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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended SEPTEMBER 28, 2002
Commission file number 1-12082
HANOVER DIRECT, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 13-0853260
(State of incorporation) (IRS Employer Identification No.)
115 RIVER ROAD, BUILDING 10, EDGEWATER, NEW JERSEY 07020
(Address of principal executive offices) (Zip Code)
(201) 863-7300
(Telephone number)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES X NO
Common stock, par value $.66 2/3 per share: 138,315,800 shares outstanding as of
November 7, 2002.
HANOVER DIRECT, INC.
TABLE OF CONTENTS
Page
----
Part I - Financial Information
Item 1. Financial Statements
Condensed Consolidated Balance Sheets -
September 28, 2002 and December 29, 2001 ......................................... 2
Condensed Consolidated Statements of Income (Loss) - 13- and 39- weeks
ended September 28, 2002 and September 29, 2001................................. 4
Condensed Consolidated Statements of Cash Flows - 39- weeks ended
September 28, 2002 and September 29, 2001....................................... 5
Notes to Condensed Consolidated Financial Statements ............................. 6
Item 2. Management's Discussion and Analysis of Consolidated Financial Condition and
Results of Operations ........................................................... 17
Item 3. Quantitative and Qualitative Disclosures about Market Risk.................. 26
Item 4. Controls and Procedures .................................................... 26
Part II - Other Information
Item 1. Legal Proceedings ......................................................... 27
Item 6. Exhibits and Reports on Form 8-K .......................................... 31
Signatures ......................................................................... 32
Certifications ..................................................................... 33
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)
SEPTEMBER 28, DECEMBER 29,
2002 2001
--------- -------------
(UNAUDITED)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 959 $ 1,121
Accounts receivable, net 15,593 19,456
Inventories 58,251 59,223
Prepaid catalog costs 18,851 14,620
Deferred tax asset, net 3,300 3,300
Other current assets 3,169 3,000
--------- ---------
Total Current Assets 100,123 100,720
--------- ---------
PROPERTY AND EQUIPMENT, AT COST:
Land 4,395 4,509
Buildings and building improvements 18,205 18,205
Leasehold improvements 9,917 12,466
Furniture, fixtures and equipment 56,489 59,287
--------- ---------
Accumulated depreciation and amortization 89,006 94,467
(58,556) (60,235)
--------- ---------
Property and equipment, net 30,450 34,232
--------- ---------
Goodwill, net 9,278 9,278
Deferred tax asset, net 11,700 11,700
Other assets 1,152 1,731
--------- ---------
Total Assets $ 152,703 $ 157,661
========= =========
See notes to Condensed Consolidated Financial Statements.
2
HANOVER DIRECT, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (CONTINUED)
(IN THOUSANDS OF DOLLARS, EXCEPT SHARE AMOUNTS)
SEPTEMBER 28, DECEMBER 29,
2002 2001
---------- ---------
(UNAUDITED)
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIENCY)
CURRENT LIABILITIES:
Current portion of long-term debt and capital lease obligations $ 3,802 $ 3,162
Accounts payable 45,488 46,348
Accrued liabilities 19,440 25,132
Customer prepayments and credits 7,398 5,143
---------- ---------
Total Current Liabilities 76,128 79,785
---------- ---------
NON-CURRENT LIABILITIES:
Long-term debt 30,400 26,548
Other 8,319 10,233
---------- ---------
Total Non-current Liabilities 38,719 36,781
---------- ---------
Total Liabilities 114,847 116,566
---------- ---------
SERIES B PARTICIPATING PREFERRED STOCK, authorized, issued and outstanding,
1,622,111 shares at September 28, 2002 and December 29, 2001 87,416 76,823
SHAREHOLDERS' EQUITY (DEFICIENCY):
Common Stock, $.66 2/3 par value, 300,000,000 shares authorized;
140,436,729 shares issued and outstanding at September 28, 2002 and
140,336,729 shares issued and outstanding at December 29, 2001 93,625 93,558
Capital in excess of par value 341,864 351,558
Accumulated deficit (481,703) (477,497)
---------- ---------
(46,214) (32,381)
---------- ---------
Less:
Treasury stock, at cost (2,120,929 shares at September 28, 2002 and
2,100,929 shares at December 29, 2001) (2,996) (2,942)
Notes receivable from sale of Common Stock (350) (405)
---------- ---------
Total Shareholders' Deficiency (49,560) (35,728)
---------- ---------
Total Liabilities and Shareholders' Equity $ 152,703 $ 157,661
========== =========
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 39- WEEKS ENDED
----------------------------- -----------------------------
SEPTEMBER 28, SEPTEMBER 29, SEPTEMBER 28, SEPTEMBER 29,
2002 2001 2002 2001
------------- -------------- -------------- -------------
NET REVENUES $ 106,030 $ 117,431 $ 329,393 $ 395,232
--------- --------- --------- ---------
OPERATING COSTS AND EXPENSES:
Cost of sales and operating expenses 68,890 76,887 210,379 252,502
Special charges 1,463 -- 1,696 6,081
Selling expenses 25,355 30,435 76,554 107,491
General and administrative expenses 11,834 13,654 36,806 44,350
Depreciation and amortization 1,393 1,780 4,376 5,679
--------- --------- --------- ---------
108,935 122,756 329,811 416,103
--------- --------- --------- ---------
LOSS FROM OPERATIONS (2,905) (5,325) (418) (20,871)
Gain on sale of Improvements -- -- 318 22,818
Gain on sale of Kindig Lane -- -- -- 1,529
--------- --------- --------- ---------
(LOSS) INCOME BEFORE INTEREST AND INCOME TAXES (2,905) (5,325) (100) 3,476
Interest expense, net 1,277 1,451 4,016 5,102
--------- --------- --------- ---------
LOSS BEFORE INCOME TAXES (4,182) (6,776) (4,116) (1,626)
Income tax provision 30 30 90 90
--------- --------- --------- ---------
NET LOSS AND COMPREHENSIVE LOSS (4,212) (6,806) (4,206) (1,716)
Preferred stock dividends and accretion 4,185 3,092 10,593 8,956
--------- --------- --------- ---------
NET LOSS APPLICABLE TO COMMON SHAREHOLDERS $ (8,397) $ (9,898) $ (14,799) $ (10,672)
========= ========= ========= =========
NET LOSS PER COMMON SHARE:
Net loss per common share - basic and diluted $ (.06) $ (.05) $ (.11) $ (.05)
========= ========= ========= =========
Weighted average common shares outstanding -
basic (thousands) 138,316 212,186 138,268 212,280
========= ========= ========= =========
Weighted average common shares outstanding -
diluted (thousands) 138,316 212,186 138,268 212,280
========= ========= ========= =========
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 39- WEEKS ENDED
-----------------------
SEPTEMBER 28, SEPTEMBER 29,
2002 2001
------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (4,206) $ (1,716)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization, including deferred fees 5,483 6,147
Special charges -- 2,389
Gain on sale of Improvements (318) (22,818)
Gain on sale of Kindig Lane -- (1,529)
Compensation expense related to stock options 724 1,601
Changes in assets and liabilities, net of sale of business:
Accounts receivable, net 3,863 9,729
Inventories 972 (56)
Prepaid catalog costs (4,231) (2,300)
Accounts payable (860) (10,245)
Accrued liabilities (5,692) (12,101)
Customer prepayments and credits 2,255 931
Other non-current liabilities (1,914) (2,070)
Other, net (164) 14
-------- --------
Net cash used in operating activities (4,088) (32,024)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisitions of property and equipment (597) (1,459)
Proceeds from sale of Improvements 318 30,235
Proceeds from sale of Kindig Lane -- 4,671
-------- --------
Net cash (used) provided by investing activities (279) 33,447
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings under Congress revolving loan facility 3,419 4,674
Borrowings under Congress Tranche B term loan facility 3,500 --
Payments under Congress Tranche A term loan facility (1,493) (4,710)
Payments under Congress Tranche B term loan facility (864) (801)
Payments of debt financing costs (528) --
Payments under capital lease obligations (102) (91)
Borrowings under capital lease obligations 32 --
Series B Preferred Stock Transaction Cost Adjustment 216 --
Redemption of 7.5% Convertible Debentures -- (751)
Other, net 25 (28)
-------- --------
Net cash provided (used) by financing activities 4,205 (1,707)
-------- --------
Net decrease in cash and cash equivalents (162) (284)
Cash and cash equivalents at the beginning of the year 1,121 1,691
-------- --------
Cash and cash equivalents at the end of the period $ 959 $ 1,407
======== ========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid for:
Interest $ 2,451 $ 4,064
======== ========
Income taxes $ 193 $ 122
======== ========
Non-cash investing and financing activities:
Series B Participating Preferred Stock redemption price increase $ 10,593 $ --
======== ========
Stock dividend and accretion of Series A Cumulative Participating Preferred Stock $ -- $ 8,956
======== ========
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. 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
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information," the consolidated operations of Hanover Direct, Inc. are reported
as one segment.
2. RETAINED EARNINGS RESTRICTIONS
The Company is restricted from paying dividends at any time on its
Common Stock or from acquiring its capital stock by certain debt covenants
contained in agreements to which the Company is a party.
3. NET INCOME (LOSS) PER SHARE
Net income (loss) per 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." The weighted average number of shares used in the calculation for both
basic and diluted net loss per share for the 13-week period ended September 28,
2002 was 138,315,800. For the 13-week period ended September 29, 2001, the
weighted average number of shares used in the calculation for basic and diluted
net loss per share was 212,186,331. The weighted average number of shares used
in the calculation for both basic and diluted net loss per share for the 39-week
periods ended September 28, 2002 and September 29, 2001 were 138,268,327 and
212,280,360 shares, respectively. Diluted net loss per share equals basic net
loss per share as the inclusion of potentially dilutive securities would have an
anti-dilutive impact on the diluted calculation as a result of the net losses
incurred during the 13 and 39-week periods ended September 28, 2002 and
September 29, 2001. The number of potentially dilutive securities excluded from
the calculation of diluted net loss per share were 472,671 and 487,979 common
share equivalents for the 13-week periods ended September 28, 2002 and September
29, 2001, respectively. The number of potentially dilutive securities excluded
from the calculation of diluted net loss per share were 3,207,612 and 1,015,252
common share equivalents for the 39-week periods ended September 28, 2002 and
September 29, 2001, respectively. Currently, all potentially dilutive securities
are issued options to purchase shares of the Company's common stock.
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. 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
6
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 which 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. Oral argument on the appeal, if scheduled, is not expected
until early 2003. 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, Inc. and Hanover
Direct Virginia, Inc. On May 14, 2002, the Court (1) granted the Company's
Motion to quash service on behalf of Hanover Direct, Hanover Brands, and Hanover
Direct Virginia, leaving only LWI Holdings, Hanover Company Store, Kitchen &
Home, and Silhouettes, as defendants, and (2) granted the Company's Motion to
Stay the action in favor of the previously filed Oklahoma action, so nothing
will proceed on this case against the remaining entities until the Oklahoma case
is decided. The Company believes it has defenses against the claims. The Company
plans to conduct a vigorous defense of this action.
A class action lawsuit was commenced on February 13, 2002 entitled Jacq
Wilson, suing on behalf of himself, all others similarly situated, and the
general public v. Brawn of California, Inc. dba International Male and
Undergear, and Does 1-100 ("Brawn") in the Superior Court of the State of
California, City and County of San Francisco. Does 1-100 are internet and
catalog direct marketers offering a selection of men's clothing, sundries, and
shoes who advertise within California and nationwide. The complaint alleges that
for at least four years, members of the class have been charged an unlawful,
unfair, and fraudulent insurance fee and tax on orders sent to them by Brawn;
that Brawn was engaged in untrue, deceptive and misleading advertising in that
it was not lawfully required or permitted to collect insurance, tax and sales
tax from customers in California; and that Brawn has engaged in acts of unfair
competition under the state's Business and Professions Code. Plaintiff and the
class seek (i) restitution and disgorgement of all monies wrongfully collected
and earned by Brawn, including interest and other gains made on account of these
practices, including reimbursement in the amount of the insurance, tax and sales
tax collected unlawfully, together with interest, (ii) an order enjoining Brawn
from charging customers insurance and tax on its order forms and/or from
charging tax on the delivery, shipping and insurance charges, (iii) an order
directing Brawn to notify the California State Board of Equalization of the
failure to pay the correct amount of tax to the state and to take appropriate
steps to provide the state with the information needed for audit, and (iv)
compensatory damages, attorneys' fees, pre-judgment interest, and costs of the
suit. The claims of the individually named plaintiff and 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 heard the argument in the Company's Motion to Stay the
action in favor of the Oklahoma action, denying the motion. In October 2002, the
Court granted the Company's motion for leave to amend the answer. Discovery is
proceeding. Trial is currently scheduled for April 14, 2003 and the Company
plans to conduct a vigorous defense of this action.
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
7
unlawful, unfair, and fraudulent tax and "sales tax" on their orders in
violation of California law and court decisions, including the state Revenue and
Taxation Code, Civil Code, and the California Board of Equalization; that Gump's
engages in unfair business practices; that Gump's engaged in untrue and
misleading advertising in that it was not lawfully required to collect tax and
sales tax from customers in California; is not lawfully required or permitted to
add tax and sales tax on separately stated shipping or delivery charges to
California consumers; and that it does not add the appropriate or applicable or
specific correct tax or sales tax to its orders. Plaintiff and the class seek
(i) restitution of all tax and sales tax charged by Gump's on each transaction
and/or restitution of tax and sales tax charged on the shipping charges; (ii) an
order enjoining Gump's from charging customers for tax on orders or from
charging tax on the shipping charges; and (iii) attorneys' fees, pre-judgment
interest on the sums refunded, and costs of the suit. On April 15, 2002, the
Company filed an Answer and Separate Affirmative Defenses to the complaint,
generally denying the allegations of the complaint and each and every cause of
action alleged, and denying that plaintiff has been damaged or is entitled to
any relief whatsoever. On September 19, 2002, the Company filed a motion for
leave to file an amended answer, containing several additional affirmative
defenses based on the proposition that the proper defendant in this litigation
(if any) is the California State Board of Equalization, not the Company, and
that plaintiff failed to exhaust its administrative remedies prior to filing
suit. Discovery is now proceeding. Trial is currently scheduled to begin on May
19, 2003. The Company plans to conduct a vigorous defense of this action.
A class action lawsuit was commenced on March 5, 2002 entitled Argonaut
Consumer Rights Advocates Inc., suing on behalf of the General Public v.
Domestications LLC, and Does 1-100 ("Domestications") in the Superior Court of
the State of California, City and County of San Francisco. The plaintiff is a
non-profit public benefit corporation suing under the California Business and
Profession Code. Does 1-100 would include persons responsible for the conduct
alleged in the complaint, including the direct sale of tangible personal
property to California consumers including the type of merchandise that
Domestications sells, by telephone, mail order, and sales through the web site
www.domestications.com. The plaintiff claims that for at least four years
members of the class have been charged an unlawful, unfair, and fraudulent tax
and sales tax for different rates and amounts on the catalog and internet orders
on the total amount of goods, tax and sales tax on shipping charges, which are
not subject to tax or sales tax under California law, in violation of California
law and court decisions, including the state Revenue and Taxation Code, Civil
Code, and the California Board of Equalization; that Domestications engages in
unfair business practices; and that Domestications engaged in untrue and
misleading advertising in that it was not lawfully required to collect tax and
sales tax from customers in California. Plaintiff and the class seek (i)
restitution of all sums, interest and other gains made on account of these
practices; (ii) prejudgment interest on all sums wrongfully collected; (iii) an
order enjoining Domestications from charging customers for tax on their orders
and/or from charging tax on the shipping charges; and (iv) attorneys' fees and
costs of the suit. The Company filed an Answer and Separate Affirmative Defenses
to the Complaint, generally denying the allegations of the Complaint and each
and every cause of action alleged, and denying that plaintiff has been damaged
or is entitled to any relief whatsoever. Discovery is now proceeding. On
September 19, 2002, the Company filed a motion for leave to file an amended
answer, containing several additional affirmative defenses based on the
proposition that the proper defendant in this litigation (if any) is the
California State Board of Equalization, not the Company, and that plaintiff
failed to exhaust its administrative remedies prior to filing suit. Discovery is
proceeding. Trial is currently scheduled to begin on June 16, 2003. 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 $149,325 for 13 weeks of
accrued and unused vacation, damages in the amount of $3,583,800, or, in the
alternative, a declaratory judgment from the court that he is entitled to all
change of control benefits under the "Hanover Direct, Inc. Thirty-Six Month
Salary Continuation Plan," and damages in the amount of $1,396,066 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 on the 30th day following his termination of employment. 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 of Mr. Kaul's causes of action, 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
8
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
requests summary judgment dismissing Mr. Kaul's claims including, without
limitation, Mr. Kaul's claim for 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 summary judgment awarding damages on the
Company's claim for reimbursement of a tax loan. Mr. Kaul requests summary
judgment dismissing certain of the Company's counterclaims and defenses. The
briefing on the motions is completed. 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 June 1994, a complaint was filed in the Supreme Court of the State
of New York, County of New York, by Donald Schupak, the former President, CEO
and Chairman of the Board of Directors of The Horn & Hardart Company, the
corporate predecessor to the Company, against the Company and Alan Grant Quasha.
The complaint asserts claims for alleged breaches of an agreement dated February
25, 1992 between Mr. Schupak and the Company (the "Agreement"), and for alleged
tortious interference with the Agreement by Mr. Quasha. Mr. Schupak seeks
compensatory damages in an amount, which is estimated to be not more than
$400,000, and punitive damages in the amount of $10 million; applicable
interest, incidental and consequential damages, plus costs and disbursements,
the expenses of the litigation and reasonable attorneys' fees. In addition,
based on the alleged breaches of the Agreement by the Company, Mr. Schupak seeks
a "parachute" payment of approximately $3 million under an earlier agreement
with the Company that he allegedly had waived in consideration of the Company's
performance of its obligations under the Agreement. The Company filed an answer
to the complaint on September 7, 1994. Discovery then commenced and documents
were exchanged. Each of the parties filed a motion for summary judgment at the
end of 1995, and both motions were denied in the spring of 1996. In April 1996,
due to health problems then being experienced by Mr. Schupak, the Court ordered
that the case be marked "off calendar" until plaintiff recovered and was able to
proceed with the litigation. In September 2002, more than six years later, Mr.
Schupak filed a motion to restore the case to the Court's calendar. The Company
filed papers in opposition to the motion on October 10, 2002, asserting that the
motion should be denied on the ground that plaintiff failed to timely comply
with the terms of the Court's order concerning restoration and, alternatively,
on the ground of laches. The plaintiff filed reply papers on November 4, 2002,
and the parties are awaiting decision by the Court. The Company believes the
claims to be without merit and intends to conduct a vigorous defense in the
event the case is restored to the calendar.
The Company was named as one of 88 defendants in a patent infringement
complaint filed in the U.S. District Court in Arizona on November 23, 2001 by
the Lemelson Medical, Education & Research Foundation, Limited Partnership (the
"Lemelson Foundation"). The Lemelson Foundation accuses the 88 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. Prior to the service of the complaint, 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. By
order of the Court entered March 20, 2002, in response to a request by the
Lemelson Foundation, the case involving the Company was stayed pending the
outcome of a related case in Nevada brought by bar code manufacturers. The
Nevada case is scheduled to go to trial in November 2002. The Order for the stay
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 and
defendants 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, evaluating the
merits of joining the joint-defense group, and discussing the license offer with
attorneys for the Lemelson Foundation. 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 thus has not established a reserve.
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.
9
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 2000 and 2001 relating to the strategic business realignment
program were $19.1 million and $11.3 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 and return to
profitability.
In the first quarter of 2002, special charges relating to the strategic
business realignment program were recorded in the amount of $0.2 million. These
charges consisted primarily of severance costs related to the elimination of an
additional 10 FTE positions and costs associated with the Company's decision to
close a product storage facility located in San Diego, California. In the second
quarter of 2002, no additional special charges relating to the strategic
business realignment program were recorded. In September 2002, the Company
supplemented this program through the integration of The Company Store and
Domestications divisions. As a result of the continued actions needed to execute
these plans, in the third quarter of 2002, an additional $1.5 million of special
charges were recorded. Of this amount, $1.3 million consisted of additional
facility exit costs resulting primarily from the integration of The Company
Store and Domestications divisions causing management to reassess its plan to
consolidate its office space utilization at the corporate offices in New Jersey.
The additional $0.2 million consisted of further severance costs for an
individual relating to the Company's strategic business realignment program.
As of the end of the third quarter of 2002, a liability was included on
the Company's balance sheet related to future costs in connection with the
Company's strategic business realignment program consisting of the following (in
thousands):
SEVERANCE &
PERSONNEL 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 340 1,356 -- 1,696
Paid in 2002 (2,377) (4,234) (162) (6,773)
-------- -------- -------- --------
Balance at September 28, 2002 $ 509 $ 5,259 $ 211 $ 5,979
======== ======== ======== ========
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. The Company's previously established
reserves for Maumelle, Arkansas were adequate based upon the terms of the final
settlement agreement.
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
services agreement with the buyer for a period of three years.
The asset purchase agreement between the Company and HSN provides that
if Keystone Internet Services, Inc. fails to perform its obligations during the
first two years of the services contract, the purchaser can 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
10
proceeds of the sale, has 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. As of September 28, 2002, the
balance in the escrow fund was $2.3 million.
The Company recognized a net gain on the sale of approximately $23.2
million in fiscal year 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 recognized $0.3 million of the deferred gain consistent with the
terms of the escrow agreement. Proceeds of $0.3 million relating to the deferred
gain were received July 2, 2002. The recognition of an additional gain of up to
approximately $2.3 million has been deferred until the contingencies described
above expire, which will occur no later than the middle of the 2003 fiscal year.
7. SALE OF KINDIG LANE PROPERTY
On May 3, 2001, as part of the Company's strategic business realignment
program, the Company sold its fulfillment warehouse in Hanover, Pennsylvania
(the "Kindig Lane Property") and certain equipment located therein for $4.7
million 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 affiliate of the Company, and to a partial repayment of the indebtedness
under the Congress Credit Facility. The Company realized a net gain on the sale
of approximately $1.5 million. The Company has continued to use the Kindig Lane
Property under a lease agreement with the third party, and will continue to
lease a portion of the Kindig Lane Property on a month-to-month basis until
March 31, 2003. Effective March 31, 2003, the Company will have transitioned the
fulfillment operations from the leased Kindig Lane distribution facility in
Hanover, Pennsylvania to its own facility in Roanoke, Virginia.
8. CHANGES IN EMPLOYMENT AGREEMENTS
Shull Employment Agreement. Effective December 5, 2000, Thomas C.
Shull, Meridian Ventures, LLC, a limited liability company controlled by Mr.
Shull ("Meridian"), and the Company entered into a Services Agreement (the
"December 2000 Services Agreement"). The December 2000 Services Agreement was
replaced by a subsequent services agreement, dated as of August 1, 2001 (the
"August 2001 Services Agreement"), among Mr. Shull, Meridian and the Company,
and a Services Agreement, dated as of December 14, 2001 (the "December 2001
Services Agreement"), among Mr. Shull, Meridian, and the Company. The December
2001 Services Agreement was replaced effective September 1, 2002 by an
Employment Agreement between Mr. Shull and the Company, dated as of September 1,
2002, as amended by Amendment No. 1 thereto dated as of September 1, 2002 (as
amended, the "Shull Employment Agreement"), pursuant to which Mr. Shull is
employed by the Company as its President and Chief Executive Officer, as
described below.
The term of the Shull Employment Agreement began on September 1, 2002
and will terminate on September 30, 2004 (the "Shull Employment Agreement
Term").
Under the Shull Employment Agreement, Mr. Shull is 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 in the Company's employee benefit plans, including but not limited
to the Company's Key Executive Eighteen Month Compensation Continuation Plan
(the "Change of Control Plan") and its transaction bonus program. The Company is
also to reimburse Mr. Shull for his reasonable out-of-pocket expenses incurred
in connection with his employment by the Company.
Under the Shull Employment Agreement, the Company shall pay the
remaining unpaid $300,000 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
Level 8 participants (as defined in such Plan) receive under such Plan for such
period, subject to all of the terms and conditions applicable generally to Level
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.
11
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, provided
the Employment Agreement has not terminated due to Willful Misconduct (as
defined in the Shull Employment Agreement) or material breach thereof by Mr.
Shull, or Mr. Shull's death or permanent disability. Such payments shall be made
notwithstanding any other termination of the Employment Agreement on or prior to
such date or as a result of another event constituting a Change of Control.
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 will be required to make
a lump sum cash payment to Mr. Shull on the date of such closing pursuant to the
Change of Control Plan, the Company's transaction bonus program and the
Company's Management Incentive 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.
Under the Shull Employment Agreement, additional amounts are payable to
Mr. Shull by the Company under certain circumstances upon the termination 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 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 (not to exceed 18 months of such Base Compensation), plus (ii) such
additional amount, if any, in severance pay which, when combined with the amount
payable pursuant to clause (i) equals 18 months of Base Compensation and such
amount of bonus as may be payable pursuant to the Company's 2002 Management
Incentive Plan or other bonus plan, as applicable (based upon the termination
date and the terms and conditions of the applicable bonus plan), as described in
paragraph 4(b), as well as such amounts as may be unpaid under the second
preceding paragraph and 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 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.
12
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 million shares of
the Company's common stock (the "Shull 2000 Stock Option Agreement"). Effective
as of September 1, 2002, 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, the Company entered into a stock option agreement
with Mr. Shull to evidence the grant to Mr. Shull of an option to purchase
500,000 shares of the Company's common stock under the Company's 2000 Management
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.
Issuance of Stock Options. On August 8, 2002, the Company issued
options to purchase 3,750,000 shares of the Company's common stock to certain
Management Incentive Plan ("MIP") Level 7 and 8 employees, including various
executive officers, at a price of $0.24 per share under the Company's 2000
Management Stock Option Plan. In addition, on August 8, 2002, the Company
authorized the President to grant options to purchase up to an aggregate of
1,045,000 and 1,366,000 shares of the Company's common stock to certain MIP
Level 4 and MIP Level 5 and 6 employees, respectively, at a price of $0.24 per
share under the Company's 2000 Management Stock Option Plan.
On October 2, 2002, the Company issued options to purchase 600,000
shares of the Company's common stock to an Executive Vice President at a price
of $0.27 per share under the Company's 2000 Management Stock Option Plan.
Charles F. Messina. In October 2002, Charles F. Messina resigned as
Executive Vice President, Chief Administrative Officer and Secretary of the
Company effective September 30, 2002. In connection with such resignation, the
Company and Mr. Messina entered into a severance agreement dated September 30,
2002 providing for cash payments of $884,500. The required accruals will be made
during the fourth quarter.
Brian C. Harriss. In October 2002, Brian C. Harriss was appointed as
Executive Vice President - Human Resources and Legal and Secretary of the
Company effective December 2, 2002. Prior to January 2002, Mr. Harriss had
served the Company as Executive Vice President and Chief Financial Officer. In
connection with such appointment, Mr. Harriss and the Company have terminated a
severance agreement entered into during January 2002 at the time of Mr. Harriss'
resignation from the Company, and Mr. Harriss has waived his rights to certain
payments under such severance agreement.
Other Executives. In October 2002, the Company entered into
arrangements with three of its Executive Vice Presidents pursuant to which it
agreed, amongst other things, to provide eighteen months of severance pay, COBRA
reimbursement and Exec-U-Care plan coverage in the event their employment with
the Company is terminated either by the Company "For Cause" or by them "For Good
Reason" (as such terms are defined). Severance payments, if any, are estimated
to be $1,630,500 in the aggregate and will not be accrued until triggered.
9. RECENTLY ISSUED ACCOUNTING STANDARDS
In July 2001, the Financial Accounting Standards Board (the "FASB")
issued SFAS No. 141, "Business Combinations" ("FAS 141"), and No. 142, "Goodwill
and Other Intangible Assets" ("FAS 142"). FAS 141 requires all
13
business combinations initiated after June 30, 2001 to be accounted for using
the purchase method. 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 September
28, 2002 is $9.3 million. The Company adopted FAS 142 effective January 1, 2002
and, as a result, the quarters ended March 30, 2002, June 29, 2002, and
September 28, 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 results of the appraisal indicated no
goodwill transition impairment based upon the requirements set forth in FAS 142.
If the provisions of FAS 142 had been implemented for the 13-week
period ended September 29, 2001 and the Company had not included an amortization
charge for goodwill, the Company's net loss would have decreased by $0.1 million
to $6.7 million. If the provisions under FAS 142 had been implemented for the
39-week period ended September 29, 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 $1.4 million. Net loss per share for both the 13-week and
39-week periods ended September 29, 2001 would have remained unchanged at $.05
for both the basic and diluted loss per share calculations.
In July 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations" ("FAS 143"). FAS 143 requires entities to record the
fair value of a liability for an asset retirement obligation in the period in
which it is incurred. When the liability is initially recorded, the entity is
required to capitalize the cost by increasing the carrying value of the related
long-lived asset. Over time, the liability is accreted to its present value each
period, 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 by the Company effective fiscal 2003. The Company
believes adoption of FAS 143 will not have a material effect on its financial
statements.
In October 2001, the FASB issued SFAS No. 144, "Accounting for
Impairment or Disposal of Long-Lived Assets" ("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 adoption has had no effect on the Company's results of
operations or financial position.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB SFAS No. 13, and Technical
Corrections" ("FAS 145"). FAS 145 rescinds SFAS No. 4, 44, and 64 and amends
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.
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
adopt the provisions of FAS 146 effective for exit or disposal activities
initiated after December 31, 2002. The Company is currently evaluating the
impact of adoption of this statement.
In October 2002, the FASB issued SFAS No. 147, "Acquisitions of Certain
Financial Institutions - An Amendment of SFAS No. 72 and SFAS No. 144 and FASB
Interpretation No. 9" ("FAS 147"). FAS 147 addresses the financial accounting
and reporting for the acquisition of all or part of a financial institution,
except for a transaction between two or more mutual enterprises. The Company has
reviewed the provisions of FAS 147 and has concluded that such statement has had
no effect on the Company's results of operations or financial position.
14
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, effective July 1,
2002, to the extent 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. 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 earnings before interest, taxes, depreciation,
amortization and certain non-cash charges covenants were also amended. In
addition, the amendment required the payment of a fee of $100,000.
On August 16, 2002, the Company amended the Congress Credit Facility to
(i) extend the term of the Tranche B Term Loan to January 31, 2004, (ii)
increase by $3,500,000 the borrowing reflected by the Tranche B Term Note to
$8,410,714, and (iii) make certain related technical amendments to the Congress
Credit Facility. The amendment required the payment of fees in the amount of
$410,000.
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. SERIES B PARTICIPATING PREFERRED STOCK
On December 19, 2001, the Company consummated a transaction (the
"Richemont Transaction") with Richemont Finance S.A. ("Richemont") in which the
Company issued to Richemont 1,622,111 shares of Series B Participating Preferred
Stock ("Series B Preferred Stock"). The Series B Preferred Stock has a par value
of $0.01 per share.
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 on 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.
In the event of the liquidation, dissolution or winding up of the
Company, the holders of the Series B Preferred Stock are entitled to a
liquidation preference (the "Liquidation Preference") which was initially $47.36
per share. During each period set forth in the table below, the Liquidation
Preference shall equal the amount set forth opposite such period:
LIQUIDATION PREFERENCE
PERIOD PER SHARE TOTAL VALUE
March 1, 2002 - May 31, 2002 $ 49.15 $ 79,726,755.65
June 1, 2002 - August 31, 2002 $ 51.31 $ 83,230,515.41
September 1, 2002 - November 30, 2002 $ 53.89 $ 87,415,561.79
December 1, 2002 - February 28, 2003 $ 56.95 $ 92,379,221.45
March 1, 2003 - May 31, 2003 $ 60.54 $ 98,202,599.94
June 1, 2003 - August 31, 2003 $ 64.74 $ 105,015,466.14
September 1, 2003 - November 30, 2003 $ 69.64 $ 112,963,810.04
December 1, 2003 - February 29, 2004 $ 72.25 $ 117,197,519.75
March 1, 2004 - May 31, 2004 $ 74.96 $ 121,593,440.56
June 1, 2004 - August 31, 2004 $ 77.77 $ 126,151,572.47
September 1, 2004 - November 30, 2004 $ 80.69 $ 130,888,136,59
December 1, 2004 - February 28, 2005 $ 83.72 $ 135,803,132.92
March 1, 2005 - May 31, 2005 $ 86.85 $ 140,880,340.35
June 1, 2005 - August 23, 2005 $ 90.11 $ 146,168,422.21
15
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 preference of the Class A Preferred Stock previously held
by Richemont.
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. The Company may redeem all or less than all of the then outstanding
shares of Series B 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 has not appointed such an
observer.
16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following table sets forth, for the fiscal periods indicated, the
percentage relationship to net revenues of certain items in the Company's
Condensed Consolidated Statements of Income (Loss):
13- WEEKS ENDED 39- WEEKS ENDED
---------------------------------- -----------------------------------
SEPTEMBER 28, SEPTEMBER 29, SEPTEMBER 28, SEPTEMBER 29,
2002 2001 2002 2001
-------------- -------------- ------------- --------------
Net revenues 100.0% 100.0% 100.0% 100.0%
Cost of sales and operating expenses 65.0 65.5 63.9 63.9
Special charges 1.4 0.0 0.5 1.5
Selling expenses 23.9 25.9 23.2 27.2
General and administrative expenses 11.2 11.6 11.2 11.2
Depreciation and amortization 1.3 1.5 1.3 1.5
Loss from operations 2.8 4.5 0.1 5.3
Gain on sale of Improvements
and Kindig Lane Property 0.0 0.0 0.1 6.2
Interest expense, net 1.2 1.3 1.2 1.3
Net loss and comprehensive loss 4.0% 5.8% 1.2% 0.4%
RESULTS OF OPERATIONS - 13- WEEKS ENDED SEPTEMBER 28, 2002 COMPARED WITH THE 13-
WEEKS ENDED SEPTEMBER 29, 2001
Net Loss and Comprehensive Loss. The Company reported a net loss of
$4.2 million for the 13- weeks ended September 28, 2002 compared with a net loss
of $6.8 million for the comparable period in the year 2001. In addition to
measures of operating performance determined in accordance with generally
accepted accounting principles, management also uses earnings before interest,
income taxes, depreciation, amortization, and compensation expense relating to
stock options ("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
increased by $1.9 million to a loss of $1.4 million for the 13- weeks ended
September 28, 2002 as compared with a loss of $3.3 million for the comparable
period in the year 2001. Net loss per common share was $.06 for the 13- weeks
ended September 28, 2002 and $.05 for the 13- weeks ended September 29, 2001.
The per share amounts were calculated after deducting the Series B Preferred
Stock redemption price increase of $4.2 million for the 13- weeks ended
September 28, 2002 and the Series A Preferred Stock dividends and accretion of
$3.1 million for the comparable period in the year 2001. The weighted average
number of shares outstanding used in both the basic and diluted net loss per
share calculation was 138,315,800 for the 13-week period ended September 28,
2002. For the 13-week period ended September 29, 2001, the weighted average
number of shares used in the calculation in both the basic and diluted net loss
per share was 212,186,331. 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 same fiscal period in the year 2001, the $2.6 million
decrease in net loss was primarily due to a decrease in the following expenses
resulting from the Company's strategic business realignment program:
(i) cost of sales and operating expenses;
(ii) selling expenses; and
(iii) general and administrative expenses;
partially offset by special charges incurred in 2002 associated with the
Company's strategic business realignment program.
17
Net Revenues. Net revenues decreased $11.4 million (9.7%) for the
13-week period ended September 28, 2002 to $106.0 million from $117.4 million
for the comparable period in the year 2001. The decrease in net revenues is due
principally to softness in demand primarily related to certain brands and
reductions in unprofitable circulation. The discontinuance of the Domestications
Kitchen & Garden, Kitchen & Home and Encore catalogs resulted in a $0.2 million
reduction in net revenues for the 13-week period ended September 28, 2002.
Cost of Sales and Operating Expenses. Cost of sales and operating
expenses decreased to 65.0% of net revenues for the 13-week period ended
September 28, 2002 as compared with 65.5% of net revenues for the comparable
period in the year 2001. This change was due primarily to 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 program to
strategically realign its business and direct the Company's resources primarily
towards a loss reduction and return to profitability. In September 2002, the
Company supplemented this program through the integration of The Company Store
and Domestications divisions. As a result of the continued actions needed to
execute these plans, the Company recorded special charges of $1.5 million for
the 13-week period ended September 28, 2002 to primarily cover additional
charges related to the Company's plan to further consolidate its office space at
its corporate offices in New Jersey. For the 13-week period ended September 29,
2001, the Company did not incur any special charges relating to the strategic
business realignment program.
Selling Expenses. Selling expenses decreased by $5.1 million to $25.3
million for the 13- weeks ended September 28, 2002 as compared with $30.4
million for the comparable period in the year 2001. As a percentage relationship
to net revenues, selling expenses decreased to 23.9% for the 13- weeks ended
September 28, 2002 versus 25.9% for the comparable period in the year 2001. This
decrease was primarily due to the impact of circulation reductions. In addition,
decreases in paper pricing also contributed to the lower percentage relationship
to net revenues.
General and Administrative Expenses. General and administrative
expenses decreased by $1.8 million to $11.8 million for the 13- weeks ended
September 28, 2002 as compared with $13.6 million for the comparable period in
the year 2001. As a percentage relationship to net revenues, general and
administrative expenses were 11.2% of net revenues for the 13- weeks ended
September 28, 2002 versus 11.6% 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 September 28, 2002. This decrease is
partially offset by additional professional and legal fees of $0.7 million
associated with the Rakesh K. Kaul complaint mentioned in Note 4, Commitments
and Contingencies, to the Condensed Consolidated Financial Statements.
Depreciation and Amortization. Depreciation and amortization decreased
$0.4 million to $1.4 million for the 13- weeks ended September 28, 2002 as
compared with $1.8 million for the comparable period in the year 2001. The
decrease is primarily due to capital expenditures that have become fully
amortized and the elimination of goodwill amortization of $0.1 million resulting
from the implementation of FAS 142. As a percentage relationship to net
revenues, depreciation and amortization was 1.3% for the 13- weeks ended
September 28, 2002 and 1.5% for the comparable period in the year 2001.
Loss from Operations. The Company's loss from operations decreased by
$2.4 million to $2.9 million for the 13- weeks ended September 28, 2002 from a
loss of $5.3 million for the comparable period in the year 2001.
Interest Expense, Net. Interest expense, net decreased $0.2 million to
$1.3 million for the 13- weeks ended September 28, 2002 as compared with $1.5
million for the comparable period in the year 2001. The decrease in interest
expense in the third 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 amendments to the Congress Credit Facility.
18
RESULTS OF OPERATIONS - 39- WEEKS ENDED SEPTEMBER 28, 2002 COMPARED WITH THE 39-
WEEKS ENDED SEPTEMBER 29, 2001
Net Loss and Comprehensive Loss. The Company reported a net loss of
$4.2 million for the 39- weeks ended September 28, 2002 compared with a net loss
of $1.7 million for the comparable period in the year 2001. EBITDA decreased by
$11.9 million to $5.0 million for the 39- weeks ended September 28, 2002 as
compared with $16.9 million for the comparable period in the year 2001. The
results for the 39-week periods ended September 28, 2002 and September 29, 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. The net loss for the 39- weeks ended September 28, 2002 would have
decreased $21.5 million over the comparable period in 2001 prior to the
recognition of these gains. EBITDA for the 39- weeks ended September 28, 2002
would have increased $18.3 million over the comparable period in 2001 prior to
the recognition of these gains. Net loss per common share was $0.11 for the 39-
weeks ended September 28, 2002 and $0.05 for the 39- weeks ended September 29,
2001. The per share amounts were calculated after deducting the Series B
Preferred Stock redemption price increase of $10.6 million for the 39- weeks
ended September 28, 2002 and the Series A Preferred Stock dividends and
accretion of $9.0 million for the comparable period in the year 2001. The
weighted average number of shares outstanding used in both the basic and diluted
net loss per share calculation was 138,268,327 for the 39-week period ended
September 28, 2002 and 212,280,360 for the 39-week period ended September 29,
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 same fiscal period period in the year 2001, the $2.5
million increase in net loss 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 a decrease in the following expenses resulting from the
Company's strategic business realignment program:
(i) cost of sales and operating expenses;
(ii) selling expenses;
(iii) general and administrative expenses; and
(iv) special charges associated with the Company's strategic business
realignment program.
Net Revenues. Net revenues decreased $65.8 million (16.7%) for the
39-week period ended September 28, 2002 to $329.4 million from $395.2 million
for the comparable period in the year 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 39-week period ended September 28,
2002. The discontinuance of the Domestications Kitchen & Garden, Kitchen & Home,
Encore and Turiya catalogs contributed $6.2 million to the reduction in net
revenues for the 39-week period ended September 28, 2002. An additional portion
of the drop in revenues amounting to $1.8 million can be attributed to the
Company's focus on continued profitable operations, thus resulting in fewer, but
more profitable, third-party clients. The remaining balance of the decrease in
net revenues can be attributed to softness in demand primarily related to
certain brands and reductions in unprofitable circulation.
Cost of Sales and Operating Expenses. Cost of sales and operating
expenses decreased $42.1 million (16.7%) for the 39-week period ended September
28, 2002 to $210.4 million from $252.5 million for the comparable period in the
year 2001, although, as a percentage relationship to net revenues, they remained
constant at 63.9% for both the 39-week period ended September 28, 2002 and the
comparable period in the year 2001. Merchandise inventory costs increased by
1.0% as a percentage of net revenues, however, were offset by decreases in
operating expenses resulting from the actions taken in connection with the
Company's strategic business realignment program. These decreases occurred
primarily in the areas of variable telemarketing and distribution costs and
information systems costs associated with the Company's fulfillment centers.
19
Special Charges. In December 2000, the Company developed a program to
strategically realign its business and direct the Company's resources primarily
towards a loss reduction and return to profitability. In September 2002, the
Company supplemented this program through the integration of The Company Store
and Domestications divisions. As a result of the continued actions needed to
execute these plans, the Company recorded special charges of $6.1 million for
the 39-week period ended September 29, 2001. Primarily, these special charges
were incurred to record 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. For the 39-week period ended
September 28, 2002, the Company recorded an additional $1.7 million of special
charges relating to 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 storage
facility.
Selling Expenses. Selling expenses decreased by $30.9 million to $76.6
million for the 39- weeks ended September 28, 2002 as compared with $107.5
million for the comparable period in the year 2001. As a percentage relationship
to net revenues, selling expenses decreased to 23.2% for the 39- weeks ended
September 28, 2002 versus 27.2% for the comparable period in the year 2001. This
decrease was primarily due to the impact of circulation reductions. In addition,
decreases in paper pricing also contributed to the lower percentage of net
revenues.
General and Administrative Expenses. General and administrative
expenses decreased by $7.6 million to $36.8 million for the 39- weeks ended
September 28, 2002 as compared with $44.4 million for the comparable period in
the year 2001. As a percentage relationship to net revenues, general and
administrative expenses remained constant at 11.2% of net revenues for both the
39- weeks ended September 28, 2002 and September 29, 2001. The Company has
incurred an increase in professional and legal fees of $2.8 million associated
with the Rakesh K. Kaul complaint mentioned in Note 4, Commitments and
Contingencies, to the Condensed Consolidated Financial Statements. This increase
is offset by reductions in costs 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 have
continued throughout the 39- weeks ended September 28, 2002.
Depreciation and Amortization. Depreciation and amortization decreased
by $1.3 million to $4.4 million for the 39- weeks ended September 28, 2002 as
compared with $5.7 million for the comparable period in the year 2001. The
decrease is primarily due to capital expenditures that have previously become
completely amortized and the elimination of goodwill amortization of $0.3
million resulting from the implementation of FAS 142. As a percentage
relationship to net revenues, depreciation and amortization was 1.3% for the 39-
weeks ended September 28, 2002 and 1.5% for the comparable period in the year
2001.
Loss from Operations. The Company's loss from operations decreased by
$20.5 million to $0.4 million for the 39- weeks ended September 28, 2002 from a
loss of $20.9 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 6.2%
of net revenues for the 39- weeks ended September 29, 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 recognized $0.3 million of the deferred
gain consistent with the terms of the escrow agreement. In the second quarter of
2001, 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 $1.1 million to
$4.0 million for the 39- weeks ended September 28, 2002 as compared with $5.1
million for the comparable period in the year 2001. The decrease in interest
expense 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 Congress
Credit Facility.
20
LIQUIDITY AND CAPITAL RESOURCES
Net cash used in operating activities. During the 39-week period ended
September 28, 2002, net cash used in operating activities was $4.6 million. Net
loss, when adjusted for depreciation, amortization and other non-cash items,
resulted in positive cash flow of $1.7 million for 39- weeks ended September 28,
2002. These funds were primarily used to reduce accounts payable, accrued
liabilities and to fund additional prepaid catalog costs in preparation for the
holiday catalog mailings. The uses of these funds were partially offset by funds
received from the collection of accounts receivable.
Net cash used by investing activities. During the 39-week period ended
September 28, 2002, net cash used by investing activities was $0.3 million. This
was due to $0.6 million of capital expenditures consisting primarily of upgrades
in equipment located at the Roanoke, Virginia distribution center and various
computer software applications, offset by $0.3 million of proceeds received
relating to the deferred gain associated with the sale of the Improvements
business.
Net cash provided by financing activities. During the 39-week period
ended September 28, 2002, net cash provided by financing activities was $4.7
million, which was primarily due to increased borrowings under both the amended
Congress Tranche B term loan facility and the Congress revolving loan 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 the payment
of an amendment fee of $410,000 to Congress.
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"). 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 recently amended $8.4 million Tranche B Term Loan. Total cumulative
borrowings, 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 incidence of additional indebtedness and on the
payment of Common Stock dividends. As of September 28, 2002, the Company had
$34.2 million of borrowings outstanding under the amended Congress Credit
Facility consisting of $16.9 million under the revolving credit facility and
$9.0 million and $8.3 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, the Company amended the Congress Credit Facility to
amend the definition of Consolidated Net Worth such that, effective July 1,
2002, to the extent that the goodwill or intangible assets of the Company and
its subsidiaries are 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. 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. In addition, the
amendment required the payment of a fee of $100,000.
On August 16, 2002, the Company amended the Congress Credit Facility to
(i) extend the term of the Tranche B Term Loan to January 31, 2004, (ii)
increase by $3.5 million the borrowing reflected by the Tranche B Term Note to
$8.4 million, and (iii) make certain related technical amendments to the
Congress Credit Facility. The amendment required the payment of fees in the
amount of $410,000.
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 services agreement with the buyer for a period of
three years.
The asset purchase agreement between the Company and HSN provides that
if Keystone Internet Services, Inc. fails to perform its obligations during the
first two years of the services contract, the purchaser can 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, has been
established for a period of two years under the terms of an escrow agreement
between
21
LWI Holdings, Inc., HSN and The Chase Manhattan Bank as a result of these
contingencies. As of September 28, 2002, the balance in the escrow fund is $2.3
million.
The Company recognized a net gain on the sale of approximately $23.2
million in fiscal year 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 recognized $0.3 million of the deferred gain consistent with the
terms of the escrow agreement. Proceeds of $0.3 million relating to the deferred
gain were received July 2, 2002. The recognition of an additional gain of up to
approximately $2.3 million has been deferred until the contingencies described
above expire, which will occur no later than the middle of the 2003 fiscal year.
General. At September 28, 2002, the Company had $1.0 million in cash
and cash equivalents compared with $1.4 million at September 29, 2001. Working
capital and current ratios at September 28, 2002 were $24.0 million and 1.32 to
1 versus $29.6 million and 1.36 to 1 at September 29, 2001. Total cumulative
borrowings, including financing under capital lease obligations, as of September
28, 2002, aggregated $34.2 million, $30.4 million of which is classified as
long-term. Remaining availability under the Congress Credit Facility as of
September 28, 2002 was $7.9 million. There were nominal capital commitments
(less than $0.1 million) at September 28, 2002.
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 action in its 2002 planning process and has been
accommodating the increased cost 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.
Management believes that the Company has sufficient liquidity and
availability under its credit agreements to fund its planned operations through
at least March 29, 2003. 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, to the Condensed Consolidated Financial Statements.
USES OF ESTIMATES AND OTHER CRITICAL ACCOUNTING POLICIES
During the third quarter ended September 28, 2002, there were no
changes in the Company's policies regarding the use of estimates and other
critical accounting policies. 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, for additional information relating to the Company's uses of estimates and
other critical accounting policies.
NEW ACCOUNTING PRONOUNCEMENTS
In July 2001, the Financial Accounting Standards Board (the "FASB")
issued SFAS No. 141, "Business Combinations" ("FAS 141"), and No. 142, "Goodwill
and Other Intangible Assets" ("FAS 142"). FAS 141 requires all business
combinations initiated after June 30, 2001 to be accounted for using the
purchase method. 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 September 28, 2002 is $9.3
million. The Company adopted FAS 142 effective January 1, 2002 and, as a result,
the quarters ended March 30, 2002, June 29, 2002, and September 28, 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 results of the appraisal indicated no goodwill transition impairment based
upon the requirements set forth in FAS 142.
If the provisions of FAS 142 had been implemented for the 13-week
period ended September 29, 2001 and the Company had not included an amortization
charge for goodwill, the Company's net loss would have decreased by $0.1 million
to $6.7 million. If the provisions under FAS 142 had been implemented for the
39-week period ended
22
September 29, 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 $1.4
million. Net loss per share for both the 13-week and 39-week periods ended
September 29, 2001 would have remained unchanged at $.05 for both the basic and
diluted loss per share calculations.
In July 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations" ("FAS 143"). FAS 143 requires entities to record the
fair value of a liability for an asset retirement obligation in the period in
which it is incurred. When the liability is initially recorded, the entity is
required to capitalize the cost by increasing the carrying value of the related
long-lived asset. Over time, the liability is accreted to its present value each
period, 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 by the Company effective fiscal 2003. The Company
believes adoption of FAS 143 will not have a material effect on its financial
statements.
In October 2001, the FASB issued SFAS No. 144, "Accounting for
Impairment or Disposal of Long-Lived Assets" ("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 adoption has had no effect on the Company's results of
operations or financial position.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB SFAS No. 13, and Technical
Corrections" ("FAS 145"). FAS 145 rescinds SFAS No. 4, 44, and 64 and amends
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.
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
adopt the provisions of FAS 146 effective for exit or disposal activities
initiated after December 31, 2002. The Company is currently evaluating the
impact of adoption of this statement.
In October 2002, the FASB issued SFAS No. 147, "Acquisitions of Certain
Financial Institutions - An Amendment of SFAS No. 72 and SFAS No. 144 and FASB
Interpretation No. 9" ("FAS 147"). FAS 147 addresses the financial accounting
and reporting for the acquisition of all or part of a financial institution,
except for a transaction between two or more mutual enterprises. The Company has
reviewed the provisions of FAS 147 and has concluded that such statement has had
no effect on the Company's results of operations or financial position.
SEASONALITY
The revenues and business for the Company are seasonal. The Company
processes and ships more catalog orders during the fourth quarter holiday season
than in any other quarter of the year. Accordingly, the Company recognizes a
disproportionate share of annual revenue during the last three months of the
year.
FORWARD-LOOKING STATEMENTS
The following statement from above constitutes a forward-looking
statement 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 agreements to fund its planned operations through
at least March 29, 2003."
23
CAUTIONARY STATEMENTS
The following material identifies important factors that could cause
actual results to differ materially from those expressed in the forward looking
statement identified above and in any other forward 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 home fashions
specifically, and leading to a reduction in consumer spending specifically with
reference to other types of merchandise the Company offers in its catalogs or
over the Internet, or which are offered by the Company's third-party fulfillment
clients.
Customer response to the Company's merchandise offerings and
circulation changes; effects of shifting patterns of e-commerce versus catalog
purchases; costs associated with printing and mailing catalogs and fulfilling
orders; effects of potential slowdowns or other disruptions in postal service;
dependence on customers' seasonal buying patterns; and fluctuations in foreign
currency exchange rates.
The ability of the Company to achieve projected levels of sales and the
ability of the Company to reduce costs commensurately with sales projections.
Increases in postage, printing and paper prices and/or the inability of the
Company to reduce expenses generally as required for profitability and/or
increase prices of the Company's merchandise to offset expense increases.
The failure of the Internet generally to achieve the projections for it
with respect to growth of e-commerce or otherwise, and the failure of the
Company to increase Internet sales. The imposition of regulatory, tax or other
requirements with respect to Internet sales. Actual or perceived technological
difficulties or security issues with respect to conducting e-commerce over the
Internet generally or through the Company's web sites or those of its
third-party fulfillment clients specifically. The failure of strategic alliances
with online retailers to achieve the benefits projected for them.
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 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. The effects, if any, of the West Coast
Dock Strike or any future strikes on the Company's ability to timely obtain and
distribute merchandise.
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,
24
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.
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 which 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, including the integration of its Domestications and The
Company Store divisions, or 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, including the integration of its Domestications and The Company Store
divisions, 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 obtain advance rates under the Congress
Credit Facility which are at least as favorable as those obtained in the past.
The ability of the Company 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.
The initiation by the Company of additional cost cutting and
restructuring initiatives, the costs associated therewith, and the ability of
the Company to timely realize any savings anticipated in connection therewith.
The ability of the Company to maintain insurance coverage required in
order to operate its businesses and as required by the Congress Credit Facility.
The 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 due to market
conditions 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 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 result 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 with the Securities and Exchange Commission.
25
ITEM 3. QUANTITIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
INTEREST RATES: The Company's exposure to market risk relates to
interest rate fluctuations for borrowings under the Congress revolving credit
facility and its term financing facility, which bear interest at variable rates.
At September 28, 2002, outstanding principal balances under these facilities
subject to variable rates of interest were approximately $25.9 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
September 28, 2002, would be approximately $0.26 million on an annual basis.
ITEM 4. CONTROLS AND PROCEDURES
Within 90 days prior to the filing of this report, an evaluation was
carried out under the supervision and with the participation of the Company's
management, including its Chief Executive Officer and Chief Financial Officer,
of the effectiveness of the design and operation of the Company's disclosure
controls and procedures (as such term is defined in Rule 13a-14c under the
Securities Exchange Act of 1934, as amended). Based upon that evaluation, the
Chief Executive Officer and the Chief Financial Officer concluded that the
design and operation of the Company's disclosure controls and procedures were
effective. No significant changes were made to the Company's internal controls
or to other factors that could significantly affect these disclosure controls
subsequent to the date of the evaluation.
26
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 which 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. Oral argument on the appeal, if scheduled, is not expected
until early 2003. 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, Inc. and Hanover
Direct Virginia, Inc. On May 14, 2002, the Court (1) granted the Company's
Motion to quash service on behalf of Hanover Direct, Hanover Brands, and Hanover
Direct Virginia, leaving only LWI Holdings, Hanover Company Store, Kitchen &
Home, and Silhouettes, as defendants, and (2) granted the Company's Motion to
Stay the action in favor of the previously filed Oklahoma action, so nothing
will proceed on this case against the remaining entities until the Oklahoma case
is decided. The Company believes it has defenses against the claims. The Company
plans to conduct a vigorous defense of this action.
A class action lawsuit was commenced on February 13, 2002 entitled Jacq
Wilson, suing on behalf of himself, all others similarly situated, and the
general public v. Brawn of California, Inc. dba International Male and
Undergear, and Does 1-100 ("Brawn") in the Superior Court of the State of
California, City and County of San Francisco. Does 1-100 are internet and
catalog direct marketers offering a selection of men's clothing, sundries, and
shoes who advertise within California and nationwide. The complaint alleges that
for at least four years, members of the class have been charged an unlawful,
unfair, and fraudulent insurance fee and tax on orders sent to them by Brawn;
that Brawn was engaged in untrue, deceptive and misleading advertising in that
it was not lawfully required or permitted to collect insurance, tax and sales
tax from customers in California; and that Brawn has engaged in acts of unfair
competition under the state's Business and Professions Code. Plaintiff and the
class seek (i) restitution and disgorgement of all monies wrongfully collected
and earned by Brawn, including interest and other gains made on account of these
practices, including reimbursement in the amount of the insurance, tax and sales
tax collected unlawfully, together with interest, (ii) an order enjoining Brawn
from charging customers insurance and tax on its order forms and/or from
27
charging tax on the delivery, shipping and insurance charges, (iii) an order
directing Brawn to notify the California State Board of Equalization of the
failure to pay the correct amount of tax to the state and to take appropriate
steps to provide the state with the information needed for audit, and (iv)
compensatory damages, attorneys' fees, pre-judgment interest, and costs of the
suit. The claims of the individually named plaintiff and for each member of the
class amount to less than $75,000. On April 15, 2002, the Company filed a Motion
to Stay the Wilson action in favor of the previously filed Martin action. On May
14, 2002, the Court heard the argument in the Company's Motion to Stay the
action in favor of the Oklahoma action, denying the motion. In October 2002, the
Court granted the Company's motion for leave to amend the answer. Discovery is
proceeding. Trial is currently scheduled for April 14, 2003 and the Company
plans to conduct a vigorous defense of this action.
A class action lawsuit was commenced on February 20, 2002 entitled
Argonaut Consumer Rights Advocates Inc., suing on behalf of the General Public
v. Gump's By Mail, Inc. ("Gump's"), and Does 1-100 in the Superior Court of the
State of California, City and County of San Francisco. The plaintiff is a
non-profit public benefit corporation suing under the California Business and
Profession Code. Does 1-100 would include persons whose activities include the
direct sale of tangible personal property to California consumers including the
type of merchandise that Gump's -- the store and the catalog -- sell, by
telephone, mail order, and sales through the web sites www.gumpsbymail.com and
www.gumps.com. The complaint alleges that for at least four years members of the
class have been charged an unlawful, unfair, and fraudulent tax and "sales tax"
on their orders in violation of California law and court decisions, including
the state Revenue and Taxation Code, Civil Code, and the California Board of
Equalization; that Gump's engages in unfair business practices; that Gump's
engaged in untrue and misleading advertising in that it was not lawfully
required to collect tax and sales tax from customers in California; is not
lawfully required or permitted to add tax and sales tax on separately stated
shipping or delivery charges to California consumers; and that it does not add
the appropriate or applicable or specific correct tax or sales tax to its
orders. Plaintiff and the class seek (i) restitution of all tax and sales tax
charged by Gump's on each transaction and/or restitution of tax and sales tax
charged on the shipping charges; (ii) an order enjoining Gump's from charging
customers for tax on orders or from charging tax on the shipping charges; and
(iii) attorneys' fees, pre-judgment interest on the sums refunded, and costs of
the suit. On April 15, 2002, the Company filed an Answer and Separate
Affirmative Defenses to the complaint, generally denying the allegations of the
complaint and each and every cause of action alleged, and denying that plaintiff
has been damaged or is entitled to any relief whatsoever. On September 19, 2002,
the Company filed a motion for leave to file an amended answer, containing
several additional affirmative defenses based on the proposition that the proper
defendant in this litigation (if any) is the California State Board of
Equalization, not the Company, and that plaintiff failed to exhaust its
administrative remedies prior to filing suit. Discovery is now proceeding. Trial
is currently scheduled to begin on May 19, 2003. The Company plans to conduct a
vigorous defense of this action.
A class action lawsuit was commenced on March 5, 2002 entitled Argonaut
Consumer Rights Advocates Inc., suing on behalf of the General Public v.
Domestications LLC, and Does 1-100 ("Domestications") in the Superior Court of
the State of California, City and County of San Francisco. The plaintiff is a
non-profit public benefit corporation suing under the California Business and
Profession Code. Does 1-100 would include persons responsible for the conduct
alleged in the complaint, including the direct sale of tangible personal
property to California consumers including the type of merchandise that
Domestications sells, by telephone, mail order, and sales through the web site
www.domestications.com. The plaintiff claims that for at least four years
members of the class have been charged an unlawful, unfair, and fraudulent tax
and sales tax for different rates and amounts on the catalog and internet orders
on the total amount of goods, tax and sales tax on shipping charges, which are
not subject to tax or sales tax under California law, in violation of California
law and court decisions, including the state Revenue and Taxation Code, Civil
Code, and the California Board of Equalization; that Domestications engages in
unfair business practices; and that Domestications engaged in untrue and
misleading advertising in that it was not lawfully required to collect tax and
sales tax from customers in California. Plaintiff and the class seek (i)
restitution of all sums, interest and other gains made on account of these
practices; (ii) prejudgment interest on all sums wrongfully collected; (iii) an
order enjoining Domestications from charging customers for tax on their orders
and/or from charging tax on the shipping charges; and (iv) attorneys' fees and
costs of the suit. The Company filed an Answer and Separate Affirmative Defenses
to the Complaint, generally denying the allegations of the Complaint and each
and every cause of action alleged, and denying that plaintiff has been damaged
or is entitled to any relief whatsoever. Discovery is now proceeding. On
September 19, 2002, the Company filed a motion for leave to file an amended
answer, containing several additional affirmative defenses based on the
proposition that the proper defendant in this litigation (if any) is the
California State Board of Equalization, not the Company, and that plaintiff
failed to exhaust its administrative remedies prior to filing suit. Discovery is
proceeding. Trial is currently scheduled to begin on June 16, 2003. The Company
plans to conduct a vigorous defense of this action.
28
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 for 13 weeks of
accrued and unused vacation, damages in the amount of $3,583,800, or, in the
alternative, a declaratory judgment from the court that he is entitled to all
change of control benefits under the "Hanover Direct, Inc. Thirty-Six Month
Salary Continuation Plan," and damages in the amount of $1,396,066 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 on the 30th day following his termination of employment. 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 of Mr. Kaul's causes of action, 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 requests summary judgment
dismissing Mr. Kaul's claims including, without limitation, Mr. Kaul's claim for
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
summary judgment awarding damages on the Company's claim for reimbursement of a
tax loan. Mr. Kaul requests summary judgment dismissing certain of the Company's
counterclaims and defenses. The briefing on the motions is completed. 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 June 1994, a complaint was filed in the Supreme Court of the State
of New York, County of New York, by Donald Schupak, the former President, CEO
and Chairman of the Board of Directors of The Horn & Hardart Company, the
corporate predecessor to the Company, against the Company and Alan Grant Quasha.
The complaint asserts claims for alleged breaches of an agreement dated February
25, 1992 between Mr. Schupak and the Company (the "Agreement"), and for alleged
tortious interference with the Agreement by Mr. Quasha. Mr. Schupak seeks
compensatory damages in an amount, which is estimated to be not more than
$400,000, and punitive damages in the amount of $10 million; applicable
interest, incidental and consequential damages, plus costs and disbursements,
the expenses of the litigation and reasonable attorneys' fees. In addition,
based on the alleged breaches of the Agreement by the Company, Mr. Schupak seeks
a "parachute" payment of approximately $3 million under an earlier agreement
with the Company that he allegedly had waived in consideration of the Company's
performance of its obligations under the Agreement. The Company filed an answer
to the complaint on September 7, 1994. Discovery then commenced and documents
were exchanged. Each of the parties filed a motion for summary judgment at the
end of 1995, and both motions were denied in the spring of 1996. In April 1996,
due to health problems then being experienced by Mr. Schupak, the Court ordered
that the case be marked "off calendar" until plaintiff recovered and was able to
proceed with the litigation. In September 2002, more than six years later, Mr.
Schupak filed a motion to restore the case to the Court's calendar. The Company
filed papers in opposition to the motion on October 10, 2002, asserting that the
motion should be denied on the ground that plaintiff failed to timely comply
with the terms of the Court's order concerning restoration and, alternatively,
on the ground of laches. The plaintiff filed reply papers on November 4, 2002,
and the parties are awaiting decision by the Court. The Company believes the
claims to be without merit and intends to conduct a vigorous defense in the
event the case is restored to the calendar.
The Company was named as one of 88 defendants in a patent infringement
complaint filed in the U.S. District Court in Arizona on November 23, 2001 by
the Lemelson Medical, Education & Research Foundation, Limited Partnership (the
"Lemelson Foundation"). The Lemelson Foundation accuses the 88 defendants of
infringing seven U.S. patents which allegedly cover "automatic identification"
technology through the defendants' use of methods for scanning production
markings
29
such as bar codes. Prior to the service of the complaint, 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. By order of the
Court entered March 20, 2002, in response to a request by the Lemelson
Foundation, the case involving the Company was stayed pending the outcome of a
related case in Nevada brought by bar code manufacturers. The Nevada case is
scheduled to go to trial in November 2002. The Order for the stay 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 and defendants 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, evaluating the merits of joining the joint-defense
group, and discussing the license offer with attorneys for the Lemelson
Foundation. 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
thus has not established a reserve.
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.
30
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
10.1 Amendment No. 1 to Employment Agreement dated as of September 1, 2002
between Thomas C. Shull and the Company.
10.2 Final form of letter agreement between the Company and certain Level 8
executive officers.
99.1 Certification signed by Thomas C. Shull.
99.2 Certification signed by Edward M. Lambert.
(b) Reports on Form 8-K
1.1 Form 8-K, filed August 2, 2002 -- reporting pursuant to Item 5 of such
Form scheduling information regarding its conference call with
management to review the fiscal year 2002 first half operating results.
1.2 Form 8-K, filed August 8, 2002 -- reporting pursuant to Item 9 of such
Form operating results for the thirteen and twenty-six weeks ended June
29, 2002.
1.3 Form 8-K, filed August 13, 2002 -- reporting pursuant to Item 5 of such
Form an unofficial transcript of its conference call with management to
review the fiscal year 2002 first half operating results and a press
release announcing operating results for the thirteen and twenty-six
weeks ended June 29, 2002.
1.4 Form 8-K, filed October 2, 2002 -- reporting pursuant to Item 5 of such
Form the appointment of Mr. Brian C. Harriss as Executive Vice
President - Human Resources and Legal and Secretary of the Company
effective December 2, 2002, and the resignation of Charles F. Messina
as Executive Vice President, Chief Administrative Officer and Secretary
of the Company, effective September 30, 2002.
1.5 Form 8-K, filed October 2, 2002 -- reporting pursuant to Item 5 of such
Form the integration of the Company's Domestications and The Company
Store divisions.
1.6 Form 8-K, filed October 30, 2002 - reporting pursuant to Item 5 of such
Form that pursuant to a previously-signed, ordinary-course, multi-year
strategic alliance with Amazon.com, Amazon.com had begun to offer
Hanover Direct merchandise to some customers through a preview site on
Amazon.com.
1.7 Form 8-K, filed November 6, 2002 -- reporting pursuant to Item 5 of
such Form scheduling information regarding its conference call with
management to review the fiscal year 2002 third quarter and nine months
operating results.
1.8 Form 8-K, filed November 7, 2002 -- reporting pursuant to Item 5 of
such Form the issuance of two press releases announcing that, pursuant
to a previously-signed, ordinary course, multi-year strategic alliance
with Amazon.com, Amazon.com today began to offer Company merchandise to
all its customers through the formal launch of its Apparel &
Accessories Store.
1.9 Form 8-K, filed November 8, 2002 -- reporting pursuant to Item 9 of
such Form operating results for the thirteen and thirty-nine weeks
ended September 28, 2002.
2.0 Form 8-K, filed November 8, 2002 -- reporting pursuant to Item 9 of
such Form a change to previous guidance given by the Company regarding
the anticipated level of its EBITDA and sales for its 2002 fiscal year.
31
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized in the City of Edgewater, State of New
Jersey.
HANOVER DIRECT, INC.
Registrant
By: /s/ Edward M. Lambert
----------------------------------------
Edward M. Lambert
Executive Vice President and
Chief Financial Officer
(On behalf of the Registrant and as
principal financial officer)
Date: November 8, 2002
32
CERTIFICATIONS
I, Edward M. Lambert, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Hanover Direct, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
the registrant's board of directors:
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls;
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 8, 2002
/s/ Edward M. Lambert
----------------------------------------
Edward M. Lambert
Executive Vice President and
Chief Financial Officer
33
CERTIFICATIONS
I, Thomas C. Shull, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Hanover Direct, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
the registrant's board of directors:
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls;
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 8, 2002
/s/ Thomas C. Shull
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Thomas C. Shull
President and Chief Executive Officer
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