executive Eighteen Month Compensation Continuation Plan, (the "Changeeffective October
29, 2003, making certain technical amendments thereto to reflect the names of
Control Plan") and its transaction bonus program.each of the Company's current subsidiaries. Similar changes were made to the
Company's other Compensation Continuation Plans.
On September 29, 2003, the Company issued shares at a price of $0.27
per option to purchase 100,000 shares of the Company's Common Stock to two
newly-elected board members.
The Company is
alsoentered into an Amendment No. 3 to reimburse Mr. Shull for his reasonable out-of-pocket expenses incurred
in connection with his employment by the Company.
Under the Shull Employment Agreement
effective as of August 3, 2003 between Thomas C. Shull and the Company shall pay(1)
extending the remaining
unpaid $300,000term of the Company's Employment Agreement with Mr.
12
Shull to March 31, 2006, (2) adjusting his Base Compensation (as defined) to
$855,000 per annum, subject to certain exceptions described therein, (3)
extending the termination date of Mr. Shull's fiscal 2001 bonus under the Company's 2001
Management Incentive Plan by no later than December 28, 2002 (or on the date of
closing of any transaction which constitutes a "change of control" thereunder,
if earlier). Mr. Shull shall receive the same bonus amount for fiscal 2002 under
the Company's 2002 Management Incentive Plan as all other Class 8 participants
(as defined in such Plan) receive under such Plan for such period, subject2000 options to
all of the terms and conditions applicable generally to Class 8 participants
thereunder. Mr. Shull shall earn annual bonuses for fiscal 2003 and 2004 under
such plans as the Company's Compensation Committee may approve in a manner
consistent with bonuses awarded to other senior executives under such plans.
Under the Shull Employment Agreement, the Company shall, on December 28,
2002 (or the date of closing of any transaction which constitutes a "change of
control" thereunder, if earlier), make the lump sum cash payment of $450,000 to
Mr. Shull previously due to be paid to Meridian on June 30, 2002. In addition,
the Company has agreed to make two equal lump sum cash payments of $225,000 each
to Mr. Shull on March 31, 2003 and September 30, 2004, notwithstanding any
"change of control."
Under the Shull Employment Agreement, upon the closing of any transaction
which constitutes a "change of control" thereunder, provided that Mr. Shull is
then employed by the Company, the Company shall make a lump sum cash payment to
Mr. Shull on the date of such closing of $1,350,000 pursuant to the Change of
Control Plan, $450,000 pursuant to the Company's transaction bonus program and
such bonuses as may be payable pursuant to the Company's Management Incentive
Plans for the applicable fiscal year. Any such lump sum payment would be in lieu
of (i) any cash payment under the Shull Employment Agreement as a result of a
termination thereof upon the first day after the acquisition of the Company
(whether by merger or the acquisition of all of its outstanding capital stock)
or the tenth day after the sale or any series of sales since April 27, 2001
involving an aggregate of 50% or more of the market value of the Company's
assets (for this purpose under the Shull Employment Agreement, such 50% amount
shall be deemed to be $107.6 million), and (ii) the aggregate amount of Base
Compensation to which Mr. Shull would have otherwise been entitled through the end of the
Shull Employment Agreement Term.
Underagreement term, and (4) making certain technical amendments set forth therein.
The Company effected salary reduction for participants in its 2003
Management Incentive Plan, including Executive Officers, effective with the Shull Employment Agreement, additional amounts are payable to
Mr. Shull bypay
period starting August 3, 2003, of 5% of base pay.
On August 1, 2003, the Company under certain circumstances upon the terminationissued shares at a price of the
Shull Employment Agreement. If the termination is on account of the expiration
of the Shull Employment Agreement Term, Mr. Shull shall be entitled to receive
such amount of bonus as may be payable pursuant to the Company's applicable
bonus plan as well as employee benefits such as accrued vacation
12
and insurance in accordance with the Company's customary practice. If the
termination is on account of the Company's material breach of the Shull
Employment Agreement or the Company's termination of the Shull Employment
Agreement where there has been no Willful Misconduct (as defined in the Shull
Employment Agreement) or material breach thereof by Mr. Shull, Mr. Shull shall
be entitled to receive (i) a lump sum payment equal to the aggregate amount of
Base Compensation to which he would have otherwise been entitled through the end
of the Shull Employment Agreement Term, plus (ii) $900,000 in severance pay and
such amount of bonus as may be payable pursuant to the Company's applicable
bonus plan as well as employee benefits such as accrued vacation and insurance
in accordance with the Company's customary practice. If the termination is on
account of the acquisition of the Company (whether by merger or the acquisition
of all of its outstanding capital stock) or the sale or any series of sales
since April 27, 2001 involving an aggregate of 50% or more of the market value
of the Company's assets (for this purpose under the Shull Employment Agreement,
such 50% amount shall be deemed to be $107.6 million) and the amount realized in
the transaction is less than $0.50$0.25 per common share (or the equivalent of $0.50
per common share), and if and only if the Change of Control Plan shall not then
be in effect, Mr. Shull shall be entitled to receive a lump sum payment equal to
the aggregate amount of Base Compensation to which he would have otherwise been
entitled through the end of the Shull Employment Agreement Term. If the
termination is on account of the acquisition of the Company (whether by merger
or the acquisition of all of its outstanding capital stock) or the sale or any
series of sales since April 27, 2001 involving an aggregate of 50% or more of
the market value of the Company's assets (for this purpose under the Shull
Employment Agreement, such 50% amount shall be deemed to be $107.6 million) and
the amount realized in the transaction equals or exceeds $0.50 per common share
(or the equivalent of $0.50 per common share), and if and only if the Change of
Control Plan shall not then be in effect, Mr. Shull shall be entitled to receive
a lump sum payment equal to the greater of the Base Compensation to which he
would have otherwise been entitled through the end of the Shull Employment
Agreement Term or $1,000,000. If the termination is on account of an acquisition
or sale of the Company (whether by merger or the acquisition of all of its
outstanding capital stock) or the sale or any series of sales since April 27,
2001 involving an aggregate of 50% or more of the market value of the Company's
assets (for this purpose under the Shull Employment Agreement, such 50% amount
shall be deemed to be $107.6 million) and the Change of Control Plan shall then
be in effect, Mr. Shull shall only be entitled to receive his benefit under the
Change of Control Plan.
Under the Shull Employment Agreement, the Company is required to maintain
directors' and officers' liability insurance for Mr. Shull during the Shull
Employment Agreement Term. The Company is also required to indemnify Mr. Shull
in certain circumstances.
Amended Thomas C. Shull Stock Option Award Agreements. During December
2000, the Company entered into a stock option agreement with Thomas C. Shull to
evidence the grant to Mr. Shull of an
option to purchase 2.7 million210,000 shares of the Company's common stock (the "Shull 2000Common Stock Option Agreement"). Effective
asto the then
existing six board members and 35,000 shares at a price of September 1, 2002,$0.25 per option of
the Company's Common Stock to a consultant to the Company has amended the Shull 2000 Stock Option
Agreement to (i) extend the final expiration date for the stock option under the
Shull 2000 Stock Option Agreement to June 30, 2005, and (ii) replace all
references therein to the December 2000 Services Agreement with references to
the Shull Employment Agreement.
During December 2001,per their agreement.
On July 29, 2003, the Company entered intoissued shares at a stock option agreement
with Mr. Shull to evidence the grant to Mr. Shullprice of an$0.25 per
option to purchase 500,000100,000 shares of the Company's common stock under the Company's 2000 ManagementCommon Stock Option Plan (the "Shull 2001 Stock Option Agreement"). Effective as of
September 1, 2002, the Company has amended the Shull 2001 Stock Option Agreement
to (i) provide that any shares purchased by Mr. Shull under the Shull 2001 Stock
Option Agreement would not be saleable until September 30, 2004, and (ii)
replace all references therein to the December 2001 Services Agreement with
references to the Shull Employment Agreement.
Amended Thomas C. Shull Transaction Bonus Letter. During May 2001, Thomas
C. Shull entered into a letter agreement with the Company (the "Shull
Transaction Bonus Letter") under which he would be paid a bonus on the
occurrence of certain transactions involving the sale of certain of the
Company's businesses. Effective as of September 1, 2002, the Company has amended
the Shull Transaction Bonus Letter to (i) increase the amount of Shull's agreed
to base salary for purposes of the transaction bonus payable thereunder from
$600,000 to $900,000, and (ii) replace all references therein to the December
2000 Services Agreement with references to the Shull Employment Agreement.
13
9.two
newly-elected board members.
8. RECENTLY ISSUED ACCOUNTING STANDARDS
In July 2001,May 2003, the Financial Accounting Standards Board (the "FASB"("FASB") issued
SFAS No. 141, "Business Combinations"150, "Accounting for Certain Financial Instruments with Characteristics
of both Liabilities and Equity" ("FAS 141"), and No. 142, "Goodwill and
Other Intangible Assets" ("FAS 142"150"). FAS 141150 establishes standards for
how an issuer classifies and measures certain financial instruments with
characteristics of both liabilities and equity. It requires all business combinations
initiatedthat an issuer
classify a financial instrument that is within its scope as a liability, many of
which had been previously classified as equity or between the liabilities and
equity sections of the consolidated balance sheet. The provisions of FAS 150 are
effective for financial instruments entered into or modified after May 31, 2003,
and otherwise is effective at the beginning of the first interim period
beginning after June 30, 200115, 2003. It is to be accountedimplemented by reporting the
cumulative effect of a change in accounting principle for usingfinancial instruments
created before the purchase method.
Underissuance of FAS 142, goodwill150 and intangible assets with indefinite lives are no
longer amortized but are reviewed annually (or more frequently if impairment
indicators arise) for impairment. Separable intangible assets that are not
deemed to have indefinite lives will continue to be amortized over their useful
lives (but with no maximum life). Goodwill relates tostill existing at the International Male andbeginning of
the Gump's brands and the net balance at June 29, 2002 is $9.3 million.interim period of adoption. The Company has adopted the provisions of FAS
142 effective January 1, 2002150 and has been impacted by the requirement to reclassify its Series B
Participating Preferred Stock as a result,liability as opposed to between the
firstliabilities and second quarters ended March 30, 2002 and June 29, 2002 did not include an
amortization charge for goodwill. The Company obtained the services of an
independent appraisal firm during the second quarter ended June 29, 2002 to
evaluate whether there was any goodwill impairment upon adoption of FAS 142. The
resultsequity sections of the appraisal indicated no goodwill transition impairment basedconsolidated balance sheet. Based upon
the requirements set forth inby FAS 142.
If the provisions150, this reclassification was subject to
implementation beginning on June 29, 2003. Upon implementation of FAS 142 had150, the
Company has reflected the accretion of the preferred stock balance as an
increase in Total Liabilities with a corresponding reduction in capital in
excess of par value, because the Company has an accumulated deficit. Such
accretion has been implementedrecorded as interest expense, resulting in a decrease in Net
Income (Loss) and Comprehensive Income (Loss) of $4.5 million for the 13-week period13 and 39-
weeks ended June 30, 2001 andSeptember 27, 2003. In addition, based upon the Company's current
projections for 2003, it is estimated the Company hadmay not includedincur a tax
reimbursement obligation for 2003 relating to the increases in the Liquidation
Preference of the Series B Participating Preferred Stock and will file for a
refund of the $0.3 million Federal tax payment made in March 2003. Due to the
FAS 150 requirements to reclassify the Series B Participating Preferred Stock to
liabilities and to record the accretion of the preferred stock balance as
interest expense, the refund has been treated as a decrease to interest expense
on the Condensed Consolidated Statements of Income (Loss) for the third quarter
and an amortization chargeincrease of Capital in excess of par value on the Condensed Consolidated
Balance Sheets. If FAS 150 was applicable for goodwill,fiscal year 2002, Net Loss and
Comprehensive Loss would have been $24.7 million. Net Income (Loss) Applicable
to Common Shareholders and Net Income (Loss) Per Common Share remains unchanged
in comparison with the Company's net earnings would haveclassification of the instrument prior to June
29, 2003. In addition, there is no cumulative effect of a change in accounting
principle as a result of the implementation of FAS 150. As of September 27,
2003, the implementation of FAS 150 has increased Total Liabilities by
$0.1 million to
$12.9approximately $104.4 million. IfShareholders' Deficiency remained unchanged since
the provisionsbalance had previously been classified between Total Liabilities and
Shareholders' Deficiency on the Condensed Consolidated Balance Sheet. The
classification of the Series B Preferred Stock as a liability under FAS 142 had been implemented150
should not change its classification as equity under state law.
In January 2003, the Securities and Exchange Commission issued a new
disclosure regulation, "Conditions for Use of Non-GAAP Financial Measures"
("Regulation G"), which is effective for all public disclosures and filings made
after March 28, 2003. Regulation G requires public companies that disclose or
release information containing financial measures that are not in accordance
with generally accepted accounting principles ("GAAP") to include in the
26-week period ended June 30, 2001disclosure or release a presentation of the most directly comparable GAAP
financial measure and a reconciliation of the disclosed non-GAAP financial
measure to the most directly comparable GAAP financial measure. The Company
had not included an
amortization charge for goodwill,became subject to Regulation G in fiscal 2003 and believes that it is in
compliance with the Company's net (loss) would have decreased
by $0.3 million to $(5.4) million. Net earnings (loss) per share for the 13-week
and 26-week periods
14new disclosure requirements.
13
ended June 30, 2001 would have remained unchanged at $.05 and $(.00) for both
basic and diluted earnings (loss) per share calculations.
In July 2001,December 2002, the FASB issued SFAS No. 143,148, "Accounting for
Asset
Retirement Obligations"Stock-Based Compensation-Transition and Disclosure - An Amendment of SFAS No.
123" ("FAS 143"148"). FAS 143 requires entities148 provides alternative methods of transition for a
voluntary change to record the fair valuevalue-based method of a liabilityaccounting for an asset retirement obligationstock-based
employee compensation. In addition, FAS 148 amends the disclosure requirements
of SFAS No. 123 to require prominent disclosures in both annual and interim
financial statements about the period in
which it is incurred. Whenmethod of accounting for stock-based employee
compensation and the liability is initially recorded, the entity is
required to capitalize the cost by increasing the carrying valueeffect of the related
long-lived asset. Over time,method used on reported results. The Company
has established several stock-based compensation plans for the liability is accreted tobenefit of its
present value
each period,officers and the capitalized cost is depreciated over the useful life of
the related asset. FAS 143 is effective for fiscal years beginning after June
15, 2002 and will be adopted byemployees. Since 1996, the Company effective fiscal 2003. The Company
believes adoption of FAS 143 will not have a material effect onhas accounted for its
financial
statements.
In October 2001,stock-based compensation to employees using the FASB issuedfair value-based methodology
under SFAS No. 144, "Accounting for Impairment
or Disposal of Long-Lived Assets" ("123, thus FAS 144"). FAS 144 addresses financial
accounting and reporting for the impairment or disposal of long-lived assets.
FAS 144 also extends the reporting requirements to report separately, as
discontinued operations, components of an entity that have either been disposed
of or classified as held-for-sale. The Company adopted the provisions of FAS 144
in fiscal 2002, and such adoption148 has had no effect on the Company's results of
operations or financial position. In AprilFor the 13- weeks ended September 27, 2003 and
September 28, 2002, the FASB issued SFAS No. 145, "RescissionCompany recorded stock compensation expense of
FASB
Statements No. 4, 44,approximately $0.1 million during each period. For the 39- weeks ended September
27, 2003 and 64, AmendmentSeptember 28, 2002, the Company recorded stock compensation expense
of FASB SFAS No. 13,$0.5 million and Technical
Corrections" ("FAS 145"). FAS 145 rescinds FASB SFAS No. 4, 44, and 64 and
amends FASB SFAS No. 13, "Accounting for Leases," to eliminate an inconsistency
between the required accounting for sale-leaseback transactions and the required
accounting for certain lease modifications that have economic effects that are
similar to sale-leaseback transactions. FAS 145 also amends other existing
authoritative pronouncements to make various technical corrections, clarify
meanings, or describe their applicability under changed conditions. The Company
adopted the provisions of FAS 145 in fiscal 2002, and such adoption has had no
effect on the Company's results of operations or financial position.$0.7 million, respectively.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" ("FAS 146"). FAS 146 nullifies
Emerging Issues Task Force Issue No. 94-3 ("EITF 94-3"). FAS 146 requires that a
liability for a cost associated with an exit or disposal activity be recognized
when the liability is incurred whereas, under EITF 94-3, the liability was
recognized at the commitment date to an exit plan. The Company is
required to adopthas adopted the
provisions of FAS 146 effective for exit or disposal activities initiated after December
31, 2002.
In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other
Intangible Assets" ("FAS 142"). Under FAS 142, goodwill and intangible assets
with indefinite lives are no longer amortized but are reviewed annually (or more
frequently if impairment indicators arise) for impairment. Separable intangible
assets that are not deemed to have indefinite lives will continue to be
amortized over their useful lives (but with no maximum life). Goodwill relates
to the International Male and the Gump's brands and the net balance at both
September 27, 2003 and September 28, 2002 was $9.3 million. The Company is currently
evaluating the impact of adoption of this statement.
10. AMENDMENT TO CONGRESS LOAN AND SECURITY AGREEMENT
In March 2002, the Company amended the Congress Credit Facility to amend
the definition of Consolidated Net Worth such that,adopted
FAS 142 effective JulyJanuary 1, 2002 to
the extentand, as a result, has not recorded an
amortization charge for goodwill since that the goodwill or intangible assets of the Company and its
subsidiaries were impaired under the provisions of FAS 142, such write-off of
assets would not be considered a reduction of total assets for the purposes of
computing consolidated net worth.time. The Company obtained the
services of an independent appraisal firm during the second quarter ended June
29, 200228, 2003 to evaluate whether there has been anyassist in the assessment of its annual goodwill transition impairment. The
results of the appraisal indicated nothat goodwill transition impairmentwas not impaired based upon the
requirements set forth in FAS 142.
The consolidated net working capital,
consolidated net worth and earnings before interest, taxes, depreciation,
amortization and certain non-cash charges covenants were also amended.9. AMENDMENTS TO CONGRESS LOAN AND SECURITY AGREEMENT
In addition, the amendment required the payment of a fee of $100,000.
On August 16, 2002,2003, the Company amended the Congress Credit Facility to
(i)make certain technical amendments thereto, including the amendment of the
definition of Consolidated Net Worth and the temporary release of a $3 million
availability reserve established thereunder. The temporary release of the $3
million availability reserve will be removed by the end of fiscal year 2003.
In October 2003, the Company amended the Congress Credit Facility to
extend the term of the Tranche B Term Loanexpiration thereof from MarchJanuary 31, 20032004 to January 31, 2007, to
reduce the amount of revolving loans available thereunder to $43,000,000, to
make adjustments to the sublimits available to the various borrowers thereunder,
to amend the EBITDA covenant to specify minimum levels of EBITDA that must be
achieved during the Company's fiscal years ending 2004, (ii) increase by $3,500,0002005 and 2006, to permit
the borrowing reflected byunder certain circumstances of up to $1,000,000 against certain
inventory in transit to locations in the Tranche B
Term Note from $4,910,714United States, and to $8,410,714, and (iii) make certain
relatedother technical amendmentsamendments.
14
In November 2003, the Company amended the Congress Credit Facility to
change the definition of Consolidated Net Worth so as to provide that for the
purposes of calculating such amount for the Company's fiscal year ending
December 27, 2003, the Company's net deferred tax assets in the amount of
$11,300,000 that are required to be fully reserved pursuant to SFAS No. 109,
"Accounting for Income Taxes" ("FAS 109"), shall be added back for the purposes
of determining the Company's assets. See Note 11 of the Company's Condensed
Consolidated Financial Statements. The Company also amended the definition of
Consolidated Working Capital so as to provide that for the purposes of
calculating such amount for the Company's fiscal year ending December 27, 2003,
the Company's current deferred tax liabilities in the amount of $2,300,000,
shall be added back for the purposes of determining the Company's current
liabilities. See Note 11 of the Company's Condensed Consolidated Financial
Statements.
The Company has restated its Consolidated Balance Sheets as of September
27, 2003 and December 28, 2002 to properly classify the Congress Credit Facility
as a current liability in accordance with EITF 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"). This restatement has no impact on the Company's results of operations
or cash flows for the 13- and 39- weeks ended September 27, 2003. The Congress
Credit Facility is classified as a current liability in accordance with EITF
95-22 since the loan and security agreement contains a subjective acceleration
clause and contractual provisions that require the cash receipts of the Company
to be used to repay amounts outstanding under the Congress Credit Facility.
The amendment required the
payment of fees in the amount of $410,000. Pursuant to this amendment, the
Company has reflectedre-examined the Tranche B borrowings outstanding of $4.0 million at
June 29, 2002 in Long-term debt on the Condensed Consolidated Balance Sheet.
Achievement of the cost savings and other objectives of the Company's strategic
business realignment program is critical to the maintenance of adequate
liquidity as is compliance with the terms and provisions of the Congress Credit Facility.
11.Based on EITF 95-22 and certain provisions in the credit agreement, the Company
is required to reclassify its revolving loan facility from long-term to
short-term debt, though the existing revolving loan facility does not mature
until January 31, 2007. As a result, the Company reclassified $13,164 and $8,819
(in thousands) as of September 27, 2003 and December 28, 2002, respectively,
from Long-term debt to Short-term debt and capital lease obligations that is
classified as current liabilities.
As of September 27, 2003, the Company had $33.6 million of cumulative
borrowings outstanding under the Congress Credit Facility. Total cumulative
borrowings comprise $20.2 million under the Revolving Loan Facility, bearing a
variable interest rate as of September 27, 2003 of 4.5%, $7.0 million under the
Tranche A Term Loan, bearing a variable interest rate as of September 27, 2003
of 4.75%, and $6.4 million under the Tranche B Term Loan, bearing a fixed
interest rate of 13.0%.
10. SERIES B PARTICIPATING PREFERRED STOCK
On December 19, 2001, the Company consummated a transaction with Richemont
(the "Richemont Transaction") in which the Company issued to Richemont Finance
S.A. ("Richemont") 1,622,111 shares
of Series B Participating Preferred Stock ("Series B Preferred Stock"). The Series B Preferred Stock hashaving a par value of $0.01 per share.share
(the "Series B Preferred Stock") in exchange for all of the outstanding shares
of the Series A Cumulative Participating Preferred Stock issued to Richemont on
August 24, 2000 for $70.0 million and 74,098,769 shares of the Common Stock of
the Company held by Richemont and the reimbursement of expenses of $1 million to
Richemont (the "Richemont Transaction"). The Richemont Transaction was made
pursuant to an Agreement, dated as of December 19, 2001 (the "Richemont
Agreement"), between the Company and Richemont. Richemont agreed, as part of the
Richemont Transaction, to forego any claim it had to the accrued but unpaid
dividends on the Series A Cumulative Participating Preferred Stock. As part of
the Richemont Transaction, the Company (i) released Richemont, the individuals
appointed by Richemont to the Board of Directors of the Company and certain of
their respective affiliates and representatives (collectively, the "Richemont
Group") from any claims by or in the right of the Company against any member of
the Richemont Group that arise out of Richemont's acts or omissions as a
stockholder of or lender to the Company or the acts or omissions of any
Richemont board designee in his capacity as such and (ii) entered into an
Indemnification Agreement (the "Indemnification Agreement") with Richemont
pursuant to which the Company agreed to indemnify each member of the Richemont
Group from any losses suffered as a result of any third party claim which is
based upon Richemont's acts as a stockholder of or lender to the Company or the
acts or omissions of any Richemont board designee in his capacity as such. The
Indemnification Agreement is not limited as to term and does not include any
limitations on maximum future payments thereunder.
The holders of the Series B Preferred Stock are entitled to ten votes
per share on any matter on which the Common Stock votes. In addition, in the
event that the Company defaults inon its obligations arising in connection with
the Richemont Transaction, the Certificate of Designations of the Series B
Preferred Stock or its agreements with Congress, or in the event that the
Company fails to redeem at least 811,056 shares of Series B Preferred Stock by
August 31, 2003, then the holders of the Series B Preferred Stock, voting as a
class, shall be entitled to elect two members to the Board of Directors of the
Company.Company as described below in further detail.
By letter dated September 2, 2003, the Company advised Chelsey that a
Voting Trigger (as defined in the Certificate of Designations, Powers,
Preferences and Rights (the "Certificate of Designations") of the Series B
Preferred Stock of the Company had occurred due to the failure by the Company to
redeem any shares of Series B Preferred Stock on or prior to August 31, 2003. As
a result, the holder or holders of the Series B Preferred Stock had the
exclusive right, voting separately as a class and by taking such actions as are
set forth in Section 7(b) of the Certificate of Designations, to elect two
directors of the Company (the "Director Right"). On September 16, 2003, Chelsey
exercised the Director Right and elected Martin L. Edelman and Wayne P. Garten
to the Company's Board of Directors. Messrs. Edelman and Garten returned certain
related paperwork to the Company on September 29, 2003, upon which they
effectively joined the Board.
In the event of the liquidation, dissolution or winding up of the
Company, the holders of the Series B Preferred
15
Stock are entitled to a liquidation preference (the "Liquidation Preference"),
which was initially $47.36 per share
and which increases quarterly, commencing March 1, 2002. As of March 1, 2002 and
June 1, 2002,share. During each period set forth in the table
below, the Liquidation Preference was $49.15 and $51.31 per share,
respectively. As of September 1, 2002 and December 1, 2002,shall equal the Liquidation
Preference will be $53.89 and $56.95 per share, respectively. As of March 1,
2003, June 1, 2003 and September 1, 2003, the Liquidation Preference will be
$60.54, $64.74 and $69.64 per share, respectively.amount set forth opposite such
period:
LIQUIDATION PREFERENCE
PERIOD PER SHARE TOTAL VALUE
------ --------- -----------
March 1, 2002 - May 31, 2002 $ 49.15 $ 79,726,755.65
June 1, 2002 - August 31, 2002 $ 51.31 $ 83,230,515.41
September 1, 2002 - November 30, 2002 $ 53.89 $ 87,415,561.79
December 1, 2002 - February 28, 2003 $ 56.95 $ 92,379,221.45
March 1, 2003 - May 31, 2003 $ 60.54 $ 98,202,599.94
June 1, 2003 - August 31, 2003 $ 64.74 $ 105,015,466.14
September 1, 2003 - November 30, 2003 $ 69.64 $ 112,963,810.04
December 1, 2003 - February 29, 2004 $ 72.25 $ 117,197,519.75
March 1, 2004 - May 31, 2004 $ 74.96 $ 121,593,440.56
June 1, 2004 - August 31, 2004 $ 77.77 $ 126,151,572.47
September 1, 2004 - November 30, 2004 $ 80.69 $ 130,888,136,59
December 1, 2004 - February 28, 2005 $ 83.72 $ 135,803,132.92
March 1, 2005 - May 31, 2005 $ 86.85 $ 140,880,340.35
June 1, 2005 - August 23, 2005 $ 90.11 $ 146,168,422.21
As a result, beginning November 30, 2003, the aggregate Liquidation
Preference of the Series B Preferred Stock will be effectively equal to the
aggregate liquidation
preferenceLiquidation Preference of the Class A Preferred Stock previously held
by Richemont.
AsCommencing January 2003, the Company utilizes the interest method to
account for the accretion of December 1, 2003, March 1, 2004, June 1, 2004, September 1, 2004 and December 1,
2004, the Series B Preferred Stock up to the maximum
amount of its Liquidation Preference. The application of the interest method
yields a result different from the above Liquidation Preference table during the
interim periods prior to the maximum Liquidation Preference. The accompanying
Condensed Consolidated Balance Sheet and Condensed Consolidated Statements of
Cash Flows indicate the result of the Company's use of the interest method.
In May 2003, the FASB issued FAS 150 that establishes standards for how
an issuer classifies and measures certain financial instruments with
characteristics of both liabilities and equity. It requires that an issuer
classify a financial instrument that is within its scope as a liability, many of
which had been previously classified as equity or between the liabilities and
equity sections of the consolidated balance sheet. The provisions of FAS 150 are
effective for financial instruments entered into or modified after May 31, 2003,
and otherwise is effective at the beginning of the first interim period
beginning after June 15,
will2003. It is to be $72.25, $74.96, $77.77, $80.69implemented by reporting the
cumulative effect of a change in accounting principle for financial instruments
created before the issuance of FAS 150 and $83.72 per share, respectively. Asstill existing at the beginning of
March 1, 2005the interim period of adoption. The Company has adopted the provisions of FAS
150 and has been impacted by the requirement to reclassify its Series B
Participating Preferred Stock as a liability as opposed to between the
liabilities and equity sections of the consolidated balance sheet. Based upon
the requirements set forth by FAS 150, this reclassification was subject to
implementation beginning on June 1, 2005,29, 2003. Upon implementation of FAS 150, the
Liquidation Preference will be $86.85Company has reflected the accretion of the preferred stock balance as an
increase in Total Liabilities with a corresponding reduction in capital in
excess of par value, because the Company has an accumulated deficit. Such
accretion in the amount of $4.5 million has been recorded as interest expense,
resulting in a decrease in Net Income (Loss) and $90.11 per share, respectively.Comprehensive Income (Loss). In
addition, the accompanying Condensed Consolidated Statement of Income (Loss)
presents $7.9 million of preferred stock dividends and accretion incurred prior
to the implementation of FAS 150. This amount comprised $7.6 million for the
accretion of the preferred stock balance and $0.3 million for the payment made
on behalf of Richemont to the Internal Revenue Service as described below in
further detail.
Dividends on the Series B Preferred Stock are required to be paid
whenever a dividend is declared on the Common Stock. The amount of any dividend
on the Series B Preferred Stock shall be determined by multiplying (i) the
amount obtained by dividing the amount of the dividend on the Common Stock by
the then current fair market value of a share of Common Stock and (ii) the
Liquidation Preference of the Series B Preferred Stock.
The Series B Preferred Stock must be redeemed by the Company on August
23, 2005.2005 consistent with Delaware General Corporation Law. The Company may
redeem all or less than all of the then outstanding shares of Series B
16
Preferred Stock at any time prior to that date. At the option of the holders
thereof, the Company must redeem the Series B Preferred Stock upon a Change of
Control or upon the consummation of an Asset Disposition or Equity Sale (all as
defined in the Certificate of Designations of the Series B Preferred Stock). The
redemption price for the Series B Preferred Stock upon a Change of Control or
upon the consummation of an Asset Disposition or Equity Sale is the then
applicable Liquidation Preference of the Series B Preferred Stock plus the
amount of any declared but unpaid dividends on the Series B Preferred Stock. The
Company's obligation to redeem the Series B Preferred Stock upon an Asset
Disposition or an Equity Sale is subject to the satisfaction of certain
conditions set forth in the Certificate of Designations of the Series B
Preferred Stock.
Pursuant to the terms of the Certificate of Designations of the Series
B Preferred Stock, the Company's obligation to pay dividends on or redeem the
Series B Preferred Stock is subject to its compliance with its agreements with
Congress.
The Certificate of Designations of the Series B Preferred Stock
provides that, for so long as Richemont is the holder of at least 25% of the
then outstanding shares of Series B Preferred Stock, it shall be entitled to
appoint a non-voting observer to attend all meetings of the Board of Directors
and any committees thereof. To date, Richemont hasdid not appointedappoint such an observer.
16During autumn 2002, Company management conducted a strategic review of
the Company's business and operations. As part of such review, Company
management considered the Company's obligations under the Richemont Agreement
and the Company's prospects and options for redemption of the Series B Preferred
Stock issued to Richemont pursuant thereto in accordance with the Richemont
Agreement terms. The review took into account the results of the Company's
strategic business realignment program in 2001 and 2002, the relative strengths
and weaknesses of the Company's competitive position and the economic and
business climate, including the depressed business environment for mergers and
acquisitions.
As a result of this review, Company management and the Company's Board
of Directors have concluded that it is unlikely that the Company will be able to
accumulate sufficient capital, surplus, or other assets under Delaware corporate
law or to obtain sufficient debt financing to either:
1. Redeem at least 811,056 shares of the Series B Preferred Stock
by August 31, 2003, as allowed for by the Richemont Agreement,
thereby resulting in the occurrence of a "Voting Trigger"
which will allow Richemont to have the option of electing two
members to the Company's Board of Directors; or
2. Redeem all of the shares of Series B Preferred Stock by August
31, 2005, as required by the Richemont Agreement, thereby
obligating the Company to take all measures permitted under
the Delaware General Corporation Law to increase the amount of
its capital and surplus legally available to redeem the Series
B Preferred Shares, without a material improvement in either
the business environment for mergers and acquisitions or other
factors, unforeseeable at the time.
Management believes that the Company has sufficient liquidity and
availability under its credit agreement to fund its planned operations through
at least December 31, 2004. The unlikelihood that the Company will be able to
redeem the Series B Preferred Stock is not expected to limit the ability of the
Company to use current and future net earnings or cash flow to satisfy its
obligations to creditors and vendors. See "Cautionary Statements" below. In
addition, the redemption price of the Series B Preferred Stock does not accrete
after August 31, 2005.
Company management met with representatives of Richemont on October 29,
2002 and outlined the results of management's strategic review in the context of
the Company's obligations to Richemont under the Richemont Agreement, and
discussed an alternative to the method for the redemption of the Series B
Preferred Stock. Under this alternative proposal, that the Company had
previously presented to Richemont, the Company would exchange two business
divisions, Silhouettes and Gump's, for all of Richemont's Series B Preferred
Stock (the "Proposal").
Pursuant to the terms of the Richemont Agreement, the redemption value
of the Series B Preferred Stock as of the date of the Proposal was $87 million.
Management based the Proposal terms on a valuation of Silhouettes and Gump's
using the valuation multiple employed in USA Network's June 2001 purchase of the
Company's Improvements
17
business division. The Proposal also included a willingness on the part of the
Company to provide continued fulfillment services for Silhouettes and Gump's on
terms to be negotiated. On November 18, 2002, a representative of Richemont
confirmed in writing to the Company that Richemont rejected the Proposal.
Representatives of Richemont indicated that it had no interest in the proffered
assets and disputed their valuation implied in the Company's Proposal.
Following the Proposal made to Richemont in the fall of 2002, on May
13, 2003, the Company made another proposal to Richemont to purchase all of
Richemont's securities in the Company consisting of 29,446,888 shares of Common
Stock of the Company (the "Common Shares") and 1,622,111 shares of Series B
Preferred Stock of the Company (the "Series B Preferred Stock" and, together
with the Common Shares, the "Shares") for a purchase price of US $45 million,
subject to a number of material contingencies, including the consummation of the
sale of certain assets of the Company to a third party or parties within 120
days and the consent of the Company's Board of Directors, shareholders and its
secured lender to such transactions. The Company's proposal, if consummated,
would have resulted in a reduction in the number of shares of Common Stock of
the Company outstanding from 138,315,800 to 108,868,912 and a reduction in the
number of shares of Series B Preferred Stock of the Company outstanding from
1,622,111 to 0. Richemont did not respond to the Company's May 2003 proposal.
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 the Shares for a purchase
price equal to US $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 may succeed to
Richemont's rights in the Common Shares and the Series B Preferred Stock,
including the right of the holder of the Series B 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 purported sale of the Shares, and
which increases to and caps at $146,168,422 on August 23, 2005, the final
redemption date of the Series B Preferred Stock.
On May 30, 2003, the Company reported that it believed that Richemont
sold the Common Shares and the Series B Preferred Stock to Chelsey while in the
possession of material, non-public information and was examining its rights with
respect to the transaction. The Company further reported that, by letter dated
May 27, 2003, the Company had requested that its transfer agent for the Common
Shares not register the transfer of the Common Shares from Richemont to Chelsey,
in whole or in part, without first notifying the Company of any request to do so
and without having first received the Company's agreement in writing to do so
while the Company was examining these issues. The Company also reported that it
intended to treat in a similar fashion any request for transfer of the Series B
Preferred Stock for which it acts as the transfer agent while it was examining
these issues.
By letter dated July 7, 2003, the Company made a definitive proposal to
Chelsey and Richemont to purchase all the Shares for a purchase price of US $45
million. This proposal was subject to a number of material contingencies,
including the consummation of the sale of certain of the Company's assets to a
third party within 60 days and the consent of the Company's Board of Directors
and its secured lender, as well as the Company's shareholders, if necessary, to
such transactions. By letter dated July 11, 2003, Chelsey rejected the Company's
proposal describing it as "inadequate and grossly undervalued" and making
numerous other assertions as to the Company's responsibilities to it. A copy of
Chelsey's July 11, 2003 letter, as well as a copy of the Company's July 14, 2003
response, were filed by the Company with the SEC on July 15, 2003 pursuant to a
Current Report on Form 8-K to which reference is hereby made.
On July 17, 2003, the Company filed an action in the Supreme Court of
the State of New York, County of New York (Index No. 03/602269) against
Richemont and Chelsey seeking a declaratory judgment as to whether Richemont
improperly transferred all of Richemont's securities in the Company consisting
of the Shares to Chelsey on or about May 19, 2003 and whether the Company can
properly recognize the transfer of those Shares from Richemont to Chelsey under
federal and/or state law. On July 29, 2003, Chelsey answered the Company's
complaint, alleged certain affirmative defenses and raised three counterclaims
against the Company, including Delaware law requiring the registration of the
Shares, damages, including attorney's fees, for the failure to register the
Shares, and tortious interference with contract. Chelsey also moved for a
preliminary injunction directing the Company to register the ownership of the
Shares in Chelsey's name. Chelsey later moved for summary judgment dismissing
the Company's complaint. Subsequently, Chelsey moved to compel production of
certain documents and for sanctions and/or costs. On August 28, 2003, Richemont
moved to dismiss the Company's complaint. It subsequently filed a motion seeking
18
sanctions and/or costs against the Company. On October 27, 2003, the Court
granted Chelsey's motion for summary judgment and Richemont's motion to dismiss
and ordered that judgment be entered dismissing the case in its entirety. The
Court also denied Chelsey's and Richemont's motions for sanctions and Chelsey's
motion to compel production of certain documents.
On Thursday, August 7, 2003 representatives of Chelsey attended a
regularly scheduled meeting of the Board of Directors of the Company at the
invitation of management of the Company endorsed by its Board of Directors.
Senior management of the Company was also present at the meeting. The Company
had requested that Chelsey make a brief (15-20 minute) presentation to the Board
solely with respect to (1) Chelsey's vision and proposed plan for value creation
opportunities at the Company above and beyond those currently articulated by
management in its recent SEC filings and other public statements; and (2)
Chelsey's specific proposal for the terms of an exchange offer by which the
Series B Preferred Stock would be exchanged for Common Stock of the Company
and/or Chelsey's specific counteroffer to the Company's July 7, 2003 proposal.
The Company wanted to afford Chelsey the opportunity to speak directly to the
entire Board of Directors and senior management of the Company and articulate
how Chelsey's approach would benefit all the Company's stakeholders.
At the meeting, Chelsey's representatives delivered to the Company a
document entitled "Recapitalization of Hanover Direct, Inc. Summary of Terms"
(the "Chelsey Proposal") and made a presentation to the Board of Directors
regarding the Chelsey Proposal. That presentation was purportedly summarized in
Chelsey's Amendment No. 3 to Schedule 13D as Exhibit E.
The Company's Board of Directors referred the Chelsey Proposal to its
Transactions Committee for consideration with a view towards making a
recommendation to the Board of Directors. The Transactions Committee, composed
of independent directors of the Company, provides assistance to the directors in
fulfilling their responsibility to the shareholders by recommending appropriate
actions to the Board of Directors on matters that require Board approval,
including material transactions with shareholders owning more than ten percent
(10%) of the voting securities of the Company. The Transactions Committee
engaged financial advisors and counsel to assist it in its deliberations with
respect to the Chelsey Proposal.
On September 18, 2003, representatives of Chelsey attended a meeting
with legal and financial advisors to the Transactions Committee of the Board of
Directors of the Company at which a document entitled "Recapitalization of
Hanover Direct, Inc. - Summary of Counteroffer Terms" (the "Counterproposal")
was discussed. The Counterproposal responded to Chelsey's Proposal to the
Company at the August 7 meeting of the Board of Directors. Chelsey's
representatives did not accept the Counterproposal. Negotiations between the
parties ensued in the weeks thereafter.
On November 10, 2003, the Company signed a Memorandum of Understanding
with Chelsey and Regan Partners, L.P. setting forth the agreement in principle
to recapitalize the Company, reconstitute the Board of Directors and settle
outstanding litigation between the Company and Chelsey. The Memorandum of
Understanding had been approved by the Transactions Committee of the Board of
Directors of the Company.
The parties agreed to effect within ten days or as soon thereafter as
possible a binding Recapitalization Agreement that would, upon the closing of
the transactions set forth in the Recapitalization Agreement, exchange 564,819
shares of a newly issued Series C Preferred Stock and 81,857,833 shares of newly
issued common stock for the 1,622,111 shares of Series B Preferred Stock
currently held by Chelsey, subject to adjustment if the transaction is not
consummated by December 17, 2003. If the closing takes place on or before
December 17, 2003, the Series C Preferred Stock will have an aggregate
liquidation preference of $56,481,900 while the outstanding Series B Preferred
Stock has a current aggregate liquidation preference of $112,963,810 and a
maximum final liquidation preference of $146,168,422 on August 23, 2005. With
the issuance of the new common shares, Chelsey will have a majority equity and
voting interest in the Company.
Upon the execution of the Recapitalization Agreement, the Company will
reconstitute the Board to eight members including four designees of Chelsey.
The Recapitalization Agreement is subject to the approval of the Transactions
Committee and the Board of Directors of the Company. It is also subject to
other consents including the approval of Congress Financial Corporation. The
Company intends to prepare and file with the Securities and Exchange Commission
and transmit to all equity holders of the Company, as required by Rule 14f-1 of
the Securities Exchange Act of 1934, as amended, a statement regarding its
intent to effect a change in majority of directors as promptly as practicable.
Following the expiration of ten days following the filing and mailing of the
statement, the Board of Directors will increase to nine members, with the
additional director being a Chelsey designee.
The proposed Series C Preferred Stock, with a liquidation preference of
$100 per share, carries a quarterly dividend, starting on January 1, 2006 at 6%
and increasing each year by 1 1/2%. In lieu of cash dividends, the Company may
elect to accrue dividends at a rate equal to 1% higher than the annual cash
dividend rate. The Series C Preferred Stock has a redemption date of January 1,
2009. The Company shall redeem the maximum number of shares of Series C
Preferred Stock as possible with the net proceeds of certain asset and equity
sales, including the disposition of the Company's non-core assets, not required
to be used to repay Congress Financial Corporation pursuant to the terms of the
19th Amendment to the Loan and Security Agreement, and Chelsey shall be
required to accept such redemptions.
The Recapitalization Agreement will also define the duties of the
Transactions Committee and provide for the reconstitution of the committees of
the Board of Directors, mutual releases and termination of litigation between
the Company and Chelsey, voting agreements between Chelsey and Regan Partners, a
major shareholder of the Company, registration rights for the new common shares
and agreements to recommend certain amendments to the Company's Certificate of
Incorporation, including a 10-for-1 reverse stock split and a decrease in the
par value of the Common Stock from $.66 2/3 per share to $.01 per share, at the
first annual meeting of shareholders following the closing.
If the closing of the Recapitalization Agreement has not occurred by
November 30, 2003, then the Company will pay Chelsey $1 million by December 3,
2003. If the closing has not occurred by the close of business on December 17,
2003, then the Memorandum of Understanding shall cease to be effective unless
either the Company or Chelsey elects to extend the closing past such date. If
the Company makes such election, the number of shares of Common Stock and
Series C Preferred Stock issued to Chelsey in the Recapitalization shall be
adjusted pursuant to the terms of the agreement. If Chelsey makes such an
election, there shall be no adjustment to the number of shares. In either case,
the Closing shall occur no later than February 29, 2004.
The Memorandum of Understanding has been filed with the Securities and
Exchange Commission as an exhibit to the Company's Current Report on Form 8-K
dated November 10, 2003. The Company strongly recommends that interested parties
refer to it for a full and complete understanding of the terms and conditions of
the Memorandum of Understanding.
For Federal income tax purposes, the increases in the Liquidation
Preference of the Series B Preferred Stock are considered distributions by the
Company to the holder of the Series B Preferred Stock, deemed made on the
commencement dates of the quarterly increases, as discussed above. These
distributions may be taxable dividends to the holder of the Series B Preferred
Stock, provided the Company has accumulated or current earnings and profits
("E&P") for each year in which the distributions are deemed to be made. Under
the terms of the Richemont Transaction, the Company is obligated to reimburse
the holder of the Series B Preferred Stock for any U.S. income tax incurred
pursuant to the Richemont Transaction. This reimbursement obligation is
transferable upon sale of the Series B Preferred Stock. Since Richemont's sale
of the Series B Preferred Stock to Chelsey has been recognized as valid (See
Note 4), the Company's tax reimbursement obligation is inapplicable to Chelsey,
because Chelsey is treated as a partnership for U.S. tax purposes and, as such,
does not incur any U.S. income taxes. 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. Accordingly, the Company did not incur a tax reimbursement
obligation for the year 2002. The Company must have current E&P in the years
2003, 2004 or 2005 to incur a tax reimbursement obligation for the scheduled
increases in Liquidation Preference. If the Company does not have current E&P in
one of those years, no tax reimbursement obligation would exist for that
particular year. The Company does not have the ability to project the exact
future tax reimbursement obligation; however, it has estimated the potential
obligation to be $0 to $2.2 million, depending upon actual 2003 E&P since
Chelsey has been determined to be the holder of the Series B Preferred Stock. In
March 2003, a payment of $0.3 million was made on behalf of Richemont to the
Internal Revenue Service. The payment was reflected as a reduction of Capital in
excess of par value on the Condensed Consolidated Balance Sheets and as an
increase to Preferred stock dividends and accretion on the Condensed
Consolidated Statements of Income (Loss). Based upon the Company's current
projections for 2003, it is estimated the Company may not incur a tax
reimbursement obligation for 2003 relating to the increases in the Liquidation
Preference of the Series B Participating Preferred Stock and will file for a
refund of the $0.3 million Federal tax payment made in March 2003. Due to the
FAS 150 requirements to reclassify the Series B Participating Preferred Stock to
liabilities and to record the accretion of the preferred stock balance as
interest expense, the refund has been treated as a decrease to interest expense
on the Condensed Consolidated Statements of Income (Loss) for the third quarter
and an increase of capital in excess of par value on the Condensed Consolidated
Balance Sheets. See Note 8 for additional details regarding the implementation
of FAS 150.
11. INCOME TAXES
SFAS No. 109, "Accounting for Income Taxes", requires that the future
tax benefit of the Company's net operating losses ("NOLs") be recorded as an
asset to the extent that management assesses the utilization of such NOLs to be
"more-likely-than-not". Based upon the Company's assessment, at December 28,
2002, of numerous factors, including its future operating plans, management
reduced its net deferred tax asset from $15.0 million to $11.3 million via a
$3.7 million deferred Federal income tax provision. Due to a number of factors,
including the continued softness in the market for the Company's products,
management has lowered its projections of taxable income for fiscal years 2003
and 2004. As a result of these lower projections of future taxable income, the
future utilization of the Company's NOLs is no longer "more-likely-than-not".
The Company has made a decision to fully reserve the remaining net deferred tax
asset by increasing the valuation allowance via an $11.3 million deferred
Federal income tax provision during the third quarter ended September 27, 2003.
19
12. RESTATEMENT
The Company has re-examined the provisions of its revolving loan
facility and based on EITF 95-22 and certain provisions in the Credit Agreement,
the Company is required to reclassify its revolving loan facility from
long-term to short-term debt, though the existing revolving loan facility does
not mature until January 31, 2007. As a result, the Company reclassified $13,164
and $8,819 (in thousands) as of September 27, 2003 and December 28, 2002,
respectively, from Long-term debt to Short-term debt and capital lease
obligations that is classified as current liabilities.
A summary of the effects of the restatement on our Consolidated Balance Sheets
as of September 28, 2003 and December 28, 2002 follows:
(IN THOUSANDS) September 27, 2003 December 28, 2002
--------------------------------------------------
As Previously As As Previously As
Reported Restated Reported Restated
--------------------------------------------------
Short-term debt and
capital lease obligations $ 10,831 $ 23,995 $ 3,802 $ 12,621
Total current liabilities $ 72,424 $ 85,588 $ 78,848 $ 87,667
Long-term debt $ 22,820 $ 9,656 $ 21,327 $ 12,508
Total non-current liabilities $135,005 $121,841 $ 27,714 $ 18,895
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-WEEKS13- WEEKS ENDED 26-WEEKS39- WEEKS ENDED
-------------- --------------
JUNE 29, JUNE 30, JUNE 29, JUNE 30,------------------------------ -----------------------------
SEPTEMBER 27, September 28, SEPTEMBER 27, SEPTEMBER 28,
2003 2002 20012003 2002
2001
------ ------ ------ ------------------- ------------- ------------- -------------
Net revenues 100.0% 100.0% 100.0% 100.0%
Cost of sales and operating expenses 61.8 62.3 63.4 63.264.8 65.0 63.8 63.9
Special charges 0.0 3.8 0.1 2.20.2 1.4 0.2 0.5
Selling expenses 23.3 28.2 22.9 27.723.6 23.9 24.3 23.2
General and administrative expenses 11.0 11.510.4 11.2 11.110.1 11.2
Depreciation and amortization 1.1 1.3 1.51.1 1.3
1.4
Earnings (loss)(Loss) income from operations 2.6 (7.3) 1.1 (5.6)(0.1) (2.8) 0.5 (0.1)
Gain on sale of Improvements and Kindig Lane Property 0.3 18.20.0 0.0 0.6 0.1 8.8
Interest expense, net 5.4 1.2 1.42.6 1.2
1.3Provision for deferred federal income taxes 11.7 0.0 3.7 0.0
Provision for state income taxes 0.0 0.0 0.0 0.0
Net earningsloss and comprehensive earnings 1.6% 9.5% 0.0% 1.8%loss (17.2)% (4.0)% (5.2)% (1.2)%
RESULTS OF OPERATIONS - 13-WEEKS13- WEEKS ENDED JUNE 29, 2002SEPTEMBER 27, 2003 COMPARED WITH THE 13-WEEKS13-
WEEKS ENDED JUNE 30, 2001SEPTEMBER 28, 2002
Net EarningsLoss and Comprehensive Earnings.Loss. The Company reported a net earningsloss of
$1.8$16.6 million for the 13-weeks13- weeks ended June 29, 2002September 27, 2003 compared with a net
earningsloss of $12.7 million for the comparable period last year. In addition to measures of
operating performance determined in accordance with generally accepted
accounting principles, management also uses earnings before interest, income
taxes, depreciation and amortization expense ("EBITDA") to evaluate performance.
EBITDA is measured because management believes that such information is useful
in evaluating the results relative to other entities that operate within its
industries. EBITDA is an alternative to, and not a replacement measure of,
operating performance as determined in accordance with generally accepted
accounting principles. EBITDA decreased by $18.2 million to $5.0 million for the
13-weeks ended June 29, 2002 as compared with $23.2$4.2 million for the comparable period in 2001.the year 2002. The results$12.4
million increase in net loss was primarily due to an $11.3 million deferred
Federal income tax provision incurred to increase the valuation allowance and
fully reserve the remaining net deferred tax asset. Due to a number of factors,
including the continued softness in the market for the 13-week periods ended June 29, 2002Company's products,
management has lowered its projections of future taxable income for fiscal years
2003 and June
30, 2001 include $0.3 million and $24.3 million, respectively, in after tax
gains resulting from2004. As a result of lower projections of future taxable income, the
salefuture utilization of the Improvements business andCompany's net operating losses is no longer
"more-likely-than-not". In addition, the Kindig Lane
Property. Net earnings (loss) and EBITDA for the 13-weeks ended June 29, 2002
increased $13.1 million and $12.0 million, respectively, over the comparable
periodincrease in 2001 priornet loss was also due to
the recognitionrecording of these gains. Net earnings (loss) per
share was $(.01) applied to common shareholders for the 13-weeks ended June 29,
2002 and $.05 for the 13-weeks ended June 30, 2001. The per share amounts were
calculated after deducting$4.5 million of additional interest expense incurred on the
Series B Participating Preferred Stock redemption price
increaseas a result of $3.5 millionthe implementation of FAS
150. Effective June 29, 2003, FAS 150 required the Company to reclassify its
Series B Participating Preferred Stock as a liability and reflect the accretion
of the preferred stock balance as interest expense. If FAS 150 were applicable
for the 13-weeks13- weeks ended June 29,September 28, 2002, net loss would have been $8.4
million. This increase was partially offset by continued reductions in general
and the Series A
Preferred Stock dividendsadministrative expenses and accretion of $3.0 milliona decrease in special charges and depreciation
and amortization. Net loss per common share was $0.12 and $0.06 for the comparable
period in 2001.13-
weeks ended September 27, 2003 and September 28, 2002, respectively. The
weighted average number of shares of Common Stock outstanding used in both the
basic and diluted net (loss)loss per common share calculation was 138,264,152138,315,800 for both
the 13-week period13- weeks ended June 29,September 27, 2003 and September 28, 2002. For the 13-week period ended June 30, 2001,
the weighted average number of shares used in the calculation for the basic and
diluted net earnings per share was 212,186,331 and 212,786,467 shares,
respectively. This decrease in weighted average shares was primarily due to the
transaction consummated with Richemont in December 2001, where the Company
repurchased and retired 74,098,769 shares of Common Stock then held by
Richemont.
Compared with the comparable period last year, the $10.9 million decrease
in net earnings was primarily due to:
(i) gain on sale of the Improvements business of $22.8 million in the year
2001; and
(ii) gain on sale of the Kindig Lane Property of $1.5 million in the year 2001;
partially offset by:
(i) decreased cost of sales and operating expenses;
(ii) decreased selling expenses;
(iii) decreased general and administrative expenses; and
(iv) decreased special charges associated with the Company's strategic business
realignment program.
17
Net Revenues. Net revenues decreased $19.6$9.4 million (14.7%(8.9%) for the
13-week period ended June 29, 2002September 27, 2003 to $113.9$96.6 million from $133.5$106.0 million for
the comparable fiscal period in 2001. Thisthe year 2002. The decrease was due in part to the sale of the
Improvements business on June 29, 2001, which accounted for $15.2 million of the
reduction in revenues for the 13-week period ended June 29, 2002. The
discontinuance of the Domestications Kitchen & Garden, Kitchen & Home and Encore
catalogs contributed $1.2 million to the reduction in net revenues for the
13-week period ended June 29, 2002. The remaining balance of the decrease in net
revenues can be attributedprincipally
to softness in demand primarily relatedand a 10.1% reduction in overall circulation for
continuing businesses from the comparable fiscal period in 2002. This reduction
resulted from the Company's continued efforts to certain
brandsreduce unprofitable circulation
and planned reductionsremain focused on its strategy of increasing profitable circulation.
Internet sales continued to grow, and comprised 28.9% of combined Internet and
catalog revenues for the 13- weeks ended September 27, 2003, and have increased
by approximately $4.6 million or 21.3% to $26.2 million from $21.6 million for
the comparable fiscal period in unprofitable circulation.the year 2002.
Cost of Sales and Operating Expenses. Cost of sales and operating
expenses decreased to 61.8%64.8% of net revenues for the 13- week13-week period ended
June 29, 2002September 27, 2003 as compared with 62.3%65.0% of net revenues for the comparable
period in 2001.the year 2002. This decrease was primarily due to lower merchandise
costs resulting from improved pricing associated with foreign merchandise
sourcing in combination with a decrease in volume of promotional offers during
the period.
20
Special Charges. In December 2000, the Company began a strategic
business realignment program that resulted in the recording of special charges
for severance, facility exit costs and asset write-offs. Special charges for the
13- weeks ended September 27, 2003 were $0.2 million, incurred to revise and
increase estimated losses related to sublease arrangements in connection with
office facilities in San Francisco, California resulting from the loss of a
subtenant, coupled with declining market values in that area of the country. For
the 13- weeks ended September 28, 2002, the Company recorded special charges of
$1.5 million to integrate The Company Store and Domestications divisions and
cover additional charges related to the Company's plan to consolidate its office
space at its corporate offices in New Jersey.
Selling Expenses. Selling expenses decreased by $2.6 million to $22.8
million for the 13- weeks ended September 27, 2003 as compared with $25.4
million for the comparable fiscal period in the year 2002. As a percentage
relationship to net revenues, selling expenses decreased to 23.6% for the 13-
weeks ended September 27, 2003 from 23.9% for the comparable period in the year
2002. This change was due primarily to decreases in paper and printing costs
realized from the Company's continued efforts to reduce unprofitable
circulation.
General and Administrative Expenses. General and administrative
expenses decreased by $1.7 million to $10.1 million for the 13- weeks ended
September 27, 2003 as compared with $11.8 million for the comparable period in
the year 2002. As a percentage relationship to net revenues, general and
administrative expenses were 10.4% of net revenues for the 13- weeks ended
September 27, 2003 compared with 11.2% of net revenues for the comparable period
in the year 2002. This decrease was primarily due to reductions in payroll costs
and incentive compensation, legal costs and the benefit recognized from the
implementation of the Company's new vacation and sick policy.
Depreciation and Amortization. Depreciation and amortization decreased
approximately $0.3 million to $1.1 million for the 13- weeks ended September 27,
2003 from $1.4 million for the comparable period in the year 2002. The decrease
was primarily due to capital expenditures that have become fully amortized
during fiscal year 2003. As a percentage relationship to net revenues,
depreciation and amortization was 1.1% for the 13- weeks ended September 27,
2003 and 1.3% for the comparable period in the year 2002.
Loss from Operations. The Company's loss from operations decreased by
$2.8 million to $0.1 million for the 13- weeks ended September 27, 2003 from a
loss of $2.9 million for the comparable period in the year 2002. See "Results of
Operations - 13- weeks ended September 27, 2003 compared with the 13- weeks
ended September 28, 2002 - Net Income and Comprehensive Income" above for
further details.
Gain on Sale of the Improvements Business. During the 13- weeks ended
September 27, 2003 and September 28, 2002, the Company did not recognize any
gain 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 increased $4.0 million to
$5.3 million for the 13- weeks ended September 27, 2003 from $1.3 million for
the comparable period in the year 2002. The increase in interest expense is
primarily due to the recording of $4.5 million of Series B Participating
Preferred Stock dividends and accretion as interest expense based upon the
implementation of FAS 150. Effective June 29, 2003, FAS 150 required the Company
to reclassify its Series B Participating Preferred Stock as a liability and
reflect the accretion of the preferred stock balance as interest expense. This
increase was partially offset by a $0.3 million expected refund for the March
2003 payment made on behalf of Richemont to the Internal Revenue Service
relating to the increases in the Liquidation Preference of the Series B
Participating Preferred Stock. The Company must have current earnings and
profits to incur a tax reimbursement obligation for the scheduled increases in
Liquidation Preference and currently estimates its obligation for 2003 to be $0.
Because FAS 150 required the reclassification of the Series B Participating
Preferred Stock to liabilities and the recording of increases in the liquidation
preference as interest expense, the expected refund on Federal Taxes previously
paid has been treated as a decrease to interest expense. In addition to this
refund, the increase in interest expense was also partially offset by a decrease
in amortization from deferred financing costs relating to the Company's
amendments to the Congress Credit Facility.
Income Taxes. During the 13- weeks ended September 27, 2003, the
Company made a decision to fully reserve the remaining net deferred tax asset by
increasing the valuation allowance via an $11.3 million deferred Federal income
tax provision. Due to a number of factors, including the continued softness in
the market for the Company's products, management has lowered its projections of
taxable income for fiscal years 2003 and 2004. As a result of lower
21
projections of future taxable income, the future utilization of the Company's
net operating losses is no longer "more-likely-than-not".
RESULTS OF OPERATIONS - 39- WEEKS ENDED SEPTEMBER 27, 2003 COMPARED WITH THE 39-
WEEKS ENDED SEPTEMBER 28, 2002
Net Loss and Comprehensive Loss. The Company reported a net loss of
$15.8 million for the 39- weeks ended September 27, 2003 compared with a net
loss of $4.2 million for the comparable period in the year 2002. The $11.6
million increase in net loss was primarily due to an $11.3 million deferred
Federal income tax provision incurred to increase the valuation allowance and
fully reserve the remaining net deferred tax asset. Due to a number of factors,
including the continued softness in the market for the Company's products,
management has lowered its projections of future taxable income for fiscal years
2003 and 2004. As a result of lower projections of future taxable income, the
future utilization of the Company's net operating losses is no longer
"more-likely-than-not". In addition, the increase in net loss was also due to
the recording of $4.5 million of additional interest expense incurred based upon
the implementation of FAS 150. Effective June 29, 2003, FAS 150 required the
Company to reclassify its Series B Participating Preferred Stock to liabilities
and to reflect the accretion of the preferred stock balance as interest expense.
This was partially offset by continued reductions in general and administrative
expenses, a decrease in special charges and depreciation and amortization, and
the recording of a $1.9 million deferred gain during the 39- weeks ended
September 27, 2003 related to the June 29, 2001 sale of the Company's
Improvements business. Net loss per common share was $0.17 for the 39- weeks
ended September 27, 2003 and $0.11 for the 39- weeks ended September 28, 2002.
The per share amounts were calculated after deducting preferred dividends and
accretion of $7.9 million and $10.6 million for the 39- weeks ended September
27, 2003 and September 28, 2002, respectively. In addition, the per share
amounts were calculated after deducting additional preferred dividends and
accretion of $4.5 million incurred as interest expense after June 28, 2003. The
weighted average number of shares of Common Stock outstanding used in both the
basic and diluted net loss per common share calculation was 138,315,800 for the
39- weeks ended September 27, 2003 and 138,268,327 for the 39- weeks ended
September 28, 2002. This increase in weighted average shares was due to
issuances of Common Stock within the Company's stock-based compensation plans.
Net Revenues. Net revenues decreased $24.5 million (7.4%) for the
39-week period ended September 27, 2003 to $304.9 million from $329.4 million
for the comparable fiscal period in the year 2002. The decrease is due
principally to softness in demand and a 5.9% reduction in overall circulation
for continuing businesses from the comparable fiscal period in 2002. This
reduction resulted from the Company's continued efforts to reduce unprofitable
circulation and remain focused on its strategy of increasing profitable
circulation. Internet sales continued to grow, and comprised 27.6% of combined
Internet and catalog revenues for the 39- weeks ended September 27, 2003, and
have increased by $17.5 million or 28.3% to $79.2 million from $61.7 million for
the comparable fiscal period in the year 2002.
Cost of Sales and Operating Expenses. Cost of sales and operating
expenses decreased to 63.8% of net revenues for the 39-week period ended
September 27, 2003 from 63.9% of net revenues for the comparable period in the
year 2002. This slight decrease was primarily due to reductions in merchandise
cost resulting from improved pricing associated with foreign merchandise
sourcing and reductions in spending related to the information technology
systems area that have resulted from actions taken in connection with the Company's strategic business realignment program.
Special Charges. In December 2000, the Company developed a plan to
strategically realign its business and direct the Company's resources primarily
towards a loss reduction and return to profitability. As a result of the
continued actions needed to execute the plan, the Company recorded special
charges of $5.0 million for the 13- week period ended June 30, 2001 to primarily
cover additional charges related to the exit of the Maumelle and Kindig Lane
buildings including the write-down for impairment of remaining assets. Also
included were severance costs relating to the elimination of associates employed
at the Kindig Lane Property,those in addition to 32 FTE positions across all
divisions of the Company's business as part of the strategic business
realignment program. For the 13-week period ended June 29, 2002, the Company did
not incur any additional special charges relating to the strategic business
realignment program.
Selling Expenses. Selling expenses decreased by $11.1 million to $26.6
million for the 13- weeks ended June 29, 2002 as compared with $37.7 million for
the comparable period in the year 2001. As a percentage relationship to net
revenues, selling expenses decreased to 23.3% for the 13- weeks ended June 29,
2002 versus 28.2% for the comparable period in the year 2001. This decrease was
due primarily to reductions in catalog paper pricing, postage costs, and
circulation. In addition, decreases in catalog printing and preparation costs
also contributed to the lower percentage relationship to net revenues.
General and Administrative Expenses. General and administrative expenses
decreased by $2.8 million to $12.6 million for the 13- weeks ended June 29, 2002
as compared with $15.4 million for the comparable period last year. As a
percentage relationship to net revenues, general and administrative expenses
were 11.0% of net revenues for the 13- weeks ended June 29, 2002 versus 11.5% of
net revenues for the comparable period in the year 2001. The reductions in costs
are primarily attributable to the elimination of a significant number of FTE
positions across all departments which began late in 2000 as part of the
Company's strategic business realignment program and has continued throughout
the 13- weeks ended June 29, 2002. This decrease is partially offset by
additional professional and legal fees associated with the Company's engagement
in legal proceedings as mentioned in Note 4, Commitments and Contingencies, to
the Condensed Consolidated Financial Statements.
Depreciation and Amortization. Depreciation and amortization decreased by
$0.5 million for the 13- weeks ended June 29, 2002 versus the comparable period
in the year 2001. The decrease is primarily due to the elimination of goodwill
amortization of $0.1 million resulting from the implementation of FAS 142 and
the complete amortization of computer software in the year 2001. As a percentage
relationship to net revenues, depreciation and amortization was 1.3% for the
13- weeks ended June 29, 2002 and 1.5% for the comparable period in the year
2001.
Earnings (Loss) from Operations. The Company's earnings from operations
increased by $12.6 million to $2.9 million for the 13- weeks ended June 29, 2002
from a loss of ($9.7) million for the comparable period in the year 2001.
Gain on sale of the Improvements business and the Kindig Lane Property.
Gain on sale of the Improvements business and the Kindig Lane Property was 18.2%
of net revenues for the 13- weeks ended June 30, 2001. The Company realized a
net gain on the sale of the Improvements business of approximately $22.8 million
in the second quarter of 2001, which represents the excess of the net proceeds
from the sale over the net assets assumed by HSN, the goodwill associated with
the Improvements business and expenses related to the transaction. In June 2002,
the Company
18
recognized $0.3 million of the deferred gain consistent with the terms of the
escrow agreement. The Company realized a net gain on the sale of the Kindig Lane
Property of approximately $1.5 million.
Interest Expense, Net. Interest expense, net decreased $0.4 million to
$1.4 million for the 13- weeks ended June 29, 2002 as compared with $1.8 million
for the comparable period in the year 2001. The decrease in interest expense in
the second quarter of 2002 is primarily due to lower average borrowings, coupled
with lower interest rates. This decrease is partially offset by an increase in
amortization from additional deferred financing costs relating to the Company's
credit facility with Congress.
RESULTS OF OPERATIONS - 26- WEEKS ENDED JUNE 29, 2002 COMPARED WITH THE
26- WEEKS ENDED JUNE 30, 2001
Net Earnings and Comprehensive Earnings. The Company reported net earnings
of $0.0 million for the 26- weeks ended June 29, 2002 compared with net earnings
of $5.1 million for the comparable period last year. EBITDA decreased by $13.8
million to $6.4 million for the 26- weeks ended June 29, 2002 as compared with
$20.2 million for the comparable period in 2001. The results for the 26-week
periods ended June 29, 2002 and June 30, 2001 include $0.3 million and $24.3
million, respectively, in after tax gains resulting from the sale of the
Improvements business and the Kindig Lane Property. Net earnings and EBITDA for
the 26- weeks ended June 29, 2002 increased $18.9 million and $16.4 million,
respectively, over the comparable period in 2001 prior to the recognition of
these gains. Net (loss) per share was $(.05) applied to common shareholders for
the 26- weeks ended June 29, 2002 and $(0.0) for the 26- weeks ended June 30,
2001. The per share amounts were calculated after deducting the Series B
Preferred Stock redemption price increase of $6.4 million for the 26- weeks
ended June 29, 2002 and the Series A Preferred Stock dividends and accretion of
$5.9 million for the comparable period in 2001. The weighted average number of
shares outstanding used in both the basic and diluted net (loss) per share
calculation was 138,244,591 for the 26-week period ended June 29, 2002 and
212,327,375 for the 26-week period ended June 30, 2001. This decrease in
weighted average shares was primarily due to the transaction consummated with
Richemont in December 2001, where the Company repurchased and retired 74,098,769
shares of Common Stock then held by Richemont.
Compared with the comparable period last year, the $5.1 million decrease
in net earnings was primarily due to:
(i) gain on sale of the Improvements business of $22.8 million in the year
2001; and
(ii) gain on sale of the Kindig Lane Property of $1.5 million in the year 2001;
partially offset by:
(i) decreased cost of sales and operating expenses;
(ii) decreased selling expenses;
(iii) decreased general and administrative expenses; and
(iv) decreased special charges associated with the Company's strategic business
realignment program.
Net Revenues. Net revenues decreased $54.4 million (19.6%) for the 26-week
period ended June 29, 2002 to $223.4 million from $277.8 million for the
comparable period in 2001. This decrease was due in part to the sale of the
Improvements business on June 29, 2001, which accounted for $34.1 million of the
reduction in revenues for the 26-week period ended June 29, 2002. The
discontinuance of the Domestications Kitchen & Garden, Kitchen & Home, Encore
and Turiya catalogs contributed $6.0 million to the reduction in net revenues
for the 26-week period ended June 29, 2002. An additional portion of the drop in
revenues amounting to $0.7 million can be attributed to the Company's decision
to scale back on its third-party fulfillment business by focusing only on
profitable operations. The remaining balance of the decrease in net revenues can
be attributed to softness in demand primarily related to certain brands and
planned reductions in unprofitable circulation.
Cost of Sales and Operating Expenses. Cost of sales and operating expenses
increased to 63.4% of net revenues for the 26-week period ended June 29, 2002 as
compared with 63.2% of net revenues for the comparable period in 2001. This
change is due to an increase in merchandise inventory costs, which accounted for
0.6% of the percentage increase, partially offset by decreases in operating
costs that have resulted from actions taken in connection with
the Company's strategic business realignment program. These decreases occurred primarilyin costs,
however, were partially offset by an increase in product postage costs for the
period. Telemarketing and distribution costs continued to remain consistent with
the comparable fiscal period in the areas of fixed telemarketing and
19
distribution costs and information systems costs associated with the Company's
fulfillment centers, which accounted for 0.4% of the offsetting percentage
decrease.year 2002.
Special Charges. In December 2000, the Company developedbegan a planstrategic
business realignment program that resulted in the recording of special charges
for severance, facility exit costs and asset write-offs. Special charges
recorded for the 39- weeks ended September 27, 2003 were $0.7 million. These
charges consisted primarily of additional severance costs and revised increases
in estimated losses related to strategically realign its business and directsub-lease arrangements in connection with office
facilities in San Francisco, California, resulting from the Company's resources primarily
towardsloss of a loss reduction and return to profitability. As a resultsubtenant,
coupled with declining market values in that area of the continued actions needed to execute the plan, the Company recorded special
charges of $6.1 million for the 26-week period ended June 30, 2001. These
special charges were recorded to primarily cover severance costs related to the
elimination of 78 FTE positions across all departments of the Company's business
and additional charges related to the exit of the Maumelle and Kindig Lane
buildings including the write-down for impairment of remaining assets.country. For the 26-week period39-
weeks ended June 29,September 28, 2002, the Company recorded an additional $0.2$1.7 million of specialin charges
relating toassociated with the strategic business realignment program. These charges
consisted primarily of additional facility and exit costs resulting from the
Company's plan to further consolidate its office space at its corporate offices
in New Jersey. In addition, special charges for the 39-week period ended
September 28, 2002, consist of severance costs related to the elimination of an
additional 10 FTE positions in various levels of catalog operations and costs
associated with the Company's decision to close the San Diego product manufacturingstorage
facility.
22
Selling Expenses. Selling expenses decreased by $25.9$2.5 million to $51.2$74.1
million for the 26-39- weeks ended June 29, 2002 as compared with $77.1September 27, 2003 from $76.6 million for the
comparable fiscal period in the year 2001.2002. As a percentage relationship to net
revenues, selling expenses decreasedincreased to 22.9%24.3% for the 26-39- weeks ended June 29,
2002 versus 27.7%September
27, 2003 from 23.2% for the comparable period in the year 2001.2002. This decreasechange was
due primarily to reductionsincreases in catalog paper pricing, catalog preparation, costs
and circulation. In addition, decreases in catalog printing and postage costs,
also contributed to the lower percentage relationship to net revenues.partially offset by reduced paper prices.
General and Administrative Expenses. General and administrative
expenses decreased by $5.7$5.9 million to $25.0$30.9 million for the 26-39- weeks ended
June 29, 2002
as compared with $30.7September 27, 2003 from $36.8 million for the comparable period last year.in the year
2002. As a percentage relationship to net revenues, general and administrative
expenses were 11.2%10.1% of net revenues for the 26-39- weeks ended June 29, 2002 versus 11.1%September 27, 2003
compared with 11.2% of net revenues for the comparable period in the year 2001.2002.
This increase isdecrease was primarily due to additional professional and legal fees associated with the
Company's engagement in legal proceedings as mentioned in Note 4, Commitments
and Contingencies, to the Condensed Consolidated Financial Statements. This
increase is partially offset by reductions in payroll costs primarily attributable toand incentive
compensation, legal costs and the elimination of a significant number of FTE positions across all departments
which began late in 2000 as partbenefit recognized from the implementation of
the Company's strategic business realignment
programnew vacation and have continued throughout the 26- weeks ended June 29, 2002.sick policy.
Depreciation and Amortization. Depreciation and amortization decreased
by
$0.9$1.0 million to $3.4 million for the 26-39- weeks ended June 29, 2002 versusSeptember 27, 2003 from
$4.4 million for the comparable period in the year 2001.2002. The decrease is
primarily due to the elimination of goodwill
amortization of $0.3 million resulting from the implementation of FAS 142 and
the complete amortization of computer software in thecapital expenditures that have become fully amortized during
fiscal year 2001.2003. As a percentage relationship to net revenues, depreciation and
amortization was 1.3%1.1% for the 26-39- weeks ended June 29, 2002September 27, 2003 and 1.4%1.3% for
the comparable period in the year 2001.
Earnings2002.
Income (Loss) from Operations. The Company's earningsincome from operations
increased by $18.0$1.9 million to $2.5$1.5 million for the 26-39- weeks ended June 29, 2002September 27,
2003 from a loss of ($15.5)$0.4 million for the comparable period in the year 2001.2002. See
"Results of Operations - 39- weeks ended September 27, 2003 compared with the
39- weeks ended September 28, 2002 - Net Income and Comprehensive Income" above
for further details.
Gain on saleSale of the Improvements business andBusiness. During the Kindig Lane Property.
Gain on sale39- weeks ended
September 27, 2003, the Company recognized the remaining deferred gain of $1.9
million consistent with the terms of the Improvements business andMarch 27, 2003 amendment made to the
Kindig Lane Property was 8.8%
of net revenues for the 26- weeks ended June 30, 2001. The Company realized a
net gain onasset purchase agreement relating to the sale of the Improvements business of approximately $22.8 million
inbusiness. For
the second quarter of 2001, which represents the excess of the net proceeds
from the sale over the net assets assumed by HSN, the goodwill associated with
the Improvements business and expenses related to the transaction. In June39- weeks ended September 28, 2002, the Company recognized $0.3 million of
the deferred gain consistent with the terms of the escrow agreement. The Company realized a net gain onSee Note 6
of Notes to the sale of
the Kindig Lane Property of approximately $1.5 million.Condensed Consolidated Financial Statements.
Interest Expense, Net. Interest expense, net decreased $1.0increased $3.8 million to
$2.7$7.8 million for the 26-39- weeks ended June 29, 2002 as compared with $3.7September 27, 2003 from $4.0 million for
the comparable period in the year 2001.2002. The decreaseincrease in interest expense is
primarily due to lower average borrowings, coupled with lowerthe recording of $4.5 million of Series B Participating
Preferred Stock dividends and accretion as interest rates.expense based upon the
implementation of FAS 150. Effective June 29, 2003, FAS 150 required the Company
to reclassify its Series B Participating Preferred Stock to liabilities and to
reflect the accretion of the preferred stock balance as interest expense. This
decrease isincrease was partially offset by ana $0.3 million expected refund for the March
2003 payment made on behalf of Richemont to the Internal Revenue Service
relating to the increases in the Liquidation Preference of the Series B
Participating Preferred Stock. The Company must have current earnings and
profits to incur a tax reimbursement obligation for the scheduled increases in
Liquidation Preference and currently estimates its obligation for 2003 to be $0.
In addition to this refund, the increase in interest expense was also partially
offset by a decrease in amortization from additional deferred financing costs relating to
the Company's credit facility with
Congress.
20
amendments to the Congress Credit Facility.
Income Taxes. During the 39- weeks ended September 27, 2003, the
Company made a decision to fully reserve the remaining net deferred tax asset by
increasing the valuation allowance via an $11.3 million deferred Federal income
tax provision. Due to a number of factors, including the continued softness in
the market for the Company's products, management has lowered its projections of
taxable income for fiscal years 2003 and 2004. As a result of lower projections
of future taxable income, the future utilization of the Company's net operating
losses is no longer "more-likely-than-not".
LIQUIDITY AND CAPITAL RESOURCES
Net cash providedused by operating activities. During the 26-week39-week period ended
June 29, 2002,September 27, 2003, net cash providedused by operating activities was $0.2$8.0 million. The
use of cash was due to increases in prepaid catalog costs and decreases in both
accrued liabilities and accounts payable. The payment of compensation and
severance benefits accrued as of
23
December 28, 2002 was the primary factor causing the reduction in accrued
liabilities. The use of cash was partially offset by positive cash flow
generated by decreases in accounts receivable and increases in customer
prepayments and credits.
Net cash provided by operating activities, when adjusted for depreciation,
amortization and other non-cash items, resulted in positive cash flow of $4.4
million for the period. These funds were primarily used to reduce accounts
payable and accrued liabilities.
Net cash used by investing activities. During the 26-week39-week period
ended June 29, 2002,September 27, 2003, net cash usedprovided by investing activities was $0.3 million, which$0.2
million. This was due to proceeds received relating to the deferred gain of $2.0
million associated with the sale of the Improvements business. These proceeds
were partially offset by $1.7 million of capital expenditures, consisting
primarily relatingof upgrades to upgrades inthe Company's distribution and fulfillment equipment
located at theits Roanoke, Virginia distribution centerfulfillment facility, telemarketing hardware,
and various computer software applications.upgrades. An additional $0.1 million of costs
relating to the early release of escrow funds associated with the sale of the
Improvements business also contributed to the offset of the proceeds received
from the sale.
Net cash usedprovided by financing activities. During the 26-week39-week period
ended June 29, 2002,September 27, 2003, net cash usedprovided by financing activities was $0.1$7.9
million, which was primarily due to payments made under the Congress term loan facility, partially
offset byincreased net borrowings of $11.4 million
under the Congress revolving creditloan facility. These borrowings were partially
offset by monthly payments made relating to both the Congress Tranche A and
Tranche B term loan facilities as well as a payment of $0.3 million for the
Company's obligation to remit withholding taxes on behalf of Richemont for
estimated taxes due from the scheduled increases in Liquidation Preference on
the Series B Preferred Stock. See Note 10 of the Company's Condensed
Consolidated Financial Statements.
Changes to Congress Credit Facility. On March 24, 2000, the Company
amended its credit facility with Congress to provide the Company with a maximum
credit line, subject to certain limitations, of up to $82.5 million (the "Congress Credit
Facility").million. The
Congress Credit Facility, as amended, expires on January 31, 2004 and comprises
a revolving loan facility, a $17.5 million Tranche A Term Loan and a $7.5an $8.4
million Tranche B Term Loan. Total cumulative borrowings under the Congress
Credit Facility, however, are subject to limitations based upon specified
percentages of eligible receivables and eligible inventory, and the Company is
required to maintain $3.0 million of excess credit availability at all times.
The Congress Credit Facility, as amended, is secured by all the assets of the
Company and places restrictions on the incidenceincurrence of additional indebtedness and
on the payment of Common Stock dividends.
As of June 29, 2002, the Company had $29.5 million of
borrowings outstanding under the amended Congress Credit Facility consisting of
$15.0 million under the revolving credit facility and $9.4 million and $5.1
million of Tranche A Term Loans and Tranche B Term Loans, respectively. The
Company may draw upon the amended Congress Credit Facility to fund working
capital requirements as needed.
In March 2002,April 2003, the Company amended the Congress Credit Facility to
amendallow the definition of Consolidated Net Worth such that, effective July 1, 2002,Company's chief financial officer or its corporate controller to
certify the extent that the goodwill or intangible assets of the Company and its
subsidiaries are impairedfinancial statements required to be delivered to Congress under the
provisionsCongress Credit Facility, rather than the chief financial officer of FAS 142, such write-off of
assets would not be considered a reduction of total assets for the purposes of
computing consolidated net worth. The Company obtained the services of an
independent appraisal firm during the second quarter ended June 29, 2002 to
evaluate whether there has been any goodwill transition impairment. The results
of the appraisal indicated no goodwill transition impairment based upon the
requirements set forth in FAS 142. The consolidated net working capital,
consolidated net worth and EBITDA covenants were also amended.each
subsidiary borrower or guarantor.
In addition, the
amendment required the payment of a fee of $100,000.
On August 16, 2002,2003, the Company amended the Congress Credit Facility to
(i)make certain technical amendments thereto, including the amendment of the
definition of Consolidated Net Worth and the temporary release of a $3 million
availability reserve established thereunder. The temporary release of the $3
million availability reserve will be removed by the end of fiscal year 2003.
In October 2003, the Company amended the Congress Credit Facility to
extend the termexpiration thereof from January 31, 2004 to January 31, 2007, to
reduce the amount of revolving loans available thereunder to $43,000,000, to
make adjustments to the sublimits available to the various borrowers thereunder,
to amend the EBITDA covenant to specify minimum levels of EBITDA that must be
achieved during the Company's fiscal years ending 2004, 2005 and 2006, to permit
the borrowing under certain circumstances of up to $1,000,000 against certain
inventory in transit to locations in the United States, and to make certain
other technical amendments.
24
In November 2003, the Company amended the Congress Credit Facility to
change the definition of Consolidated Net Worth so as to provide that for the
purposes of calculating such amount for the Company's fiscal year ending
December 27, 2003, the Company's net deferred tax assets in the amount of
$11,300,000 that are required to be fully reserved pursuant to SFAS No. 109,
"Accounting for Income Taxes" ("FAS 109"), shall be added back for the purposes
of determining the Company's assets. See Note 11 of the Company's Condensed
Consolidated Financial Statements. The Company also amended the definition of
Consolidated Working Capital so as to provide that for the purposes of
calculating such amount for the Company's fiscal year ending December 27, 2003,
the Company's current deferred tax liabilities in the amount of $2,300,000,
shall be added back for the purposes of determining the Company's current
liabilities. See Note 11 of the Company's Condensed Consolidated Financial
Statements.
The Company has restated its Consolidated Balance Sheets as of September
27, 2003 and December 28, 2002 to properly classify the revolving loan facility
as a current liability in accordance with EITF 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"). This restatement has no impact on the Company's results of operations
or cash flows for the 13- and 39- weeks ended September 27, 2003. The revolving
loan facility is classified as a current liability in accordance with EITF 95-22
since the loan and security agreement contains a subjective acceleration clause
and contractual provisions that require the cash receipts of the Company be used
to repay amounts outstanding under the Congress Credit Facility.
The Company has re-examined the provisions of the Congress Credit Facility.
Based on EITF 95-22 and certain provisions in the credit agreement, the Company
is required to reclassify its revolving loan facility from long-term to
short-term debt, though the existing revolving loan facility does not mature
until January 31, 2007. As a result, the Company reclassified $13,164 and $8,819
(in thousands) as of September 27, 2003 and December 28, 2002, respectively,
from Long-term debt to Short-term debt and capital lease obligations that is
classified as current liabilities.
A summary of the effects of the restatement on our Consolidated Balance
Sheets as of September 27, 2003 and December 28, 2002 follows:
As of September 27, 2003, the Company had $33.6 million of cumulative
borrowings outstanding under the Congress Credit Facility. Total cumulative
borrowings comprise $20.2 million under the Revolving Loan Facility, bearing a
variable interest rate as of September 27, 2003 of 4.5%, $7.0 million under the
Tranche A Term Loan, bearing a variable interest rate as of September 27, 2003
of 4.75%, and $6.4 million under the Tranche B Term Loan, from March 31, 2003 to January
31, 2004, (ii) increase by $3,500,000 the borrowing reflected by the Tranche B
Term Note from $4,910,714 to $8,410,714, and (iii) make certain related
technical amendments to the Congress Credit Facility. The amendment required the
paymentbearing a fixed
interest rate of fees in the amount of $410,000. Pursuant to this amendment, the
Company has reflected the Tranche B borrowings outstanding of $4.0 million at
June 29, 2002 in Long-term debt on the Condensed Consolidated Balance Sheet.13.0%.
Achievement of the cost savings and other objectives of the Company's strategic business realignment program is
critical to the maintenance of adequate liquidity, as is compliance with the
terms and provisions of the Congress Credit Facility as mentionedand the Company's ability
to operate effectively during the remaining 2003 fiscal year and the 2004 fiscal
year. In the event of a softer than expected economic climate, management has
available several courses of action to maintain liquidity and help maintain
compliance with financial covenants, including selective reductions in Note 10, Amendment to Congress Loancatalog
circulation, additional expense reductions and Security
Agreement, to the Condensed Consolidated Financial Statements.sales of non-core assets.
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 servicesservice agreement with the buyer for a period of
three years.
The asset purchase agreement between the Company and HSN providesprovided that
if Keystone Internet Services Inc. failsfailed to perform its obligations during the first
two years of the services contract, the purchaser cancould 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 hasof
approximately $33.0 million, had been established for a period of two years
under the terms of an escrow agreement between LWI Holdings, Inc., HSN and The
Chase Manhattan Bank as a result of these contingencies.
AsOn March 27, 2003, the Company and HSN amended the asset purchase
agreement to provide for the release of June 29, 2002, the remaining $2.0 million balance inof
the escrow fund is $2.6
million.and to terminate the escrow agreement. By agreeing to the terms
of the amendment, HSN forfeited its ability to receive a reduction in the
original purchase price of up to $2.0 million if Keystone Internet Services
failed to perform its obligations during the first two years of the services
contract. In consideration for the release, Keystone Internet Services issued a
credit to HSN for $100,000, which could be applied by HSN against any invoices
of Keystone Internet Services to HSN. This credit was utilized by HSN during the
March 2003 billing period. On March 28, 2003, the remaining $2.0 million escrow
balance was received by the Company, thus terminating the escrow agreement.
The Company recognized a net gain on the sale of approximately $23.2
million, includingnet of a non-cash goodwill charge of $6.1 million, in fiscal year 2001,
which representsrepresented the excess of the net proceeds from the sale over the net
assets assumedacquired by HSN, the goodwill associated with the Improvements business
and expenses related to the 21
transaction. In JuneDuring fiscal year 2002, the Company
recognized $0.3approximately $0.6 million of the deferred gain consistent with the
terms of the escrow agreement. Proceeds of $0.3 million
relating toDuring the 13- weeks ended March 29, 2003, the
Company
25
recognized the remaining net deferred gain were received July 2, 2002. The recognition of an
additional gain of up to approximately $2.3$1.9 million has been deferred untilfrom the contingencies described above expire, which will occur no later than the middlereceipt of
the 2003 fiscal year.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.
General. At June 29, 2002,September 27 2003, the Company had $0.9 million in cash and
cash equivalents, compared with $2.1$1.0 million at June 30, 2001. Working capital and
current ratios at June 29, 2002 were $23.1 million and 1.32 to 1 versus $17.1
million and 1.18 to 1 at June 30, 2001.September 28, 2002. Total
cumulative borrowings, including financing under capital lease obligations, as
of June 29, 2002,September 27, 2003, aggregated $29.6
million, $26.5 million of which is classified as long-term.$33.6 million. Remaining availability under
the Congress Credit Facility as of June 29, 2002September 27, 2003 was $7.3$7.2 million. There were nominal capital commitments (less than $0.1 million) at June
29, 2002.
The Company entered into an agreement with the landlord and the
sublandlord to terminate its sublease of the Company's closed 497,200 square
foot warehouse and telemarketing facility located in Maumelle, Arkansas. The
agreement provided for the payment by the Company to the sublandlord of
$1,600,000, plus taxes through April 30, 2002 in the amount of $198,000. The
Company made all of the payments in four weekly installments between May 2, 2002
and May 24, 2002. Upon the satisfaction by the Company of all of its obligations
under the agreement, the sublease terminated and the Company was released from
all further obligations under the sublease.
On March 22, 2002, the Postal Rate Commission approved a settlement that
allowed postal rates to increase an average of 7.7% on June 30, 2002. The
Company had anticipated this actionapproximately $0.4 million in its 2002 planning process and will
accommodate the increased costshort-term capital commitments as part of
normal business operations. The
Company has implemented cost conservation measures, such as reduced paper
weights and trim size changes, as a way of mitigating such cost increases.September 27, 2003.
Management believes that the Company has sufficient liquidity and
availability under its credit agreementsagreement to fund its planned operations through
at least December 28, 2002.31, 2004. See "Cautionary Statements," below. Achievement of
the cost saving and other objectives of the Company's strategic business
realignment program is critical to the maintenance of adequate liquidity as is
compliance with the terms and provisions of the Congress Credit Facility as
mentioned in Note 10, Amendment to Congress
Loan and Security Agreement, to9 of the Condensed Consolidated Financial Statements.
USES OF ESTIMATES AND OTHER CRITICAL ACCOUNTING POLICIES
During the second quarter ended June 29, 2002, there were no changes in
the Company's policies regardingIn addition to the use of estimates and other critical accounting
policies.policies disclosed in our Annual Report on Form 10-K for the fiscal year ended
December 28, 2002, an understanding of the below use of estimates and other
critical accounting policies is necessary to analyze our financial results for
the 13 and 39-week periods ended September 27, 2003.
Revenue is recognized for catalog and internet sales when merchandise
is shipped to customers and at the time of sale for retail sales. Shipping terms
for catalog and internet sales are FOB shipping point, and title passes to the
customer at the time and place of shipment. Prices for all merchandise are
listed in the Company's catalogs and Web sites and are confirmed with the
customer upon order. The customer has no cancellation privileges other than
customary rights of return that are accounted for in accordance with SFAS No. 48
"Revenue Recognition When Right of Return Exists." The Company accrues a sales
return allowance for estimated returns of merchandise subsequent to the balance
sheet date that relate to sales prior to the balance sheet date. Amounts billed
to customers for shipping and handling fees related to catalog and internet
sales are included in other revenues at the time of shipment.
During June 2003, the Company established and issued a new Company-wide
vacation and sick policy to better administer vacation and sick benefits. For
purposes of the policy, employees were converted to a fiscal year for earning
vacation benefits. Under the new policy, vacation benefits are deemed earned and
thus accrued ratably throughout the fiscal year and employees must utilize all
vacation earned by the end of the same year. Generally, any unused vacation
benefits not utilized by the end of a fiscal year will be forfeited. In prior
periods, employees earned vacation in the twelve months prior to the year that
it would be utilized. The policy has been modified in certain locations to
comply with state and local laws or written agreements. As a result of the
transition to this new policy, the Company has recognized a benefit of
approximately $0.5 million and $1.3 million for the 13 and 39- weeks ended
September 27, 2003. Approximately $0.2 million and $0.7 million of general and
administrative expenses were reduced as a result of the recognition of this
benefit for the 13 and 39- weeks ended September 27, 2003, respectively.
Approximately $0.3 million and $0.6 million of operating expenses were reduced
as a result of the recognition of this benefit for the 13 and 39- weeks ended
September 27, 2003, respectively.
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 29, 2001,28, 2002, for additional
information relating to the Company's usesuse of estimates and other critical
accounting policies.
NEW ACCOUNTING PRONOUNCEMENTS
In May 2003, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics
of both Liabilities and Equity" ("FAS 150"). FAS 150 establishes standards for
how an issuer classifies and measures certain financial instruments with
characteristics of both liabilities and equity. It requires that an issuer
classify a financial instrument that is within its scope as a liability, many of
which had been previously classified as equity or between the liabilities and
equity sections of the consolidated balance sheet.
26
The provisions of FAS 150 are effective for financial instruments entered into
or modified after May 31, 2003, and otherwise is effective at the beginning of
the first interim period beginning after June 15, 2003. It is to be implemented
by reporting the cumulative effect of a change in accounting principle for
financial instruments created before the issuance of FAS 150 and still existing
at the beginning of the interim period of adoption. The Company has adopted the
provisions of FAS 150 and has been impacted by the requirement to reclassify its
Series B Participating Preferred Stock as a liability as opposed to between the
liabilities and equity sections of the consolidated balance sheet. Based upon
the requirements set forth by FAS 150, this reclassification was subject to
implementation beginning on June 29, 2003. Upon implementation of FAS 150, the
Company has reflected the accretion of the preferred stock balance as an
increase in Total Liabilities with a corresponding reduction in capital in
excess of par value, because the Company has an accumulated deficit. Such
accretion has been recorded as interest expense, resulting in a decrease in Net
Income (Loss) and Comprehensive Income (Loss) of $4.5 million for the 13 and 39-
weeks ended September 27, 2003. Based upon the Company's current projections for
2003, it is estimated the Company may not incur a tax reimbursement obligation
for 2003 relating to the increases in the Liquidation Preference of the Series B
Participating Preferred Stock and will file for a refund of the $0.3 million
Federal tax payment made in March 2003. Due to the FAS 150 requirements to
reclassify the Series B Participating Preferred Stock to liabilities and to
record the accretion of the preferred stock balance as interest expense, the
refund has been treated as a decrease to interest expense on the Condensed
Consolidated Statements of Income (Loss) for the third quarter and an increase
of capital in excess of par value on the Condensed Consolidated Balance Sheets.
If FAS 150 was applicable for fiscal year 2002, Net Loss and Comprehensive Loss
would have been $24.7 million. Net Income (Loss) Applicable to Common
Shareholders and Net Income (Loss) Per Common Share remains unchanged in
comparison with the Company's classification of the instrument prior to June 29,
2003. In addition, there is no cumulative effect of a change in accounting
principle as a result of the implementation of FAS 150. As of September 27,
2003, the implementation of FAS 150 has increased Total Liabilities by
approximately $104.4 million. Shareholders' Deficiency remained unchanged since
the balance had previously been classified between Total Liabilities and
Shareholders' Deficiency on the Condensed Consolidated Balance Sheet. The
classification of the Series B Preferred Stock as a liability under FAS 150
should not change its classification as equity under state law.
In January 2003, the Securities and Exchange Commission issued a new
disclosure regulation, "Conditions for Use of Non-GAAP Financial Measures"
("Regulation G"), which is effective for all public disclosures and filings made
after March 28, 2003. Regulation G requires public companies that disclose or
release information containing financial measures that are not in accordance
with generally accepted accounting principles ("GAAP") to include in the
disclosure or release a presentation of the most directly comparable GAAP
financial measure and a reconciliation of the disclosed non-GAAP financial
measure to the most directly comparable GAAP financial measure. The Company
became subject to Regulation G in fiscal 2003 and believes that it is in
compliance with the new disclosure requirements.
In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation-Transition and Disclosure - An Amendment of SFAS No.
123" ("FAS 148"). FAS 148 provides alternative methods of transition for a
voluntary change to the fair value-based method of accounting for stock-based
employee compensation. In addition, FAS 148 amends the disclosure requirements
of SFAS No. 123 to require prominent disclosures in both annual and interim
financial statements about the method of accounting for stock-based employee
compensation and the effect of the method used on reported results. The Company
has established several stock-based compensation plans for the benefit of its
officers and employees. Since 1996, the Company has accounted for its
stock-based compensation to employees using the fair value-based methodology
under SFAS No. 123, thus FAS 148 has had no effect on the Company's results of
operations or financial position. For the 13- weeks ended September 27, 2003 and
September 28, 2002, the Company recorded stock compensation expense of
approximately $0.1 million during each period. For the 39- weeks ended September
27, 2003 and September 28, 2002, the Company recorded stock compensation expense
of $0.5 million and $0.7 million, respectively.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" ("FAS 146"). FAS 146 nullifies
Emerging Issues Task Force Issue No. 94-3 ("EITF 94-3"). FAS 146 requires that a
liability for a cost associated with an exit or disposal activity be recognized
when the liability is incurred whereas, under EITF 94-3, the liability was
recognized at the commitment date to an exit plan. The Company has adopted the
provisions of FAS 146 for exit or disposal activities initiated after December
31, 2002.
27
In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other
Intangible Assets" ("FAS 142"). Under FAS 142, goodwill and intangible assets
with indefinite lives are no longer amortized but are reviewed annually (or more
frequently if impairment indicators arise) for impairment. Separable intangible
assets that are not deemed to have indefinite lives will continue to be
amortized over their useful lives (but with no maximum life). Goodwill relates
to the International Male and the Gump's brands and the net balance at both
September 27, 2003 and September 28, 2002 was $9.3 million. The Company adopted
FAS 142 effective January 1, 2002 and, as a result, the first and second quarters ended March 30, 2002 and June 29, 2002 didhas not includerecorded an
amortization charge for goodwill.goodwill since that time. The Company obtained the
services of an independent appraisal firm during the second quarter ended June
29, 200228, 2003 to evaluate whether there has been anyassist in the assessment of its annual goodwill transition impairment. The
results of the appraisal indicated nothat goodwill transition impairmentwas not impaired based upon the
requirements set forth in FAS 142.
If the provisions of FAS 142 had been implemented for the 13-week period
ended June 30, 2001 and the Company had not included an amortization charge for
goodwill, the Company's net earnings would have increased by $0.1 million to
$12.9 million. If the provisions under FAS 142 had been implemented for the
26-week period ended June 30, 2001 and the Company had not included an
amortization charge for goodwill, the Company's net (loss) would have decreased
by $0.3 million to $(5.4) million. Net earnings (loss) per share for the 13-week
and 26-week periods ended June 30, 2001 would have remained unchanged at $.05
and $(.00) for both basic and diluted earnings (loss) per share calculations.
22
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 29, 200128, 2002 and Note 9 herein8 of the
Condensed Consolidated Financial Statements for additional information relating
to new accounting pronouncements whichthat the Company has adopted.
SEASONALITY
The Company does not consider its business seasonal. The revenues and business for
the Company are seasonal.proportionally consistent for each quarter during a fiscal year.
The Company
processespercentage of annual revenues for the first, second, third and ships more catalog orders during the fourth
quarter holiday season
than in any other quarter of the year. Accordingly,quarters recognized by the Company, recognizes a
disproportionate share of annual revenue during the last three months of the
year.respectively, were as follows: 2002 - 23.9%,
24.9%, 23.2% and 28.0%; and 2001 - 27.1%, 25.1%, 22.1% and 25.7%.
FORWARD-LOOKING STATEMENTS
The following statementstatements from above constitutes aconstitute forward-looking
statementstatements within the meaning of the Private Securities Litigation Reform Act of
1995:
"Management believes that the Company has sufficient liquidity and
availability under its credit agreementsagreement to fund its planned operations through
at least December 28, 2002.31, 2004."
"The unlikelihood that the Company will be able to redeem the Series B
Preferred Shares is not expected to limit the ability of the Company to use
current and future net earnings or cash flow to satisfy its obligations to
creditors and vendors."
CAUTIONARY STATEMENTS
The following material identifies important factors that could cause
actual results to differ materially from those expressed in the forward looking
statementforward-looking
statements identified above and in any other forward lookingforward-looking statements
contained elsewhere herein:
- - The recent general deterioration in economic conditions in the United
States leading to reduced consumer confidence, reduced disposable
income and increased competitive activity and the business failure of
companies in the retail, catalog and direct marketing industries. Such
economic conditions leading to a reduction in consumer spending
generally and in homein-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-partythird 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 commensuratelycommensurate with sales
projections. Increases in postage, printing and paper prices and/or the
inability of the
28
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 webWeb sites or those
of its third-partythird party fulfillment clients specifically.
- - The ability of the Company to attract and retain management and
employees generally and specifically with the requisite experience in
e-commerce, Internet and direct marketing businesses. The ability of
employees of the Company who have been promoted as a result of the
Company's strategic business realignment program to perform the
responsibilities of their new positions.
- - The recent general deterioration in economic conditions in the United
States leading to key vendors and suppliers reducing or withdrawing
trade credit to companies in the retail, and 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
23
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. Vendors beginning to withhold shipments
of merchandise to the Company. 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, as a result of foreign sourcing or otherwise, leading to an increase in backorders and cancellations.
- - Defaults under the Congress Credit Facility, or inadequacy of available
borrowings thereunder, reducing or impairing the Company's ability to
obtain letters of credit or other credit to support its purchase of
inventory and support normal operations, impacting the Company's
ability to obtain, market and sell merchandise in a timely manner.
- - Continued compliance by the Company with and the enforcement by
Congress of financial and other covenants and limitations contained in
the Congress Credit Facility, including net worth, net working capital,
capital expenditure and EBITDA covenants, and limitations based upon
specified percentages of eligible receivables and eligible inventory,
and the requirement that the Company maintain $3.0 million of excess
credit availability at all times, affecting the ability of the Company
to continue to make borrowings under the Congress Credit Facility as needed.Facility.
- - Continuation of the Company's history of operating losses, and the
incidence of costs associated with the Company's strategic business
realignment program, resulting in the Company failing to comply with
certain financial and other covenants contained in the Congress Credit
Facility, including net worth, net working capital, capital expenditure
and EBITDA covenants and the ability of the Company to obtain waivers
from Congress in the event that future internal and/or external events
result in performance whichthat results in noncompliance by the Company with
the terms of the Congress Credit Facility requiring remediation.
The ability of the Company to complete the Company's strategic business
realignment program within the time periods anticipated by the Company.- - The ability of the Company to realize the aggregate cost savings and
other objectives anticipated in connection with the strategic business
realignment program, or within the time periods anticipated therefor.
The aggregate costs of effecting the strategic business realignment
program may be greater than the amounts anticipated by the Company.
- - The ability of the Company to obtainmaintain advance rates under the Congress
Credit Facility whichthat are at least as favorable as those obtained in the
past.
The abilitypast due to market conditions affecting the value of the Companyinventory,
which is periodically re-appraised in order to extend the term of the Congress Credit
Facility beyond January 31, 2004, its scheduled expiration date, or obtain other
credit facilities on the expiration of the Congress Credit Facility on terms at
least as favorable as those under the Congress Credit Facility.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.
29
- - The ability of the Company to maintain insurance coverage required in
order to operate its businesses and as required by the Congress Credit
Facility. The ability of the Company to obtain certain types of
insurance, including directors' and officers' liability insurance, or
to accept reduced policy limits or coverage, or to incur substantially
increased costs to obtain the same or similar coverage, due to recently
enacted and proposed changes to laws and regulations affecting public
companies, including the provisions of the Sarbanes-Oxley Act of 2002
and rules of the Securities and Exchange Commission thereunder.
- - The inability of the Company to access the capital markets due to
market conditions generally, including a lowering of the market
valuation of companies in the direct marketing and retail businesses,
and the Company's business situation specifically.
- - The inability of the Company to sell non-core assets at industry multiples or at
all due to market
conditions generally, as a result of market conditions
following the events of September 11, 2001 and otherwise
24
or otherwise.
- - The Company's dependence up to August 24, 2000 on Richemont and its
affiliates for financial support and the fact that they are not under
any obligation ever to provide any additional support in the future.
- - The ability of the Company to redeem the Series B Preferred Stock on a
timely basis, or at all, actions by any holder in response thereto, if
any, and future interpretations of applicable law and contract.
- - The ability of the Company to maintain the listing of its Common Stock
on the American Stock Exchange.
- - The continued willingness of customers to place and receive mail orders
in light of worries about bio-terrorism.
- - The ability of the Company to sublease, or terminate or renegotiate the
leases of its vacant facilities in Weehawken, New Jersey San Francisco,
California and certain other
locations.
- - The Company undertakes no obligation to publicly update any
forward-looking statement whether as a resultability of new information, future events
or otherwise. Readers are advised, however, to consult any further disclosures the Company may make on related subjects in its Forms 10-Q, 8-K, 10-K or any
other reports filed withto evaluate and implement the requirements
of the Sarbanes-Oxley Act of 2002 and the rules of the Securities and
Exchange Commission.Commission thereunder, as well as proposed changes to listing
standards by the American Stock Exchange, in a cost effective manner.
- - The ability of the Company to achieve cross channel synergies, create
successful affiliate programs, effect profitable brand extensions or
establish popular loyalty and buyers' club programs.
- - Uncertainty in the U.S. economy and decreases in consumer confidence
leading to a slowdown in economic growth and spending resulting from
the invasion of, 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.
- - The inability of the Company to continue to source goods from foreign
sources, particularly India and Pakistan, leading to increased costs of
sales.
- - The necessity of the Company obtaining the approval of Congress
Financial Corporation to any recapitalization proposal or
counter-proposal made by Chelsey.
- - Any recapitalization of the Company potentially constituting an Event
of Default under the Congress Credit Facility.
- - Any recapitalization of the Company potentially constituting a Change
in Control under the Company's Key Executive Eighteen Month
Compensation Continuation Plan, Key Executive Twelve Month Compensation
Continuation Plan, Key Executive Six Month Compensation Continuation
Plan and Director Change of Control Plan.
30
ITEM 3. QUANTITATIVEQUANTITIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
INTEREST RATES: The Company's exposure to market risk relates to
interest rate fluctuations for borrowings under the Congress revolving credit
facility and its term financing facility,facilities, which bear interest at variable
rates. At June
29, 2002,September 27, 2003, outstanding principal balances under these
facilities subject to variable rates of interest were approximately $24.4$27.2
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
June 29, 2002,September 27, 2003, would be approximately $0.24$0.3 million on an annual basis.
25ITEM 4. CONTROLS AND PROCEDURES
DISCLOSURE CONTROLS AND PROCEDURES. The Company's management, with the
participation of the 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
report 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.
31
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
A class action lawsuit was commenced on March 3, 2000 entitled Edwin L.
Martin v. Hanover Direct, Inc. and John Does 1 through 10, bearing case no.
CJ2000-177 in the State Court of Oklahoma (District Court in and for Sequoyah
County). Plaintiff commenced the action on behalf of himself and a class of
persons who have at any time purchased a product from the Company and paid for
an "insurance charge." The complaint sets forth claims for breach of contract,
unjust enrichment, recovery of money paid absent consideration, fraud and a
claim under the New Jersey Consumer Fraud Act. The complaint alleges that the
Company charges its customers for delivery insurance even though, among other
things, the Company's common carriers already provide insurance and the
insurance charge provides no benefit to the Company's customers. Plaintiff also
seeks a declaratory judgment as to the validity of the delivery insurance. The
damages sought are (i) an order directing the Company to return to the plaintiff
and class members the "unlawful revenue" derived from the insurance charges,
(ii) declaring the rights of the parties, (iii) permanently enjoining the
Company from imposing the insurance charge, (iv) awarding threefold damages of
less than $75,000 per plaintiff and per class member, and (v) attorneys' fees
and costs. On April 12, 2001, the Court held a hearing on plaintiff's class
certification motion. Subsequent to the April 12, 2001 hearing on plaintiff's
class certification motion, plaintiff filed a motion to amend the definition of
the class. On July 23, 2001, plaintiff's class certification motion was granted,
defining the class as "All persons in the United States who are customers of any
catalog or catalog company owned by Hanover Direct, Inc. and who have at any
time purchased a product from such company and paid money that was designated to
be an `insurance' charge." On August 21, 2001, the Company filed an appeal of
the order with the Oklahoma Supreme Court and subsequently moved to stay
proceedings in the district court pending resolution of the appeal. The appeal
has been fully briefed. At a subsequent status hearing, the parties agreed that
issues pertaining to notice to the class would be stayed pending resolution of
the appeal, that certain other issues would be subject to limited discovery, and
that the issue of a stay for any remaining issues would be resolved if and when
such issues arise. The Oklahoma Supreme Court has not yet ruled on the pending
appeal. Oral argument on the appeal, if scheduled, was expected during the first
half of 2003 but has yet to be scheduled by the Court. The Company believes it
has defenses against the claims and plans to conduct a vigorous defense of this
action.
On August 15, 2001, the Company was served with a summons and
four-count complaint filed in Superior Court for the City and County of San
Francisco, California, entitled Teichman v. Hanover Direct, Inc., Hanover
Brands, Inc., Hanover Direct Virginia, Inc., and Does 1-100. The complaint was
filed by a California resident, seeking damages and other relief for herself and
a class of all others similarly situated, arising out of the insurance fee
charged by catalogs and internet sites operated by subsidiaries of the Company.
Defendants, including the Company, have filed motions to dismiss based on a lack
of personal jurisdiction over them. In January 2002, plaintiff sought leave to
name six additional entities: International Male, Domestications Kitchen &
Garden, Silhouettes, Hanover Company Store, Kitchen & Home, and Domestications
as co-defendants. On March 12, 2002, the Company was served with the First
Amended Complaint in which plaintiff named as defendants the Company, Hanover
Brands, Hanover Direct Virginia, LWI Holdings, Hanover Company Store, Kitchen
and Home, and Silhouettes. On April 15, 2002, the Company filed a Motion to Stay
the Teichman action in favor of the previously filed Martin action and also
filed a Motion to quash service of summons for lack of personal jurisdiction on
behalf of defendants Hanover Direct, Inc., Hanover Brands and Hanover Direct
Virginia. On May 14, 2002, the Court (1) granted the Company's Motion to quash
service on behalf of Hanover Direct, Hanover Brands, and Hanover Direct
Virginia, leaving only LWI Holdings, Hanover Company Store, Kitchen and Home,
and Silhouettes, as defendants, and (2) granted the Company's Motion to Stay the
action in favor of the previously filed Oklahoma action. The Company believes it
has defenses against the claims and plans to conduct a vigorous defense of this
action.
A lawsuit was commenced as both a class action and for the benefit of
the general public on February 13, 2002 entitled Jacq Wilson, suing on behalf of
himself, all others similarly situated, and the general public v. Brawn of
California, Inc. dba International Male and Undergear, and Does 1-100 ("Brawn")
in the Superior Court of the State of California, City and County of San
Francisco. Does 1-100 are allegedly Internet and catalog direct marketers
offering a selection of men's clothing, sundries, and shoes who advertise within
California and nationwide. The complaint alleges that for at least four years,
members of the class and the general public have been charged an unlawful,
unfair and fraudulent insurance fee and tax on orders sent to them by Brawn;
that Brawn was engaged in untrue, deceptive and misleading advertising in that
it was not lawfully required or permitted to collect insurance, tax
32
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
seeks (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 fee, tax and
sales tax collected unlawfully, together with interest, (ii) an order enjoining
Brawn from charging customers insurance fee and tax on its order forms and/or
from charging tax on the delivery, shipping and insurance charges, (iii) an
order directing Brawn to notify the California State Board of Equalization of
the failure to pay the correct amount of tax to the state and to take
appropriate steps to provide the state with the information needed for audit,
and (iv) compensatory damages, attorneys' fees, pre-judgment interest and costs
of the suit. The Plaintiff alleged that the claims of the individually named
plaintiff and for each member of the class amount to less than $75,000. On April
15, 2002, the Company filed a Motion to Stay the Wilson action in favor of the
previously filed Martin action. On May 14, 2002, the Court denied the Motion to
Stay. The Wilson case proceeded to trial before the Honorable Dian 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. The Court
requested and received closing arguments and Proposed Statements of Decision in
July 2003. On September 18, 2003, the Court issued its Proposed Statement of
Decision and Proposed Judgment After Trial (the "Proposed Judgment"). The
Proposed Judgment would find: 1) that Jacq Wilson has abandoned his individual
claims and has pursued the case only on behalf of the general public; 2) that
Brawn had violated Business and Professions Code Section 17200 and 17500 by
identifying its $1.48 charge to customers as an `insurance' charge and that said
charge was for an illusory benefit that was likely to deceive consumers; and 3)
that plaintiff had failed to prove that Brawn had violated Business and
Professions Code Section 17200 by collecting, sales tax on delivery charges for
goods shipped to its customers. The Proposed Judgment would order Brawn to
"locate, identify and pay restitution to each of its customers for each
transaction in which a $1.48 charge for `insurance' was paid from February 13,
1998 through January 15, 2003" with interest from the date paid. The Proposed
Judgment states that such restitution must be made on or before June 30, 2004.
On October 10, 2003 Brawn filed its Objections to the Court's Proposed Decision
and its Amended [Tentative] Statement of Decision, based on Brawn's belief that
the Court failed to properly consider certain undisputed evidence, reached other
conclusions not supported by any admissible evidence and improperly applied the
law concerning the insurance fee. (Plaintiff's co-counsel (on the tax matter)
requested an opportunity to respond and intended to file its response on or
before October 24, 2003.) The potential estimated exposure is in the range of $0
to $4.0 million. If the trial court fails to amend or modify its Proposed
Judgment, the Company expects to take an appeal and conduct a vigorous defense
of this action.
A class action lawsuit was commenced on October 28, 2002 entitled John
Morris, individually and on behalf of all other persons & entities similarly
situated v. Hanover Direct, Inc., and Hanover Brands, Inc. (referred to here as
"Hanover"), No. L 8830-02 in the Superior Court of New Jersey, Bergen County --
Law Division. The plaintiff brings the action individually and on behalf of a
class of all persons and entities in New Jersey who purchased merchandise from
Hanover within six years prior to filing of the lawsuit and continuing to the
date of judgment. On the basis of a purchase made by the plaintiff in August
2002 of certain clothing from Hanover (which was from a men's division catalog,
the only one which retained the insurance line item in 2002), the Plaintiff
claims that for at least six years, Hanover maintained a policy and practice of
adding a charge for "insurance" to the orders it received and concealed and
failed to disclose its policy with respect to all class members. Plaintiff
claims that Hanover's conduct was (i) in violation of the New Jersey Consumer
Fraud Act, as otherwise deceptive, misleading and unconscionable; (ii) such as
to constitute Unjust Enrichment of Hanover at the expense and to the detriment
of plaintiff and the class; and (iii) unconscionable per se under the Uniform
Commercial Code for contracts related to the sale of goods. Plaintiff and the
class seek damages equal to the amount of all insurance charges, interest
thereon, treble and punitive damages, injunctive relief, costs and reasonable
attorneys' fees, and such other relief as may be just, necessary, and
appropriate. Plaintiff filed an Amended Complaint adding International Male as a
defendant. On December 13, 2002, the Company filed a Motion to Stay the Morris
action in favor of the previously filed Martin action. Hearing on the Motion to
Stay took place on June 6, 2003 and the Court granted the Company's motion to
stay until December 31, 2003, at which time the Court will revisit the issue if
the parties request that it do so. The Company plans to conduct a vigorous
defense of this action.
On June 28, 2001, Rakesh K. Kaul, the Company's former President and
Chief Executive Officer, filed a five-count complaint (the "Complaint") in New
York State Court against the Company, seeking damages and other relief arising
out of his separation of employment from the Company, including severance
payments of $2,531,352 plus the cost of employee benefits, attorneys' fees and
costs incurred in connection with the enforcement of his rights under his
employment agreement with the Company, payment of $298,650 for 13 weeks of
accrued and unused vacation,
33
damages in the amount of $3,583,800, or, in the alternative, a declaratory
judgment from the Court that he is entitled to all change of control benefits
under the "Hanover Direct, Inc. Thirty-Six Month Salary Continuation Plan," and
damages in the amount of $1,396,066 or $850,000 due to the Company's purported
breach of the terms of the "Long-Term Incentive Plan for Rakesh K. Kaul" by
failing to pay him a "tandem bonus" he alleges was due and payable to him within
the 30 days following his resignation. The Company removed the case to the U.S.
District Court for the Southern District of New York on July 25, 2001. Mr. Kaul
filed an Amended Complaint ("Amended Complaint") in the U.S. District Court for
the Southern District of New York on September 18, 2001. The Amended Complaint
repeats many of the claims made in the original Complaint and adds ERISA claims.
On October 11, 2001, the Company filed its Answer, Defenses and Counterclaims to
the Amended Complaint, denying liability under each and every of Mr. Kaul's
causes of action, challenging all substantive assertions, raising several
defenses and stating nine counterclaims against Mr. Kaul. The counterclaims
include (1) breach of contract; (2) breach of the Non-Competition and
Confidentiality Agreement with the Company; (3) breach of fiduciary duty; (4)
unfair competition; and (5) unjust enrichment. The Company seeks damages,
including, without limitation, the $341,803 in severance pay and car allowance
Mr. Kaul received following his resignation, $412,336 for amounts paid to Mr.
Kaul for car allowance and related benefits, the cost of a long-term disability
policy, and certain payments made to personal attorneys and consultants retained
by Mr. Kaul during his employment, $43,847 for certain services the Company
provided and certain expenses the Company incurred, relating to the renovation
and leasing of office space occupied by Mr. Kaul's spouse at 115 River Road,
Edgewater, New Jersey, the Company's current headquarters, $211,729 on a tax
loan to Mr. Kaul outstanding since 1997 and interest, compensatory and punitive
damages and attorneys' fees. The case is pending. The discovery period has
closed, the Company has moved to amend its counterclaims, and the parties have
each moved for summary judgment. The Company seeks summary judgment: dismissing
Mr. Kaul's claim for severance under his employment agreement on the ground that
he failed to provide the Company with a general release of, among other things,
claims for change of control benefits; dismissing Mr. Kaul's claim for
attorneys' fees on the grounds that they are not authorized under his employment
agreement; dismissing Mr. Kaul's claims related to change in control benefits
based on an administrative decision that he is not entitled to continued
participation in the plan or to future benefits thereunder; dismissing Mr.
Kaul's claim for a tandem bonus payment on the ground that no payment is owing;
dismissing Mr. Kaul's claim for vacation payments based on Company policy
regarding carry over vacation; and seeking judgment on the Company's
counterclaim for unjust enrichment based on Mr. Kaul's failure to pay under a
tax note. Mr. Kaul seeks summary judgment: dismissing the Company's defenses and
counterclaims relating to a release on the grounds that he tendered a release or
that the Company is estopped from requiring him to do so; dismissing the
Company's defenses and counterclaims relating to his alleged violations of his
non-compete and confidentiality obligations on the grounds that he did not
breach the obligations as defined in the agreement; and dismissing the Company's
claims based on his alleged breach of fiduciary duty, including those based on
his monthly car allowance payments and the leased space to his wife, on the
grounds that he was entitled to the car payments and did not involve himself in
or make misrepresentations in connection with the leased space. The Company has
concurrently moved to amend its Answer and Counterclaims to state a claim that
it had cause for terminating Mr. Kaul's employment based on, among other things,
after acquired evidence that Mr. Kaul received a monthly car allowance and other
benefits totaling $412,336 that had not been authorized by the Company's Board
of Directors and that his wife's lease and related expense was not properly
authorized by the Company's Board of Directors, and to clarify or amend the
scope of the Company's counterclaims for reimbursement. The briefing on the
motions is completed and the parties are awaiting the decision of the Court. No
trial date has been set. It is too early to determine the potential outcome,
which could have a material impact on the Company's results of operations when
resolved in a future period.
The Company was named as one of 88 defendants in a patent infringement
complaint filed on November 23, 2001 by the Lemelson Medical, Education &
Research Foundation, Limited Partnership (the "Lemelson Foundation"). The
complaint, filed in the U.S. District Court in Arizona, was not served on the
Company until March 2002. In the complaint, the Lemelson Foundation accuses the
named defendants of infringing seven U.S. patents, which allegedly cover
"automatic identification" technology through the defendants' use of methods for
scanning production markings such as bar codes. The Company received a letter
dated November 27, 2001 from attorneys for the Lemelson Foundation notifying the
Company of the complaint and offering a license. The Court entered a stay of the
case on March 20, 2002, requested by the Lemelson Foundation, pending the
outcome of a related case in Nevada being fought by bar code manufacturers. The
trial in the Nevada case began on November 18, 2002 and ended on January 17,
2003. The parties in the Nevada case submitted post trial briefs by the end of
May 2003, and a decision is expected in the near future. The Order for the stay
in the Lemelson case provides that the Company need not answer the complaint,
although it has the option to do so. The Company has been invited to join a
common interest/joint-defense group consisting of
34
defendants named in the complaint as well as in other actions brought by the
Lemelson Foundation. The Company is currently in the process of analyzing the
merits of the issues raised by the complaint, notifying vendors of its receipt
of the complaint and letter, evaluating the merits of joining the joint-defense
group, and having discussions with attorneys for the Lemelson Foundation
regarding the license offer. A preliminary estimate of the royalties and
attorneys' fees, which the Company may pay if it decides to accept the license
offer from the Lemelson Foundation, range from about $125,000 to $400,000. The
Company has decided to gather further information, but will not agree to a
settlement at this time, and has not established a reserve.
In early March 2003, the Company learned that one of its business units
had engaged in certain travel transactions that may have constituted violations
under the provisions of U.S. government regulations promulgated pursuant to 50
U.S.C. App. 1-44, which proscribe certain transactions related to travel to
certain countries. The Company immediately commenced an inquiry into the matter,
incurred resulting charges, made an initial voluntary disclosure to the
appropriate U.S. government agency under its program for such disclosures and
has submitted to that agency a detailed report on the results of the inquiry. In
addition, the Company has taken steps to ensure that all of its business units
are acting in compliance with the travel and transaction restrictions and other
requirements of all applicable U.S. government programs. Although the Company is
uncertain of the extent of the penalties, if any, that may be imposed on it by
virtue of the transactions voluntarily disclosed, it does not currently believe
that any such penalties will have a material effect on its business or financial
condition.
On July 17, 2003, the Company filed an action in the Supreme Court of
the State of New York, County of New York (Index No. 03/602269) against
Richemont Finance S.A. ("Richemont"), and Chelsey Direct, LLC, a Delaware
limited liability company ("Chelsey"), seeking a declaratory judgment as to
whether Richemont improperly transferred 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 (collectively, the "Shares") to Chelsey
on or about May 19, 2003 and whether the Company can properly recognize the
transfer of those Shares from Richemont to Chelsey under federal and/or state
law. On July 29, 2003, Chelsey answered the Company's complaint, alleged certain
affirmative defenses and raised three counterclaims against the Company,
including Delaware law requiring the registration of the Shares, damages,
including attorney's fees, for the failure to register the Shares, and tortious
interference with contract. Chelsey also moved for a preliminary injunction
directing the Company to register the ownership of the Shares in Chelsey's name.
Chelsey later moved for summary judgment dismissing the Company's complaint.
Subsequently, Chelsey moved to compel production of certain documents and for
sanctions and/or costs. On August 28, 2003, Richemont moved to dismiss the
Company's complaint. It subsequently filed a motion seeking sanctions and/or
costs against the Company. On October 27, 2003, the Court granted Chelsey's
motion for summary judgment and Richemont's motion to dismiss and ordered that
judgment be entered dismissing the case in its entirety. The Court also denied
Chelsey's and Richemont's motions for sanctions and Chelsey's motion to compel
production of certain documents.
In addition, the Company is involved in various routine lawsuits of a
nature, which are deemed customary and incidental to its businesses. In the
opinion of management, the ultimate disposition of these actions will not have a
material adverse effect on the Company's financial position or results of
operations.
ITEM 5. OTHER INFORMATION
On July 17, 2003, the Company increased the size of its Board of
Directors from five to seven members and elected Jeffrey A. Sonnenfeld and A.
David Brown as members of the newly-expanded Board of Directors, subject to the
fulfillment of certain conditions precedent, which were fulfilled on July 29,
2003. As a result of this action, the Committees of the Board were reconstituted
as follows: The members of the Audit Committee are Robert H. Masson (Chairman),
E. Pendleton James and Kenneth J. Krushel. The members of the Compensation
Committee are Jeffrey A. Sonnenfeld (Chairman), A. David Brown and Robert H.
Masson. The members of the Nominating Committee are E. Pendleton James
(Chairman), A. David Brown and Jeffrey A. Sonnenfeld. The members of the
Transactions Committee are Kenneth J. Krushel (Chairman), A. David Brown, E.
Pendleton James, Robert H. Masson and Jeffrey A. Sonnenfeld.
On July 23, 2003, the Company increased the size of its Executive
Committee from three to five members, subject to the fulfillment of certain
conditions precedent, which were fulfilled on July 29, 2003, and reconstituted
the Executive Committee to include Thomas C. Shull, the Chairman of the Board,
President and Chief Executive Officer of
35
the Company, Robert H. Masson, the Chairman of the Company's Audit Committee,
Kenneth J. Krushel, the Chairman of the Company's Transactions and Executive
Committees, Basil P. Regan, and Jeffrey A. Sonnenfeld, the Chairman of the
Company's Compensation Committee.
By letter dated September 2, 2003, the Company advised Chelsey Direct,
LLC ("Chelsey") that a Voting Trigger (as defined in the Certificate of
Designations, Powers, Preferences and Rights (the "Certificate of Designations")
of the Series B Participating Preferred Stock (the "Series B Preferred Stock")
of the Company had occurred due to the failure by the Company to redeem any
shares of Series B Preferred Stock on or prior to August 31, 2003. As a result,
the holder or holders of the Series B Preferred Stock had the exclusive right,
voting separately as a class and by taking such actions as are set forth in
Section 7(b) of the Certificate of Designations, to elect two directors of the
Company (the "Director Right"). On September 16, 2003, Chelsey exercised the
Director Right and elected Martin L. Edelman and Wayne P. Garten to the
Company's Board of Directors. Messrs. Edelman and Garten returned certain
related paperwork to the Company on September 29, 2003, upon which they
effectively joined the Board.
On November 3, 2003, Charles E. Blue was appointed Chief Financial
Officer of the Company effective November 11, 2003, replacing Edward M. Lambert
as Chief Financial Officer, effective on such date, in connection with the
Company's ongoing strategic business realignment program. Mr. Blue joined the
Company in 1999 and had most recently served as Senior Vice President, Finance,
a position eliminated by this finance department restructuring.
Mr. Lambert will continue to serve as Executive Vice President of the
Company until January 2, 2004. In connection with such change, Mr. Lambert and
the Company have entered into a severance agreement dated November 4, 2003
providing a minimum of $600,000 and a maximum of $640,000 of cash payments as
well as other benefits that will be accrued and paid in the fourth quarter of
2003. Mr. Lambert is also entitled to receive a payment under the Company's 2003
Management Incentive Plan; however, the Company's current forecast does not
project any such payment for the 2003 Plan year.
On Thursday, August 7, 2003 representatives of Chelsey attended a
regularly scheduled meeting of the Board of Directors of the Company at the
invitation of management of the Company endorsed by its Board of Directors.
Senior management of the Company was also present at the meeting. The Company
had requested that Chelsey make a brief (15-20 minute) presentation to the Board
solely with respect to (1) Chelsey's vision and proposed plan for value creation
opportunities at the Company above and beyond those currently articulated by
management in its recent SEC filings and other public statements; and (2)
Chelsey's specific proposal for the terms of an exchange offer by which the
Series B Preferred Stock would be exchanged for Common Stock of the Company
and/or Chelsey's specific counteroffer to the Company's July 7, 2003 proposal.
The Company wanted to afford Chelsey the opportunity to speak directly to the
entire Board of Directors and senior management of the Company and articulate
how Chelsey's approach would benefit all the Company's stakeholders.
At the meeting, Chelsey's representatives delivered to the Company a
document entitled "Recapitalization of Hanover Direct, Inc. Summary of Terms"
(the "Chelsey Proposal") and made a presentation to the Board of Directors
regarding the Chelsey Proposal. That presentation was purportedly summarized in
Chelsey's Amendment No. 3 to Schedule 13D as Exhibit E.
The Company's Board of Directors referred the Chelsey Proposal to its
Transactions Committee for consideration with a view towards making a
recommendation to the Board of Directors. The Transactions Committee, composed
of independent directors of the Company, provides assistance to the directors in
fulfilling their responsibility to the shareholders by recommending appropriate
actions to the Board of Directors on matters that require Board approval,
including material transactions with shareholders owning more than ten percent
(10%) of the voting securities of the Company. The Transactions Committee
engaged financial advisors and counsel to assist it in its deliberations with
respect to the Chelsey Proposal.
On September 18, 2003, representatives of Chelsey attended a meeting
with legal and financial advisors to the Transactions Committee of the Board of
Directors of the Company at which a document entitled "Recapitalization of
Hanover Direct, Inc. - Summary of Counteroffer Terms" (the "Counterproposal")
was discussed. The Counterproposal responded to Chelsey's Proposal to the
Company at the August 7 meeting of the Board of Directors. Chelsey's
representatives did not accept the Counterproposal. Negotiations between the
parties ensued in the weeks thereafter.
On November 10, 2003, the Company signed a Memorandum of Understanding
with Chelsey and Regan Partners, L.P. setting forth the agreement in principle
to recapitalize the Company, reconstitute the Board of Directors and settle
outstanding litigation between the Company and Chelsey. The Memorandum of
Understanding had been approved by the Transactions Committee of the Board of
Directors of the Company.
The parties agreed to effect within ten days or as soon thereafter as
possible a binding Recapitalization Agreement that would, upon the closing of
the transactions set forth in the Recapitalization Agreement, exchange 564,819
shares of a newly issued Series C Preferred Stock and 81,857,833 shares of newly
issued common stock for the 1,622,111 shares of Series B Preferred Stock
currently held by Chelsey, subject to adjustment if the transaction is not
consummated by December 17, 2003. If the closing takes place on or before
December 17, 2003, the Series C Preferred Stock will have an aggregate
liquidation preference of $56,481,900 while the outstanding Series B Preferred
Stock has a current aggregate liquidation preference of $112,963,810 and a
maximum final liquidation preference of $146,168,422 on August 23, 2005. The new
common shares will have an effective issue price of $.69. With the issuance of
the new common shares, Chelsey will have a majority equity and voting interest
in the Company.
Upon the execution of the Recapitalization Agreement, the Company will
reconstitute the Board to eight members, including four designees of Chelsey.
The Recapitalization Agreement is subject to the approval of the Transactions
Committee and the Board of Directors of the Company. It is also subject to
other consents including the approval of Congress Financial Corporation. The
Company intends to prepare and file with the Securities and Exchange Commission
and transmit to all equity holders of the Company, as required by Rule 14f-1 of
the Securities Exchange Act of 1934, as amended, a statement regarding its
intent to effect a change in majority of directors as promptly as practicable.
Following the expiration of ten days following the filing and mailing of the
statement, the Board of Directors will increase to nine members, with the
additional director being a Chelsey designee.
The proposed Series C Preferred Stock, with a liquidation preference of
$100 per share, carries a quarterly dividend, starting on January 1, 2006 at 6%
and increasing each year by 1 1/2%. In lieu of cash dividends, the Company may
elect to accrue dividends at a rate equal to 1% higher than the annual cash
dividend rate. The Series C Preferred Stock has a redemption date of January 1,
2009. The Company shall redeem the maximum number of shares of Series C
Preferred Stock as possible with the net proceeds of certain asset and equity
sales, including the disposition of the Company's non-core assets, not required
to be used to repay Congress Financial Corporation pursuant to the terms of the
19th Amendment to the Loan and Security Agreement, and Chelsey shall be
required to accept such redemptions.
The Recapitalization Agreement will also define the duties of the
Transactions Committee and provide for the reconstitution of the committees of
the Board of Directors, mutual releases and termination of litigation between
the Company and Chelsey, voting agreements between Chelsey and Regan Partners, a
major shareholder of the Company, registration rights for the new common shares
and agreements to recommend certain amendments to the Company's Certificate of
Incorporation, including a 10-for-1 reverse stock split and a decrease in the
par value of the Common Stock from $.66 2/3 per share to $.01 per share, at the
first annual meeting of shareholders following the closing.
If the closing of the Recapitalization Agreement has not occurred by
November 30, 2003, then the Company will pay Chelsey $1 million by December 3,
2003. If the closing has not occurred by the close of business on December 17,
2003, then the Memorandum of Understanding shall cease to be effective unless
either the Company or Chelsey elects to extend the closing past such date. If
the Company makes such election, the number of shares of Common Stock and
Series C Preferred Stock issued to Chelsey in the Recapitalization shall be
adjusted pursuant to the terms of the agreement. If Chelsey makes such an
election, there shall be no adjustment to the number of shares. In either case,
the Closing shall occur no later than February 29, 2004.
The Memorandum of Understanding has been filed with the Securities and
Exchange Commission as an exhibit to the Company's Current Report on Form 8-K
dated November 10, 2003. The Company strongly recommends that interested parties
refer to it for a full and complete understanding of the terms and conditions of
the Memorandum of Understanding.
36
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
10.1 Employment Agreement dated as of September 1, 2002 between the Company
and Thomas C. Shull.
10.2 Amendment Number 1 to Agreement dated May 14, 2001 between Thomas C. Shull
and the Company.
10.3 Form of letter agreement between the Company and certain Level 8 executive
officers.
10.4 Twenty-Second Amendment to Loan and Security Agreement, dated as of
August 16, 2002, among Congress Financial Corporation and certain
Subsidiaries of the Company.
99.1 Certification signed by Thomas C. Shull.
99.2 Certification signed by Edward M. Lambert.
26Exhibits:
10.1 Twenty-sixth Amendment to Loan and Security Agreement, dates as of
August 29, 2003, among Congress Financial Corporation and certain
Subsidiaries of the Company. Incorporated by reference to the
Company's Quarterly Report on Form 10-Q for the quarter ended
September 27, 2003.
10.2 Twenty-seventh Amendment to Loan and Security Agreement, dates as of
October 31, 2003, among Congress Financial Corporation and certain
Subsidiaries of the Company. Incorporated by reference to the
Company's Quarterly Report on Form 10-Q for the quarter ended
September 27, 2003.
10.3 Twenty-eighth Amendment to Loan and Security Agreement, dates as of
November 4, 2003, among Congress Financial Corporation and certain
Subsidiaries of the Company. Incorporated by reference to the
Company's Quarterly Report on Form 10-Q for the quarter ended
September 27, 2003.
10.4 Amendment No. 3 to the Hanover Direct, Inc. Key Executive Eighteen
Month Compensation Continuation Plan. Incorporated by reference to the
Company's Quarterly Report on Form 10-Q for the quarter ended
September 27, 2003.
10.5 Amendment No. 2 to the Hanover Direct, Inc. Key Executive Twelve Month
Compensation Continuation Plan. Incorporated by reference to the
Company's Quarterly Report on Form 10-Q for the quarter ended
September 27, 2003.
10.6 Amendment No. 2 to the Hanover Direct, Inc. Key Executive Six Month
Compensation Continuation Plan. Incorporated by reference to the
Company's Quarterly Report on Form 10-Q for the quarter ended
September 27, 2003.
31.1 Certification signed by Thomas C. Shull. FILED HEREWITH.
31.2 Certification signed by Charles E. Blue. FILED HEREWITH.
32.1 Certification signed by Thomas C. Shull and Charles E. Blue.
FILED HEREWITH.
(b) Reports on Form 8-K:
1.1 Form 8-K, filed July 15, 2003 -- reporting pursuant to Item 5 of such
Form the exchange of certain correspondence with Chelsey Direct, LLC.
1.2 Form 8-K, filed July 17, 2003 - reporting pursuant to Item 5 of such
Form the filing by the Company of an action in the Supreme Court of the
State of New York against Richemont Finance S.A. and Chelsey Direct,
LLC.
1.3 Form 8-K, filed July 30, 2003 - reporting pursuant to Item 5 of such
Form the increase in the size of the Company's Board of Directors and
the election of Jeffrey A. Sonnenfeld and A. David Brown as directors.
1.4 Form 8-K, filed August 1, 2003 - reporting pursuant to Item 5 of such
Form certain agreements of the parties in the matter of Hanover Direct,
Inc. v. Richemont Finance S.A. and Chelsey Direct, LLC.
1.5 Form 8-K, filed August 5, 2003 -- reporting pursuant to Item 5 of such
Form scheduling information regarding its conference call with
management to review the operating results for the fiscal quarter ended
June 28, 2003.
1.6 Form 8-K, filed August 7, 2003 - reporting pursuant to Item 9 of such
Form (information furnished pursuant to Item 12 of such Form) the
issuance of a press release announcing operating results for the fiscal
quarter ended June 28, 2003.
1.7 Form 8-K, filed August 11, 2003 - reporting pursuant to Item 9 of such
Form an unofficial transcript of its conference call with management to
review the operating results for the quarter ended June 28,
37
2003.
1.8 Form 8-K, filed August 14, 2003 - reporting pursuant to Item 5 of such
Form that (i) on Thursday, August 7, 2003 representatives of Chelsey
Direct, LLC attended a regularly scheduled meeting of the Company's
Board of Directors at the invitation of management of the Company
endorsed by its Board of Directors, (ii) at the meeting, Chelsey's
representatives delivered to the Company a document entitled
"Recapitalization of Hanover Direct, Inc. Summary of Terms" and made a
presentation to the Board of Directors regarding the Proposal, (iii)
the Company's Board of Directors referred the Proposal to its
Transactions Committee for consideration with a view towards making a
recommendation to the Board of Directors, (iv) the Transactions
Committee had engaged financial advisors and counsel to assist it in
its deliberations with respect to the Proposal and would need time to
properly consider and respond to the Proposal, and (v) the Company had
agreed to the temporary registration of the 29,446,888 shares of Common
Stock of the Company and the 1,622,111 shares of Series B Participating
Preferred Stock of the Company sold by Richemont Finance S.A.
("Richemont") to Chelsey Direct, LLC on or about May 19, 2003, pending
the resolution of certain litigation between the Company, Chelsey and
Richemont described in the Company's Current Reports on Form 8-K filed
on July 17, 2003 and August 1, 2003.
1.9 Form 8-K, filed September 9, 2003 - reporting pursuant to Item 5 of
such Form the existence of an Escrow Agreement, dated as of July 2,
2003, by and among Richemont, Chelsey and JPMorgan Chase Bank, as
escrow agent, and the side letter referred to therein, dated as of May
19, 2003, by and between Richemont and Chelsey.
2.0 Form 8-K, filed September 9, 2003 - reporting pursuant to Item 5 of
such Form that prior to a meeting with representatives of Chelsey
Direct, LLC on September 18, 2003, advisors to the Transactions
Committee of the Board of Directors of the Company delivered to Chelsey
a document entitled "Recapitalization of Hanover Direct, Inc. - Summary
of Counteroffer Terms," which responded to the proposal made by Chelsey
to the Company at a meeting of the Board of Directors held on August 7,
2003, which counterproposal Chelsey rejected.
2.1 Form 8-K, filed October 2, 2003 - reporting pursuant to Item 5 of such
Form that (i) a Voting Trigger (as defined in the Certificate of
Designations, Powers, Preferences and Rights of the Series B
Participating Preferred Stock of the Company) had occurred, (ii) that
Chelsey Direct, LLC had elected Martin L. Edelman and Wayne P. Garten
to the Company's Board of Directors and (iii) Messrs. Edelman and
Garten had returned certain related paperwork to the Company on
September 29, 2003, upon which they effectively joined the Board.
2.2 Form 8-K, filed November 4, 2003 - reporting pursuant to Item 5 of such
Form information regarding the issuance of the Twenty-Seventh Amendment
to the Company's Loan and Security Agreement with Congress Financial
Corporation and the appointment of Mr. Charles E. Blue as Chief
Financial Officer, effective November 11, 2003, and the resignation of
Edward M. Lambert as Chief Financial Officer effective on such date.
2.3 Form 8-K, filed November 7, 2003 - reporting pursuant to Item 5 of such
Form information regarding its conference call with management to
review operating results for the quarter ended September 27, 2003.
2.4 Form 8-K, filed November 10, 2003 - reporting pursuant to Item 5 of
such Form the Company entering into a Memorandum of Understanding with
Chelsey Direct, LLC and Regan Partners, L.P. and issuing a press
release announcing that it had signed the Memorandum of Understanding.
38
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this amendment no. 1 to report to be signed on
its behalf by the undersigned thereunto duly authorized in the City of Edgewater, State of New
Jersey.authorized.
HANOVER DIRECT, INC.
Registrant
By: /s/ Edward M. Lambert
-------------------------------------
Edward M. Lambert
ExecutiveCharles E. Blue
---------------------------------------------
Charles E. Blue
Senior Vice President and
Chief Financial Officer
(On behalf of the Registrant and as
principal financial officer)
Date: August 19, 2002
27April 9, 2004
39