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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 MARCH 29, 2003
Commission file number 1-12082
HANOVER DIRECT, INC.
--------------------
(Exact name of registrant as specified in its charter)
DELAWARE 13-0853260
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(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
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(Telephone number)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES X NO __
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). YES __ NO X
Common stock, par value $.66 2/3 per share: 138,315,800 shares outstanding
(excluding treasury shares) as of May 9, 2003.
HANOVER DIRECT, INC.
TABLE OF CONTENTS
Page
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Part I - Financial Information
Item 1. Financial Statements
Condensed Consolidated Balance Sheets -
March 29, 2003 and December 28, 2002 ................................................................... 2
Condensed Consolidated Statements of Income (Loss) - 13- weeks ended
March 29, 2003 and March 30, 2002 ...................................................................... 4
Condensed Consolidated Statements of Cash Flows - 13- weeks ended
March 29, 2003 and March 30, 2002....................................................................... 5
Notes to Condensed Consolidated Financial Statements...................................................... 6
Item 2. Management's Discussion and Analysis of Consolidated Financial Condition and
Results of Operations................................................................................... 18
Item 3. Quantitative and Qualitative Disclosures about Market Risk.......................................... 25
Item 4. Controls and Procedures............................................................................. 25
Part II - Other Information
Item 1. Legal Proceedings................................................................................... 26
Item 5. Other Information................................................................................... 30
Item 6. Exhibits and Reports on Form 8-K.................................................................... 32
Signatures................................................................................................... 33
Certifications............................................................................................... 34
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)
MARCH 29, DECEMBER 28,
2003 2002
----------- ------------
(UNAUDITED)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 2,594 $ 785
Accounts receivable, net 13,580 16,945
Inventories 53,425 53,131
Prepaid catalog costs 17,222 13,459
Other current assets 4,016 3,967
--------- ----------
Total Current Assets 90,837 88,287
--------- ----------
PROPERTY AND EQUIPMENT, AT COST:
Land 4,395 4,395
Buildings and building improvements 18,208 18,205
Leasehold improvements 9,915 9,915
Furniture, fixtures and equipment 56,632 56,094
--------- ----------
89,150 88,609
Accumulated depreciation and amortization (60,570) (59,376)
--------- ----------
Property and equipment, net 28,580 29,233
--------- ----------
Goodwill, net 9,278 9,278
Deferred tax asset 13,600 12,400
Other assets 263 902
--------- ----------
Total Assets $ 142,558 $ 140,100
========= ==========
Continued on next page.
2
HANOVER DIRECT, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (CONTINUED)
(IN THOUSANDS OF DOLLARS, EXCEPT SHARE AMOUNTS)
MARCH 29, DECEMBER 28,
2003 2002
----------- ------------
(UNAUDITED)
LIABILITIES AND SHAREHOLDERS' DEFICIENCY
CURRENT LIABILITIES:
Current portion of long-term debt and capital lease obligations $ 29,423 $ 3,802
Accounts payable 44,581 42,873
Accrued liabilities 19,964 26,351
Customer prepayments and credits 6,900 4,722
Deferred tax liability 2,300 1,100
--------- ----------
Total Current Liabilities 103,168 78,848
--------- ----------
NON-CURRENT LIABILITIES:
Long-term debt 25 21,327
Other 5,804 6,387
--------- ----------
Total Non-current Liabilities 5,829 27,714
--------- ----------
Total Liabilities 108,997 106,562
--------- ----------
SERIES B REDEEMABLE PREFERRED STOCK, authorized, issued and outstanding
1,622,111 shares at March 29, 2003 and December 28, 2002; liquidation preference
was $98,203 and $92,379 at March 29, 2003 and December 28, 2002 95,664 92,379
SHAREHOLDERS' DEFICIENCY:
Common Stock, $.66 2/3 par value, authorized 300,000,000 shares;
140,436,729 shares issued at March 29, 2003 and December 28, 2002 93,625 93,625
Capital in excess of par value 334,053 337,507
Accumulated deficit (486,435) (486,627)
--------- ----------
(58,757) (55,495)
--------- ----------
Less:
Treasury stock, at cost (2,120,929 shares at March 29, 2003 and
December 28, 2002) (2,996) (2,996)
Notes receivable from sale of Common Stock (350) (350)
--------- ----------
Total Shareholders' Deficiency (62,103) (58,841)
--------- ----------
Total Liabilities and Shareholders' Deficiency $ 142,558 $ 140,100
========= ==========
See notes to Condensed Consolidated Financial Statements.
3
HANOVER DIRECT, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (LOSS)
(IN THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
FOR THE 13- WEEKS ENDED
---------------------------
MARCH 29, MARCH 30,
2003 2002
--------- ---------
NET REVENUES $ 102,474 $ 109,511
--------- ---------
OPERATING COSTS AND EXPENSES:
Cost of sales and operating expenses 65,539 71,163
Special charges 277 233
Selling expenses 24,453 24,620
General and administrative expenses 11,278 12,420
Depreciation and amortization 1,183 1,502
--------- ---------
102,730 109,938
--------- ---------
LOSS FROM OPERATIONS (256) (427)
Gain on sale of Improvements 1,911 -
--------- ---------
INCOME (LOSS) BEFORE INTEREST AND INCOME TAXES 1,655 (427)
Interest expense, net 1,448 1,353
--------- ---------
INCOME (LOSS) BEFORE INCOME TAXES 207 (1,780)
Provision for state income taxes 15 30
--------- ---------
NET INCOME (LOSS) AND COMPREHENSIVE INCOME (LOSS) 192 (1,810)
Preferred stock dividends and accretion 3,632 2,904
--------- ---------
NET LOSS APPLICABLE TO COMMON SHAREHOLDERS $ (3,440) $ (4,714)
========= =========
NET LOSS PER COMMON SHARE:
Net loss per common share - basic and diluted $ (.02) $ (.03)
========= =========
Weighted average common shares outstanding - basic (thousands) 138,316 138,225
========= =========
Weighted average common shares outstanding - diluted (thousands) 138,316 138,225
========= =========
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 13- WEEKS ENDED
---------------------------
MARCH 29, MARCH 30,
2003 2002
--------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 192 $ (1,810)
Adjustments to reconcile net income (loss) to net cash (used) by operating activities:
Depreciation and amortization, including deferred fees 1,680 1,847
Provision for doubtful accounts 179 -
Special charges 16 -
Gain on the sale of Improvements (1,911) -
Gain on the sale of property and equipment (2) -
Compensation expense related to stock options 177 317
Changes in assets and liabilities:
Accounts receivable 3,186 5,154
Inventories (294) 3,459
Prepaid catalog costs (3,763) (2,043)
Accounts payable 1,708 (6,599)
Accrued liabilities (6,387) (4,232)
Customer prepayments and credits 2,178 1,284
Other, net (455) (798)
--------- ---------
Net cash used by operating activities (3,496) (3,421)
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisitions of property and equipment (546) (88)
Proceeds from sale of Improvements 2,000 -
Costs related to the early release of escrow funds (89) -
Proceeds from disposal of property and equipment 2 -
--------- ---------
Net cash provided (used) by investing activities 1,367 (88)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings under Congress revolving loan facility 5,270 4,239
Payments under Congress Tranche A term loan facility (497) (497)
Payments under Congress Tranche B term loan facility (450) (268)
Payments of long-term debt and capital lease obligations (4) (62)
Payment of debt issuance costs (34) -
Payment of estimated Richemont tax obligation on Series B Preferred Stock dividends (347) -
--------- ---------
Net cash provided by financing activities 3,938 3,412
--------- ---------
Net increase (decrease) in cash and cash equivalents 1,809 (97)
Cash and cash equivalents at the beginning of the year 785 1,121
--------- ---------
Cash and cash equivalents at the end of the period $ 2,594 $ 1,024
========= =========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid for:
Interest $ 806 $ 831
Income taxes $ 196 $ 75
Non-cash investing and financing activities:
Series B Preferred Stock redemption price increase $ 3,285 $ 2,904
Tandem share expirations $ - $ 55
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 28, 2002. In the opinion of management, the
accompanying unaudited interim condensed consolidated financial statements
contain all material adjustments, consisting of normal recurring accruals,
necessary to present fairly the financial condition, results of operations and
cash flows of the Company and its consolidated subsidiaries for the interim
periods. Operating results for interim periods are not necessarily indicative of
the results that may be expected for the entire year. Certain prior year amounts
have been reclassified to conform to the current year presentation. Pursuant to
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information," the consolidated operations of the Company are reported as one
segment.
2. ACCUMULATED DEFICIENCY 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 LOSS PER COMMON SHARE
Net loss per common share is computed using the weighted average number
of common shares outstanding in accordance with the provisions of Statement of
Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share" ("FAS
128"). The weighted average number of shares used in the calculation for both
basic and diluted net loss per common share was 138,315,800 for the 13-week
period ended March 29, 2003 and 138,225,031 for the 13-week period ended March
30, 2002. Diluted net loss per common share equals basic net loss per common
share as the inclusion of potentially dilutive securities would have an
anti-dilutive impact on the dilutive calculation as a result of the net losses
incurred during the 13-week periods ended March 29, 2003 and March 30, 2002.
Currently, all potentially dilutive securities consist of options to purchase
shares of the Company's common stock that have been issued and are outstanding.
Outstanding options to purchase 14.5 million and 9.2 million shares of the
Company's common stock at prices ranging from $0.20 to $3.50 for the 13-week
periods ended March 29, 2003 and March 30, 2002, respectively, were excluded
from the calculation of diluted earnings per share because they would have been
anti-dilutive. Of these options, 10,037 and 1,990,310 had exercise prices below
the average price of a common share for the 13-week periods ended March 29, 2003
and March 30, 2002, respectively.
4. COMMITMENTS AND CONTINGENCIES
A class action lawsuit was commenced on March 3, 2000 entitled Edwin
L. Martin v. Hanover Direct, Inc. and John Does 1 through 10, bearing case no.
CJ2000-177 in the State Court of Oklahoma (District Court in and for Sequoyah
County). Plaintiff commenced the action on behalf of himself and a class of
persons who have at any time purchased a product from the Company and paid for
an "insurance charge." The complaint sets forth claims for breach of contract,
unjust enrichment, recovery of money paid absent consideration, fraud and a
claim under the New Jersey Consumer Fraud Act. The complaint alleges that the
Company charges its customers for delivery insurance even though, among other
things, the Company's common carriers already provide insurance and the
insurance charge provides no benefit to the Company's customers. Plaintiff also
seeks a declaratory judgment as to the validity of the delivery insurance. The
damages sought are (i) an order directing the Company to return to the plaintiff
and class members the "unlawful revenue" derived from the insurance charges,
(ii) declaring the rights of the parties, (iii) permanently enjoining the
Company from imposing the insurance charge, (iv) awarding threefold damages of
less than $75,000 per plaintiff and per class member, and (v) attorneys' fees
and costs. 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
6
motion was granted, defining the class as "All persons in the United States who
are customers of any catalog or catalog company owned by Hanover Direct, Inc.
and who have at any time purchased a product from such company and paid money
that was designated to be an 'insurance' charge." On August 21, 2001, the
Company filed an appeal of the order with the Oklahoma Supreme Court and
subsequently moved to stay proceedings in the District Court pending resolution
of the appeal. The appeal has been fully briefed. At a subsequent status
hearing, the parties agreed that issues pertaining to notice to the class would
be stayed pending resolution of the appeal, that certain other issues would be
subject to limited discovery, and that the issue of a stay for any remaining
issues would be resolved if and when such issues arise. The Oklahoma Supreme
Court has not yet ruled on the pending appeal. Oral argument on the appeal, if
scheduled, was expected during the first half of 2003 but has yet to be
scheduled by the Court. The Company believes it has defenses against the claims
and plans to conduct a vigorous defense of this action.
On August 15, 2001, the Company was served with a summons and
four-count complaint filed in Superior Court for the City and County of San
Francisco, California, entitled Teichman v. Hanover Direct, Inc., Hanover
Brands, Inc., Hanover Direct Virginia, Inc., and Does 1-100. The complaint was
filed by a California resident, seeking damages and other relief for herself and
a class of all others similarly situated, arising out of the insurance fee
charged by catalogs and Internet sites operated by subsidiaries of the Company.
Defendants, including the Company, have filed motions to dismiss based on a lack
of personal jurisdiction over them. In January 2002, plaintiff sought leave to
name six additional entities: International Male, Domestications Kitchen &
Garden, Silhouettes, Hanover Company Store, Kitchen & Home, and Domestications
as co-defendants. On March 12, 2002, the Company was served with the First
Amended Complaint in which plaintiff named as defendants the Company, Hanover
Brands, Hanover Direct Virginia, LWI Holdings, Hanover Company Store, Kitchen
and Home, and Silhouettes. On April 15, 2002, the Company filed a Motion to Stay
the Teichman action in favor of the previously filed Martin action and also
filed a Motion to quash service of summons for lack of personal jurisdiction on
behalf of defendants Hanover Direct, Inc., Hanover Brands, and Hanover Direct
Virginia. On May 14, 2002, the Court (1) granted the Company's Motion to quash
service on behalf of Hanover Direct, Hanover Brands, and Hanover Direct
Virginia, leaving only LWI Holdings, Hanover Company Store, Kitchen & 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 and plans to conduct a
vigorous defense of this action.
A lawsuit was commenced as both a class action and for the benefit of
the general public on February 13, 2002 entitled Jacq Wilson, suing on behalf of
himself, all others similarly situated, and the general public v. Brawn of
California, Inc. dba International Male and Undergear, and Does 1-100 ("Brawn")
in the Superior Court of the State of California, City and County of San
Francisco. Does 1-100 are allegedly Internet and catalog direct marketers
offering a selection of men's clothing, sundries, and shoes who advertise within
California and nationwide. The complaint alleges that for at least four years
members of the class and the general public have been charged an unlawful,
unfair and fraudulent insurance fee and tax on orders sent to them by Brawn;
that Brawn was engaged in untrue, deceptive and misleading advertising in that
it was not lawfully required or permitted to collect an insurance fee, tax and
sales tax from customers in California; and that Brawn has engaged in acts of
unfair competition under the state's Business and Professions Code. Plaintiff
seeks (i) restitution and disgorgement of all monies wrongfully collected and
earned by Brawn, including interest and other gains made on account of these
practices, including reimbursement in the amount of the insurance fee, tax and
sales tax collected unlawfully, together with interest, (ii) an order enjoining
Brawn from charging customers the insurance fee and tax on its order forms
and/or from charging tax on the delivery, shipping and insurance charges, (iii)
an order directing Brawn to notify the California State Board of Equalization of
the failure to pay the correct amount of tax to the state and to take
appropriate steps to provide the state with the information needed for audit,
and (iv) compensatory damages, attorneys' fees, pre-judgment interest and costs
of the suit. The Plaintiff alleged that the claims of the individually named
plaintiff and for each member of the class amount to less than $75,000. On April
15, 2002, the Company filed a Motion to Stay the Wilson action in favor of the
previously filed Martin action. On May 14, 2002, the Court heard the argument on
the Company's Motion to Stay the action in favor of the Martin action, denying
the Motion. In October 2002, the Court granted the Company's Motion for leave to
amend the answer. Discovery is completed. A mandatory settlement conference was
held on April 7, 2003 and a bench trial took place from April 14 through 17,
2003. At the bench trial, Plaintiff withdrew the class action allegations and
continued to proceed individually and on behalf of the general public pursuant
to California Business and Professions Code Section 17200 et seq. Post-trial
briefing should be completed in the third quarter of 2003. No date for decision
has been set by the Court. The Company plans to continue its vigorous defense of
this action.
7
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
Professions 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 -- sells, 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; that it 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. That motion was granted. On March
17, 2003, the Court granted Plaintiff's Request for Dismissal and the case was
dismissed with prejudice.
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
Professions Code. Does 1-100 would include persons responsible for the conduct
alleged in the complaint, including the direct sale of tangible personal
property to California consumers including the type of merchandise that
Domestications sells, by telephone, mail order, and sales through the web site
www.domestications.com. The plaintiff claims that for at least four years
members of the class have been charged an unlawful, unfair, and fraudulent tax
and sales tax for different rates and amounts on the catalog and Internet orders
on the total amount of goods, tax and sales tax on shipping charges, which are
not subject to tax or sales tax under California law, in violation of California
law and court decisions, including the state Revenue and Taxation Code, Civil
Code, and the California Board of Equalization; that Domestications engages in
unfair business practices; and that Domestications engaged in untrue and
misleading advertising in that it was not lawfully required to collect tax and
sales tax from customers in California. Plaintiff and the class seek (i)
restitution of all sums, interest and other gains made on account of these
practices; (ii) prejudgment interest on all sums wrongfully collected; (iii) an
order enjoining Domestications from charging customers for tax on their orders
and/or from charging tax on the shipping charges; and (iv) attorneys' fees and
costs of the suit. The Company filed an Answer and Separate Affirmative Defenses
to the Complaint, generally denying the allegations of the Complaint and each
and every cause of action alleged, and denying that plaintiff has been damaged
or is entitled to any relief whatsoever. On 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. That motion was granted. On
February 28, 2003, the Company filed a notice of Motion and memorandum of points
and authorities in support of its Motion for summary judgment setting forth that
Plaintiff's claims are without merit and incorrect as a matter of law. On March
17, 2003, the Court granted Plaintiff's Request for Dismissal and the case was
dismissed with prejudice.
A class action lawsuit was commenced on October 28, 2002 entitled John
Morris, individually and on behalf of all other persons & entities similarly
situated v. Hanover Direct, Inc., and Hanover Brands, Inc. (referred to here as
"Hanover"), No. L 8830-02 in the Superior Court of New Jersey, Bergen County --
Law Division. The plaintiff brings the action individually and on behalf of a
class of all persons and entities in New Jersey who purchased merchandise from
Hanover within six years prior to filing of the lawsuit and continuing to the
date of judgment. On the basis of a purchase made by plaintiff in August 2002 of
certain clothing from Hanover (which was from a men's division catalog,
8
the only one which retained the insurance line item in 2002), Plaintiff claims
that for at least six years, Hanover maintained a policy and practice of adding
a charge for "insurance" to the orders it received and concealed and failed to
disclose its policy with respect to all class members. Plaintiff claims that
Hanover's conduct was (i) in violation of the New Jersey Consumer Fraud Act, as
otherwise deceptive, misleading and unconscionable; (ii) such as to constitute
Unjust Enrichment of Hanover at the expense and to the detriment of plaintiff
and the class; and (iii) unconscionable per se under the Uniform Commercial Code
for contracts related to the sale of goods. Plaintiff and the class seek damages
equal to the amount of all insurance charges, interest thereon, treble and
punitive damages, injunctive relief, costs and reasonable attorneys' fees, and
such other relief as may be just, necessary, and appropriate. On December 13,
2002, the Company filed a Motion to Stay the Morris action in favor of the
previously filed Martin action. Plaintiff then filed an Amended Complaint adding
International Male as a defendant. The Company's response to the Amended
Complaint was filed on February 5, 2003. Plaintiff's response brief was filed
on March 17, 2003, and the Company's reply brief was filed on March 31, 2003.
Hearing on the Company's Motion to Stay is scheduled for May 9, 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 $298,650 for 13 weeks of
accrued and unused vacation, damages in the amount of $3,583,800, or, in the
alternative, a declaratory judgment from the court that he is entitled to all
change of control benefits under the "Hanover Direct, Inc. Thirty-Six Month
Salary Continuation Plan," and damages in the amount of $1,396,066 or $850,000
due to the Company's purported breach of the terms of the "Long-Term Incentive
Plan for Rakesh K. Kaul" by failing to pay him a "tandem bonus" he alleges was
due and payable to him within the 30 days following his resignation. The Company
removed the case to the U.S. District Court for the Southern District of New
York on July 25, 2001. Mr. Kaul filed an Amended Complaint ("Amended Complaint")
in the U.S. District Court for the Southern District of New York on September
18, 2001. The Amended Complaint repeats many of the claims made in the original
Complaint and adds ERISA claims. On October 11, 2001, the Company filed its
Answer, Defenses and Counterclaims to the Amended Complaint, denying liability
under each and every of Mr. Kaul's causes of action, challenging all substantive
assertions, raising several defenses and stating nine counterclaims against Mr.
Kaul. The counterclaims include (1) breach of contract; (2) breach of the
Non-Competition and Confidentiality Agreement with the Company; (3) breach of
fiduciary duty; (4) unfair competition; and (5) unjust enrichment. The Company
seeks damages, including, without limitation, the $341,803 in severance pay and
car allowance Mr. Kaul received following his resignation, $412,336 for amounts
paid to Mr. Kaul for car allowance and related benefits, the cost of a long-term
disability policy, and certain payments made to personal attorneys and
consultants retained by Mr. Kaul during his employment, $43,847 for certain
services the Company provided and certain expenses the Company incurred,
relating to the renovation and leasing of office space occupied by Mr. Kaul's
spouse at 115 River Road, Edgewater, New Jersey, the Company's current
headquarters, $211,729 on a tax loan to Mr. Kaul outstanding since 1997 and
interest, compensatory and punitive damages and attorneys' fees. The case is
pending. The discovery period has closed, the Company has moved to amend its
counterclaims, and the parties have each moved for summary judgment. The Company
seeks summary judgment: dismissing Mr. Kaul's claim for severance under his
employment agreement on the ground that he failed to provide the Company with a
general release of, among other things, claims for change of control benefits;
dismissing Mr. Kaul's claim for attorneys' fees on the ground that they are not
authorized under his employment agreement; dismissing Mr. Kaul's claims related
to change in control benefits based on an administrative decision that he is not
entitled to continued participation in the plan or to future benefits
thereunder; dismissing Mr. Kaul's claim for a tandem bonus payment on the ground
that no payment is owing; dismissing Mr. Kaul's claim for vacation payments
based on Company policy regarding carry over vacation; and seeking judgment on
the Company's counterclaim for unjust enrichment based on Mr. Kaul's failure to
pay under a tax note. Mr. Kaul seeks summary judgment: dismissing the Company's
defenses and counterclaims relating to a release on the grounds that he tendered
a release or that the Company is estopped from requiring him to do so;
dismissing the Company's defenses and counterclaims relating to his alleged
violations of his non-compete and confidentiality obligations on the ground that
he did not breach the obligations as defined in the agreement; and dismissing
the Company's claims based on his alleged breach of fiduciary duty, including
those based on his monthly car allowance payments and the leased space to his
wife, on the ground that he was entitled to the car payments and did not involve
himself in or make misrepresentations in connection with the leased space. The
Company has concurrently moved to amend its Answer and Counterclaims to state a
claim that it had cause for terminating Mr. Kaul's employment based on, among
other things, after acquired
9
evidence that Mr. Kaul received a monthly car allowance and other benefits
totaling $412,336 that had not been authorized by the Company's Board of
Directors and that his wife's lease and related expense was not properly
authorized by the Company's Board of Directors, and to clarify or amend the
scope of the Company's counterclaims for reimbursement. The briefing on the
motions is completed and the parties are awaiting the decision of the Court. No
trial date has been set. It is too early to determine the potential outcome,
which could have a material impact on the Company's results of operations when
resolved in a future period.
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 asserted 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
sought compensatory damages in an amount, which was 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
sought 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. On November 20, 2002, the court denied Mr.
Schupak's motion to restore the case to the calendar as "unnecessary and moot"
on the ground that the case had been improperly marked off calendar in the first
instance, ruled that the case therefore remained "active," and fixed a trial
date of March 4, 2003. On January 27, 2003, the parties reached agreement fully
and finally settling all of Mr. Schupak's claims in consideration of a payment
by the Company and the exchange of mutual general releases. The Stipulation and
Order of Dismissal with Prejudice was signed by counsel on February 11, 2003 and
ordered by the Judge and filed in the clerk's office on February 28, 2003.
The Company was named as one of 88 defendants in a patent infringement
complaint filed on November 23, 2001 by the Lemelson Medical, Education &
Research Foundation, Limited Partnership (the "Lemelson Foundation"). The
complaint, filed in the U.S. District Court in Arizona, was not served on the
Company until March 2002. In the complaint, the Lemelson Foundation accuses the
named defendants of infringing seven U.S. patents, which allegedly cover
"automatic identification" technology through the defendants' use of methods for
scanning production markings such as bar codes. The Company received a letter
dated November 27, 2001 from attorneys for the Lemelson Foundation notifying the
Company of the complaint and offering a license. The Court entered a stay of the
case on March 20, 2002, requested by the Lemelson Foundation, pending the
outcome of a related case in Nevada being fought by bar code manufacturers. The
trial in the Nevada case began on November 18, 2002 and ended on January 17,
2003. The parties in the Nevada case are now required to submit post trial
briefs on or before May 16, 2003, and a decision is expected two months or more
thereafter. The Order for the stay in the Lemelson case provides that the
Company need not answer the complaint, although it has the option to do so. The
Company has been invited to join a common interest/joint-defense group
consisting of defendants named in the complaint as well as in other actions
brought by the Lemelson Foundation. The Company is currently in the process of
analyzing the merits of the issues raised by the complaint, notifying vendors of
its receipt of the complaint and letter, evaluating the merits of joining the
joint-defense group, and having discussions with attorneys for the Lemelson
Foundation regarding the license offer. A preliminary estimate of the royalties
and attorneys' fees which the Company may pay if it decides to accept the
license offer from the Lemelson Foundation range from approximately $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 early March 2003, the Company learned that one of its business units
had engaged in certain travel transactions that may have constituted violations
under the provisions of U.S. government regulations promulgated pursuant to 50
U.S.C. App. 1-44, which proscribe certain transactions related to travel to
certain countries. See Note 12.
10
In addition, the Company is involved in various routine lawsuits of a
nature that are deemed customary and incidental to its businesses. In the
opinion of management, the ultimate disposition of these actions will not have a
material adverse effect on the Company's financial position or results of
operations.
5. SPECIAL CHARGES
In December 2000, the Company began a strategic business realignment
program that resulted in the recording of special charges for severance,
facility exit costs and asset write-offs. Special charges recorded in fiscal
years 2002, 2001 and 2000 relating to the strategic business realignment program
were $4.4 million, $11.3 million and $19.1 million, respectively. The actions
related to the strategic business realignment program were taken in an effort to
direct the Company's resources primarily towards a loss reduction strategy and a
return to profitability.
In the first quarter of 2003, special charges were recorded in the
amount of $0.3 million. These charges consisted primarily of additional
severance costs associated with the Company's strategic business realignment
program.
As of the end of the first quarter of 2003, a liability of
approximately $3.2 million was included within Accrued Liabilities and a
liability of approximately $4.2 million was included within Other Non-Current
Liabilities. These liabilities relate to future payments in connection with the
Company's strategic business realignment program and consist of the following
(in thousands):
SEVERANCE & REAL ESTATE INFORMATION
PERSONNEL LEASE & TECHNOLOGY
COSTS EXIT COSTS LEASES TOTAL
----- ---------- ------ -----
Balance at December 29, 2001 $ 2,546 $ 8,137 $ 373 $ 11,056
2002 Expenses 1,817 2,952 - 4,769
Paid in 2002 (2,911) (4,672) (210) (7,793)
----------- ----------- ----------- ---------
Balance at December 28, 2002 $ 1,452 $ 6,417 $ 163 $ 8,032
2003 Expenses 261 - - 261
Paid in 2003 (452) (359) (33) (844)
----------- ----------- ----------- -------
Balance at March 29, 2003 $ 1,261 $ 6,058 $ 130 $ 7,449
=========== =========== =========== ========
A summary of the liability related to Real Estate Lease and Exit Costs,
by location, as of March 29, 2003 and December 28, 2002 is as follows (in
thousands):
MARCH 29, DECEMBER 28,
2003 2002
---------- ------------
Gump's facility, San Francisco, California $ 3,335 $ 3,349
Corporate facility, Weehawken, New Jersey 2,108 2,325
Corporate facility, Edgewater, New Jersey 396 439
Administrative and telemarketing facility, San Diego, California 143 179
Retail store facilities, Los Angeles and San Diego, California 76 125
---------- -----------
Total Lease and Exit Cost Liability $ 6,058 $ 6,417
========== ===========
11
6. SALE OF IMPROVEMENTS BUSINESS
On June 29, 2001, the Company sold certain assets and liabilities of
its Improvements business to HSN, a division of USA Networks, Inc.'s Interactive
Group for approximately $33.0 million. In conjunction with the sale, the
Company's Keystone Internet Services, Inc. subsidiary agreed to provide
telemarketing and fulfillment services for the Improvements business under a
service agreement with the buyer for a period of three years.
The asset purchase agreement between the Company and HSN provided that
if Keystone Internet Services, Inc. failed to perform its obligations during the
first two years of the services contract, the purchaser could receive a
reduction in the original purchase price of up to $2.0 million. An escrow fund
of $3.0 million, which was withheld from the original proceeds of the sale of
approximately $33.0 million, had been established for a period of two years
under the terms of an escrow agreement between LWI Holdings, Inc., HSN and The
Chase Manhattan Bank as a result of these contingencies.
On March 27, 2003, the Company and HSN amended the asset purchase
agreement to provide for the release of the remaining $2.0 million balance of
the escrow fund and to terminate the escrow agreement. By agreeing to the terms
of the amendment, HSN forfeited its ability to receive a reduction in the
original purchase price of up to $2.0 million if Keystone Internet Services
failed to perform its obligations during the first two years of the services
contract. In consideration for the release, Keystone Internet Services issued a
credit to HSN for $100,000, which could be applied by HSN against any invoices
of Keystone Internet Services to HSN. This credit was utilized by HSN during
the March 2003 billing period. On March 28, 2003, the remaining $2.0 million
escrow balance was received by the Company, thus terminating the escrow
agreement.
The Company recognized a net gain on the sale of approximately $23.2
million, net of a non-cash goodwill charge of $6.1 million, in fiscal year 2001,
which represented the excess of the net proceeds from the sale over the net
assets acquired by HSN, the goodwill associated with the Improvements business
and expenses related to the transaction. During fiscal year 2002, the Company
recognized approximately $0.6 million of the deferred gain consistent with the
terms of the escrow agreement. During the 13- weeks ended March 29, 2003, the
Company recognized the remaining net deferred gain of $1.9 million from the
receipt of the escrow balance on March 28, 2003. This gain was reported net of
the costs incurred to provide the credit to HSN of approximately $0.1 million.
7. CHANGES IN MANAGEMENT AND EMPLOYMENT
Michael D. Contino. In January 1998, the Company made a $75,000
non-interest-bearing loan to Michael D. Contino, currently the Company's
Executive Vice President and Chief Operating Officer, for the purchase by Mr.
Contino of a new principal residence in the State of New Jersey. The terms of
the loan agreement, as amended, included a provision for the Company to forgive
the original amount of the principal on the fifth anniversary of the loan. The
loan was secured by the residence that the proceeds were used to purchase. The
loan was forgiven in full in accordance with its terms during January 2003. In
addition to the loan forgiveness, the Company paid all applicable withholding
taxes totaling $64,063.
2002 Directors' Option Plan. Effective January 1, 2003, the 2002 Stock
Option Plan for Directors was amended to increase the annual service award for
Directors who are not employees of the Company from 25,000 to 35,000 options to
purchase shares of common stock.
8. AMERICAN STOCK EXCHANGE NOTIFICATION
By letter dated May 2, 2001, the American Stock Exchange (the
"Exchange") notified the Company that it was below certain of the Exchange's
continued listing guidelines set forth in the Exchange's Company Guide. The
Exchange instituted a review of the Company's eligibility for continuing listing
of the Company's common stock on the Exchange. On January 17, 2002, the Company
received a letter dated January 9, 2002 from the Exchange confirming that the
Exchange determined to continue the Company's listing on the Exchange pending
quarterly reviews of the Company's compliance with the steps of its strategic
business realignment program. This determination was made subject to the
Company's favorable progress in satisfying the Exchange's guidelines for
continued listing and to the Exchange's periodic review of the Company's
Securities and Exchange Commission and other filings.
12
On November 11, 2002, the Company received a letter dated November 8,
2002 from the Exchange updating its position regarding the Company's compliance
with certain of the Exchange's continued listing standards as set forth in Part
10 of the Exchange's Company Guide. Although the Company had been making
favorable progress in satisfying the Exchange's guidelines for continued listing
based on its compliance with the steps of its strategic business realignment
program shared with the Exchange in 2001 and updated in 2002, the Exchange
informed the Company that it had now become strictly subject to the procedures
and requirements of Part 10 of the Company Guide. Specifically, the Company must
not fall below the requirements of: (i) Section 1003(a)(i) with shareholders'
equity of less than $2,000,000 and losses from continuing operations and/or net
losses in two out of its three most recent fiscal years; (ii) Section
1003(a)(ii) with shareholders' equity of less than $4,000,000 and losses from
continuing operations and/or net losses in three out of its four most recent
fiscal years; and (iii) Section 1003(a)(iii) with shareholders' equity of less
than $6,000,000 and losses from continuing operations and/or net losses in its
five most recent fiscal years. The Exchange requested that the Company submit a
plan to the Exchange by December 11, 2002, advising the Exchange of action it
has taken, or will take, that would bring it into compliance with the continued
listing standards by December 28, 2003. The Company submitted a plan to the
Exchange on December 11, 2002, in an effort to maintain the listing of the
Company's common stock on the Exchange.
On January 28, 2003, the Company received a letter from the Exchange
confirming that, as of the date of the letter, the Company had evidenced
compliance with the requirements necessary for continued listing on the
Exchange. Such compliance resulted from a recent rule change by the Exchange
approved by the Securities and Exchange Commission related to continued listing
on the basis of compliance with total market capitalization or total assets and
revenues standards as alternatives to shareholders' equity standards including
the requirement that each listed company maintain $15 million of public float.
The letter is subject to changes in the American Stock Exchange Rules that might
supersede the letter or require the Exchange to re-evaluate its position.
9. RECENTLY ISSUED ACCOUNTING STANDARDS
In January 2003, the Securities and Exchange Commission issued a new
disclosure regulation, "Conditions for Use of Non-GAAP Financial Measures"
("Regulation G"), which is effective for all public disclosures and filings made
after March 28, 2003. Regulation G requires public companies that disclose or
release information containing financial measures that are not in accordance
with generally accepted accounting principles ("GAAP") to include in the
disclosure or release a presentation of the most directly comparable GAAP
financial measure and a reconciliation of the disclosed non-GAAP financial
measure to the most directly comparable GAAP financial measure. The Company
became subject to Regulation G in fiscal 2003 and believes that it is in
compliance with the new disclosure requirements.
In December 2002, the Financial Accounting Standards Board ("FASB")
issued SFAS No. 148, "Accounting for Stock-Based Compensation-Transition and
Disclosure - An Amendment of SFAS No. 123" ("FAS 148"). FAS 148 provides
alternative methods of transition for a voluntary change to the fair value-based
method of accounting for stock-based employee compensation. In addition, FAS 148
amends the disclosure requirements of SFAS No. 123 to require prominent
disclosures in both annual and interim financial statements about the method of
accounting for stock-based employee compensation and the effect of the method
used on reported results. The Company has established several stock-based
compensation plans for the benefit of its officers and employees. Since 1996,
the Company has accounted for its stock-based compensation to employees using
the fair value-based methodology under SFAS No. 123, thus FAS 148 has had no
effect on the Company's results of operations or financial position. For the 13-
weeks ended March 29, 2003 and March 30, 2002, the Company recorded stock
compensation expense of $0.2 million and $0.3 million, respectively.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" ("FAS 146"). FAS 146 nullifies
Emerging Issues Task Force Issue No. 94-3 ("EITF 94-3"). FAS 146 requires that a
liability for a cost associated with an exit or disposal activity be recognized
when the liability is incurred whereas, under EITF 94-3, the liability was
recognized at the commitment date to an exit plan. The Company has adopted the
provisions of FAS 146 for exit or disposal activities initiated after December
31, 2002.
13
10. AMENDMENTS TO CONGRESS LOAN AND SECURITY AGREEMENT
In February 2003, the Company amended the Congress Credit Facility to
amend the existing change in control Event of Default. The prior change in
control Event of Default under the Congress Credit Facility was based upon NAR
Group Limited, a former shareholder of the Company, ceasing to be the direct or
indirect beneficial owner of a sufficient number of issued and outstanding
shares of capital stock of the Company on a fully diluted basis to elect a
majority of the members of the Company's Board of Directors. This was replaced
during February 2003 with a new change in control Event of Default, which is
patterned on the Change In Control concepts in the Company's various Key
Executive Compensation Continuation Plans. The new Event of Default would be
triggered by certain transfers of assets, certain liquidations or dissolutions,
the acquisition by a person or group (other than a Permitted Holder, as defined)
of a majority of the total outstanding voting stock of the Company, and certain
changes in the composition of the Company's Board of Directors.
In April 2003, the Company amended the Congress Credit Facility to
allow the Company's chief financial officer or its corporate controller to
certify the financial statements required to be delivered to Congress under the
Congress Credit Facility, rather than the chief financial officer of each
subsidiary borrower or guarantor.
The Congress Credit Facility expires on January 31, 2004. As a result,
effective January 31, 2003, borrowings classified as long-term under the
Congress Credit Facility were reclassified as short-term in the Company's
Condensed Consolidated Financial Statements. Total cumulative borrowings under
the Congress Credit Facility at March 29, 2003 aggregated $29.4 million, all of
which is classified as short-term. The Company has begun discussions with
Congress Financial Corporation and other potential lenders to replace the
Congress Credit Facility.
11. SERIES B PARTICIPATING PREFERRED STOCK
On December 19, 2001, the Company issued to Richemont Finance S.A.
("Richemont") 1,622,111 shares (the "Series B Preferred Shares") of Series B
Participating Preferred Stock having a par value of $0.01 per share (the "Series
B Preferred Stock") in exchange for all of the outstanding shares of the Series
A Cumulative Participating Preferred Stock issued to Richemont on August 24,
2000 for $70.0 million and 74,098,769 shares of the Common Stock of the Company
held by Richemont and the reimbursement of expenses of $1 million to Richemont
(the "Richemont Transaction"). The Richemont Transaction was made pursuant to an
Agreement, dated as of December 19, 2001 (the "Richemont Agreement"), between
the Company and Richemont. Richemont agreed, as part of the Richemont
Transaction, to forego any claim it had to the accrued but unpaid dividends on
the Series A Cumulative Participating Preferred Stock. As part of the Richemont
Transaction, the Company (i) released Richemont, the individuals appointed by
Richemont to the Board of Directors of the Company and certain of their
respective affiliates and representatives (collectively, the "Richemont Group")
from any claims by or in the right of the Company against any member of the
Richemont Group that arise out of Richemont's acts or omissions as a stockholder
of or lender to the Company or the acts or omissions of any Richemont board
designee in his capacity as such and (ii) entered into an Indemnification
Agreement (the "Indemnification Agreement") with Richemont pursuant to which the
Company agreed to indemnify each member of the Richemont Group from any losses
suffered as a result of any third party claim which is based upon Richemont's
acts as a stockholder of or lender to the Company or the acts or omissions of
any Richemont board designee in his capacity as such. The Indemnification
Agreement is not limited as to term and does not include any limitations on
maximum future payments thereunder.
The holders of the Series B Preferred Stock are entitled to ten votes
per share on any matter on which the common stock votes. In addition, in the
event that the Company defaults 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 Financial Corporation, 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:
14
LIQUIDATION PREFERENCE
PERIOD PER SHARE TOTAL VALUE
------ --------- -----------
March 1, 2002 - May 31, 2002 $ 49.15 $ 79,726,755.65
June 1, 2002 - August 31, 2002 $ 51.31 $ 83,230,515.41
September 1, 2002 - November 30, 2002 $ 53.89 $ 87,415,561.79
December 1, 2002 - February 28, 2003 $ 56.95 $ 92,379,221.45
March 1, 2003 - May 31, 2003 $ 60.54 $ 98,202,599.94
June 1, 2003 - August 31, 2003 $ 64.74 $ 105,015,466.14
September 1, 2003 - November 30, 2003 $ 69.64 $ 112,963,810.04
December 1, 2003 - February 29, 2004 $ 72.25 $ 117,197,519.75
March 1, 2004 - May 31, 2004 $ 74.96 $ 121,593,440.56
June 1, 2004 - August 31, 2004 $ 77.77 $ 126,151,572.47
September 1, 2004 - November 30, 2004 $ 80.69 $ 130,888,136,59
December 1, 2004 - February 28, 2005 $ 83.72 $ 135,803,132.92
March 1, 2005 - May 31, 2005 $ 86.85 $ 140,880,340.35
June 1, 2005 - August 23, 2005 $ 90.11 $ 146,168,422.21
As a result, beginning November 30, 2003, the aggregate Liquidation
Preference of the Series B Preferred Stock is effectively equal to the aggregate
liquidation preference of the Class A Preferred Stock previously held by
Richemont. Commencing January 2003, the Company utilizes the interest method to
account for the accretion of the Series B Preferred Stock up to the maximum
amount of its liquidation preference. The Company reflects the accretion as an
increase in the Series B Preferred Stock with a corresponding reduction in
capital in excess of par value. Such accretion has been and will continue to be
recorded as a reduction of net income available to common shareholders.
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 consistent with Delaware General Corporation Law. 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.
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.
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 Financial Corporation.
During autumn 2002, Company management conducted a strategic review of
the Company's business and operations. As part of such review, Company
management considered the Company's obligations under the Richemont Agreement
and the Company's prospects and options for redemption of the Series B Preferred
Shares issued to Richemont pursuant thereto in accordance with the Richemont
Agreement terms. The review took into account the results of the Company's
strategic business realignment program in 2001 and 2002, the relative strengths
and weaknesses of the Company's competitive position and the economic and
business climate, including the depressed business environment for mergers and
acquisitions.
15
As a result of this review, Company management and the Company's Board
of Directors have concluded that it is unlikely that the Company will be able to
accumulate sufficient capital, surplus, or other assets under Delaware corporate
law or to obtain sufficient debt financing to either:
1. Redeem at least 811,056 shares of the Series B Preferred Stock
by August 31, 2003, as allowed for by the Richemont Agreement,
thereby resulting in the occurrence of a "Voting Trigger"
which will allow Richemont to have the option of electing two
members to the Company's Board of Directors; or
2. Redeem all of the shares of Series B Preferred Stock by August
31, 2005, as required by the Richemont Agreement, thereby
obligating the Company to take all measures permitted under
the Delaware General Corporation Law to increase the amount of
its capital and surplus legally available to redeem the Series
B Preferred Shares, without a material improvement in either
the business environment for mergers and acquisitions or other
factors, unforeseeable at the time.
Management believes that the Company has sufficient liquidity and
availability under its credit agreement to fund its planned operations through
at least January 31, 2004. The unlikelihood that the Company will be able to
redeem the Series B Preferred Shares is not expected to limit the ability of the
Company to use current and future net earnings or cash flow to satisfy its
obligations to creditors and vendors. See "Cautionary Statements," below. In
addition, the redemption price of the Series B Preferred Stock does not accrete
after August 31, 2005.
Company management met with representatives of Richemont on October 29,
2002 and outlined the results of management's strategic review in the context of
the Company's obligations to Richemont under the Richemont Agreement, and
discussed an alternative to the method for the redemption of the Series B
Preferred Shares. Under this alternative proposal, that the Company had
previously presented to Richemont, the Company would exchange two business
divisions, Silhouettes and Gump's, for all of Richemont's Series B Preferred
Shares (the "Proposal").
Pursuant to the terms of the Richemont Agreement, the redemption value
of the Series B Preferred Shares as of the date of the Proposal was $87 million.
Management based the Proposal terms on a valuation of Silhouettes and Gump's
using the valuation multiple employed in USA Network's June 2001 purchase of the
Company's Improvements business division. The Proposal also included a
willingness on the part of the Company to provide continued fulfillment services
for Silhouettes and Gump's on terms to be negotiated. On November 18, 2002, a
representative of Richemont confirmed in writing to the Company that Richemont
rejected the Proposal. Representatives of Richemont have indicated that it has
no interest in the proffered assets and disputes their valuation implied in the
Company's Proposal.
The Company will continue to explore all reasonable opportunities to
redeem and retire the Series B Preferred Stock.
For Federal income tax purposes, the increases in the Liquidation
Preference of the Series B Preferred Stock are considered distributions, by the
Company to Richemont, deemed made on the commencement dates of the quarterly
increases, as discussed above. These distributions may be taxable dividends to
Richemont, provided the Company has accumulated or current earnings and profits
("E&P") for each year in which the distributions are deemed to be made. Under
the terms of the Richemont Transaction, the Company is obligated to reimburse
Richemont for any U.S. income tax incurred pursuant to the Richemont
Transaction. Based on the Company's past income tax filings and its current
income tax position, the Company had an E&P deficit as of December 28, 2002.
Accordingly, the Company did not incur a tax reimbursement obligation for year
2002. The Company must have current E&P in years 2003, 2004 or 2005 to incur a
tax reimbursement obligation from the scheduled increases in Liquidation
Preference. If the Company does not have current E&P in one of those years, no
tax reimbursement obligation would exist for that particular year. The Company
does not have the ability to project the exact future tax reimbursement
obligation; however, it has estimated the potential obligation to be in the
range of $0 to $23.1 million. In March 2003, a payment of $0.3 million was made
on behalf of Richemont to the Internal Revenue Service. The payment was
reflected as a reduction of Capital in excess of par value on the Condensed
Consolidated Balance Sheets and as an increase to Preferred stock dividends and
accretion on the Condensed Consolidated Statements of Income (Loss).
16
12. REGULATION 50 U.S.C. APP. 1-44 ISSUE
In early March 2003, the Company learned that one of its business units
had engaged in certain travel transactions that may have constituted violations
under the provisions of U.S. government regulations promulgated pursuant to 50
U.S.C. App. 1-44, which proscribe certain transactions related to travel to
certain countries. The Company immediately commenced an inquiry into the matter,
incurred resulting charges, made an initial voluntary disclosure to the
appropriate U.S. government agency under its program for such disclosures and
has submitted to that agency a detailed report on the results of the inquiry. In
addition, the Company has taken steps to ensure that all of its business units
are acting in compliance with the travel and transaction restrictions and other
requirements of all applicable U.S. government programs. Although the Company is
uncertain of the extent of the penalties, if any, that may be imposed on it by
virtue of the transactions voluntarily disclosed, it does not currently believe
that any such penalties will have a material effect on its business or financial
condition.
17
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following table sets forth, for the fiscal periods indicated, the
percentage relationship to net revenues of certain items in the Company's
Condensed Consolidated Statements of Income (Loss):
13- WEEKS ENDED
------------------------------
MARCH 29, March 30,
2003 2002
--------- ---------
Net revenues 100.0% 100.0%
Cost of sales and operating expenses 64.0 65.0
Special charges 0.3 0.2
Selling expenses 23.9 22.5
General and administrative expenses 11.0 11.3
Depreciation and amortization 1.1 1.4
Loss from operations 0.3 0.4
Gain on sale of Improvements 1.9 0.0
Interest expense, net 1.4 1.3
Provision for state income taxes 0.0 0.0
Net income (loss) and comprehensive income (loss) 0.2% (1.7)%
RESULTS OF OPERATIONS - 13- WEEKS ENDED MARCH 29, 2003 COMPARED WITH THE 13-
WEEKS ENDED MARCH 30, 2002
Net Income (Loss) and Comprehensive Income (Loss). The Company reported
net income of $0.2 million for the 13- weeks ended March 29, 2003 compared with
a net loss of $(1.8) million for the comparable period in the year 2002.
Compared with the same fiscal period in the year 2002, the $2.0 million increase
in net income was primarily due to the recording of a $1.9 million deferred gain
during the 13- weeks ended March 29, 2003 related to the June 29, 2001 sale of
the Company's Improvements business and continued reductions in cost of sales
and operating expenses resulting from the Company's strategic business
realignment program. Net loss per common share was $(.02) and $(.03) for the 13-
weeks ended March 29, 2003 and March 30, 2002, respectively. The per share
amounts were calculated after deducting preferred dividends and accretion of
$3.6 million and $2.9 million for the 13- weeks ended March 29, 2003 and March
30, 2002, respectively. The weighted average number of shares of common stock
outstanding used in both the basic and diluted net loss per common share
calculation was 138,315,800 for the 13- weeks ended March 29, 2003 and
138,225,031 for the 13- weeks ended March 30, 2002. This increase in weighted
average shares was due to issuances of common stock within the Company's
stock-based compensation plans.
Net Revenues. Net revenues decreased $7.0 million (6.4%) for the
13-week period ended March 29, 2003 to $102.5 million from $109.5 million for
the comparable fiscal period in the year 2002. The decrease is due principally
to softness in demand and a 2.1% reduction in overall circulation for continuing
businesses from the comparable fiscal period in 2002. This reduction resulted
from the Company's continued efforts to reduce unprofitable circulation and
remain focused on its strategy of increasing profitable circulation. Internet
sales continue to increase, and comprise 26.5% of combined Internet and catalog
revenues for the 13- weeks ended March 29, 2003, and have improved by $6.3
million or 32.5% to $25.5 million from $19.2 million for the comparable fiscal
period in the year 2002.
Cost of Sales and Operating Expenses. Cost of sales and operating
expenses decreased to 64.0% of net revenues for the 13-week period ended March
29, 2003 as compared with 65.0% of net revenues for the comparable period in the
year 2002. This decrease was primarily due to reductions in merchandise cost and
spending related to the information technology systems area that have resulted
from actions taken in connection with the Company's strategic business
realignment program. These decreases in costs, however, were partially offset by
a slight increase in product postage costs for the period. Telemarketing and
distribution costs held constant with the comparable fiscal period in the year
2002.
18
Special Charges. In December 2000, the Company began a strategic
business realignment program that resulted in the recording of special charges
for severance, facility exit costs and asset write-offs. Special charges
recorded for the 13- weeks ended March 29, 2003 were $0.3 million. These charges
consisted primarily of additional severance costs associated with the Company's
strategic business realignment program. For the 13- weeks ended March 30, 2002,
the Company recorded $0.2 million in charges associated with the strategic
business realignment program. These charges consisted primarily of severance
costs relating to positions eliminated within various catalog operations and the
Company's closure of the San Diego product storage facility.
Selling Expenses. Selling expenses decreased by $0.1 million to $24.5
million for the 13- weeks ended March 29, 2003 as compared with $24.6 million
for the comparable fiscal period in the year 2002. As a percentage relationship
to net revenues, selling expenses increased to 23.9% for the 13- weeks ended
March 29, 2003 compared with 22.5% for the comparable period in the year 2002.
This change was due primarily to increases in catalog preparation, printing and
postage costs, offset by reduced paper prices.
General and Administrative Expenses. General and administrative
expenses decreased by $1.1 million to $11.3 million for the 13- weeks ended
March 29, 2003 as compared with $12.4 million for the comparable period in the
year 2002. As a percentage relationship to net revenues, general and
administrative expenses were 11.0% of net revenues for the 13- weeks ended March
29, 2003 compared with 11.3% of net revenues for the comparable period in the
year 2002. The reductions for the 13- weeks ended March 29, 2003 continue to
reflect the effects of the Company's strategic business realignment program
across all departments.
Depreciation and Amortization. Depreciation and amortization decreased
$0.3 million to $1.2 million for the 13- weeks ended March 29, 2003 as compared
with $1.5 million for the comparable period in the year 2002. The decrease is
primarily due to capital expenditures that have become fully amortized. As a
percentage relationship to net revenues, depreciation and amortization was 1.1%
for the 13- weeks ended March 29, 2003 and 1.4% for the comparable period in the
year 2002.
Loss from Operations. The Company's loss from operations decreased by
$0.1 million to $0.3 million for the 13- weeks ended March 29, 2003 from a loss
of $0.4 million for the comparable period in the year 2002.
Gain on Sale of the Improvements Business. During the 13- weeks ended
March 29, 2003, the Company recognized the remaining deferred gain of $1.9
million consistent with the terms of the March 27, 2003 amendment made to the
asset purchase agreement relating to the sale of the Improvements business. See
Note 6 of the Condensed Consolidated Financial Statements.
Interest Expense, Net. Interest expense, net increased $0.1 million to
$1.5 million for the 13- weeks ended March 29, 2003 as compared with $1.4
million for the comparable period in the year 2002. The increase in interest
expense in the first quarter of 2003 is primarily due to an increase in
amortization from additional deferred financing costs relating to the Company's
amendments to the Congress Credit Facility.
LIQUIDITY AND CAPITAL RESOURCES
Net cash used by operating activities. During the 13-week period ended
March 29, 2003, net cash used by operating activities was $3.5 million.
Increases in both prepaid catalog costs and inventory, in coordination with
decreases in accrued liabilities, contributed to this use of cash by operating
activities. This use of cash was partially offset by positive cash flow
generated by decreases in accounts receivable and customer prepayments and
credits.
Net cash provided by investing activities. During the 13-week period
ended March 29, 2003, net cash provided by investing activities was $1.4
million. This was primarily due to proceeds received relating to the deferred
gain of $2.0 million associated with the sale of the Improvements business.
These proceeds were partially offset by $0.5 million of capital expenditures,
consisting primarily of various computer software upgrades and telemarketing
hardware and $0.1 million of costs relating to the early release of escrow funds
associated with the sale of the Improvements business.
Net cash provided by financing activities. During the 13-week period
ended March 29, 2003, net cash provided by financing activities was $3.9
million, which was primarily due to increased borrowings of $5.3 million under
the Congress revolving loan facility. These borrowings were partially offset by
monthly payments made relating to both the
19
Congress Tranche A and Tranche B term loan facilities as well as a payment of
$0.3 million for the Company's obligation to remit withholding taxes on behalf
of Richemont for estimated taxes due from the scheduled increases in Liquidation
Preference on the Series B Preferred Stock. See Note 11 of the Condensed
Consolidated Financial Statements.
Congress Credit Facility. On March 24, 2000, the Company amended its
credit facility with Congress Financial Corporation ("Congress") to provide the
Company with a maximum credit line, subject to certain limitations, of up to
$82.5 million. The Congress Credit Facility, as amended, expires on January 31,
2004 and comprises a revolving loan facility, a $17.5 million Tranche A Term
Loan and a $8.4 million Tranche B Term Loan. Total cumulative borrowings under
the Congress Credit Facility, however, are subject to limitations based upon
specified percentages of eligible receivables and eligible inventory, and the
Company is required to maintain $3.0 million of excess credit availability at
all times. The Congress Credit Facility, as amended, is secured by all the
assets of the Company and places restrictions on the incurrence of additional
indebtedness and on the payment of common stock dividends.
In February 2003, the Company amended the Congress Credit Facility to
amend the existing change in control Event of Default. The existing change in
control Event of Default under the Congress Credit Facility was based upon NAR
Group Limited, a former shareholder of the Company, ceasing to be the direct or
indirect beneficial owner of a sufficient number of issued and outstanding
shares of capital stock of the Company on a fully diluted basis to elect a
majority of the members of the Company's Board of Directors. This was replaced
during February 2003 with a new change in control Event of Default, which is
patterned on the Change In Control concepts in the Company's various Key
Executive Compensation Continuation Plans. The new Event of Default would be
triggered by certain transfers of assets, certain liquidations or dissolutions,
the acquisition by a person or group (other than a Permitted Holder, as defined)
of a majority of the total outstanding voting stock of the Company, and certain
changes in the composition of the Company's Board of Directors.
In April 2003, the Company amended the Congress Credit Facility to
allow the Company's chief financial officer or its corporate controller to
certify the financial statements required to be delivered to Congress under the
Congress Credit Facility, rather than the chief financial officer of each
subsidiary borrower or guarantor.
The Congress Credit Facility expires on January 31, 2004. As a result,
effective January 31, 2003, borrowings classified as long-term under the
Congress Credit Facility were reclassified as short-term in the Company's
Condensed Consolidated Financial Statements. As of March 29, 2003, the Company
had $29.4 million of cumulative short-term borrowings outstanding under the
Congress Credit Facility, comprising $14.1 million under the Revolving Loan
Facility, bearing an interest rate of 4.75%, $8.0 million under the Tranche A
Term Loan, bearing an interest rate of 5.0%, and $7.4 million under the Tranche
B Term Loan, bearing an interest rate of 13.0%. The Company has begun
discussions with Congress and other potential lenders to replace the Congress
Credit Facility. The Company is confident that the replacement of the Congress
Credit Facility will occur prior to the expiration of the existing facility.
See "Cautionary Statements," below.
Achievement 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 and the Company's ability
to operate effectively during the 2003 fiscal year. In the event of a softer
than expected economic climate, management has available several courses of
action to maintain liquidity and help maintain compliance with financial
covenants, including selective reductions in catalog circulation, additional
expense reductions and sales of non-core assets.
Sale of Improvements Business. On June 29, 2001, the Company sold
certain assets and liabilities of its Improvements business to HSN, a division
of USA Networks, Inc.'s Interactive Group for approximately $33.0 million. In
conjunction with the sale, the Company's Keystone Internet Services, Inc.
subsidiary agreed to provide telemarketing and fulfillment services for the
Improvements business under a service agreement with the buyer for a period of
three years.
The asset purchase agreement between the Company and HSN provided that
if Keystone Internet Services, Inc. failed to perform its obligations during the
first two years of the services contract, the purchaser could receive a
reduction in the original purchase price of up to $2.0 million. An escrow fund
of $3.0 million, which was withheld from the original proceeds of the sale of
approximately $33.0 million, had been established for a period of two years
under
20
the terms of an escrow agreement between LWI Holdings, Inc., HSN and The Chase
Manhattan Bank as a result of these contingencies.
On March 27, 2003, the Company and HSN amended the asset purchase
agreement to provide for the release of the remaining $2.0 million balance of
the escrow fund and to terminate the escrow agreement. By agreeing to the terms
of the amendment, HSN forfeited its ability to receive a reduction in the
original purchase price of up to $2.0 million if Keystone Internet Services
failed to perform its obligations during the first two years of the services
contract. In consideration for the release, Keystone Internet Services issued a
credit to HSN for $100,000, which could be applied by HSN against any invoices
of Keystone Internet Services to HSN. This credit was utilized by HSN during the
fiscal March 2003 billing period. On March 28, 2003, the remaining $2.0 million
escrow balance was received by the Company, thus terminating the escrow
agreement.
The Company recognized a net gain on the sale of approximately $23.2
million, net of a non-cash goodwill charge of $6.1 million, in fiscal year 2001,
which represented the excess of the net proceeds from the sale over the net
assets acquired by HSN, the goodwill associated with the Improvements business
and expenses related to the transaction. During fiscal year 2002, the Company
recognized approximately $0.6 million of the deferred gain consistent with the
terms of the escrow agreement. During the 13- weeks ended March 29, 2003, the
Company recognized the remaining net deferred gain of $1.9 million from the
receipt of the escrow balance on March 28, 2003. This gain was reported net of
the costs incurred to provide the credit to HSN of approximately $0.1 million.
General. At March 29 2003, the Company had $2.6 million in cash and
cash equivalents, compared with $0.8 million at March 30, 2002. Total cumulative
borrowings, including financing under capital lease obligations, as of March 29,
2003, aggregated $29.5 million, $29.4 million of which is classified as
short-term since the Congress Credit Facility is due to expire on January 31,
2004. Remaining availability under the Congress Credit Facility as of March 29,
2003 was $14.6 million. The Company had approximately $0.4 million in short-term
capital commitments as of March 29, 2003.
Management believes that the Company has sufficient liquidity and
availability under its credit agreement to fund its planned operations through
at least January 31, 2004. See "Cautionary Statements," below. The Company has
started discussions with Congress and other potential lenders to replace the
Congress Credit Facility. The Company is confident that the replacement of the
Congress Credit Facility will occur prior to the expiration of the existing
facility. See "Cautionary Statements," below. Achievement of the cost saving and
other objectives of the Company's strategic business realignment program is
critical to the maintenance of adequate liquidity as is compliance with the
terms and provisions of the Congress Credit Facility as mentioned in Note 10 of
the Condensed Consolidated Financial Statements.
USES OF ESTIMATES AND OTHER CRITICAL ACCOUNTING POLICIES
During the first quarter ended March 29, 2003, 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 28, 2002, for additional
information relating to the Company's use of estimates and other critical
accounting policies.
NEW ACCOUNTING PRONOUNCEMENTS
In January 2003, the Securities and Exchange Commission issued a new
disclosure regulation, "Conditions for Use of Non-GAAP Financial Measures"
("Regulation G"), which is effective for all public disclosures and filings made
after March 28, 2003. Regulation G requires public companies that disclose or
release information containing financial measures that are not in accordance
with generally accepted accounting principles ("GAAP") to include in the
disclosure or release a presentation of the most directly comparable GAAP
financial measure and a reconciliation of the disclosed non-GAAP financial
measure to the most directly comparable GAAP financial measure. The Company
became subject to Regulation G in fiscal 2003 and believes that it is in
compliance with the new disclosure requirements.
In December 2002, the Financial Accounting Standards Board ("FASB")
issued SFAS No. 148, "Accounting for Stock-Based Compensation-Transition and
Disclosure - An Amendment of SFAS No. 123" ("FAS 148"). FAS 148
21
provides alternative methods of transition for a voluntary change to the fair
value-based method of accounting for stock-based employee compensation. In
addition, FAS 148 amends the disclosure requirements of SFAS No. 123 to require
prominent disclosures in both annual and interim financial statements about the
method of accounting for stock-based employee compensation and the effect of the
method used on reported results. The Company has established several stock-based
compensation plans for the benefit of its officers and employees. Since 1996,
the Company has accounted for its stock-based compensation to employees using
the fair value-based methodology under SFAS No. 123, thus FAS 148 has had no
effect on the Company's results of operations or financial position. For the 13-
weeks ended March 29, 2003 and March 30, 2002, the Company recorded stock
compensation expense of $0.2 million and $0.3 million, respectively.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" ("FAS 146"). FAS 146 nullifies
Emerging Issues Task Force Issue No. 94-3 ("EITF 94-3"). FAS 146 requires that a
liability for a cost associated with an exit or disposal activity be recognized
when the liability is incurred whereas, under EITF 94-3, the liability was
recognized at the commitment date to an exit plan. The Company has adopted the
provisions of FAS 146 for exit or disposal activities initiated after December
31, 2002.
See "Management's Discussion and Analysis of Consolidated Financial
Condition and Results of Operations," found in the Company's Annual Report on
Form 10-K for the fiscal year ended December 28, 2002 and Note 9 of the
Condensed Consolidated Financial Statements for additional information relating
to new accounting pronouncements that the Company has adopted.
SEASONALITY
The Company does not consider its business seasonal. The revenues for
the Company are proportionally consistent for each quarter during a fiscal year.
The percentage of annual revenues for the first, second, third and fourth
quarters recognized by the Company, respectively, were as follows: 2002 - 23.9%,
24.9%, 23.2% and 28.0%; and 2001 - 27.1%, 25.1%, 22.1% and 25.7%.
FORWARD-LOOKING STATEMENTS
The following statements from above constitute forward-looking
statements 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 agreement to fund its planned operations through
at least January 31, 2004."
"The unlikelihood that the Company will be able to redeem the Series B
Preferred Shares is not expected to limit the ability of the Company to use
current and future net earnings or cash flow to satisfy its obligations to
creditors and vendors."
"The Company is confident that the replacement of the Congress Credit
Facility will occur prior to the expiration of the existing facility."
CAUTIONARY STATEMENTS
The following material identifies important factors that could cause
actual results to differ materially from those expressed in the forward-looking
statements identified above and in any other forward-looking statements
contained elsewhere herein:
- - 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.
22
- - Customer response to the Company's merchandise offerings and
circulation changes; effects of shifting patterns of e-commerce versus
catalog purchases; costs associated with printing and mailing catalogs
and fulfilling orders; effects of potential slowdowns or other
disruptions in postal service; dependence on customers' seasonal buying
patterns; and fluctuations in foreign currency exchange rates. The
ability of the Company to reduce unprofitable circulation and to
effectively manage its customer lists.
- - The ability of the Company to achieve projected levels of sales and the
ability of the Company to reduce costs commensurate with sales
projections. Increases in postage, printing and paper prices and/or the
inability of the Company to reduce expenses generally as required for
profitability and/or increase prices of the Company's merchandise to
offset expense increases.
- - The failure of the Internet generally to achieve the projections for it
with respect to growth of e-commerce or otherwise, and the failure of
the Company to increase Internet sales. The success of the Amazon.com
venture. The imposition of regulatory, tax or other requirements with
respect to Internet sales. Actual or perceived technological
difficulties or security issues with respect to conducting e-commerce
over the Internet generally or through the Company's Web sites or those
of its third party fulfillment clients specifically.
- - The ability of the Company to attract and retain management and
employees generally and specifically with the requisite experience in
e-commerce, Internet and direct marketing businesses. The ability of
employees of the Company who have been promoted as a result of the
Company's strategic business realignment program to perform the
responsibilities of their new positions.
- - 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, catalog and direct marketing
industries. The risk that key vendors or suppliers may reduce or
withdraw trade credit to the Company, convert the Company to a cash
basis or otherwise change credit terms, or require the Company to
provide letters of credit or cash deposits to support its purchase of
inventory, increasing the Company's cost of capital and impacting the
Company's ability to obtain merchandise in a timely manner. The ability
of the Company to find alternative vendors and suppliers on competitive
terms if vendors or suppliers who exist cease doing business with the
Company.
- - The inability of the Company to timely obtain and distribute
merchandise, leading to an increase in backorders and cancellations.
- - Defaults under the Congress Credit Facility, or inadequacy of available
borrowings thereunder, reducing or impairing the Company's ability to
obtain letters of credit or other credit to support its purchase of
inventory and support normal operations, impacting the Company's
ability to obtain, market and sell merchandise in a timely manner.
- - Continued compliance by the Company with and the enforcement by
Congress of financial and other covenants and limitations contained in
the Congress Credit Facility, including net worth, net working capital,
capital expenditure and EBITDA covenants, and limitations based upon
specified percentages of eligible receivables and eligible inventory,
and the requirement that the Company maintain $3.0 million of excess
credit availability at all times, affecting the ability of the Company
to continue to make borrowings under the Congress Credit Facility.
- - Continuation of the Company's history of operating losses, and the
incidence of costs associated with the Company's strategic business
realignment program, resulting in the Company failing to comply with
certain financial and other covenants contained in the Congress Credit
Facility, 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 that 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 the Domestications
and The Company Store divisions and the integration of the Gump's store
and the Gump's By Mail catalog divisions, 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
23
program, or within the time periods anticipated therefor. The aggregate
costs of effecting the strategic business realignment program may be
greater than the amounts anticipated by the Company.
- - The ability of the Company to maintain advance rates under the Congress
Credit Facility that are at least as favorable as those obtained in the
past due to market conditions affecting the value of the inventory,
which is periodically re-appraised in order to re-set such advance
rates.
- - Inability of the Company to timely replace its existing private label
credit card agreement, and to transition its existing credit card
customers to a new private label credit card issuer.
- - The ability of the Company to dispose of assets related to its third
party fulfillment business, to the extent not transferred to other
facilities.
- - The 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 ability of the Company to obtain certain types of
insurance, including directors' and officers' liability insurance, or
to accept reduced policy limits or coverage, or to incur substantially
increased costs to obtain the same or similar coverage, due to recently
enacted and proposed changes to laws and regulations affecting public
companies, including the provisions of the Sarbanes-Oxley Act of 2002
and rules of the Securities and Exchange Commission thereunder.
- - The inability of the Company to access the capital markets due to
market conditions generally, including a lowering of the market
valuation of companies in the direct marketing and retail businesses,
and the Company's business situation specifically.
- - The inability of the Company to sell non-core assets 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 redeem the Series B Preferred Stock
currently held by Richemont on a timely basis, or at all, actions by
Richemont or any subsequent holder in response thereto, if any, and
future interpretations of applicable law and contract.
- - The ability of the Company to maintain the listing of its Common Stock
on the American Stock Exchange.
- - The continued willingness of customers to place and receive mail orders
in light of worries about bio-terrorism.
- - The ability of the Company to sublease, terminate or renegotiate the
leases of its vacant facilities in Weehawken, New Jersey and other
locations.
- - The ability of the Company to evaluate and implement the requirements
of the Sarbanes-Oxley Act of 2002 and the rules of the Securities and
Exchange Commission thereunder, as well as proposed changes to listing
standards by the American Stock Exchange, in a cost effective manner.
- - The ability of the Company to achieve cross channel synergies, create
successful affiliate programs, effect profitable brand extensions or
establish popular loyalty and buyers' club programs.
24
- - Uncertainty in the U.S. economy and decreases in consumer confidence
leading to a slowdown in economic growth and spending resulting from
the invasion of, war with and occupation of Iraq, which may result in
future acts of terror. Such activities, either domestically or
internationally, may affect the economy and consumer confidence and
spending within the United States and adversely affect the Company's
business.
- - The inability of the Company to continue to source goods from foreign
sources, particularly India and Pakistan, as a result of the war with
Iraq or otherwise, leading to increased costs of sales.
ITEM 3. QUANTITIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
INTEREST RATES: The Company's exposure to market risk relates to
interest rate fluctuations for borrowings under the Congress revolving credit
facility and its term financing facilities, which bear interest at variable
rates. At March 29, 2003, outstanding principal balances under these facilities
subject to variable rates of interest were approximately $22.1 million. If
interest rates were to increase by one percent from current levels, the
resulting increase in interest expense, based upon the amount outstanding at
March 29, 2003, would be approximately $0.2 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 Rules 13a-14c and 15d-14(c)
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 in the Company's
internal controls or to other factors that could significantly affect these
disclosure controls subsequent to the date of the evaluation.
25
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
A class action lawsuit was commenced on March 3, 2000 entitled Edwin
L. Martin v. Hanover Direct, Inc. and John Does 1 through 10, bearing case no.
CJ2000-177 in the State Court of Oklahoma (District Court in and for Sequoyah
County). Plaintiff commenced the action on behalf of himself and a class of
persons who have at any time purchased a product from the Company and paid for
an "insurance charge." The complaint sets forth claims for breach of contract,
unjust enrichment, recovery of money paid absent consideration, fraud and a
claim under the New Jersey Consumer Fraud Act. The complaint alleges that the
Company charges its customers for delivery insurance even though, among other
things, the Company's common carriers already provide insurance and the
insurance charge provides no benefit to the Company's customers. Plaintiff also
seeks a declaratory judgment as to the validity of the delivery insurance. The
damages sought are (i) an order directing the Company to return to the plaintiff
and class members the "unlawful revenue" derived from the insurance charges,
(ii) declaring the rights of the parties, (iii) permanently enjoining the
Company from imposing the insurance charge, (iv) awarding threefold damages of
less than $75,000 per plaintiff and per class member, and (v) attorneys' fees
and costs. On April 12, 2001, the Court held a hearing on plaintiff's class
certification motion. Subsequent to the April 12, 2001 hearing on plaintiff's
class certification motion, plaintiff filed a motion to amend the definition of
the class. On July 23, 2001, plaintiff's class certification motion was granted,
defining the class as "All persons in the United States who are customers of any
catalog or catalog company owned by Hanover Direct, Inc. and who have at any
time purchased a product from such company and paid money that was designated to
be an 'insurance' charge." On August 21, 2001, the Company filed an appeal of
the order with the Oklahoma Supreme Court and subsequently moved to stay
proceedings in the District Court pending resolution of the appeal. The appeal
has been fully briefed. At a subsequent status hearing, the parties agreed that
issues pertaining to notice to the class would be stayed pending resolution of
the appeal, that certain other issues would be subject to limited discovery, and
that the issue of a stay for any remaining issues would be resolved if and when
such issues arise. The Oklahoma Supreme Court has not yet ruled on the pending
appeal. Oral argument on the appeal, if scheduled, was expected during the first
half of 2003 but has yet to be scheduled by the Court. The Company believes it
has defenses against the claims and plans to conduct a vigorous defense of this
action.
On August 15, 2001, the Company was served with a summons and
four-count complaint filed in Superior Court for the City and County of San
Francisco, California, entitled Teichman v. Hanover Direct, Inc., Hanover
Brands, Inc., Hanover Direct Virginia, Inc., and Does 1-100. The complaint was
filed by a California resident, seeking damages and other relief for herself and
a class of all others similarly situated, arising out of the insurance fee
charged by catalogs and Internet sites operated by subsidiaries of the Company.
Defendants, including the Company, have filed motions to dismiss based on a lack
of personal jurisdiction over them. In January 2002, plaintiff sought leave to
name six additional entities: International Male, Domestications Kitchen &
Garden, Silhouettes, Hanover Company Store, Kitchen & Home, and Domestications
as co-defendants. On March 12, 2002, the Company was served with the First
Amended Complaint in which plaintiff named as defendants the Company, Hanover
Brands, Hanover Direct Virginia, LWI Holdings, Hanover Company Store, Kitchen
and Home, and Silhouettes. On April 15, 2002, the Company filed a Motion to Stay
the Teichman action in favor of the previously filed Martin action and also
filed a Motion to quash service of summons for lack of personal jurisdiction on
behalf of defendants Hanover Direct, Inc., Hanover Brands, and Hanover Direct
Virginia. On May 14, 2002, the Court (1) granted the Company's Motion to quash
service on behalf of Hanover Direct, Hanover Brands, and Hanover Direct
Virginia, leaving only LWI Holdings, Hanover Company Store, Kitchen & 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 and plans to conduct a
vigorous defense of this action.
A lawsuit was commenced as both a class action and for the benefit of
the general public on February 13, 2002 entitled Jacq Wilson, suing on behalf of
himself, all others similarly situated, and the general public v. Brawn of
California, Inc. dba International Male and Undergear, and Does 1-100 ("Brawn")
in the Superior Court of the State of California, City and County of San
Francisco. Does 1-100 are allegedly Internet and catalog direct marketers
offering a selection of men's clothing, sundries, and shoes who advertise within
California and nationwide. The complaint alleges that for at least four years
members of the class and the general public have been charged an unlawful,
unfair and fraudulent insurance fee and tax on orders sent to them by Brawn;
that Brawn was engaged in untrue, deceptive and misleading advertising in that
it was not lawfully required or permitted to collect an insurance fee, tax and
sales tax from
26
customers in California; and that Brawn has engaged in acts of unfair
competition under the state's Business and Professions Code. Plaintiff seeks (i)
restitution and disgorgement of all monies wrongfully collected and earned by
Brawn, including interest and other gains made on account of these practices,
including reimbursement in the amount of the insurance fee, tax and sales tax
collected unlawfully, together with interest, (ii) an order enjoining Brawn from
charging customers the insurance fee and tax on its order forms and/or from
charging tax on the delivery, shipping and insurance charges, (iii) an order
directing Brawn to notify the California State Board of Equalization of the
failure to pay the correct amount of tax to the state and to take appropriate
steps to provide the state with the information needed for audit, and (iv)
compensatory damages, attorneys' fees, pre-judgment interest and costs of the
suit. The Plaintiff alleged that the claims of the individually named plaintiff
and for each member of the class amount to less than $75,000. On April 15, 2002,
the Company filed a Motion to Stay the Wilson action in favor of the previously
filed Martin action. On May 14, 2002, the Court heard the argument on the
Company's Motion to Stay the action in favor of the Martin action, denying the
Motion. In October 2002, the Court granted the Company's Motion for leave to
amend the answer. Discovery is completed. A mandatory settlement conference was
held on April 7, 2003 and a bench trial took place from April 14 through 17,
2003. At the bench trial, Plaintiff withdrew the class action allegations and
continued to proceed individually and on behalf of the general public pursuant
to California Business and Professions Code Section 17200 et seq. Post-trial
briefing should be completed in the third quarter of 2003. No date for decision
has been set by the Court. The Company plans to continue its 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 -- sells, 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; that it 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. That motion was granted. On March
17, 2003, the Court granted Plaintiff's Request for Dismissal and the case was
dismissed with prejudice.
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
Professions 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
27
account of these practices; (ii) pre-judgment interest on all sums wrongfully
collected; (iii) an order enjoining Domestications from charging customers for
tax on their orders and/or from charging tax on the shipping charges; and (iv)
attorneys' fees and costs of the suit. The Company filed an Answer and Separate
Affirmative Defenses to the Complaint, generally denying the allegations of the
Complaint and each and every cause of action alleged, and denying that plaintiff
has been damaged or is entitled to any relief whatsoever. On 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. That motion was granted. On
February 28, 2003, the Company filed a notice of Motion and memorandum of points
and authorities in support of its Motion for summary judgment setting forth that
Plaintiff's claims are without merit and incorrect as a matter of law. On March
17, 2003, the Court granted Plaintiff's Request for Dismissal and the case was
dismissed with prejudice.
A class action lawsuit was commenced on October 28, 2002 entitled John
Morris, individually and on behalf of all other persons & entities similarly
situated v. Hanover Direct, Inc., and Hanover Brands, Inc. (referred to here as
"Hanover"), No. L 8830-02 in the Superior Court of New Jersey, Bergen County --
Law Division. The plaintiff brings the action individually and on behalf of a
class of all persons and entities in New Jersey who purchased merchandise from
Hanover within six years prior to filing of the lawsuit and continuing to the
date of judgment. On the basis of a purchase made by plaintiff in August 2002 of
certain clothing from Hanover (which was from a men's division catalog, the only
one which retained the insurance line item in 2002), Plaintiff claims that for
at least six years, Hanover maintained a policy and practice of adding a charge
for "insurance" to the orders it received and concealed and failed to disclose
its policy with respect to all class members. Plaintiff claims that Hanover's
conduct was (i) in violation of the New Jersey Consumer Fraud Act, as otherwise
deceptive, misleading and unconscionable; (ii) such as to constitute Unjust
Enrichment of Hanover at the expense and to the detriment of plaintiff and the
class; and (iii) unconscionable per se under the Uniform Commercial Code for
contracts related to the sale of goods. Plaintiff and the class seek damages
equal to the amount of all insurance charges, interest thereon, treble and
punitive damages, injunctive relief, costs and reasonable attorneys' fees, and
such other relief as may be just, necessary, and appropriate. On December 13,
2002, the Company filed a Motion to Stay the Morris action in favor of the
previously filed Martin action. Plaintiff then filed an Amended Complaint adding
International Male as a defendant. The Company's response to the Amended
Complaint was filed on February 5, 2003. Plaintiff's response brief was filed
on March 17, 2003, and the Company's reply brief was filed on March 31, 2003.
Hearing on the Company's Motion to Stay is scheduled for May 9, 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 $298,650 for 13 weeks of
accrued and unused vacation, damages in the amount of $3,583,800, or, in the
alternative, a declaratory judgment from the court that he is entitled to all
change of control benefits under the "Hanover Direct, Inc. Thirty-Six Month
Salary Continuation Plan," and damages in the amount of $1,396,066 or $850,000
due to the Company's purported breach of the terms of the "Long-Term Incentive
Plan for Rakesh K. Kaul" by failing to pay him a "tandem bonus" he alleges was
due and payable to him within the 30 days following his resignation. The Company
removed the case to the U.S. District Court for the Southern District of New
York on July 25, 2001. Mr. Kaul filed an Amended Complaint ("Amended Complaint")
in the U.S. District Court for the Southern District of New York on September
18, 2001. The Amended Complaint repeats many of the claims made in the original
Complaint and adds ERISA claims. On October 11, 2001, the Company filed its
Answer, Defenses and Counterclaims to the Amended Complaint, denying liability
under each and every of Mr. Kaul's causes of action, challenging all substantive
assertions, raising several defenses and stating nine counterclaims against Mr.
Kaul. The counterclaims include (1) breach of contract; (2) breach of the
Non-Competition and Confidentiality Agreement with the Company; (3) breach of
fiduciary duty; (4) unfair competition; and (5) unjust enrichment. The Company
seeks damages, including, without limitation, the $341,803 in severance pay and
car allowance Mr. Kaul received following his resignation, $412,336 for amounts
paid to Mr. Kaul for car allowance and related benefits, the cost of a long-term
disability policy, and certain payments made to personal attorneys and
consultants retained by Mr. Kaul during his employment, $43,847 for certain
services the Company provided and certain expenses the Company incurred,
relating to the renovation and leasing of office space occupied by Mr. Kaul's
spouse at 115 River Road, Edgewater, New Jersey, the Company's current
headquarters, $211,729 on a tax loan to Mr. Kaul outstanding since
28
1997 and interest, compensatory and punitive damages and attorneys' fees. The
case is pending. The discovery period has closed, the Company has moved to amend
its counterclaims, and the parties have each moved for summary judgment. The
Company seeks summary judgment: dismissing Mr. Kaul's claim for severance under
his employment agreement on the ground that he failed to provide the Company
with a general release of, among other things, claims for change of control
benefits; dismissing Mr. Kaul's claim for attorneys' fees on the ground that
they are not authorized under his employment agreement; dismissing Mr. Kaul's
claims related to change in control benefits based on an administrative decision
that he is not entitled to continued participation in the plan or to future
benefits thereunder; dismissing Mr. Kaul's claim for a tandem bonus payment on
the ground that no payment is owing; dismissing Mr. Kaul's claim for vacation
payments based on Company policy regarding carry over vacation; and seeking
judgment on the Company's counterclaim for unjust enrichment based on Mr. Kaul's
failure to pay under a tax note. Mr. Kaul seeks summary judgment: dismissing the
Company's defenses and counterclaims relating to a release on the grounds that
he tendered a release or that the Company is estopped from requiring him to do
so; dismissing the Company's defenses and counterclaims relating to his alleged
violations of his non-compete and confidentiality obligations on the ground that
he did not breach the obligations as defined in the agreement; and dismissing
the Company's claims based on his alleged breach of fiduciary duty, including
those based on his monthly car allowance payments and the leased space to his
wife, on the ground that he was entitled to the car payments and did not involve
himself in or make misrepresentations in connection with the leased space. The
Company has concurrently moved to amend its Answer and Counterclaims to state a
claim that it had cause for terminating Mr. Kaul's employment based on, among
other things, after acquired evidence that Mr. Kaul received a monthly car
allowance and other benefits totaling $412,336 that had not been authorized by
the Company's Board of Directors and that his wife's lease and related expense
was not properly authorized by the Company's Board of Directors, and to clarify
or amend the scope of the Company's counterclaims for reimbursement. The
briefing on the motions is completed and the parties are awaiting the decision
of the Court. No trial date has been set. It is too early to determine the
potential outcome, which could have a material impact on the Company's results
of operations when resolved in a future period.
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 asserted 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
sought compensatory damages in an amount, which was 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
sought 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. On November 20, 2002, the court denied Mr.
Schupak's motion to restore the case to the calendar as "unnecessary and moot"
on the ground that the case had been improperly marked off calendar in the first
instance, ruled that the case therefore remained "active," and fixed a trial
date of March 4, 2003. On January 27, 2003, the parties reached agreement fully
and finally settling all of Mr. Schupak's claims in consideration of a payment
by the Company and the exchange of mutual general releases. The Stipulation and
Order of Dismissal with Prejudice was signed by counsel on February 11, 2003 and
ordered by the Judge and filed in the clerk's office on February 28, 2003.
The Company was named as one of 88 defendants in a patent infringement
complaint filed on November 23, 2001 by the Lemelson Medical, Education &
Research Foundation, Limited Partnership (the "Lemelson Foundation"). The
complaint, filed in the U.S. District Court in Arizona, was not served on the
Company until March 2002. In the complaint, the Lemelson Foundation accuses the
named defendants of infringing seven U.S. patents, which allegedly cover
"automatic identification" technology through the defendants' use of methods for
scanning production markings
29
such as bar codes. The Company received a letter dated November 27, 2001 from
attorneys for the Lemelson Foundation notifying the Company of the complaint and
offering a license. The Court entered a stay of the case on March 20, 2002,
requested by the Lemelson Foundation, pending the outcome of a related case in
Nevada being fought by bar code manufacturers. The trial in the Nevada case
began on November 18, 2002 and ended on January 17, 2003. The parties in the
Nevada case are now required to submit post trial briefs on or before May 16,
2003, and a decision is expected two months or more thereafter. The Order for
the stay in the Lemelson case provides that the Company need not answer the
complaint, although it has the option to do so. The Company has been invited to
join a common interest/joint-defense group consisting of defendants named in the
complaint as well as in other actions brought by the Lemelson Foundation. The
Company is currently in the process of analyzing the merits of the issues raised
by the complaint, notifying vendors of its receipt of the complaint and letter,
evaluating the merits of joining the joint-defense group, and having discussions
with attorneys for the Lemelson Foundation regarding the license offer. A
preliminary estimate of the royalties and attorneys' fees which the Company may
pay if it decides to accept the license offer from the Lemelson Foundation range
from approximately $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 early March 2003, the Company learned that one of its business units
had engaged in certain travel transactions that may have constituted violations
under the provisions of U.S. government regulations promulgated pursuant to 50
U.S.C. App. 1-44, which proscribe certain transactions related to travel to
certain countries. See Note 12 to the Condensed Consolidated Financial
Statements.
In addition, the Company is involved in various routine lawsuits of a
nature that are deemed customary and incidental to its businesses. In the
opinion of management, the ultimate disposition of these actions will not have a
material adverse effect on the Company's financial position or results of
operations.
ITEM 5. OTHER INFORMATION
By letter dated May 2, 2001, the American Stock Exchange (the
"Exchange") notified the Company that it was below certain of the Exchange's
continued listing guidelines set forth in the Exchange's Company Guide. The
Exchange instituted a review of the Company's eligibility for continuing listing
of the Company's common stock on the Exchange. On January 17, 2002, the Company
received a letter dated January 9, 2002 from the Exchange confirming that the
Exchange determined to continue the Company's listing on the Exchange pending
quarterly reviews of the Company's compliance with the steps of its strategic
business realignment program. This determination was made subject to the
Company's favorable progress in satisfying the Exchange's guidelines for
continued listing and to the Exchange's periodic review of the Company's
Securities and Exchange Commission and other filings.
On November 11, 2002, the Company received a letter dated November 8,
2002 from the Exchange updating its position regarding the Company's compliance
with certain of the Exchange's continued listing standards as set forth in Part
10 of the Exchange's Company Guide. Although the Company had been making
favorable progress in satisfying the Exchange's guidelines for continued listing
based on its compliance with the steps of its strategic business realignment
program shared with the Exchange in 2001 and updated in 2002, the Exchange
informed the Company that it had now become strictly subject to the procedures
and requirements of Part 10 of the Company Guide. Specifically, the Company must
not fall below the requirements of: (i) Section 1003(a)(i) with shareholders'
equity of less than $2,000,000 and losses from continuing operations and/or net
losses in two out of its three most recent fiscal years; (ii) Section
1003(a)(ii) with shareholders' equity of less than $4,000,000 and losses from
continuing operations and/or net losses in three out of its four most recent
fiscal years; and (iii) Section 1003(a)(iii) with shareholders' equity of less
than $6,000,000 and losses from continuing operations and/or net losses in its
five most recent fiscal years. The Exchange requested that the Company submit a
plan to the Exchange by December 11, 2002, advising the Exchange of action it
has taken, or will take, that would bring it into compliance with the continued
listing standards by December 28, 2003. The Company submitted a plan to the
Exchange on December 11, 2002, in an effort to maintain the listing of the
Company's common stock on the Exchange.
On January 28, 2003, the Company received a letter from the Exchange
confirming that, as of the date of the letter, the Company had evidenced
compliance with the requirements necessary for continued listing on the
Exchange. Such compliance resulted from a recent rule change by the Exchange
approved by the Securities and Exchange Commission related to continued listing
on the basis of compliance with total market capitalization or total assets and
30
revenues standards as alternatives to shareholders' equity standards such as the
requirement for each listed company to maintain $15 million in public float. The
letter is subject to changes in the American Stock Exchange Rules that might
supersede the letter or require the Exchange to re-evaluate its position.
31
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
10.1 Twenty-fifth Amendment to Loan and Security Agreement, dated as of
April 21, 2003, among Congress Financial Corporation and certain
Subsidiaries of the Company.
99.1 Certification signed by Thomas C. Shull and Edward M. Lambert.
(b) Reports on Form 8-K:
1.1 Form 8-K, filed January 29, 2003 -- reporting pursuant to Item 5 of
such Form the issuance of a press release announcing unaudited revenue
results for the fiscal year ended December 28, 2002 and the expansion
of the Company's brand offerings with Amazon.com during the first
quarter of 2003.
1.2 Form 8-K, filed January 30, 2003 -- reporting pursuant to Item 5 of
such Form the receipt of a letter from the American Stock Exchange (the
"Exchange") confirming that, as of the date of the letter, the Company
had evidenced compliance with the requirements necessary for continued
listing on the Exchange.
1.3 Form 8-K, filed March 20, 2003 -- reporting pursuant to Item 5 of such
Form scheduling information regarding its conference call with
management to review the fiscal year 2002 operating results.
1.4 Form 8-K, filed March 26, 2003 -- reporting pursuant to Item 9 of such
Form the issuance of a press release announcing operating results for
the 52 weeks ended December 28, 2002.
1.5 Form 8-K, filed March 26, 2003 -- reporting pursuant to Item 5 of such
Form the issuance of a press release announcing the launch of its new
Investor Relations Web site.
1.6 Form 8-K, filed March 28, 2003 -- reporting pursuant to Item 9 of such
Form an unofficial transcript of its conference call with management to
review the fiscal year 2002 operating results.
1.7 Form 8-K, filed May 7, 2003 -- reporting pursuant to Item 5 of such
Form scheduling information regarding its conference call with
management to review the operating results for the fiscal quarter ended
March 29, 2003.
32
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HANOVER DIRECT, INC.
Registrant
/s/ Edward M. Lambert
By: ___________________________________
Edward M. Lambert
Executive Vice President and
Chief Financial Officer
(On behalf of the Registrant and as
principal financial officer)
Date: May 12, 2003
33
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; and
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.
/s/ Edward M. Lambert
_______________________________
Edward M. Lambert
Executive Vice President and
Chief Financial Officer
Date: May 12, 2003
34
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; and
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.
/s/ Thomas C. Shull
______________________________
Thomas C. Shull
President and Chief Executive Officer
Date: May 12, 2003
35