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FORM 10-K

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

or

Commission File Number 1-9637

LILLIAN VERNON CORPORATION

Registrant’s telephone number including area code: (914) 925-1200

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:
            None

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this Chapter) is not contained herein and will not be contained, to the best of registrant’s knowledge, in definitive proxy information statement, included in Part III of this Form 10-K or any amendment to this Form 10-K.

Indicate by checkmark whether the Registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).

Yes      No  X

The aggregate market value for the Voting Stock held by non-affiliates (based upon the closing price on August 24, 2002) was approximately $28,332,168.

As of August 24, 2002, there were 8,333,051 shares of Common Stock, par value $.01 per share, outstanding.

The Index to Exhibits appears on page 43.

Table of Contents

LILLIAN VERNON CORPORATION
FISCAL 2003 FORM 10-K ANNUAL REPORT

TABLE OF CONTENTS

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PART I

General

     Lillian Vernon Corporation (the “Company”) is a direct mail specialty catalog and online company concentrating on the marketing of gift, houseware, garden, Christmas and children’s products. The Company, a predecessor of which was founded in 1951, seeks to provide customers with reasonably priced products that can be differentiated from competitive products either by design, price or personalization. In fiscal 2003, the Company published 33 catalog editions, and mailed approximately 150,000,000 catalogs to past and prospective customers.

     The Company has developed a proprietary customer data base containing information about its customers, including such data as order frequency, size and date of last order, and type of products purchased. These and other factors are analyzed by computer to rank and segment customers to determine those most likely to purchase products offered in the Company’s catalogs. The data base contains information with respect to over 27 million customers, gift recipients and people who have requested the Company’s catalogs.

     In addition to offering its products through its catalogs, the Company offers its products over the Internet from its websites, www.lillianvernon.com and www.ruedefrance.com. The Company derives a small portion of its revenue from the rental of its customer list to direct mail marketers and other organizations and from a telephone program selling magazine subscriptions, club memberships and other products. The Company has a Business to Business operation which sells premium and incentive items, and other products to businesses. Business to Business also sells to the wholesale market. The Company also operates a chain of outlet stores which sell Lillian Vernon merchandise.

     The following table reflects the Company’s history in the areas of circulation of its catalogs, number of orders received and average revenue per order received, over the last five fiscal years.

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Catalogs and Products

     The Company’s catalogs are designed to capture the readers’ interest through the use of distinctive covers, colorful product presentations and product descriptions that highlight significant features. The catalogs are created and produced by the Company’s in-house creative staff, which includes designers, writers and production personnel. The Company also hires free-lance designers and photographers as needed. The combination of in-house and free-lance staff enables the Company to maintain both quality control and flexibility in the production of its catalogs.

     The Company strategically varies the quantity of its catalog mailings based on the selling season, anticipated revenue per catalog, the price of paper and other catalog costs, and its capacity to process and fill orders.

     Merchandise offered by the Company includes gifts, holiday products, toys and children’s products, personal and home accessories, kitchen and

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houseware products, garden and outdoor products. The Company employs a staff of experienced buyers who seek reliable sources for unique quality merchandise. The buyers attend numerous domestic and international trade and merchandise shows, study merchandising trends, and review the performance of merchandise previously offered. The Company also uses both its product development staff and free-lance artists to develop distinctive designs for many of its products which the Company copyrights and has manufactured to its specifications. The Company provides free monogramming and full name personalization on many of the products it sells. In the past fiscal year, products which can be personalized or which were manufactured to the Company’s exclusive design specifications accounted for approximately half of the products offered by the Company.

Company Catalogs and Internet Activities

     The Lillian Vernon Catalog (the “Core Catalog”, 9 editions in fiscal 2003) offers a wide variety of products including gifts, holiday products, toys, and children’s products, personal and home accessories, kitchen and houseware products and outdoor products.

     The Company’s Lilly’s Kids Catalog (6 editions in fiscal 2003) features toys, games, baby products, room decor and fashion accessories for children.

     The Company’s Christmas Memories Catalog (1 edition in fiscal 2003) is targeted to the Christmas season and offers ornaments, holiday decor, gifts, cards and many unique and exclusive products.

     The Favorites Catalog (5 editions in fiscal 2003) features many of the best-selling products from all Lillian Vernon catalogs.

     The Company’s Personalized Gifts Catalog (3 editions in fiscal 2003) features gift items, all offered with personalization.

     The Lillian Vernon Gardening Catalog (2 editions in fiscal 2003) features a cross section of functional garden products, as well as garden and floral-themed decorative accessories.

     The Rue de France Catalog (4 editions in fiscal 2003) features upscale room decor and customized window treatments and draperies with a French country theme.

     The Sales and Bargains Catalog (3 editions in fiscal 2003) is primarily used to sell overstocked and discontinued merchandise and is generally mailed only to customers in the Company’s data base.

     The number of products offered in each catalog varies from 300 products to 800 products depending on the time of the year.

     The Company first offered its products over the Internet in 1995, and has continually upgraded its site since that time. In fiscal 2002, the Company launched a completely redesigned and reengineered e-commerce Internet site, www.lillianvernon.com. This state-of-the-art website incorporates features that represent industry-wide best practices. These include: sophisticated cross-sell and promotional-sell merchandising

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capabilities, real-time inventory availability of products, the ability to view printed catalogs online, and the opportunity for customers to see and buy all of the products that the Company offers. The Company anticipates that on-line usage by its existing customer base will continue to grow, and is now marketing the site in ways that will expand the customer base. In fiscal 2003, orders received through the web site increased 47% over fiscal 2002, and comprised approximately 21% of total orders, compared to approximately 13% of total orders in fiscal 2002.

     The Company offers a deferred billing program to its customers, in which it agrees to charge the customers’ credit cards for the full amount of their purchase at a future date specified in each catalog. The Company does not charge interest to the customers who participate in the deferred billing program.

     All products sold, including personalized products, are unconditionally guaranteed. A customer may return any product, even if personalized, for any reason. The dollar value of refunds requested by customers under the guarantee in fiscal 2003 approximated 3.8% of net revenues.

     The Company purchases its products from approximately 900 suppliers. Approximately 83% of the merchandise is purchased abroad predominantly from manufacturers located in Taiwan, India, Hong Kong and throughout the Peoples’ Republic of China, Italy, Thailand and France. Most purchase orders are denominated in U.S. dollars. Although no manufacturer is individually material to the Company’s operations, the Company buys significant quantities through several Far East trading companies which utilize multiple manufacturers. The Company buys approximately 6% of its purchases through one Far Eastern buying agent which acts as the Company’s representative in its dealings with many different manufacturers in the Peoples’ Republic of China, including Hong Kong. The Company also buys approximately 8% of its purchases through another Hong Kong vendor. As a result of the recent SARS epidemic, the Company’s buyers have restricted travel to the Far East. However they still perform their buying functions by attending trade shows that are being staged domestically with supplier representation from the Far East. Additionally the Company’s Far East suppliers have sent pictures of new merchandise electronically which enable the buyers to choose new merchandise they wish to order.

Marketing

     The Company maintains a proprietary customer data base containing information with respect to over 27 million customers, gift recipients and people who have requested its catalogs. In addition, the Company rents from and exchanges mailing lists or specific portions of lists with direct marketers and other organizations to gain new customers. Approximately 150,000,000 catalogs were mailed in fiscal 2003 of which approximately 80% were mailed to people whose names were in the Company’s proprietary data base and approximately 20% were mailed to prospects derived from rented lists.

     The Company offers customers special promotions such as gifts with purchase, free shipping and handling, and a deferred billing option in order to increase sales.

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     The Company believes that the size of its computerized data base and its ability to analyze it as well as rented lists and to select recipients for a particular mailing are important factors in its operation. The Company analyzes various factors (e.g., frequency of order, date of last order, order size, type of products purchased and demographic data) to rank its customer and prospect groups in order to target its catalog mailings to those most likely to purchase its merchandise. The Company updates its data base to include new customers and eliminate non-responders.

     The Company periodically conducts focus groups and participates in customer surveys to enhance its marketing efforts.

Third-Party Sales Programs

     The Company operates a telemarketing program in which inbound order callers are offered the opportunity to subscribe to magazines of their choice, to enroll in a third party membership program or to purchase special product offerings. The membership program offers its members discounts at restaurants, movies and other national chains. The third party marketers provide revenue to the Company for every magazine, membership or special product sold.

List Rental

     The Company derives a small portion of its revenue from the rental of its data base to direct mail marketers and other organizations and from the placement of advertisements for other companies’ products in its outgoing packages.

Order Fulfillment and Distribution

     Orders for merchandise are received by telephone, mail, fax, and over the Internet. Orders are received and processed at the Company’s National Distribution Center in Virginia Beach, Virginia. Customer Service operations are also conducted at this facility. The Company also operates a seasonal telephone order call center to handle peak season order volume. The Company receives telephone and Internet orders on a 24-hour basis, seven days a week, with orders entered directly into the computer. Orders received by mail are opened, compared to payments, batched and entered into computer terminals.

     The Company’s telephone representatives conduct upselling and cross-selling in which customers are offered merchandise at special prices or a substitute product if the product they ordered is unavailable or an additional product related to the one ordered by the customer.

     The majority of orders are processed, packed and shipped at the Company’s National Distribution Center. Some products are drop-shipped from vendors directly to customers when this is the most cost-effective way of satisfying the customer. Approximately 92% of customer orders were shipped by the U.S. Postal Service in fiscal 2003. The Company also ships orders via UPS Second Day Air delivery as an option to its customers for

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an extra charge. In addition, the Company ships orders via UPS Next Day Air as an option to Internet customers for an extra charge.

     The Company’s National Distribution Center, an 821,000 square foot facility is located in Virginia Beach, Virginia. Almost all of the Company’s distribution, and a majority of its warehousing activities, are conducted at this facility. The National Distribution Center is generally operated on a five-day-a-week basis, except during the Christmas holiday season, when, depending upon demand, it may operate on a six or seven-day-a-week, three-shift basis. Personalization of products is also done at the Company’s National Distribution Center. The Company believes that its ability to personalize many types of products using a variety of personalization techniques, generally within several days’ processing time, gives it a unique niche in the retail marketplace. The Company also owned a 154,000 square foot building in Virginia Beach used for additional distribution and warehousing space. This facility was sold in May 2003 and the functions that were handled at this facility were consolidated into the main facility.

     The Company continually assesses the need to upgrade the capacity of its telemarketing and distribution facilities. (See “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”)

Paper and Mailing Costs

     The Company expends significant amounts on paper in the production of its catalogs. The Company also uses substantial amounts of packing supplies and corrugated boxes to ship its products. In fiscal 2003, the Company spent approximately $18.1 million in total paper costs and also spent approximately $51.2 million in mailing catalogs and packages to its customers.

     In recent years, the U.S. Postal Service has increased its rates for both the mailing of catalogs and packages. There were postal rate increases related to the mailings of catalogs of 9.1% in late fiscal 2001, 1.6% in July of 2001 followed by a postal rate increase of 7.5% in June 2002. No assurance can be given that postal rates will not continue to increase in the future; however, no increase is anticipated to occur until 2006. The Company also considers the use of alternative parcel delivery services besides the U.S. Postal Service but has determined that the U.S. Postal Service offers the best balance of cost and service level for the bulk of its shipments. The other parcel carriers also have a history of significant rate increases from year to year.

     The price of paper is dependent upon supply and demand in the marketplace. The Company’s paper cost per page decreased approximately 9% in fiscal 2003 as compared to fiscal 2002, and is expected to be higher in fiscal year 2004 as compared to fiscal 2003 principally because of the Company’s intention to upgrade the quality of its paper, as well as a tightening paper market.

     The Company continually monitors the paper market and periodically meets with its paper suppliers in order to react to changes in the paper supply market. In addition, the Company entered into a paper collar

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contract to provide price protection in the form of a floor and ceiling in purchasing certain of its paper requirements, (see Item 7(A) — “Quantitative and Qualitative Disclosure About Market Risk” for further discussion). While the Company cannot estimate the magnitude of future paper and postage increases or decreases, such changes may impact the Company’s future earnings. (See “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”)

Merchandise Overstocks

     The Company sells its overstocks to its customers at reduced prices, primarily through its Sales and Bargains catalogs, its outlet stores and through special offers made to customers placing orders by telephone and on the Internet.

Seasonality

     The Company’s business is seasonal. Historically approximately 65% — 75% of the Company’s revenues and substantially all of its net income has been realized during its third and fourth fiscal quarters which encompass the period September through February. Lower revenue and net losses are typically incurred during its first and second fiscal quarters, comprising the period March through August. The Company believes this is the general pattern associated with other mail order and retail gift businesses. Further discussion of the effect of seasonality upon revenues and income is contained in “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Government Regulations

     The Company complies with Federal, state and local laws affecting its business. In particular, the Company is subject to Federal Trade Commission regulations governing the Company’s advertising and trade practices and Consumer Product Safety Commission regulations governing the standards its products, particularly toys, must meet. The Company believes it is presently in compliance with such regulations. In the event of noncompliance the Company may be subject to cease and desist orders, injunctive proceedings, civil fines and other penalties. To date such governmental regulations have not had a material adverse effect on the Company. On occasion products offered by the Company have been subject to voluntary recall. No such recall has had a material adverse effect on the Company.

     The United States and the other countries in which the Company’s products are manufactured may, from time to time, impose new or adjust existing quotas, duties, tariffs or other restrictions, with the result that the Company’s ability to continue to import merchandise at required levels could be adversely affected. Although the Company attempts to identify secondary sources for its merchandise the Company cannot predict the likelihood of any such events occurring or the effect on its business of any such event.

     In the past, various states had taken action to require mail order retailers to collect sales tax from residents in their states even if the only contact with such states is the mailing of catalogs into the states. On May 26, 1992, the Supreme Court ruled that state governments could not

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require out of state mail order companies to collect and remit sales and use taxes without Congressional authorization. Since that time bills have periodically been introduced in Congress which would allow states to impose sales tax collection responsibility upon mail order companies. No bills have been enacted into law. Similarly, Congress is currently studying Internet taxation issues, but to date has not enacted any bills which would require companies to collect sales tax on Internet transactions in states where they do not have a physical presence.

     Although management is unable to predict the likelihood of Congress passing sales tax legislation in the future the Company does not expect that the collection of sales tax will have a material effect on its results of operations or financial position in fiscal 2004.

Trademarks and Copyrights

     The Company has federally registered service marks and/or logos for “Lillian Vernon” and many of its catalog titles. In the opinion of the management of the Company the service mark “Lillian Vernon” is of significant value because of its market recognition as a result of many years of use and the large quantity of catalogs circulated.

     The Company also possesses numerous copyrights and/or trademarks on its products, none of which is individually material to the Company.

Employees

     As of February 22, 2003, the Company and its subsidiaries employed approximately 1,200 employees. During the peak holiday season, the Company utilizes approximately 4,600 people including seasonal employees working in the telephone order, order processing and distribution areas. Employees are not covered by collective bargaining agreements. The Company considers its employee relations to be good.

Competition

     The retail business in general, and mail order in particular, is highly competitive. The Company competes primarily with other mail order catalogs, as well as Internet websites and retail stores, including specialty shops and department stores, many of which have substantially greater financial resources than the Company. The Company competes on the basis of its exclusive product selection, its personalization capabilities, its proprietary customer list, the quality of its customer service and its unconditional guarantee. Although the Company attempts to market products not available elsewhere, certain products similar to those marketed by the Company may be purchased through other mail order catalogs, online, or in retail stores.

Acquisition — Rue de France, Inc.

     On April 6, 2000, the Company completed the purchase of the assets of Rue de France, Inc., a privately owned catalog and online company based in Newport, Rhode Island. The Company paid a cash purchase price of $2.8 million. Additionally the Company agreed to make future payments contingent upon Rue de France, Inc. achieving certain cumulative earnings

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before tax targets during the five year fiscal period of the Company commencing on February 27, 2000. No such payments have been required to date.

     Rue de France, Inc., a 20 year-old business focusing on window treatments, home furnishings and accessories, markets its products through catalogs, a web site and retail stores in Newport and Portsmouth, Rhode Island. Rue de France, Inc.’s founder joined Lillian Vernon Corporation under a multi-year employment contract as President of the subsidiary which acquired the assets of Rue de France, Inc.

Merger

     On April 15, 2003, the Company signed a definitive merger agreement (the “Merger Agreement”) with a private equity fund managed by Ripplewood Holdings L.L.C., pursuant to which Ripplewood will acquire the Company for $7.25 per share in cash (the “Merger”). Ripplewood’s Industrial Partner, ZelnickMedia, will be responsible for the day-to-day management of the Company. The Company will continue to operate in the catalog and direct marketing business. The Company also simultaneously entered into a consulting agreement with ZelnickMedia Corporation under which the Company agreed to pay ZelnickMedia $62,500 per month for advisory and consulting services. Mr. Strauss Zelnick will be the Chairman of the new company. Following the acquisition, Ms. Lillian Vernon, the founder, current Chairman of the Board and largest stockholder of the Company, will serve as the Company’s non-executive Chairman as well as the Company’s spokesperson. Ms. Vernon will no longer be responsible for the day-to-day operations of the business, and is expected to own 5% of the acquired company following the merger. Ms. Vernon will not be a director or an officer of the Company subsequent to the merger. Detailed information about the proposed merger can be found in a definitive proxy statement which the Company filed with the Securities and Exchange Commission on May 28, 2003 and thereafter mailed to its stockholders. A special meeting of stockholders will be held on June 23, 2003 to approve the Merger Agreement. The Merger Agreement is also subject to the satisfaction of other closing conditions including the receipt of required financing. If the merger transaction is not consummated under certain circumstances, the Company would be required to pay a merger termination fee of $1,850,000. Commitment letters have been obtained with respect to all necessary financing in connection with the transaction. Furthermore, the Company has agreed to enter into sale and leaseback agreements for its National Distribution Center as part of the financing of the transaction. The transaction is expected to close by June 30, 2003.

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Available Information

     Lillian Vernon Corporation is required to file annual and quarterly reports, proxy statements and other information with the SEC. Investors may read and copy any document that Lillian Vernon Corporation files, including this Form 10-K, at the SEC’s Public Reference Room at 450 Fifth Street, N.W., Washington D.C. 20549. Investors may obtain information regarding access to the Public Reference Room by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains an Internet site at http://www.sec.gov that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC, from which investors can electronically access the Company’s SEC filings.

     The Company’s corporate headquarters and administrative offices are located in a 65,000 square foot building in Rye, New York. The corporate headquarters includes the executive offices, merchandising, creative, marketing, Internet and finance departments, as well as the Business to Business division. This facility is leased under a sublease agreement expiring on January 30, 2005. In addition to base rent, the sublease provides that the Company is responsible for increases in real estate taxes and operating costs over a base year. The Company has two renewal options, each for five years, from the owners of the building, an unaffiliated entity, upon the expiration of the sublease, in 2005.

     The Company’s 821,000 square foot National Distribution Center is located on approximately 61 acres in Virginia Beach, Virginia. The facility became fully operational during the summer of 1988.

     The Company also owned a 154,000 square foot building in Virginia Beach, which it utilized for additional distribution and warehousing space. The Company sold this building in May 2003.

     Almost all distribution and warehousing activities, as well as mail order processing, customer service and most telemarketing activities, are conducted at the Virginia Beach facility.

     The Company leases approximately 20,000 square feet in an office complex in Las Vegas, Nevada, as an additional telemarketing facility. The lease expires March 31, 2005. The Company is responsible for its share of operating expenses, real estate taxes and utility charges. Due to the Company’s restructuring plan (See “Management’s Discussion and Analysis of Financial Condition and Results of Operations”), the Nevada facility was closed in May 2001. The Company attempted to sublease the facility, but was unable to do so. On April 24, 2002 the Company decided to reactivate the facility as a seasonal call center.

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     Previously, the Company leased 11,000 square feet in an office building in New Rochelle, New York, which was used as a seasonal telemarketing facility. The lease expired December 31, 2002. The Company did not renew this lease at the end of its term.

     The Company leases sixteen retail locations, which principally serve as outlet stores, in the states of Virginia, New York, Delaware, South Carolina, Rhode Island, Vermont and Tennessee. The typical retail store is approximately 3,000 square feet. The retail store leases expire from fiscal 2004 through fiscal 2009 and contain various renewal options through fiscal 2014. The Company may lease additional outlet store locations on a short-term basis, particularly during the holiday season.

     The Company believes that its facilities are adequate and that its properties are in good condition.

     The Company’s earnings are impacted by fluctuating paper prices. In order to partially mitigate this risk, the Company entered into a paper collar contract, the ISDA Master Agreement (the “Agreement”), with Enron North America Corp. (formerly known as Enron Capital and Trade Resources Corp.) (“Enron”) dated as of December 15, 1998. See Item 7A “Quantitative and Qualitative Disclosure about Market Risk” for a description of the Agreement. Enron has sent written notice to the Company alleging that it failed to pay Enron amounts owed pursuant to the Agreement. Additionally, Enron has asserted that the Company’s failure to pay the invoiced amounts constituted an Event of Default and designated March 27, 2002 as the Early Termination Date for all outstanding transactions under the Agreement. At February 22, 2003, the Company has recorded a liability in the amount of $5.6 million to cover all obligations in connection with this contract. On May 12, 2003, the Company signed a Settlement Agreement and Mutual Release with Enron whereby the Company agreed to pay $3.0 million as consideration for the release and settlement of all claims under the paper collar contract. The Settlement Agreement and the Mutual Release have been approved by Enron’s creditors’ committee and the Bankruptcy Court. The Company will record the effect of this release and settlement in the financial statements in fiscal 2004.

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     On April 15, 2003, the Company signed a definitive merger agreement (the “Merger Agreement”) with a private equity fund managed by Ripplewood Holdings L.L.C., pursuant to which Ripplewood will acquire the Company for $7.25 per share in cash (“the Merger”). The Company, its directors and Ripplewood Holdings L.L.C. have been named as defendants in a class action lawsuit filed by North Border Investments on or about April 18, 2003 in the Court of Chancery of the State of Delaware in and for New Castle County. The plaintiff purports to represent a class of public stockholders of the Company whose stock will be converted into the right to receive the $7.25 per share cash payment on the completion of the Merger. The complaint alleges, among other things, that the $7.25 cash price per share to be paid to stockholders in connection with the Merger is unfair and inadequate. It also alleges that the Company’s directors discouraged other potential buyers from coming forward and thus allowed the price of the Company to be capped. As a result, the plaintiff alleges that the Company’s directors breached their fiduciary duties to the Company’s stockholders in approving the Merger Agreement. The complaint seeks unspecified monetary damages, attorneys’ and experts’ fees and injunctive relief that would, if granted, prevent the completion of the Merger. The Company believes the action is wholly without merit and intends to contest it vigorously.

     None.

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PART II

     The Company’s Common Stock is traded on the American Stock Exchange (symbol: LVC). The following table sets forth the high and low sale prices for each quarterly period for the two most recent fiscal years. The stock prices are rounded to the nearest cent.

     As of May 16, 2003, there were 360 registered holders of the Company’s Common Stock.

     The Company paid 41 consecutive quarterly cash dividends on its common stock since an initial quarterly dividend of five cents ($.05) per share was paid in May of 1992. The quarterly dividend was increased to seven cents ($.07) per share payable September 1, 1994, and to eight cents ($.08) per share in March 1998. Subsequently, the dividend was reduced to four cents ($.04) per share payable on March 1, 2002. At its February 28, 2002 meeting the Board of Directors voted to discontinue the regular quarterly cash dividend effective after the payment of the March 1, 2002 dividend to conserve cash for reinvestment in the business.

     On October 10, 1995, the Board of Directors authorized the Company to repurchase up to 1 million shares of its common stock in the open market from time to time subject to market conditions. As of September 3, 1998, the Company completed the one million share repurchase program. On October 7, 1998, the Board of Directors approved a new stock repurchase program which authorized the Company to repurchase up to an additional one million shares of its common stock in the open market from time to time subject to market conditions. On September 28, 1999, the Board of Directors authorized the Company to repurchase an additional 500,000 shares of its common stock. As of May 19, 2003, the Company had repurchased 1,178,442 shares at a total cost of approximately $11.4 million under the current stock repurchase program. The Company uses these shares to make matching contributions to its Profit Sharing/401(k) Plan and to issue shares under its Stock Option and Employee Stock Purchase Plans.

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     The following selected financial data should be read in conjunction with the Company’s Consolidated Financial Statements and the accompanying notes presented elsewhere herein.

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(2)  See Notes 6, 7, 8 and 16 to the consolidated financial statements.

     The following table sets forth, for the periods indicated, the results of operations as a percentage of revenues.

Fiscal 2003 Compared to Fiscal 2002

     Revenues for fiscal 2003 were $238.0 million compared to $259.6 million last year, a decrease of $21.6 million, or 8.3%. Revenues decreased primarily because of the difficult retail environment and a 7.5% planned reduction in the number of catalogs circulated during the fiscal year ended February 22, 2003. Specifically, the Company’s Neat Ideas catalog was consolidated into its other catalogs; the Sales and Bargains catalog was not mailed in the first quarter; the Spring Favorites as well as the September Christmas Memories catalog were not mailed. Revenue per catalog increased by 1.4% compared to the same period last year. While the total number of orders shipped decreased by approximately 8.1% compared to fiscal 2002, orders received through the Company’s website increased 47% from the prior year, and represented 21% of total orders in fiscal 2003 as compared to 13% last year. The Company believes much of this increase is due to customers now ordering from its website as opposed to ordering by telephone.

     Product and delivery costs include the cost of merchandise sold, the cost of receiving, personalizing, filling and shipping orders for the

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Company’s customers. Product and delivery costs in fiscal 2003 were $140.5 million, a decrease of $13.8 million, or 9.0% compared to $154.3 million for fiscal 2002. This decrease was primarily a result of the decline in the volume of orders shipped by the Company in fiscal 2003. As a percentage of revenue, product and delivery costs decreased from 59.4% in fiscal 2002 to 59.0% in fiscal 2003. The decrease as a percentage of revenue was primarily due to higher gross profit on products sold, as a result of less inventory liquidation in fiscal 2003. Additionally fulfillment costs on a per-order basis declined principally because of increased productivity associated with the pay-for-performance program introduced by the Company in the second quarter of fiscal 2003. The pay-for-performance program rewards Distribution Center employees for increased efficiency. These savings, however, were significantly offset in the current year by the non-recurring consulting fees of approximately $1.6 million paid to implement the program.

     Selling, general and administrative (“SG&A”) expenses were $117.0 million in fiscal 2003 compared to $118.9 million in fiscal 2002, a decrease of $1.8 million, or 1.5%. As a percentage of revenue, SG&A increased from 45.8% in fiscal 2002 to 49.2% in fiscal 2003. The decline in these costs as a result of a 7.5% reduction in circulation was offset by an increase principally due to higher postal rates to mail catalogs, higher software amortization costs of the Company’s upgraded website of $ 1.1 million, higher internet marketing expenditures of $1.1 million and an increase of $1.0 million associated with amortization of catalog costs related to the Company’s paper collar contract (as more fully discussed below).

     The cost of producing, printing and mailing the Company’s catalogs represents the single largest component of SG&A expenses. The Company’s paper cost per page decreased by approximately 9% in fiscal 2003 compared to fiscal 2002, and is expected to rise for fiscal 2004 principally due to tightening in the paper market as well as the Company’s intention to upgrade the quality of the paper used in its Lillian Vernon Core catalogs to improve the appearance of the catalog and increase sales. Postal rates have continued to rise. Postal rate increases of 9% in January 2001 and 1.6% in July 2001 were followed by a further increase in June 2002 of 7.5%. Another increase is not anticipated to occur until 2006. To mitigate the impact of the postal rate increases, the Company takes steps such as reducing the weight of the catalogs, making adjustments to catalog page counts, and increasing the density of the photographs. In addition, the Company increased the shipping and handling fees that are charged to customers in July 2002. Overall, the Company’s average cost to produce and mail a catalog is expected to be higher in fiscal 2004 compared to 2003. The Company expects to significantly reduce catalog circulation in fiscal 2004 to eliminate marginal catalogs and circulation and also plans to reduce its other SG&A expenses.

     The Company continually monitors the paper market and periodically meets with its paper suppliers in order to react to changes in the paper supply market. In addition, the Company entered into a paper collar contract to provide price protection in the form of a floor and ceiling in purchasing certain of its paper requirements. (See Item 7(A)-“Quantitative and Qualitative Disclosure About Market Risk” for further

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discussion). FAS No. 133 requires that all derivative financial instruments such as this contract be recorded on the balance sheet as either assets or liabilities at fair value. Changes in the fair value of derivatives are recorded each period in earnings or other comprehensive earnings (losses), depending on whether a derivative is designated and effective as part of a hedge transaction and, if it is, the type of hedge transaction. Gains and losses on derivative instruments reported in other comprehensive earnings (losses) are reclassified to earnings in the periods in which earnings are affected by the hedged item. The paper collar contract had been designated, and was effective as a hedge through November 2001. During the nine months ended November 24, 2001, ineffectiveness related to the paper collar contract was not significant.

     Due to the financial situation of the counterparty, Enron North America Corporation (“Enron”), the Company discontinued hedge accounting subsequent to November 2001. As a result, $1.7 million (net of taxes of $1.1 million) previously recorded in Accumulated Other Comprehensive Losses under hedge accounting through November 24, 2001 are being reclassified to earnings as a component of selling, general and administrative expenses (catalog costs) in the period in which earnings are affected by the paper costs, through the end of the contract. For fiscal years 2003 and 2002, these amounts were $.8 million (net of taxes of $.6 million) and $.2 million (net of taxes of $.1 million), respectively. In addition, any changes in the fair value of the contract subsequent to November 24, 2001 will be recorded in earnings as financing expense. For fiscal years 2003 and 2002, these amounts were $2.3 million and $.5 million, respectively, on a pre-tax basis. The fair value of the non-current portion of the contract at February 22, 2003 and February 23, 2002 was $2.6 million and $2.8 million, respectively, which is included in other liabilities in the Company’s financial statements.

     At February 22, 2003 the Company has $3.0 million included in accounts payable and accrued expenses relating to this obligation in addition to the fair value of the contract of $2.6 million included in other liabilities. The total liability to Enron recorded as of February 22, 2003 is $5.6 million. On May 12, 2003 the Company signed a Settlement Agreement and Mutual Release with Enron, whereby the Company agreed to pay $3.0 million as consideration for the release and settlement of all claims under the paper collar contract. The Settlement Agreement and Mutual Release have been approved by Enron’s creditors’ committee and the Bankruptcy Court. The Company will record the effect of this release and settlement in the financial statements in fiscal 2004.

     During fiscal 2001, the Company approved a restructuring plan to streamline operations and reduce costs in light of decreased consumer spending and an uncertain economy (“the Plan”). Under the Plan, the Company eliminated approximately 12% of its salaried workforce and consolidated its Las Vegas Call Center into its National Distribution Center located in Virginia Beach. On April 24, 2002, the Company decided to reactivate the Las Vegas Call Center as a seasonal call center. As a result of this decision, the remaining accrual of $.4 million for the lease termination costs for this facility was reversed in the first quarter of fiscal 2003.

     Interest income in fiscal 2003 was $.2 million compared to $.7

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million income in fiscal 2002. The decrease of $.5 million was due primarily to lower interest rates on the Company’s cash investments as well as lower amounts invested.

     Financing expense was $2.6 million in fiscal 2003, compared to $.8 million in fiscal 2002. The current fiscal year includes a financing charge of $2.3 million to record the change in the fair value of the Company’s paper collar contract. There were no short-term borrowings during fiscal years 2003, 2002 or 2001.

     The Company’s effective income tax benefit rate of 13.6% in fiscal 2003 differs from the statutory rate of 34% primarily due to the Company’s recording of a deferred income tax valuation allowance because of its potential inability to fully realize the benefit from future net deductible expenses and to fully utilize its net operating loss carryforwards prior to expiration. As of February 22, 2003, the Company has recorded a net deferred tax asset of $4.0 million after the recording of the valuation allowance. The ultimate realization of the Company’s net deferred tax asset is dependent upon the generation of sufficient amounts of future taxable income during the years in which the related net expenses become deductible and the related net operating loss and tax credit carryforwards may be utilized prior to expiration. The Company’s ability to generate sufficient taxable income in future periods is contingent upon a number of factors, including general economic conditions and the Company’s sales levels in future periods. Although management has developed plans which should enable the Company to achieve sufficient income levels in the future, there can be no assurance that the plans will be successful in enabling the Company to generate sufficient taxable income from operations in the periods in which the net expenses become deductible and prior to the expiration of the net operating loss carryforwards. The Company has developed certain tax planning strategies relating to the potential sale and leaseback of its National Distribution Center which could be employed, if necessary, to generate taxable income. However, it has been determined that the taxable income generated by the tax planning strategies will more likely than not be insufficient to fully offset the impact of the future net deductible expenses and fully utilize the net operating loss carryforwards prior to expiration. Therefore, the Company has recorded a tax charge of $4.6 million for the fiscal year 2003 to record a deferred income tax valuation allowance. The Company expects to record a valuation allowance on future tax benefits until it can be determined that it is more likely than not that the deferred tax asset will be realized. The Company did not record a valuation allowance with respect to the net deferred tax asset as of February 23, 2002.

     The net loss for fiscal year 2003 was $18.6 million, compared to the net loss of $9.1 million in fiscal 2002. As more fully discussed above, significant factors affecting the net loss for fiscal year 2003 included financing charges and SG&A (catalog expense) totaling $2.4 million after taxes to account for the Company’s paper collar contract (approximately $1.9 million more than fiscal 2002), a charge of $.7 million after taxes for higher software amortization of the Company’s upgraded website and a charge of $.7 million after taxes, for increased internet advertising expenses. Fiscal 2003 results also included a tax charge associated with the recognition of a deferred tax valuation allowance of $4.6 million,

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related to the potential inability of the Company to fully realize the benefit from future net deductible expenses and fully utilize its net operating loss and tax credit carryforwards.

Fiscal 2002 Compared to Fiscal 2001

     Revenues for fiscal 2002 were $259.6 million compared to $287.1 million in fiscal 2001, a decrease of $27.5 million, or 9.6%. Revenues decreased primarily because of a 6% reduction in catalog circulation, and 5% lower revenue per catalog mailed, as a result of the recession, the effects of September 11th and consumer concerns about anthrax in the mail. While the overall number of orders received by the Company during fiscal 2002 declined 9.2%, orders received through the Company’s website increased 33% from the prior year, and represent 13% of total orders in fiscal 2002 as compared to 9% last year. The Company believes most of this increase is due to customers now ordering from its website as opposed to ordering by telephone.

     Product and delivery costs include the cost of merchandise sold, the cost of receiving, personalizing, filling and shipping orders for the Company’s customers. Product and delivery costs in fiscal 2002 were $154.3 million, a decrease of $8.3 million, or 5.1% compared to $162.6 million for fiscal 2001. This decrease was primarily a result of the decline in the number of orders received by the Company in fiscal 2002. As a percentage of revenue, product and delivery costs increased from 56.7% in fiscal 2001 to 59.4% in fiscal 2002. This increase was due primarily to postal rate increases on packages shipped to customers, effective in both January 2001 and July 2001, and reduced order volume, which resulted in less productivity and lower absorption of fixed costs in the Company’s National Distribution Center.

     Selling, general and administrative (“SG&A”) expenses were $118.9 million in fiscal 2002 compared to $123.4 million in fiscal 2001, a decrease of $4.5 million, or 3.7%. The principal reasons for the decline in these expenses were a 6% reduction in catalog circulation, and a salary and workforce reduction plan that was implemented by the Company to cut costs. As a percentage of revenue, SG&A increased from 43.0% in fiscal 2001 to 45.8% in fiscal 2002 primarily because of weaker response to the Company’s catalogs. Specifically, the Company’s mailings generated 5% less revenue per catalog in fiscal 2002 than fiscal 2001. Additionally, the continuing investment in Lillian Vernon Online led to an increase in Internet development costs.

     The cost of producing, printing and mailing the Company’s catalogs represent the single largest component of SG&A expenses. The Company’s paper cost per page decreased by approximately 12% in fiscal 2002 compared to fiscal 2001. Postal rates, however, continue to rise. A postal rate increase of 9% in January 2001 was followed by a further increase in July 2001 of 1.6%. To mitigate the impact of the postal rate increases, the Company takes steps such as reducing the weight of the catalogs, making adjustments to catalog page counts, and increasing the density of the photographs.

     In connection with the paper collar contract, the total amount

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recorded in earnings for fiscal 2002 approximated $.9 million. The Company is hedging transactions through August 2005.

     During fiscal 2001, the Company recorded pretax restructuring and other charges aggregating $2.1 million, which included severance pay for a former officer ($.4 million) and costs of a restructuring plan ($1.7 million). The restructuring plan (the “Plan”) was approved in February 2001 to streamline operations and reduce costs in light of decreased consumer spending and an uncertain economy. Under the Plan, the Company eliminated approximately 12% of its salaried workforce and closed its Las Vegas, Nevada Call Center, consolidating its operations into the National Distribution Center located in Virginia Beach. The costs of the Plan included $ .7 million for employee-related costs (mostly severance pay), $.3 million of asset write-offs from the call center closure, $.7 million of projected future lease payments and sublease costs for the call center. The restructuring and other charges reduced fiscal 2001 net income by $1.3 million net-of-tax ($.15 per share), and had no material impact on fiscal 2002. As of the end of fiscal 2002, all employee-related costs and asset write-offs have been recorded. The Company has attempted to sublease the Las Vegas facility, but has been unable to do so. On April 24, 2002, the Company decided to reactivate the facility as a seasonal call center.

     Interest income in fiscal 2002 was $.7 million compared to $1.5 million in fiscal 2001. The decrease of $.8 million was due primarily to lower interest rates on the Company’s cash investments as well as lower amounts invested. Financing expense was $.8 million in fiscal 2002, compared to $.3 million in fiscal 2001, principally because a $.5 million financing expense was recorded in the fourth quarter of fiscal 2002 to reflect the valuation of the paper collar contract. There were no short-term borrowings during fiscal year 2002 or 2001.

     The Company’s effective income tax benefit rate of 33.2% in fiscal 2002 is primarily due to the ability of the Company to carry back its fiscal 2002 loss to obtain a refund of prior years’ taxes. As of February 23, 2002, the Company has recorded a net deferred tax asset of $1.4 million. The ultimate realization of the Company’s net deferred tax asset is dependent upon the generation of sufficient amounts of future taxable income during the years in which the related net expenses become deductible. The Company’s ability to generate sufficient taxable income in future periods is contingent upon a number of factors, including general economic conditions and the Company’s sales levels in future periods. Although management has developed plans which should enable the Company to achieve sufficient income levels in the future, there can be no assurance that the plans will be successful in enabling the Company to generate sufficient taxable income in the periods in which the net expenses become deductible. However, the Company has developed certain tax planning strategies relating to the sale and leaseback of certain of its facilities, which could be employed, if necessary, to generate taxable income in amounts sufficient enough to offset the impact of the net deductible expenses. Accordingly, the Company has not recorded a valuation allowance with respect to the net deferred tax asset as of February 23, 2002. The Company’s unusually high effective income tax rate in fiscal 2001 was primarily due to recognizing the expiration of charitable contribution tax carryforwards. The Company recorded

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additional tax expense of $.8 million in fiscal 2001 related to the expiration of these credits, which reduced earnings per share by $.09.

     Fiscal 2001 results included a cumulative effect of an accounting change (after-tax) of $.6 million, or $.07 per share, as a result of the adoption of SEC Staff Accounting Bulletin No. 101, relating to revenue recognition.

     The net loss for fiscal year 2002 was ($9.1) million, or ($1.08) per share, compared to the net loss of ($1.4) million, or ($.16) per share, in fiscal 2001.

Seasonality

     The Company’s business is seasonal. Historically, approximately 65% — 75% of the Company’s revenue and substantially all of its net income has been realized during the third and fourth fiscal quarters, which encompass the period September through February. Lower revenue and net losses are typically incurred during the first and second fiscal quarters, comprising the period March through August. The Company believes this is the general pattern associated with other mail order and retail gift businesses.

Liquidity and Capital Resources

     The Company’s cash and cash equivalents totaled $24.2 million as of February 22, 2003; the current ratio was 2.9:1 at February 22, 2003 compared to 3.3:1 at February 23, 2002. The reduction in the current ratio was due principally to lower inventory and prepayments and other current assets as of February 22, 2003 compared to prior year. Included in prepayments and other current assets is an income tax receivable of $4.2 million at February 23, 2002 and there was no comparable receivable at February 22, 2003.

     In fiscal 2003 the Company’s operating activities generated funds of $.3 million, compared to $1.5 million in fiscal 2002. The effect of the $9.5 million increase in net loss year-over-year was partially offset by lower inventory purchases and the collection of the income tax receivable and higher non-cash expenses such as the financing expense related to the Company’s paper collar contract of $2.3 million and higher amortization costs of $1.4 million. Inventory levels were $9.5 million or 35.6% lower this year as compared to last year reflecting the Company’s successful efforts to reduce inventory and enhance cash flow. The Company did not borrow money in fiscal 2003; its working capital needs were met with funds on hand and cash generated from operations.

     In fiscal 2003 the Company’s use of funds for investing activities totaled $1.4 million. Capital spending in fiscal 2003 was $1.2 million. These expenditures were made principally to upgrade the Company’s computer equipment and distribution machinery and equipment. For fiscal 2004 the Company will continue to implement tight controls on capital expenditures and make commitments for items that have a positive return on investment.

     The Company has commitments under non-cancelable operating leases for real estate and equipment that total $7.8 million for the six fiscal years ending 2004 through 2009.

     The Company generated $.5 million of cash from the reissuance of

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common stock through its employee benefit plans during fiscal 2003, compared to $.6 million in fiscal 2002.

     The Company paid 41 consecutive quarterly cash dividends on its common stock since an initial quarterly dividend of five cents ($.05) per share was paid in May of 1992. The quarterly dividend was increased to seven cents ($.07) per share payable September 1, 1994, and to eight cents ($.08) per share in March 1998. Subsequently, the dividend was reduced to four cents ($.04) per share payable on March 1, 2002. At its February 28, 2002 meeting the Board of Directors voted to discontinue the regular quarterly cash dividend effective after the payment of the March 1, 2002 dividend to conserve cash for reinvestment in the business. The Company will evaluate its dividend policy on an ongoing basis in view of its earnings, financial position, capital requirements and other relevant factors.

     On October 10, 1995, the Board of Directors authorized the Company to repurchase up to 1 million shares of its common stock in the open market from time to time subject to market conditions. As of September 3, 1998, the Company completed the one million share repurchase program. On October 7, 1998, the Board of Directors approved a new stock repurchase program which authorized the Company to repurchase up to an additional one million shares of its common stock in the open market from time to time subject to market conditions. On September 28, 1999, the Board of Directors authorized the Company to repurchase an additional 500,000 shares of its common stock. The Company has repurchased 1,178,442 shares at a total cost of approximately $11.4 million under the current stock repurchase program. No shares have been purchased since February 28, 2002. The Company uses these shares to make matching contributions to its Profit Sharing/401(k) Plan and to issue shares under its Stock Option and Employee Stock Purchase Plans.

     On May 8, 2003, the Company amended its revolving credit facility. The facility now provides for an available credit line totaling $15 million, which will expire on August 31, 2003. A portion of the credit facility (up to $5 million) can be used for general corporate purposes including working capital needs and capital expenditures and the balance of the facility (up to $10 million) can be used for letters of credit to purchase inventory. If the Company draws down on the $5 million portion of the credit line the Company has agreed to give the bank a security interest in its accounts receivable and on all of the personal property at its Distribution Center in Virginia Beach, Virginia, including inventory and equipment. At the Company’s option interest is payable at a) LIBOR plus 100 basis points, b) prime rate, c) bankers’ acceptance rate plus 100 basis points, or d) a fixed rate. The Company is subject to various quarterly financial covenants principally relating to its earnings, working capital, net worth, interest coverage ratio and capital spending restrictions. The Company may not be able to meet all of its financial covenants on a quarterly basis. While the Company has amended its facility in the past in order to meet these covenant requirements, there can be no assurance that future amendments or waivers will be granted or that such amendments or waivers, if granted, would be on terms satisfactory to the Company. In the event that the Company cannot meet all of the financial covenants and it is not able to obtain an amendment or a waiver, it would be in default and the lenders could declare any

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funds borrowed under the credit line immediately due and payable and could require additional collateral with respect to the letters of credit. In addition, if the Merger Agreement with Ripplewood Holdings L.L.C. (see Note 16 to the Consolidated Financial Statements) is not consummated by August 31, 2003 or if the Merger Agreement is terminated before that date an event of default will occur. At that time, the Company will need to obtain a new credit facility. There can be no assurance that the Company will be able to obtain a new credit facility that would be on terms satisfactory to the Company. The Company has not borrowed under the credit line in fiscal years 2003 or 2002, however the Company has used letters of credit to purchase inventory. During the fiscal years ended 2003 and 2002 the highest level of outstanding letters of credit amounted to approximately $6,465,000 and $8,679,000, respectively. At February 22, 2003 the Company had outstanding letters of credit of $5,096,000 for the purchase of inventory in the normal course of business.

     On April 6, 2000, the Company purchased the assets of Rue de France, Inc., a privately owned catalog company based in Newport, Rhode Island for a cash purchase price of $2.8 million. Additionally, the Company agreed to make future payments contingent upon Rue de France, Inc. achieving certain cumulative earnings targets during the five fiscal years commencing February 27, 2000. The maximum amount of potential future payments through the remaining two fiscal years of the agreement is $1.0 million. No such payments have been required to date.

     On April 15, 2003, the Company signed a definitive Merger Agreement with a private equity fund managed by Ripplewood Holdings L.L.C. pursuant to which Ripplewood will acquire the Company for $7.25 per share in cash. Ripplewood’s Industrial Partner, ZelnickMedia, will be responsible for the day-to-day management of the Company. The Company will continue to operate in the catalog and direct marketing business. The Company also simultaneously entered into a consulting agreement with ZelnickMedia Corporation under which the Company agreed to pay ZelnickMedia $62,500 per month for advisory and consulting services. Mr. Strauss Zelnick will be the Chairman of the new company. Following the acquisition, Ms. Lillian Vernon, the founder, current Chairman of the Board and largest stockholder of the Company, will serve as the Company’s non-executive Chairman as well as the Company’s spokesperson. Ms. Vernon will no longer be responsible for the day–to-day operations of the business, and is expected to own 5% of the acquired company following the merger. Ms. Vernon will not be a director or an officer of the Company subsequent to the merger. Detailed information about the proposed Merger can be found in a definitive proxy statement which was filed with the Securities and Exchange Commission on May 28, 2003 and thereafter mailed to its stockholders. A special meeting of stockholders will be held on June 23, 2003 to approve the Merger Agreement. The Merger Agreement is also subject to the satisfaction of other closing conditions, including the receipt of required financing. If the Merger transaction is not consummated, under certain circumstances the Company would be required to pay a merger termination fee of $1,850,000. Commitment letters have been obtained with respect to all necessary financing in connection with the transaction. The Company has agreed to enter into sale and leaseback agreements for its National Distribution Center as part of the financing of the transaction. The transaction is expected to close by June 30, 2003.

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     The Company continues to focus on returning to profitability through evaluating business operations and implementing changes that will increase efficiency, reduce costs and improve cash flow. For fiscal 2004, the Company plans to scale back catalog circulation to eliminate marginal catalogs and circulation and also plans to reduce its SG&A expenses. The Company is also testing new forms of advertising; particularly on the Internet, in order to increase revenues.

     On May 15, 2003, the Company sold the smaller of its warehouses for $4,300,000 of net cash proceeds. In order to generate additional cash flow, the Company could, if required enter into a sale/leaseback arrangement of its National Distribution Center.

     The Company believes that its cash flow from operations, funds on hand, its existing credit facility and additional borrowing capacity will be sufficient to meet its operating needs for the upcoming fiscal year, even if the Merger Agreement is not consummated.

Effects of Inflation and Foreign Exchange

     The Company is generally able to reflect cost increases and decreases resulting from the effects of inflation and foreign currency fluctuations in its selling prices. In addition, most foreign purchase orders are denominated in U.S. dollars. Accordingly, the results of operations for the periods discussed have not been significantly affected by these factors.

Recently Issued Accounting Standards

     In July 2002, the Financial Accounting Standards Board (“FASB”) issued Statement No. 146 (“FAS 146”), “Accounting for Costs Associated with Exit or Disposal Activities”, which the Company is required to adopt on February 23, 2003 or the beginning of fiscal 2004. FAS 146 requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. The provisions of FAS 146 will be effective for any exit and disposal activities initiated in fiscal 2004.

     In November 2002, the FASB issued Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others”. Interpretation No. 45 requires certain guarantees to be recorded at fair value rather than the current practice of recording a liability only when a loss is probable and reasonably estimatable and also requires a guarantor to make new guaranty disclosures, even when the likelihood of making any payments under the guarantee is remote. The accounting requirements of FIN 45 are effective for guarantees issued or modified after December 31, 2002, and the disclosure requirements are effective for financial statements of interim or annual periods ending after December 15, 2002. The Company does not expect the adoption of the accounting requirements of Interpretation No. 45 to have a material impact on its consolidated financial position or results of operations and the Company has adopted the disclosure requirements.

     In December 2002, the FASB issued FAS 148, “Accounting for Stock-Based Compensation – Transition and Disclosure”, an amendment of FAS 123,

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which provided alternative transition methods to the expensing of employee stock-based compensation under FAS 123. The Company is not required to adopt the fair value method prescribed by FAS 123 and, accordingly, will continue to account for stock-based compensation under the intrinsic value method in accordance with APB No. 25.

Forward Looking Statements

     Except for the historical information contained herein, statements included in this Form 10-K may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements relate to the Company’s future performance, including, without limitation, statements with respect to the Company’s anticipated results of operations, revenues, cash flows and/or level of business. Such statements represent the Company’s current expectations only and are subject to certain risks, assumptions and uncertainties. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated or projected. Among the factors that could cause actual results to materially differ include the overall strength of the economy, the level of consumer confidence and spending, customer preferences, circulation changes and other initiatives, increased competition in the direct mail industry and the growing Internet market, changes in government regulations, risks associated with the social, political, economic and other conditions affecting foreign sourcing, including possible disruptions caused by the current global situation, and possible future increases in operating costs including postage and paper costs.

Critical Accounting Policies and Estimates

     In addition to the forward-looking estimates and assumptions mentioned in the paragraph above, the accounting policies listed below represent the Company’s most critical accounting policies with respect to the financial results reported.

Provision for Inventory Allowance

     The Company records a charge to product and delivery costs in the current year related to products in inventory that it expects to sell below its cost. These estimates are based on assumptions of future sales, prices, and disposition plans. If actual sales are less favorable than those projected, additional write-downs may be required.

Catalog Costs

     Catalog costs are deferred ($4.0 million as of February 22, 2003) and amortized over the estimated useful life of the catalog, generally three months. The estimated life is based on the projected total revenues of the catalog. The related costs of the catalog are expensed according to the percentage that actual revenue as of an income statement date comprises of total revenue projected at that time. Should this future sales projection prove to be incorrect, catalog costs may not be properly matched to the proper periods that include the revenues.

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Income Taxes

     The Company accounts for income taxes in accordance with FAS 109, “Accounting for Income Taxes”, which requires that deferred tax assets and liabilities be recognized using enacted tax rates for the effect of temporary differences between the book and tax basis of recorded assets and liabilities. FAS 109 also requires that deferred assets be reduced by a valuation allowance if it is more likely than not that some portion or all of the deferred tax asset will not be realized. The Company evaluates quarterly the realizability of the deferred tax assets by assessing the need for a valuation allowance and by adjusting the amount of such allowance if necessary. The factors used to assess the likelihood of realization is the Company’s forecast of future taxable income and the available tax planning strategies that could be implemented to realize the net deferred tax assets. Factors that may affect the Company’s ability to achieve sufficient forecasted taxable income include but are not limited to general economic conditions and the Company’s sales levels and profit margins in future periods. As of February 22, 2003 the Company has a net deferred tax asset recorded of $4.0 million, ($8.6 million, net of a valuation allowance of $4.6 million.)

Capitalized Software Costs

     Capitalized software costs are amortized over estimated useful lives of two to five years. Should it be decided that the actual useful lives of these assets are less than those estimated due to technology changes or operability of the software or other reason, there would be a significant negative impact on the future earnings of the Company. As of February 22, 2003 the Company has recorded capitalized software of $1.7 million, ($13.1 million net of accumulated amortization of $11.4 million.)

Paper Collar Contract

     The Company has a paper collar contract with a third party. (See Item 7a-“Quantitative and Qualitative Disclosure about Market Risk”). Since the end of the third quarter of fiscal 2002, the Company discontinued hedge accounting, and therefore, any changes in the fair value of the contract subsequent to November 24, 2001 will be recorded in earnings as financing expense. The fair value of the Company’s contract is based on projected future paper prices. The price of paper is dependent upon supply and demand in the marketplace. If paper prices vary from those estimated the Company would be required to record an additional liability.

     The Company’s earnings are impacted by fluctuating paper prices. In order to partially mitigate this risk, the Company entered into a paper collar contract in December 1998. This contract covered certain grades of paper used by the Company to produce its catalogs. There was a floor and ceiling on paper prices within the contract. If paper prices remained within the range of the contract there would have been no payment to either party to the contract. If paper prices exceeded the established

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ceiling the Company would have been entitled to be reimbursed by the counterparty for the excess. Conversely, if paper prices fell below the established floor the Company would have been required to pay the counterparty. The Company did not pay a premium at the inception of the contract. The contract has an expiration date of August 2005.

     The paper collar contract had been designated as, and was effective as, a hedge through November 2001. During the nine months ended November 24, 2001, ineffectiveness related to the paper collar contract was not significant.

     Due to the financial situation of the counterparty, Enron North America Corporation (“Enron”), the Company discontinued hedge accounting subsequent to November 2001. As a result, $1.7 million (net of taxes of $1.1 million) previously recorded in Accumulated Other Comprehensive Losses under hedge accounting through November 24, 2001 are being reclassified to earnings as a component of selling, general and administrative expenses (catalog costs) in the period in which earnings are affected by the paper costs, through the end of the contract. For fiscal year 2003 this amount was $.8 million (net of taxes of $.6 million). In addition, any changes in the fair value of the contract subsequent to November 24, 2001 will be recorded in earnings as financing expense. For fiscal year 2003 this amount was $2.3 million on a pre-tax basis. The fair value of the non-current portion of the contract at February 22, 2003 was $2.6 million which is included in other liabilities in the Company’s financial statements.

     On February 22, 2003 the Company had $3.0 million included in accounts payable and accrued expenses relating to this obligation in addition to the fair value of the contract of $2.6 million included in other liabilities. The total liability to Enron recorded as of February 22, 2003 is $5.6 million. On May 12, 2003 the Company signed a Settlement Agreement and Mutual Release with Enron, whereby the Company agreed to pay $3.0 million as consideration for the release and settlement of all claims under the paper collar contract. The Settlement Agreement and Mutual Release have been approved by Enron’s creditors’ committee and the Bankruptcy Court. The Company will record the effect of this release and settlement in the financial statements in fiscal 2004.

     The Financial Statements and Supplementary Data are found in Part IV at pages F-1 through F-25 herein.

None.

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PART III

The following table sets forth the name, age and position of the Directors and Executive Officers of the Company:

Directors

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     Lina V. LoRusso’s employment as Senior Vice President — Merchandising terminated on May 2, 2003.

     Lillian Vernon is the founder of the Company and has served as its Chairman of the Board and Chief Executive Officer since the Company’s inception. She served as President from inception until July 1989. Lillian Vernon is the mother of David Hochberg, an officer, director, and a principal stockholder of the Company. Ms. Vernon also serves on the boards of several not-for-profit organizations including New York University and Lincoln Center for the Performing Arts. On April 16, 2003, the Company announced the signing of a definitive merger agreement with a private equity fund managed by Ripplewood Holdings L.L.C. pursuant to which Ripplewood will acquire Lillian Vernon Corporation for $7.25 per share in cash. Following the acquisition, Ms. Vernon, will continue to serve as the Company’s non-executive Chairman as well as the Company’s spokesperson. Ms. Vernon will no longer be responsible for the day-to-day operations of the business, and is expected to own 5% of the acquired company following the merger. Ms. Vernon is currently a member of the Executive Committee.

     Richard A. Berman – Director since 1997 — He has served as President of Manhattanville College since January 1995. From November 1991 until December 1994, he was employed by Howe-Lewis International, first serving as President of North America, and finally as President and Chief Executive Officer of that company. Howe-Lewis International is a company engaged in executive search and management consulting in a variety of industries. Before joining Howe-Lewis International, Mr. Berman was engaged for over 20 years in the health care industry. Mr. Berman serves on the boards of several not-for-profit organizations including Health Insurance Plan of Greater New York, HIP Foundation, and The Independent College Fund. Mr. Berman is a member of the Executive, Compensation and Audit Committees.

     Elizabeth M. Eveillard – Director since 1997 — She served as Senior Managing Director and Consultant, respectively, Investment Banking Division of Bear Stearns Co. Inc. from December 2000 until May 2003. She served as Managing Director, Investment Banking Division of PaineWebber Incorporated from April 1988 until December 2000. Prior to her association with PaineWebber Incorporated, Ms. Eveillard served in various capacities, rising ultimately to Managing Director at Shearson Lehman Brothers. Ms. Eveillard serves on the board of directors of Mayors Jewelers, Inc., Retail Ventures, Inc. and Too Inc. and on the boards of

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two private companies. Ms. Eveillard also serves on the boards of two not-for-profit organizations. Ms. Eveillard is a member of the Compensation Committee and effective May 20, 2003, is a member of the Audit Committee.

     Jonah Gitlitz – Director since 1997 — He was appointed Acting President of the Company on December 18, 1998 and served in that capacity until June, 2000, when Kevin Green was appointed President. Mr. Gitlitz served as President and Chief Executive Officer of the Direct Marketing Association (“DMA”) from January 1985 through December 1996. He joined the DMA in May 1981 as Senior Vice President, Public Affairs. Prior to joining the DMA, he served as Executive Vice President of the American Advertising Federation from 1968 to 1981. Since January 1997, when he retired from the DMA, Mr. Gitlitz has been involved in management consulting activities. He serves on the boards of several non-profit organizations and private companies. Mr. Gitlitz is a member of the Compensation and Audit Committees.

     David C. Hochberg – Director since 1978 – He has served as Vice President – Public Affairs since 1986. He joined the Company in 1978 and was subsequently promoted to Director-Public Affairs. Mr. Hochberg is a member of the Executive Committee.

     Joel Salon – Director since 1999 – He is a senior partner of the law firm of Salon, Marrow, Dyckman & Newman, LLP, which acts as general and securities counsel to the Company.

     Bert W. Wasserman – Director since 1995 – He served as Executive Vice President and Chief Financial Officer of Time Warner, Inc. from 1990 until his retirement in 1995 and served on the Board of Directors of Time Warner, Inc. and its predecessor company, Warner Communications, Inc., from 1981 to 1993. He joined Warner Communications in 1966 and had been an officer of that company since 1970. Mr. Wasserman is a director of the Dreyfus Family of Funds. He is also a director of PSC, Inc. In February 2003, Mr. Wasserman joined the Board of Directors of Arotech Corp. as a Director and Chairman of their Audit Committee. Mr. Wasserman is a graduate of Baruch College on whose Board he has served as Vice President, President and continues to serve on the Board of Directors. Mr. Wasserman is a Certified Public Accountant and received a law degree from Brooklyn Law School. Mr. Wasserman is a member of the Compensation and Audit Committees.

     Kevin A. Green was appointed as President in June 2000 after serving as Executive Vice President — Marketing/Merchandising/Lillian Vernon Online since March 2000. He previously served as Senior Vice President-Marketing since April 1996. From December 1993 until April 1996, he served as Vice President - Marketing. Mr. Green joined the Company in March 1990 as Manager — Marketing and subsequently in April 1992 was promoted to Director-Marketing. Prior to joining the Company, Mr. Green held various marketing positions at Doubleday Book and Music Club and Better Homes and Gardens Book Club.

     Richard P. Randall rejoined the Company in May 2002 as Executive Vice

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President, Chief Operating Officer and Chief Financial Officer. Mr. Randall had previously served as Senior Vice President — Chief Financial Officer of the Company from September 1998 until May 2000, at which time he became Senior Vice President and Chief Financial Officer of Coach, Inc. From September 1997 until he originally joined the Company, Mr. Randall was a management consultant providing financial and management services to Perry Ellis International f/k/a Supreme International Inc., a men’s sportswear designer/importer and Mondo, Inc., a men’s better sportswear designer/importer. Mr. Randall held senior management positions with Salant Corporation, a men’s multinational apparel manufacturer/importer, Warner Cosmetics, Inc. (a subsidiary of Warner Communications) and Revlon, Inc. Mr. Randall is a Certified Public Accountant.

     Norman Foster joined the Company in August 1983 as Director of Distribution and served in that position until March 1988 when he assumed the position of Director of Inventory. In May 1992 Mr. Foster was promoted to Vice President-Quality Assurance. In December 1998, he was promoted to Senior Vice President — Quality Assurance and in June 2001 he was named Senior Vice President — Outlet Stores. From 1969 until he joined the Company in 1983, Mr. Foster held various distribution, inventory, operational and production planning positions for the Sherwin Williams Co., a paint manufacturing and distribution company.

     Paul C. Pecorin was promoted to Senior Vice President — Chief Information Officer in July 1997. Prior to his promotion, he served as Vice President-Chief Information Officer since joining the Company in 1984. From 1982 until he joined the Company, Mr. Pecorin was Vice President-Systems of Lands’ End, Inc., a direct mail catalog company marketing apparel and related products. Prior to his employment at Lands’ End, Inc., Mr. Pecorin was manager, systems development for Pratt & Whitney Aircraft Co.

     William L. Sharkey, Jr. was promoted to Senior Vice President — Human Resources in June 2001. From 1995 until his promotion, he served as Vice President — Human Resources. Prior to his promotion as Vice President and since joining the Company in August 1990, he served as Director — Human Resources. From 1980 until he joined the Company, Mr. Sharkey was Director of Personnel for Anheuser-Busch/Busch Gardens in Williamsburg, Virginia. From 1972 until 1980, Mr. Sharkey held various personnel and operational management positions in the theme park industry with Busch Gardens and Opryland, USA.

     Ralph J. Thomann was promoted to Senior Vice President-Operations in January 1998. Prior to his promotion he served as Vice President — Operations since July 1996. Since joining the Company in February 1984, Mr. Thomann has held a variety of positions including Vice President-Distribution, Director-Order Processing, Director-Distribution, and Director-Engineering. From June 1967 until joining the Company, Mr. Thomann held various engineering positions with Avon Products, Inc., a

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manufacturer and distributor of cosmetics and beauty related products.

     Susan C. Handler joined the Company in April 1989 as Corporate Controller and Secretary. She was promoted to Vice President in July 1994. From 1982 to April 1989, Ms. Handler was employed by Coopers & Lybrand, a predecessor of PricewaterhouseCoopers LLP, Certified Public Accountants, in various capacities, the last position being as audit manager. Ms. Handler is a Certified Public Accountant.

Meetings of Board of Directors and Committees

     During the last fiscal year, the Board of Directors held six meetings. The Company believes that attendance at meetings is one means by which Directors can contribute to the effective management of the Company and that the contributions of all Directors have been substantial and highly valued.

     The Compensation Committee, which administers the Company’s employee compensation plans, met five times in fiscal 2003. The Audit Committee, which reviews and makes recommendations to the Board of Directors with respect to the Report of the Independent Accountants and reviews the accounting systems and controls of the Company on a continuous basis, met two times in fiscal 2003.

     All of the Directors attended at least 75% of the aggregate of all Board meetings and meetings of the committees of the Board of which he or she is a member.

Section 16(a) Beneficial Ownership Reporting Compliance

     Section 16(a) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), requires the Company’s officers and Directors, and persons who beneficially own more than 10% of a registered class of the Company’s equity securities, to file reports of ownership and changes in ownership with the Securities and Exchange Commission (the “Commission”) and the American Stock Exchange. Officers, Directors and greater-than-10% stockholders are required by the Commission’s regulations to furnish the Company with copies of all Section 16(a) forms they file.

     Based solely on a review of the copies of such forms furnished to the Company, the Company believes that during Fiscal 2003, all Section 16(a) filing requirements applicable to its Officers, Directors and greater-

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than-10% beneficial owners were complied with in a timely fashion.

Summary Compensation Table

     The following table sets forth certain summary information concerning compensation paid or accrued by the Company, to or on behalf of the Company’s Chief Executive Officer and each of the four other most highly compensated executive officers of the Company (determined as of February 22, 2003) (the “Named Executive Officers”) for the Company’s last three fiscal years:

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Option Grants in the Last Fiscal Year

     The following table sets forth information concerning grants of stock options to the Named Executive Officers during the Company’s fiscal year ended February 22, 2003.

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Aggregated Option Exercises in the Last Fiscal Year and Fiscal Year-End Option Values

     The following table sets forth information concerning the exercise of options by the Named Executive Officers of the Company during the Company’s fiscal year ended February 22, 2003, and the value of unexercised options held by the Named Executive Officers as of the end of the fiscal year: