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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 JUNE 28, 2003
Commission file number 1-08056
HANOVER DIRECT, INC.
--------------------
(Exact name of registrant as specified in its charter)
DELAWARE 13-0853260
------------------------ ----------------------------------
(State of incorporation) (IRS Employer Identification No.)
115 RIVER ROAD, BUILDING 10, EDGEWATER, NEW JERSEY 07020
-------------------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
(201) 863-7300
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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 August 6, 2003.
HANOVER DIRECT, INC.
TABLE OF CONTENTS
PAGE
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Part I - Financial Information
Item 1. Financial Statements
Condensed Consolidated Balance Sheets -
June 28, 2003 and December 28, 2002 ..................................................................... 2
Condensed Consolidated Statements of Income (Loss) - 13- and 26- weeks ended
June 28, 2003 and June 29, 2002 ......................................................................... 4
Condensed Consolidated Statements of Cash Flows - 26- weeks ended
June 28, 2003 and June 29, 2002.......................................................................... 5
Notes to Condensed Consolidated Financial Statements....................................................... 6
Item 2. Management's Discussion and Analysis of Consolidated Financial Condition and
Results of Operations.................................................................................... 20
Item 3. Quantitative and Qualitative Disclosures about Market Risk........................................... 29
Item 4. Controls and Procedures.............................................................................. 29
Part II - Other Information
Item 1. Legal Proceedings.................................................................................... 30
Item 4. Submission of Matters to a Vote of Security Holders.................................................. 33
Item 5. Other Information.................................................................................... 33
Item 6. Exhibits and Reports on Form 8-K..................................................................... 35
Signatures.................................................................................................... 37
1
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
HANOVER DIRECT, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS OF DOLLARS, EXCEPT SHARE AMOUNTS)
JUNE 28, DECEMBER 28,
2003 2002
------------ ------------
(UNAUDITED)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 708 $ 785
Accounts receivable, net 15,360 16,945
Inventories 49,382 53,131
Prepaid catalog costs 15,091 13,459
Other current assets 4,126 3,967
--------- ---------
Total Current Assets 84,667 88,287
--------- ---------
PROPERTY AND EQUIPMENT, AT COST:
Land 4,351 4,395
Buildings and building improvements 18,210 18,205
Leasehold improvements 9,817 9,915
Furniture, fixtures and equipment 56,223 56,094
Construction in progress 578 -
--------- ---------
89,179 88,609
Accumulated depreciation and amortization (61,080) (59,376)
--------- ---------
Property and equipment, net 28,099 29,233
--------- ---------
Goodwill, net 9,278 9,278
Deferred tax assets 13,600 12,400
Other assets 253 902
--------- ---------
Total Assets $ 135,897 $ 140,100
========= =========
Continued on next page.
2
HANOVER DIRECT, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (CONTINUED)
(IN THOUSANDS OF DOLLARS, EXCEPT SHARE AMOUNTS)
JUNE 28, DECEMBER 28,
2003 2002
----------- ------------
(UNAUDITED)
LIABILITIES AND SHAREHOLDERS' DEFICIENCY
CURRENT LIABILITIES:
Current portion of long-term debt and capital lease obligations $ 29,659 $ 3,802
Accounts payable 41,245 42,873
Accrued liabilities 15,760 26,351
Customer prepayments and credits 7,118 4,722
Deferred tax liabilities 2,300 1,100
--------- ---------
Total Current Liabilities 96,082 78,848
--------- ---------
NON-CURRENT LIABILITIES:
Long-term debt 23 21,327
Other 5,378 6,387
--------- ---------
Total Non-current Liabilities 5,401 27,714
--------- ---------
Total Liabilities 101,483 106,562
--------- ---------
SERIES B REDEEMABLE PREFERRED STOCK, authorized, issued
and outstanding 1,622,111 shares at June 28, 2003 and December
28, 2002; liquidation preference was $105,015 and $92,379 at June
28, 2003 and December 28, 2002 99,954 92,379
SHAREHOLDERS' DEFICIENCY:
Common Stock, $.66 2/3 par value, authorized 300,000,000 shares;
140,436,729 shares issued at June 28, 2003 and December 28,
2002 93,625 93,625
Capital in excess of par value 329,926 337,507
Accumulated deficit (485,745) (486,627)
--------- ---------
(62,194) (55,495)
--------- ---------
Less:
Treasury stock, at cost (2,120,929 shares at June 28, 2003 and
December 28, 2002) (2,996) (2,996)
Notes receivable from sale of Common Stock (350) (350)
--------- ---------
Total Shareholders' Deficiency (65,540) (58,841)
--------- ---------
Total Liabilities and Shareholders' Deficiency $ 135,897 $ 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 FOR THE 26- WEEKS ENDED
-------------------------- --------------------------
JUNE 28, JUNE 29, JUNE 28, JUNE 29,
2003 2002 2003 2002
---------- ---------- ---------- ---------
NET REVENUES $ 105,765 $ 113,852 $ 208,239 $ 223,363
---------- ---------- ---------- ---------
OPERATING COSTS AND EXPENSES:
Cost of sales and operating expenses 66,265 70,326 131,804 141,489
Special charges 211 - 488 233
Selling expenses 26,859 26,579 51,312 51,199
General and administrative expenses 9,487 12,552 20,765 24,972
Depreciation and amortization 1,138 1,481 2,321 2,983
---------- ---------- ---------- ---------
103,960 110,938 206,690 220,876
---------- ---------- ---------- ---------
INCOME FROM OPERATIONS 1,805 2,914 1,549 2,487
Gain on sale of Improvements - 318 1,911 318
---------- ---------- ---------- ---------
INCOME BEFORE INTEREST AND
INCOME TAXES 1,805 3,232 3,460 2,805
Interest expense, net 1,120 1,386 2,568 2,739
---------- ---------- ---------- ---------
INCOME BEFORE INCOME TAXES 685 1,846 892 66
Provision (benefit) for state income taxes (5) 30 10 60
---------- ---------- ---------- ---------
NET INCOME AND COMPREHENSIVE
INCOME 690 1,816 882 6
Preferred stock dividends and accretion 4,290 3,503 7,922 6,407
---------- ---------- ---------- ---------
NET LOSS APPLICABLE TO COMMON
SHAREHOLDERS $ (3,600) $ (1,687) $ (7,040) $ (6,401)
========== ========== ========== =========
NET LOSS PER COMMON SHARE:
Net loss per common share - basic and diluted $ (.03) $ (.01) $ (.05) $ (.05)
========== ========== ========== =========
Weighted average common shares outstanding -
basic (thousands) 138,316 138,264 138,316 138,245
========== ========== ========== =========
Weighted average common shares outstanding -
diluted (thousands) 138,316 138,264 138,316 138,245
========== ========== ========== =========
See notes to Condensed Consolidated Financial Statements.
4
HANOVER DIRECT, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS OF DOLLARS)
(UNAUDITED)
FOR THE 26- WEEKS ENDED
---------------------------
JUNE 28, JUNE 29,
2003 2002
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 882 $ 6
Adjustments to reconcile net income to net cash (used) provided by operating activities:
Depreciation and amortization, including deferred fees 2,966 3,696
Provision for doubtful accounts 298 83
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 341 627
Changes in assets and liabilities:
Accounts receivable 1,287 1,513
Inventories 3,749 7,957
Prepaid catalog costs (1,632) (2,721)
Accounts payable (1,628) (5,838)
Accrued liabilities (10,591) (4,961)
Customer prepayments and credits 2,396 2,253
Other, net (1,087) (2,426)
-------- --------
Net cash (used) provided by operating activities (4,916) 189
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisitions of property and equipment (1,202) (300)
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 711 (300)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings under Congress revolving loan facility 6,453 1,477
Payments under Congress Tranche A term loan facility (994) (995)
Payments under Congress Tranche B term loan facility (900) (536)
Payments of long-term debt and capital lease obligations (6) (96)
Payment of debt issuance costs (78) -
Proceeds from issuance of common stock - 25
Payment of estimated Richemont tax obligation on Series B Preferred Stock accretion (347) -
-------- --------
Net cash provided (used) by financing activities 4,128 (125)
-------- --------
Net decrease in cash and cash equivalents (77) (236)
Cash and cash equivalents at the beginning of the year 785 1,121
-------- --------
Cash and cash equivalents at the end of the period $ 708 $ 885
======== ========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid for:
Interest $ 1,642 $ 1,706
Income taxes $ 663 $ 137
Non-cash investing and financing activities:
Series B Preferred Stock redemption price increase $ 7,575 $ 6,407
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.
Uses of Estimates and Other Critical Accounting Policies
In addition to the use of estimates and other critical accounting
policies disclosed in our Annual Report on Form 10-K for the fiscal year ended
December 28, 2002, an understanding of the Company's employee vacation and sick
policy is necessary to analyze our quarterly financial results for the 13- weeks
ended June 28, 2003.
During June 2003, the Company established and issued a new Company-wide
vacation and sick policy to better administer vacation and sick benefits. For
purposes of the policy, employees were converted to a fiscal year for earning
vacation benefits. Under the new policy, vacation benefits are deemed earned and
thus accrued ratably throughout the fiscal year and employees must utilize all
vacation earned by the end of the same year. Generally, any unused vacation
benefits not utilized by the end of a fiscal year will be forfeited. In prior
periods, employees earned vacation in the twelve months prior to the year that
it would be utilized. The policy has been modified in certain locations to
comply with state and local laws or written agreements. As a result of the
transition to this new policy, vacation earned by certain employees during the
prior period was forfeited and the Company recognized a benefit of approximately
$0.8 million for the 13- weeks ended June 28, 2003. Approximately $0.5 million
and $0.3 million of general and administrative and operating expenses,
respectively, were reduced as a result of the recognition of this benefit.
See "Management's Discussion and Analysis of Consolidated Financial
Condition and Results of Operations," found in the Company's Annual Report on
Form 10-K for the fiscal year ended December 28, 2002, for additional
information relating to the Company's use of estimates and other critical
accounting policies.
2. 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 for the 13-week periods ended June
28, 2003 and June 29, 2002 was 138,315,800 and 138,264,152 shares, respectively.
The weighted average number of shares used in the calculation for both basic and
diluted net loss per common share for the 26-week periods ended June 28, 2003
and June 29, 2002 was 138,315,800 and 138,244,591 shares, respectively. Diluted
net loss per common share equals basic net loss per common share as the
inclusion of potentially dilutive
6
securities would have an anti-dilutive impact on the dilutive calculation as a
result of the net losses incurred during the 13 and 26-week periods ended June
28, 2003 and June 29, 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 8.8 million shares of the Company's Common Stock at prices ranging from
$0.20 to $3.50 for the 13 and 26-week periods ended June 28, 2003 and June 29,
2002, respectively, were excluded from the per share calculation of diluted
earnings per share because they would have been anti-dilutive. Options that had
exercise prices below the average price of a common share for the 13-week
periods ended June 28, 2003 and June 29, 2002, were 11,153 and 1,442,642,
respectively. Options that had exercise prices below the average price of a
common share for the 26-week periods ended June 28, 2003 and June 29, 2002 were
10,602 and 1,702,238, 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 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
7
entitled Jacq Wilson, suing on behalf of himself, all others similarly situated,
and the general public v. Brawn of California, Inc. dba International Male and
Undergear, and Does 1-100 ("Brawn") in the Superior Court of the State of
California, City and County of San Francisco. Does 1-100 are allegedly Internet
and catalog direct marketers offering a selection of men's clothing, sundries,
and shoes who advertise within California and nationwide. The complaint alleges
that for at least four years, members of the class and the general public have
been charged an unlawful, unfair and fraudulent insurance fee and tax on orders
sent to them by Brawn; that Brawn was engaged in untrue, deceptive and
misleading advertising in that it was not lawfully required or permitted to
collect insurance, tax and sales tax from customers in California; and that
Brawn has engaged in acts of unfair competition under the state's Business and
Professions Code. Plaintiff seeks (i) restitution and disgorgement of all monies
wrongfully collected and earned by Brawn, including interest and other gains
made on account of these practices, including reimbursement in the amount of the
insurance fee, tax and sales tax collected unlawfully, together with interest,
(ii) an order enjoining Brawn from charging customers insurance fee and tax on
its order forms and/or from charging tax on the delivery, shipping and insurance
charges, (iii) an order directing Brawn to notify the California State Board of
Equalization of the failure to pay the correct amount of tax to the state and to
take appropriate steps to provide the state with the information needed for
audit, and (iv) compensatory damages, attorneys' fees, pre-judgment interest and
costs of the suit. The plaintiff alleged that the claims of the individually
named plaintiff and for each member of the class amount to less than $75,000. On
April 15, 2002, the Company filed a Motion to Stay the Wilson action in favor of
the previously filed Martin action. On May 14, 2002, the Court heard the
argument in 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 trial commenced on April 14,
2003 and a bench trial took place from April 14 through April 17, 2003. At the
bench trial, the 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 conduct a vigorous defense of
this action.
A class action lawsuit was commenced on October 28, 2002 entitled John
Morris, individually and on behalf of all other persons & entities similarly
situated v. Hanover Direct, Inc., and Hanover Brands, Inc. (referred to here as
"Hanover"), No. L 8830-02 in the Superior Court of New Jersey, Bergen County --
Law Division. The plaintiff brings the action individually and on behalf of a
class of all persons and entities in New Jersey who purchased merchandise from
Hanover within six years prior to filing of the lawsuit and continuing to the
date of judgment. On the basis of a purchase made by the plaintiff in August
2002 of certain clothing from Hanover (which was from a men's division catalog,
the only one which retained the insurance line item in 2002),the plaintiff
claims that for at least six years, Hanover maintained a policy and practice of
adding a charge for "insurance" to the orders it received and concealed and
failed to disclose its policy with respect to all class members. Plaintiff
claims that Hanover's conduct was (i) in violation of the New Jersey Consumer
Fraud Act, as otherwise deceptive, misleading and unconscionable; (ii) such as
to constitute Unjust Enrichment of Hanover at the expense and to the detriment
of plaintiff and the class; and (iii) unconscionable per se under the Uniform
Commercial Code for contracts related to the sale of goods. Plaintiff and the
class seek damages equal to the amount of all insurance charges, interest
thereon, treble and punitive damages, injunctive relief, costs and reasonable
attorneys' fees, and such other relief as may be just, necessary, and
appropriate. 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 March 17, 2003, and the Company's reply
brief was filed on March 31, 2003. Hearing on the motion to stay took place on
June 6, 2003 at which time the Court granted the Company's motion to stay until
December 31, 2003, at which time the Court will revisit the issue if the
parties request that it do so. The Company plans to conduct a vigorous defense
of this action.
On June 28, 2001, Rakesh K. Kaul, the Company's former President and
Chief Executive Officer, filed a five-count complaint (the "Complaint") in New
York State Court against the Company, seeking damages and other relief arising
out of his separation of employment from the Company, including severance
payments of $2,531,352 plus the cost of employee benefits, attorneys' fees and
costs incurred in connection with the enforcement of his rights under his
employment agreement with the Company, payment of $298,650 for 13 weeks of
accrued and unused vacation, 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
8
within the 30 days following his resignation. The Company removed the case to
the U.S. District Court for the Southern District of New York on July 25, 2001.
Mr. Kaul filed an Amended Complaint ("Amended Complaint") in the U.S. District
Court for the Southern District of New York on September 18, 2001. The Amended
Complaint repeats many of the claims made in the original Complaint and adds
ERISA claims. On October 11, 2001, the Company filed its Answer, Defenses and
Counterclaims to the Amended Complaint, denying liability under each and every
of Mr. Kaul's causes of action, challenging all substantive assertions, raising
several defenses and stating nine counterclaims against Mr. Kaul. The
counterclaims include (1) breach of contract; (2) breach of the Non-Competition
and Confidentiality Agreement with the Company; (3) breach of fiduciary duty;
(4) unfair competition; and (5) unjust enrichment. The Company seeks damages,
including, without limitation, the $341,803 in severance pay and car allowance
Mr. Kaul received following his resignation, $412,336 for amounts paid to Mr.
Kaul for car allowance and related benefits, the cost of a long-term disability
policy, and certain payments made to personal attorneys and consultants retained
by Mr. Kaul during his employment, $43,847 for certain services the Company
provided and certain expenses the Company incurred, relating to the renovation
and leasing of office space occupied by Mr. Kaul's spouse at 115 River Road,
Edgewater, New Jersey, the Company's current headquarters, $211,729 on a tax
loan to Mr. Kaul outstanding since 1997 and interest, compensatory and punitive
damages and attorneys' fees. The case is pending. The discovery period has
closed, the Company has moved to amend its counterclaims, and the parties have
each moved for summary judgment. The Company seeks summary judgment: dismissing
Mr. Kaul's claim for severance under his employment agreement on the ground that
he failed to provide the Company with a general release of, among other things,
claims for change of control benefits; dismissing Mr. Kaul's claim for
attorneys' fees on the grounds that they are not authorized under his employment
agreement; dismissing Mr. Kaul's claims related to change in control benefits
based on an administrative decision that he is not entitled to continued
participation in the plan or to future benefits thereunder; dismissing Mr.
Kaul's claim for a tandem bonus payment on the ground that no payment is owing;
dismissing Mr. Kaul's claim for vacation payments based on Company policy
regarding carry over vacation; and seeking judgment on the Company's
counterclaim for unjust enrichment based on Mr. Kaul's failure to pay under a
tax note. Mr. Kaul seeks summary judgment: dismissing the Company's defenses and
counterclaims relating to a release on the grounds that he tendered a release or
that the Company is estopped from requiring him to do so; dismissing the
Company's defenses and counterclaims relating to his alleged violations of his
non-compete and confidentiality obligations on the grounds that he did not
breach the obligations as defined in the agreement; and dismissing the Company's
claims based on his alleged breach of fiduciary duty, including those based on
his monthly car allowance payments and the leased space to his wife, on the
grounds that he was entitled to the car payments and did not involve himself in
or make misrepresentations in connection with the leased space. The Company has
concurrently moved to amend its Answer and Counterclaims to state a claim that
it had cause for terminating Mr. Kaul's employment based on, among other things,
after acquired evidence that Mr. Kaul received a monthly car allowance and other
benefits totaling $412,336 that had not been authorized by the Company's Board
of Directors and that his wife's lease and related expense was not properly
authorized by the Company's Board of Directors, and to clarify or amend the
scope of the Company's counterclaims for reimbursement. The briefing on the
motions is completed and the parties are awaiting the decision of the Court. No
trial date has been set. It is too early to determine the potential outcome,
which could have a material impact on the Company's results of operations when
resolved in a future period.
The Company was named as one of 88 defendants in a patent infringement
complaint filed on November 23, 2001 by the Lemelson Medical, Education &
Research Foundation, Limited Partnership (the "Lemelson Foundation"). The
complaint, filed in the U.S. District Court in Arizona, was not served on the
Company until March 2002. In the complaint, the Lemelson Foundation accuses the
named defendants of infringing seven U.S. patents, which allegedly cover
"automatic identification" technology through the defendants' use of methods for
scanning production markings such as bar codes. The Company received a letter
dated November 27, 2001 from attorneys for the Lemelson Foundation notifying the
Company of the complaint and offering a license. The Court entered a stay of the
case on March 20, 2002, requested by the Lemelson Foundation, pending the
outcome of a related case in Nevada being fought by bar code manufacturers. The
trial in the Nevada case began on November 18, 2002 and ended on January 17,
2003. The parties in the Nevada case submitted post trial briefs at the end of
June 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
9
attorneys' fees, which the Company may pay if it decides to accept the license
offer from the Lemelson Foundation, range from about $125,000 to $400,000. The
Company has decided to gather further information, but will not agree to a
settlement at this time, and has not established a reserve.
In early March 2003, the Company learned that one of its business units
had engaged in certain travel transactions that may have constituted violations
under the provisions of U.S. government regulations promulgated pursuant to 50
U.S.C. App. 1-44, which proscribe certain transactions related to travel to
certain countries. See Note 12.
On July 17, 2003, the Company filed an action in the Supreme Court of
the State of New York, County of New York (Index No. 03/602269) against
Richemont Finance S.A. ("Richemont"), and Chelsey Direct, LLC, a Delaware
limited liability company ("Chelsey"), seeking a declaratory judgment as to
whether Richemont improperly transferred all of Richemont's securities in the
Company consisting of 29,446,888 shares of Common Stock and 1,622,111 shares of
Series B Participating Preferred Stock (collectively, the "Shares") to Chelsey
on or about May 19, 2003 and whether the Company can properly recognize the
transfer of those Shares from Richemont to Chelsey under federal and/or state
law. The Company believes that Richemont sold the Shares to Chelsey while in the
possession of confidential, material non-public information concerning the
Company that it had received from the Company pursuant to a confidentiality
agreement that barred it from using the information other than in connection
with Richemont's relationship or business with the Company. The Company believes
that Richemont improperly used this information in connection with its sale of
the Shares to Chelsey and that it would be improper for the Company and/or its
transfer agent to register the transfer of the Shares to Richemont without a
court first deciding the issue.
On July 29, 2003, Chelsey answered the Company's complaint, alleged
certain affirmative defenses and raised three counterclaims against the Company,
including Delaware law requiring the registration of the Shares, damages,
including attorney's fees, for the failure to register the Shares, and tortious
interference with contract. Chelsey also moved for a preliminary injunction
directing the Company to register the ownership of the Shares in Chelsey's name.
The parties appeared before the Court on July 29 and July 30, 2003. On
July 30, 2003, an agreement was reached between the parties and read into the
Court record and midday on July 31, 2003 the agreement reached between the
parties and read into the Court record was ordered by the Court. The agreement
includes the following:
1. The Company will register ownership of the Shares in Chelsey's name
on a temporary basis, subject to final resolution of the rights of
the parties in the litigation.
2. Chelsey will have the right to elect as a class two directors of the
Company, after August 31, 2003, on a temporary basis, subject to
final resolution of the rights of the parties in the litigation, if
the Company does not redeem one-half of the Preferred Shares on or
prior to that date, as called for by the Certificate of
Designations.
3. Chelsey will be entitled to select immediately, on a temporary
basis, subject to final resolution of the rights of the parties in
the litigation, an individual reasonably acceptable to the Company
to attend all meeting of the Board of Directors of the Company and
any committee thereof as a non-voting observer (the "Observer"),
subject to certain limitations set forth in the Certificate of
Designations. Both Chelsey and the Observer are required by the
Certificate of Designations to execute and deliver to the Company a
confidentiality agreement in form and substance reasonably
satisfactory to the Company whereby each agrees to hold confidential
all information learned as a result of the attendance by the
Observer at the Board of Director and committee meetings.
4. The Company and Chelsey will use their reasonable best efforts to
prosecute and defend the pending declaratory judgment action as
expeditiously as possible. The Company is serving Richemont with the
complaint pursuant to the Hague Convention and the complaint has
been delivered to the Central Authority in the Grand Duchy of
Luxembourg. It cannot know how soon service of the complaint on
Richemont will be effected by the Central Authority. Richemont will
have 30 days to respond to the complaint after service on it under
the Hague Convention. Discovery is to be concluded 60 days following
Richemont's responsive pleadings and a trial to be held as soon as
may be practicable, subject to the calendar of the Justice.
5. Until the Justice in the pending action renders a decision in the
litigation, if Chelsey has a good faith intention to sell the
Shares, it has agreed to give the Company at least two business
days' prior notice before consummating such a sale.
The parties agreed that none of the foregoing agreements shall give
rise to an adverse inference with respect to the positions of the parties in the
underlying litigation.
In addition, the Company is involved in various routine lawsuits of a
nature, which are deemed customary and incidental to its businesses. In the
opinion of management, the ultimate disposition of these actions will not have a
material adverse effect on the Company's financial position or results of
operations.
5. SPECIAL CHARGES
In December 2000, the Company began a strategic business realignment
program that resulted in the recording of special charges for severance,
facility exit costs and 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. During the second quarter of 2003, special charges were recorded in the
amount of $0.2 million, incurred to revise estimated losses related to sublease
arrangements for office facilities in San Francisco, California. Increased
anticipated losses on sublease arrangements for the San Francisco office space
resulted from the loss of a subtenant, coupled with declining market values in
that area of the country.
As of the end of the second quarter of 2003, a liability of
approximately $2.6 million was included within Accrued Liabilities and a
liability of approximately $3.9 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):
10
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 261 223 - 484
Paid in 2003 (1,033) (882) (81) (1,996)
--------- --------- ------- ---------
Balance at June 28, 2003 $ 680 $ 5,758 $ 82 $ 6,520
========= ========= ======= =========
A summary of the liability related to real estate lease and exit costs,
by location, as of June 28, 2003 and December 28, 2002 is as follows (in
thousands):
JUNE 28, DECEMBER 28,
2003 2002
---------- ------------
Gump's facility, San Francisco, California $ 3,378 $ 3,349
Corporate facility, Weehawken, New Jersey 1,885 2,325
Corporate facility, Edgewater, New Jersey 351 439
Administrative and telemarketing facility, San Diego, California 141 179
Retail store facilities, Los Angeles and San Diego, California 3 125
---------- ----------
Total Lease and Exit Cost Liability $ 5,758 $ 6,417
========== ==========
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 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
11
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
The Company entered into an Amendment No. 2 to Employment Agreement
dated as of June 23, 2003 between Thomas C. Shull and the Company adjusting Mr.
Shull's Base Compensation (as defined), subject to certain exceptions described
therein, and obtaining his consent to the recent changes to the Company's
vacation and merchandise discount policies which constitute part of his employee
benefits. See Note 1 of the Condensed Consolidated Financial Statements.
The Company entered into an Amendment NO. 3 to Employement Agreement
effective as of August 3, 2003 between Thomas C. Shull and the Company (1)
extending the term of the Company's Employment Agreement with Mr. Shull to
March 31, 2006, (2) adjusting his Base Compensation (as defined) to $885,000
per annum, subject to certain exceptions described therein, (3) extending the
termination date fo Mr. Shull's 2000 options to the end of the agreement term,
and (4) making certain technical amendments set forth therein.
The Company effected salary reduction for participants in its 2003
Management Incentive Plan, including Executive Officers, effective with the pay
period starting August 3, 2003, of 5% of base pay.
During June 2003, the Company established and implemented a new
Company-wide vacation and sick policy applicable to all employees, including
Executive Officers, to better administer vacation and sick benefits. See Note 1
of the Condensed Consolidated Financial Statements.
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.
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.
12
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 May 2003, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics
of both Liabilities and Equity" ("FAS 150"). FAS 150 establishes standards for
how an issuer classifies and measures certain financial instruments with
characteristics of both liabilities and equity. It requires that an issuer
classify a financial instrument that is within its scope as a liability, many of
which have been previously classified as equity or between the liabilities and
equity sections of the consolidated balance sheet. The provisions of SFAS 150
are effective for financial instruments entered into or modified after May 31,
2003, and otherwise is effective at the beginning of the first interim period
beginning after June 15, 2003. It is to be implemented by reporting the
cumulative effect of a change in accounting principle for financial instruments
created before the issuance of FAS 150 and still existing at the beginning of
the interim period of adoption. The Company has adopted the provisions of FAS
150 and will be impacted by the requirement to reclasify its Series B
Participating Preferred Stock as a liability as opposed to between the
liabilities and equity sections of the consolidated balance sheet. Based upon
the requirements set forth by FAS 150, this reclassification will be subject to
implementation beginning on June 29, 2003. Upon implementation of FAS 150, the
Company will reflect each increase in liquidation preference as an increase in
Total Liabilities with a corresponding reduction in capital in excess of par
value. Such accretion will be recorded as interest expense, resulting in a
decrease in Net Income (Loss) and Comprehensive Income (Loss). If FAS 150 was
applicable for fiscal year 2002, Net Loss and Comprehensive Loss would have been
$24.7 million. Net Income (Loss) Applicable to Common Shareholders and Net
Income (Loss) Per Common Share will remain unchanged in comparison with the
Company's classification of the instrument prior to June 29, 2003. In addition,
there is no cumulative effect of a change in accounting principle as a result
of the implementation of FAS 150. If the implementation of FAS 150 had been
required for the 26- weeks ended June 28, 2003, Total Liabilities would have
increased by approximately $100 million. Shareholders' Deficiency would remain
unchanged since the balance is classified between Total Liabilities and
Shareholders' Deficiency on the Condensed Consolidated Balance Sheet. The
classification of the Series B Preferred Stock as a liability under FAS 150
should not change its classification as equity under state law.
In January 2003, the Securities and Exchange Commission issued a new
disclosure regulation, "Conditions for Use of Non-GAAP Financial Measures"
("Regulation G"), which is effective for all public disclosures and filings made
after March 28, 2003. Regulation G requires public companies that disclose or
release information containing financial measures that are not in accordance
with generally accepted accounting principles ("GAAP") to include in the
disclosure or release a presentation of the most directly comparable GAAP
financial measure and a reconciliation of the disclosed non-GAAP financial
measure to the most directly comparable GAAP financial measure. The Company
became subject to Regulation G in fiscal 2003 and believes that it is in
compliance with the new disclosure requirements.
In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation-Transition and Disclosure - An Amendment of SFAS No.
123" ("FAS 148"). FAS 148 provides alternative methods of transition for a
voluntary change to the fair value-based method of accounting for stock-based
employee compensation. In addition, FAS 148 amends the disclosure requirements
of SFAS No. 123 to require prominent disclosures in both annual and interim
financial statements about the method of accounting for stock-based employee
compensation and the effect of the method used on reported results. The Company
has established several stock-based compensation plans for the benefit of its
officers and employees. Since 1996, the Company has accounted for its
stock-based compensation to employees using the fair value-based methodology
under SFAS No. 123, thus FAS 148 has had no effect on the Company's results of
operations or financial position. For the 13- weeks ended June 28, 2003 and June
29, 2002, the Company recorded stock compensation expense of $0.16 million and
$0.31 million, respectively. For the 26- weeks
13
ended June 28, 2003 and June 29, 2002, the Company recorded stock compensation
expense of $0.3 million and $0.6 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.
In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other
Intangible Assets" ("FAS 142"). Under FAS 142, goodwill and intangible assets
with indefinite lives are no longer amortized but are reviewed annually (or more
frequently if impairment indicators arise) for impairment. Separable intangible
assets that are not deemed to have indefinite lives will continue to be
amortized over their useful lives (but with no maximum life). Goodwill relates
to the International Male and the Gump's brands and the net balance at both June
28, 2003 and June 29, 2002 was $9.3 million. The Company adopted FAS 142
effective January 1, 2002 and, as a result, has not recorded an amortization
charge for goodwill since that time. The Company obtained the services of an
independent appraisal firm during the second quarter ended June 28, 2003 to
assist in the assessment of its annual goodwill impairment. The results of the
appraisal indicated that goodwill was not impaired based upon the requirements
set forth in FAS 142.
10. AMENDMENTS TO CONGRESS LOAN AND SECURITY AGREEMENT
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 Financial
Corporation ("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 previously 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 June 28, 2003 aggregated $29.7 million, all of
which is classified as short-term. The Company has continued 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 1,622,111 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, or in the event
14
that the Company fails to redeem at least 811,056 shares of Series B Preferred
Stock by August 31, 2003, then the holders of the Series B Preferred Stock,
voting as a class, shall be entitled to elect two members to the Board of
Directors of the Company.
In the event of the liquidation, dissolution or winding up of the
Company, the holders of the Series B Preferred Stock are entitled to a
liquidation preference (the "Liquidation Preference"), which was initially
$47.36 per share. During each period set forth in the table below, the
Liquidation Preference shall equal the amount set forth opposite such period:
LIQUIDATION PREFERENCE
PERIOD PER SHARE TOTAL VALUE
------ --------- -----------
March 1, 2002 - May 31, 2002 $ 49.15 $ 79,726,755.65
June 1, 2002 - August 31, 2002 $ 51.31 $ 83,230,515.41
September 1, 2002 - November 30, 2002 $ 53.89 $ 87,415,561.79
December 1, 2002 - February 28, 2003 $ 56.95 $ 92,379,221.45
March 1, 2003 - May 31, 2003 $ 60.54 $ 98,202,599.94
June 1, 2003 - August 31, 2003 $ 64.74 $ 105,015,466.14
September 1, 2003 - November 30, 2003 $ 69.64 $ 112,963,810.04
December 1, 2003 - February 29, 2004 $ 72.25 $ 117,197,519.75
March 1, 2004 - May 31, 2004 $ 74.96 $ 121,593,440.56
June 1, 2004 - August 31, 2004 $ 77.77 $ 126,151,572.47
September 1, 2004 - November 30, 2004 $ 80.69 $ 130,888,136,59
December 1, 2004 - February 28, 2005 $ 83.72 $ 135,803,132.92
March 1, 2005 - May 31, 2005 $ 86.85 $ 140,880,340.35
June 1, 2005 - August 23, 2005 $ 90.11 $ 146,168,422.21
As a result, beginning November 30, 2003, the aggregate Liquidation
Preference of the Series B Preferred Stock will be effectively equal to the
aggregate Liquidation Preference of the Class A Preferred Stock previously held
by Richemont.
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 application of the interest method
yields a result different from the above Liquidation Preference table during
the interim periods prior to the maximum Liquidation Preference. The
accompanying Condensed Consolidated Balance Sheet and Condensed Consolidated
Statements of Cash Flows indicate the result of the Company's use of the
interest method. The Company reflects the accretion as an increase in the
Series B Preferred Stock with a corresponding reduction in the stated amount of
capital in excess of par value. Such accretion has been recorded as a reduction
of the net income available to common shareholders. See Note 9 for future
accounting treatment in accordance with FAS 150. The accompanying Condensed
Consolidated Statement of Income (Loss) presents $7.9 million of preferred
stock dividends and accretion. This amount is comprised of $7.6 million for
the increase in the Liquidation Preference and $0.3 million for the payment
made on behalf of Richemont to the Internal Revenue Service as described below
in further detail.
Dividends on the Series B Preferred Stock are required to be paid
whenever a dividend is declared on the Common Stock. The amount of any dividend
on the Series B Preferred Stock shall be determined by multiplying (i) the
amount obtained by dividing the amount of the dividend on the Common Stock by
the then current fair market value of a share of Common Stock and (ii) the
Liquidation Preference of the Series B Preferred Stock.
The Series B Preferred Stock must be redeemed by the Company on August
23, 2005 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.
Pursuant to the terms of the Certificate of Designations of the Series
B Preferred Stock, the Company's obligation to pay dividends on or redeem the
Series B Preferred Stock is subject to its compliance with its agreements with
Congress.
The Certificate of Designations of the Series B Preferred Stock
provides that, for so long as Richemont is the holder of at least 25% of the
then outstanding shares of Series B Preferred Stock, it shall be entitled to
appoint a non-voting observer to attend all meetings of the Board of Directors
and any committees thereof. Richemont has not appointed such an observer.
15
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
Stock issued to Richemont pursuant thereto in accordance with the Richemont
Agreement terms. The review took into account the results of the Company's
strategic business realignment program in 2001 and 2002, the relative strengths
and weaknesses of the Company's competitive position and the economic and
business climate, including the depressed business environment for mergers and
acquisitions.
As a result of this review, Company management and the Company's Board
of Directors have concluded that it is unlikely that the Company will be able to
accumulate sufficient capital, surplus, or other assets under Delaware corporate
law or to obtain sufficient debt financing to either:
1. Redeem at least 811,056 shares of the Series B Preferred Stock by
August 31, 2003, as allowed for by the Richemont Agreement, thereby
resulting in the occurrence of a "Voting Trigger" which will allow
Richemont to have the option of electing two members to the
Company's Board of Directors; or
2. Redeem all of the shares of Series B Preferred Stock by August 31,
2005, as required by the Richemont Agreement, thereby obligating the
Company to take all measures permitted under the Delaware General
Corporation Law to increase the amount of its capital and surplus
legally available to redeem the Series B Preferred Shares, without a
material improvement in either the business environment for mergers
and acquisitions or other factors, unforeseeable at the time.
Management believes that the Company has sufficient liquidity and
availability under its credit agreement to fund its planned operations through
at least January 31, 2004. The unlikelihood that the Company will be able to
redeem the Series B Preferred Stock is not expected to limit the ability of the
Company to use current and future net earnings or cash flow to satisfy its
obligations to creditors and vendors. See "Cautionary Statements" below. In
addition, the redemption price of the Series B Preferred Stock does not accrete
after August 31, 2005.
Company management met with representatives of Richemont on October 29,
2002 and outlined the results of management's strategic review in the context of
the Company's obligations to Richemont under the Richemont Agreement, and
discussed an alternative to the method for the redemption of the Series B
Preferred Stock. Under this alternative proposal, that the Company had
previously presented to Richemont, the Company would exchange two business
divisions, Silhouettes and Gump's, for all of Richemont's Series B Preferred
Stock (the "Proposal").
Pursuant to the terms of the Richemont Agreement, the redemption value
of the Series B Preferred Stock as of the date of the Proposal was $87 million.
Management based the Proposal terms on a valuation of Silhouettes and Gump's
using the valuation multiple employed in USA Network's June 2001 purchase of the
Company's Improvements business division. The Proposal also included a
willingness on the part of the Company to provide continued fulfillment services
for Silhouettes and Gump's on terms to be negotiated. On November 18, 2002, a
representative of Richemont confirmed in writing to the Company that Richemont
rejected the Proposal. Representatives of Richemont indicated that it had no
interest in the proffered assets and disputed their valuation implied in the
Company's Proposal.
Following the Proposal made to Richemont in the fall of 2002, on May
13, 2003, the Company made another proposal to Richemont to purchase all of
Richemont's securities in the Company consisting of 29,446,888 shares of Common
Stock of the Company (the "Common Shares") and 1,622,111 shares of Series B
Preferred Stock of the Company (the "Series B Preferred Stock" and, together
with the Common Shares, the "Shares") for a purchase price of US $45 million,
subject to a number of material contingencies, including the consummation of the
sale of certain assets of the Company to a third party or parties within 120
days and the consent of the Company's Board of Directors, shareholders and its
secured lender to such transactions. The Company's proposal, if consummated,
would have resulted in a reduction in the number of shares of Common Stock of
the Company outstanding from 138,315,800 to 108,868,912 and a reduction in the
number of shares of Series B Preferred Stock of the Company outstanding from
1,622,111 to 0. Richemont did not respond to the Company's May 2003 proposal.
As a result of filings made by Richemont and certain related parties
with the Securities and Exchange Commission on May 21, 2003, the Company learned
that Richemont sold to Chelsey, on May 19, 2003 all of the Shares
16
for a purchase price equal to US $40 million. The Company was not a party to
such transaction and did not provide Chelsey with any material, non-public
information in connection with such transaction, nor did the Company's Board of
Directors endorse the transaction. As a result of the transaction, Chelsey may
succeed to Richemont's rights in the Common Shares and the Series B Preferred
Stock, including the right of the holder of the Series B Preferred Stock to a
Liquidation Preference with respect to such shares which was equal to
$98,202,600 on May 19, 2003, the date of the purported sale of the Shares, and
which increases to and caps at $146,168,422 on August 23, 2005, the final
redemption date of the Series B Preferred Stock.
On May 30, 2003, the Company reported that it believed that Richemont
sold the Common Shares and the Series B Preferred Stock to Chelsey while in the
possession of material, non-public information and was examining its rights with
respect to the transaction. The Company further reported that, by letter dated
May 27, 2003, the Company had requested that its transfer agent for the Common
Shares not register the transfer of the Common Shares from Richemont to Chelsey,
in whole or in part, without first notifying the Company of any request to do so
and without having first received the Company's agreement in writing to do so
while the Company was examining these issues. The Company also reported that it
intended to treat in a similar fashion any request for transfer of the Series B
Preferred Stock for which it acts as the transfer agent while it was examining
these issues.
By letter dated July 7, 2003, the Company made a definitive proposal to
Chelsey and Richemont to purchase all the Shares for a purchase price of US $45
million. This proposal was subject to a number of material contingencies,
including the consummation of the sale of certain of the Company's assets to a
third party within 60 days and the consent of the Company's Board of Directors
and its secured lender, as well as the Company's shareholders, if necessary, to
such transactions. By letter dated July 11, 2003, Chelsey rejected the Company's
proposal describing it as "inadequate and grossly undervalued" and making
numerous other assertions as to the Company's responsibilities to it. A copy of
Chelsey's July 11, 2003 letter, as well as a copy of the Company's July 14, 2003
response, were filed by the Company with the SEC on July 15, 2003 pursuant to a
Current Report on Form 8-K to which reference is hereby made.
On July 17, 2003, the Company filed an action in the Supreme Court of
the State of New York, County of New York (Index No. 03/602269) against
Richemont and Chelsey seeking a declaratory judgment as to whether Richemont
improperly transferred all of Richemont's securities in the Company consisting
of the Shares to Chelsey on or about May 19, 2003 and whether the Company can
properly recognize the transfer of those Shares from Richemont to Chelsey under
federal and/or state law. The Company believes that Richemont sold the Shares to
Chelsey while in the possession of confidential, material non-public information
concerning the Company that it had received from the Company pursuant to a
confidentiality agreement that barred it from using the information other than
in connection with Richemont's relationship or business with the Company. The
Company believes that Richemont improperly used this information in connection
with its sale of the Shares to Chelsey and that it would be improper for the
Company and/or its transfer agent to register the transfer of the Shares to
Chelsey without a court first deciding the issue.
On July 29, 2003, Chelsey answered the Company's complaint, alleged
certain affirmative defenses and raised three counterclaims against the Company,
including Delaware law requiring the registration of the Shares, damages,
including attorney's fees, for the failure to register the Shares, and tortious
interference with contract. Chelsey also moved for a preliminary injunction
directing the Company to register the ownership of the Shares in Chelsey's name.
The parties appeared before the Court on July 29 and July 30, 2003. On
July 30, 2003, an agreement was reached between the parties and read into the
Court record and midday on July 31, 2003 the agreement reached between the
parties and read into the Court record was ordered by the Court. The agreement
includes the following:
1. The Company will register ownership of the Shares in Chelsey's name
on a temporary basis, subject to final resolution of the rights of
the parties in the litigation.
2. Chelsey will have the right to elect as a class two directors of the
Company, after August 31, 2003, on a temporary basis, subject to
final resolution of the rights of the parties in the litigation, if
the Company does not redeem one-half of the Preferred Shares on or
prior to that date, as called for by the Certificate of
Designations.
17
3. Chelsey will be entitled to select immediately, on a temporary
basis, subject to final resolution of the rights of the parties in
the litigation, an individual reasonably acceptable to the Company
to attend all meeting of the Board of Directors of the Company and
any committee thereof as a non-voting observer (the "Observer"),
subject to certain limitations set forth in the Certificate of
Designations. Both Chelsey and the Observer are required by the
Certificate of Designations to execute and deliver to the Company a
confidentiality agreement in form and substance reasonably
satisfactory to the Company whereby each agrees to hold confidential
all information learned as a result of the attendance by the
Observer at the Board of Director and committee meetings.
4. The Company and Chelsey will use their reasonable best efforts to
prosecute and defend the pending declaratory judgment action as
expeditiously as possible. The Company is serving Richemont with the
complaint pursuant to the Hague Convention and the complaint has
been delivered to the Central Authority in the Grand Duchy of
Luxembourg. It cannot know how soon service of the complaint on
Richemont will be effected by the Central Authority. Richemont will
have 30 days to respond to the complaint after service on it under
the Hague Convention. Discovery is to be concluded 60 days following
Richemont's responsive pleadings and a trial to be held as soon as
may be practicable, subject to the calendar of the Justice.
5. Until the Justice in the pending action renders a decision in the
litigation, if Chelsey has a good faith intention to sell the
Shares, it has agreed to give the Company at least two business
days' prior notice before consummating such a sale.
The parties agreed that none of the foregoing agreements shall give
rise to an adverse inference with respect to the positions of the parties in the
underlying litigation.
For Federal income tax purposes, the increases in the Liquidation
Preference of the Series B Preferred Stock are considered distributions by the
Company to the holder of the Series B Preferred Stock, deemed made on the
commencement dates of the quarterly increases, as discussed above. These
distributions may be taxable dividends to the holder of the Series B Preferred
Stock, provided the Company has accumulated or current earnings and profits
("E&P") for each year in which the distributions are deemed to be made. Under
the terms of the Richemont Transaction, the Company is obligated to reimburse
the holder of the Series B Preferred Stock for any U.S. income tax incurred
pursuant to the Richemont Transaction. This reimbursement obligation is
transferable upon the sale of the Series B Preferred Stock. If it is determined
that Richemont's sale of the Series B Preferred Stock to Chelsey is valid, the
Company's tax reimbursement obligation would be inapplicable to Chelsey, since
Chelsey is treated as a partnership for U.S. tax purposes and, as such, does not
pay any U.S. income taxes. Based on the Company's past income tax filings and
its current income tax position, the Company had an E&P deficit as of December
28, 2002. Accordingly, the Company did not incur a tax reimbursement obligation
for year 2002. The Company must have current E&P in years 2003, 2004 or 2005 to
incur a tax reimbursement obligation for the scheduled increases in Liquidation
Preference. If the Company does not have current E&P in one of those years, no
tax reimbursement obligation would exist for that particular year. The Company
does not have the ability to project the exact future tax reimbursement
obligation; however, it has estimated the potential obligation to be in the
range of $0 to $23.1 million if Richemont remains the holder for 2003 through
2005 and $0 to $2.2 million, if Chelsey is determined to be the holder of the
Series B Preferred Stock. In March 2003, a payment of $0.3 million was made on
behalf of Richemont to the Internal Revenue Service. The payment was reflected
as a reduction of Capital in excess of par value on the Condensed Consolidated
Balance Sheets and as an increase to Preferred stock dividends and accretion on
the Condensed Consolidated Statements of Income (Loss).
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
18
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.
19
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following table sets forth, for the fiscal periods indicated, the
percentage relationship to net revenues of certain items in the Company's
Condensed Consolidated Statements of Income (Loss):
13- WEEKS ENDED 26- WEEKS ENDED
---------------------------- ---------------------------
JUNE 28, June 29, JUNE 28, June 29,
2003 2002 2003 2002
-------- -------- -------- --------
Net revenues 100.0% 100.0% 100.0% 100.0%
Cost of sales and operating expenses 62.6 61.8 63.3 63.4
Special charges 0.2 0.0 0.2 0.1
Selling expenses 25.4 23.3 24.7 22.9
General and administrative expenses 9.0 11.0 10.0 11.2
Depreciation and amortization 1.1 1.3 1.1 1.3
Income from operations 1.7 2.6 0.7 1.1
Gain on sale of Improvements 0.0 0.3 0.9 0.1
Interest expense, net 1.1 1.2 1.2 1.2
Provision for state income taxes 0.0 0.0 0.0 0.0
Net income and comprehensive
income 0.6% 1.6% 0.4% 0.0%
RESULTS OF OPERATIONS - 13- WEEKS ENDED JUNE 28, 2003 COMPARED WITH THE 13-
WEEKS ENDED JUNE 29, 2002
Net Income and Comprehensive Income. The Company reported net income of
$0.7 million for the 13- weeks ended June 28, 2003 compared with net income of
$1.8 million for the comparable period in the year 2002. Compared with the same
fiscal period in the year 2002, the $1.1 million decline in net income was
primarily due to a decrease in revenues resulting from a softer economic
climate. The decrease in revenues prompted an increase in catalog cost
amortization, resulting in higher selling costs. This was partially offset by
continued reductions in general and administrative expenses as well as the
recording of a $0.3 million deferred gain during the 13- weeks ended June 29,
2002 relating to the June 29, 2001 sale of the Company's Improvements business.
Net loss per common share was $.03 and $.01 for the 13- weeks ended June 28,
2003 and June 29, 2002, respectively. The per share amounts were calculated
after deducting preferred dividends and accretion of $4.3 million and $3.5
million for the 13- weeks ended June 28, 2003 and June 29, 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 and
138,264,152 for the 13- weeks ended June 28, 2003 and June 29, 2002,
respectively. 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 $8.1 million (7.1%) for the
13-week period ended June 28, 2003 to $105.8 million from $113.9 million for the
comparable fiscal period in the year 2002. The decrease was due principally to
softness in demand and a 6.6% reduction in overall circulation for continuing
businesses from the comparable fiscal period in 2002. This reduction resulted
from the Company's continued efforts to reduce unprofitable circulation and
remain focused on its strategy of increasing profitable circulation. Internet
sales continued to increase, and comprised 27.5% of combined Internet and
catalog revenues for the 13- weeks ended June 28, 2003, and have improved by
approximately $6.7 million or 31.9% to $27.5 million from $20.8 million for the
comparable fiscal period in the year 2002.
Cost of Sales and Operating Expenses. Cost of sales and operating
expenses increased to 62.6% of net revenues for the 13-week period ended June
28, 2003 as compared with 61.8% of net revenues for the comparable period in the
year 2002. This increase was primarily due to increases in product postage
costs, partially offset by decreases in merchandise costs that have resulted
from actions taken in connection with the Company's strategic business
realignment program. Telemarketing and distribution costs continued to remain
consistent with those in the comparable fiscal period in the year 2002.
20
Special Charges. In December 2000, the Company began a strategic
business realignment program that resulted in the recording of special charges
for severance, facility exit costs and asset write-offs. Special charges for the
13- weeks ended June 28, 2003 were $0.2 million, incurred to revise estimated
losses related to sublease arrangements in connection with office facilities in
San Francisco, California. Increased anticipated losses on sublease arrangements
for the San Francisco office space resulted from the loss of a subtenant,
coupled with declining market values in that area of the country. For the 13-
weeks ended June 29, 2002, the Company did not incur any additional special
charges relating to the strategic business realignment program.
Selling Expenses. Selling expenses increased by $0.3 million to $26.9
million for the 13- weeks ended June 28, 2003 as compared with $26.6 million for
the comparable fiscal period in the year 2002. As a percentage relationship to
net revenues, selling expenses increased to 25.4% for the 13- weeks ended June
28, 2003 compared with 23.3% for the comparable period in the year 2002. This
change was due primarily to increases in printing and postage costs incurred in
the production of catalog mailings.
General and Administrative Expenses. General and administrative
expenses decreased by $3.1 million to $9.5 million for the 13- weeks ended June
28, 2003 as compared with $12.6 million for the comparable period in the year
2002. As a percentage relationship to net revenues, general and administrative
expenses were 9.0% of net revenues for the 13- weeks ended June 28, 2003
compared with 11.0% of net revenues for the comparable period in the year 2002.
This decrease was primarily due to reductions in payroll costs and incentive
compensation, legal costs and the benefit recognized for the implementation of
the Company's new vacation and sick policy.
Depreciation and Amortization. Depreciation and amortization decreased
approximately $0.4 million to $1.1 million for the 13- weeks ended June 28, 2003
as compared with $1.5 million for the comparable period in the year 2002. The
decrease was 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 June 28, 2003 and 1.3% for the
comparable period in the year 2002.
Income from Operations. The Company's income from operations decreased
by $1.1 million to $1.8 million for the 13- weeks ended June 28, 2003 from
income of $2.9 million for the comparable period in the year 2002. See above
discussion of "Results of Operations - 13- weeks ended June 28, 2003 compared
with the 13- weeks ended June 29, 2002 - Net Income and Comprehensive Income"
for further details.
Gain on Sale of the Improvements Business. During the 13- weeks ended
June 28, 2003, the Company did not recognize any gain relating to the sale of
the Improvements business. Effective March 28, 2003, the remaining $2.0 million
escrow balance was received by the Company, thus terminating the agreement. For
the 13- weeks ended June 29, 2002, the Company recognized $0.3 million of the
deferred gain consistent with the terms of the agreements. See Note 6 of the
Condensed Consolidated Financial Statements.
Interest Expense, Net. Interest expense, net decreased $0.3 million to
$1.1 million for the 13- weeks ended June 28, 2003 as compared with $1.4 million
for the comparable period in the year 2002. The decrease in interest expense is
primarily due to a decrease in amortization from deferred financing costs
relating to the Company's amendments to the Congress Credit Facility.
RESULTS OF OPERATIONS - 26- WEEKS ENDED JUNE 28, 2003 COMPARED WITH THE 26-
WEEKS ENDED JUNE 29, 2002
Net Income and Comprehensive Income. The Company reported net income of
$0.9 million for the 26- weeks ended June 28, 2003 compared with net income of
$0.0 million for the comparable period in the year 2002. Compared with the same
fiscal period in the year 2002, the $0.9 million increase in net income was
primarily due to continued reductions in general and administrative expenses as
well as the recording of a $1.9 million deferred gain during the 26- weeks ended
June 28, 2003 related to the June 29, 2001 sale of the Company's Improvements
business. This was partially offset by a decrease in revenues resulting from a
softer economic climate and, as a result, increases in catalog cost
amortization, prompting selling costs to increase. Net loss per common share was
$.05 for both the 26- weeks ended June 28, 2003 and June 29, 2002. The per share
amounts were calculated after deducting preferred dividends and accretion of
$7.9 million and $6.4 million for the 26- weeks ended June 28, 2003 and June 29,
2002, respectively. The weighted average number of shares of Common Stock
outstanding used in both the basic and diluted net loss per
21
common share calculation was 138,315,800 for the 26- weeks ended June 28, 2003
and 138,244,591 for the 26- weeks ended June 29, 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 $15.2 million (6.8%) for the
26-week period ended June 28, 2003 to $208.2 million from $223.4 million for the
comparable fiscal period in the year 2002. The decrease is due principally to
softness in demand and a 4.5% reduction in overall circulation for continuing
businesses from the comparable fiscal period in 2002. This reduction resulted
from the Company's continued efforts to reduce unprofitable circulation and
remain focused on its strategy of increasing profitable circulation. Internet
sales continued to increase, and comprised 27.0% of combined Internet and
catalog revenues for the 26- weeks ended June 28, 2003, and have improved by
$12.9 million or 32.2% to $53.1 million from $40.2 million for the comparable
fiscal period in the year 2002.
Cost of Sales and Operating Expenses. Cost of sales and operating
expenses decreased to 63.3% of net revenues for the 26-week period ended June
28, 2003 as compared with 63.4% of net revenues for the comparable period in the
year 2002. This slight 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 those in the Company's strategic
business realignment program. These decreases in costs, however, were partially
offset by an increase in product postage costs for the period. Telemarketing and
distribution costs continued to remain consistent with the comparable fiscal
period in the year 2002.
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 26- weeks ended June 28, 2003 were $0.5 million. These charges
consisted primarily of additional severance costs and revised estimated losses
related to sub-lease arrangements in connection with office facilities in San
Francisco, California. Increased anticipated losses on sublease arrangements for
the San Francisco office space resulted from the loss of a subtenant, coupled
with declining market values in that area of the country. For the 26- weeks
ended June 29, 2002, the Company recorded $0.2 million in charges associated
with the strategic business realignment program. These charges consisted
primarily of severance costs related to the elimination of an additional 10 FTE
positions in various levels of catalog operations and costs associated with the
Company's decision to close the San Diego product storage facility.
Selling Expenses. Selling expenses increased by $0.1 million to $51.3
million for the 26- weeks ended June 28, 2003 as compared with $51.2 million for
the comparable fiscal period in the year 2002. As a percentage relationship to
net revenues, selling expenses increased to 24.7% for the 26- weeks ended June
28, 2003 compared with 22.9% for the comparable period in the year 2002. This
change was due primarily to increases in catalog preparation, printing and
postage costs, partially offset by reduced paper prices.
General and Administrative Expenses. General and administrative
expenses decreased by $4.2 million to $20.8 million for the 26- weeks ended June
28, 2003 as compared with $25.0 million for the comparable period in the year
2002. As a percentage relationship to net revenues, general and administrative
expenses were 10.0% of net revenues for the 26- weeks ended June 28, 2003
compared with 11.2% of net revenues for the comparable period in the year 2002.
This decrease was primarily due to reductions in payroll costs and incentive
compensation, legal costs and the benefit recognized for the implementation of
the Company's new vacation and sick policy.
Depreciation and Amortization. Depreciation and amortization decreased
$0.7 million to $2.3 million for the 26- weeks ended June 28, 2003 as compared
with $3.0 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 26- weeks ended June 28, 2003 and 1.3% for the comparable period in the
year 2002.
Income from Operations. The Company's income from operations decreased
by $0.9 million to $1.6 million for the 26- weeks ended June 28, 2003 from
income of $2.5 million for the comparable period in the year 2002. See above
discussion of "Results of Operations - 26- weeks ended June 28, 2003 compared
with the 26- weeks ended June 29, 2002 - Net Income and Comprehensive Income"
for further details.
22
Gain on Sale of the Improvements Business. During the 26- weeks ended
June 28, 2003, the Company recognized the remaining deferred gain of $1.9
million consistent with the terms of the March 27, 2003 amendment made to the
asset purchase agreement relating to the sale of the Improvements business. For
the 26- weeks ended June 29, 2002, the Company recognized $0.3 million of the
deferred gain consistent with the terms of the escrow agreement. See Note 6 of
the Condensed Consolidated Financial Statements.
Interest Expense, Net. Interest expense, net decreased $0.1 million to
$2.6 million for the 26- weeks ended June 28, 2003 as compared with $2.7 million
for the comparable period in the year 2002. The decrease in interest expense is
primarily due to a decrease in amortization from 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 26-week period ended
June 28, 2003, net cash used by operating activities was $4.9 million. Increases
in prepaid catalog costs, in coordination with decreases in accrued liabilities
and accounts payable, 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 inventory and increases in customer
prepayments and credits.
Net cash provided by investing activities. During the 26-week period
ended June 28, 2003, net cash provided by investing activities was $0.7 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 $1.2 million of capital expenditures,
consisting primarily of upgrades to the Company's distribution and fulfillment
equipment located at its Roanoke, Virginia fulfillment facility, telemarketing
hardware, and various computer software upgrades. An additional $0.1 million of
costs relating to the early release of escrow funds associated with the sale of
the Improvements business also contributed to the offset of the proceeds
received from the sale.
Net cash provided by financing activities. During the 26-week period
ended June 28, 2003, net cash provided by financing activities was $4.1 million,
which was primarily due to increased net borrowings of $6.5 million under the
Congress revolving loan facility. These borrowings were partially offset by
monthly payments made relating to both the Congress Tranche A and Tranche B term
loan facilities as well as 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 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 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 previously classified as long-term under
the Congress Credit Facility were reclassified as short-term in the Company's
Condensed Consolidated Financial Statements. As of June 28, 2003, the Company
had $29.7 million of cumulative short-term borrowings outstanding under the
Congress Credit Facility, comprising $15.3 million under the Revolving Loan
Facility, bearing an interest rate of 4.75%, $7.5 million under the Tranche A
Term Loan, bearing an interest rate of 5.0%, and $6.9 million under the Tranche
B Term Loan, bearing an interest rate of 13.0%. The Company has continued
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.
23
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 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.
General. At June 28 2003, the Company had $0.7 million in cash and cash
equivalents, compared with $0.9 million at June 29, 2002. Total cumulative
borrowings, including financing under capital lease obligations, as of June 28,
2003, aggregated $29.7 million and are 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 June 28, 2003 was $9.5
million. The Company had approximately $0.4 million in short-term capital
commitments as of June 28, 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.
24
USES OF ESTIMATES AND OTHER CRITICAL ACCOUNTING POLICIES
In addition to the use of estimates and other critical accounting
policies disclosed in our Annual Report on Form 10-K for the fiscal year ended
December 28, 2002, an understanding of the Company's employee vacation and sick
policy is necessary to analyze our quarterly financial results for the 13- weeks
ended June 28, 2003.
During June 2003, the Company established and issued a new Company-wide
vacation and sick policy to better administer vacation and sick benefits. For
purposes of the policy, employees were converted to a fiscal year for earning
vacation benefits. Under the new policy, vacation benefits are deemed earned and
thus accrued ratably throughout the fiscal year and employees must utilize all
vacation earned by the end of the same year. Generally, any unused vacation
benefits not utilized by the end of a fiscal year will be forfeited. In prior
periods, employees earned vacation in the twelve months prior to the year that
it would be utilized. The policy has been modified in certain locations to
comply with state and local laws or written agreements. As a result of the
transition to this new policy, vacation earned by certain employees during the
prior period was forfeited and the Company recognized a benefit of approximately
$0.8 million for the 13- weeks ended June 28, 2003. Approximately $0.5 million
and $0.3 million of general and administrative and operating expenses,
respectively, were reduced as a result of the recognition of this benefit.
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 May 2003, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics
of both Liabilities and Equity" ("FAS 150"). FAS 150 establishes standards for
how an issuer classifies and measures certain financial instruments with
characteristics of both liabilities and equity. It requires that an issuer
classify a financial instrument that is within its scope as a liability, many of
which have been previously classified as equity or between the liabilities and
equity sections of the consolidated balance sheet. The provisions of SFAS 150
are effective for financial instruments entered into or modified after May 31,
2003, and otherwise is effective at the beginning of the first interim period
beginning after June 15, 2003. It is to be implemented by reporting the
cumulative effect of a change in accounting principle for financial instruments
created before the issuance of FAS 150 and still existing at the beginning of
the interim period of adoption. The Company has adopted the provisions of FAS
150 and will be impacted by the requirement to reclassify its Series B
Participating Preferred Stock as a liability as opposed to between the
liabilities and equity sections of the consolidated balance sheet. Based upon
the requirements set forth by FAS 150, this reclassification will be subject to
implementation beginning on June 29, 2003. Upon implementation of FAS 150, the
Company will reflect each increase in liquidation preference as an increase in
Total Liabilities with a corresponding reduction in capital in excess of par
value. Such accretion will be recorded as interest expense, resulting in a
decrease in Net Income (Loss) and Comprehensive Income (Loss). If FAS 150 was
applicable for fiscal year 2002, Net Loss and Comprehensive Loss would have been
$24.7 million. Net Income (Loss) Applicable to Common Shareholders and Net
Income (Loss) Per Common Share will remain unchanged in comparison with the
Company's classification of the instrument prior to June 29, 2003. In addition,
there is no cumulative effect of a change in accounting principle as a result
of the implementation of FAS 150. If the implementation of FAS 150 had been
required for the 26- weeks ended June 28, 2003, Total Liabilities would have
increased by approximately $100 million. Shareholders' Deficiency would remain
unchanged since the balance is classified between Total Liabilities and
Shareholders' Deficiency on the Condensed Consolidated Balance Sheet. The
classification of the Series B Preferred Stock as a liability under FAS 150
should not change its classification as equity under state law.
In January 2003, the Securities and Exchange Commission issued a new
disclosure regulation, "Conditions for Use of Non-GAAP Financial Measures"
("Regulation G"), which is effective for all public disclosures and filings made
after March 28, 2003. Regulation G requires public companies that disclose or
release information containing financial measures that are not in accordance
with generally accepted accounting principles ("GAAP") to include in the
disclosure or release a presentation of the most directly comparable GAAP
financial measure and a reconciliation of the disclosed non-GAAP financial
measure to the most directly comparable GAAP financial measure. The Company
became subject to Regulation G in fiscal 2003 and believes that it is in
compliance with the new disclosure requirements.
25
In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation-Transition and Disclosure - An Amendment of SFAS No.
123" ("FAS 148"). FAS 148 provides alternative methods of transition for a
voluntary change to the fair value-based method of accounting for stock-based
employee compensation. In addition, FAS 148 amends the disclosure requirements
of SFAS No. 123 to require prominent disclosures in both annual and interim
financial statements about the method of accounting for stock-based employee
compensation and the effect of the method used on reported results. The Company
has established several stock-based compensation plans for the benefit of its
officers and employees. Since 1996, the Company has accounted for its
stock-based compensation to employees using the fair value-based methodology
under SFAS No. 123, thus FAS 148 has had no effect on the Company's results of
operations or financial position. For the 26- weeks ended June 28, 2003 and June
29, 2002, the Company recorded stock compensation expense of $0.3 million and
$0.6 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.
In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other
Intangible Assets" ("FAS 142"). Under FAS 142, goodwill and intangible assets
with indefinite lives are no longer amortized but are reviewed annually (or more
frequently if impairment indicators arise) for impairment. Separable intangible
assets that are not deemed to have indefinite lives will continue to be
amortized over their useful lives (but with no maximum life). Goodwill relates
to the International Male and the Gump's brands and the net balance at both June
28, 2003 and June 29, 2002 was $9.3 million. The Company adopted FAS 142
effective January 1, 2002 and, as a result, has not recorded an amortization
charge for goodwill since that time. The Company obtained the services of an
independent appraisal firm during the second quarter ended June 28, 2003 to
assist in the assessment of its annual goodwill impairment review. The results
of the appraisal indicated that goodwill was not impaired based upon the
requirements set forth in FAS 142.
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."
26
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.
- - 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.
27
- - 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 realize the aggregate cost savings and other
objectives anticipated in connection with the strategic business
realignment program, or within the time periods anticipated therefor. The
aggregate costs of effecting the strategic business realignment program may
be greater than the amounts anticipated by the Company.
- - The ability of the Company to maintain advance rates under the Congress
Credit Facility that are at least as favorable as those obtained in the
past due to market conditions affecting the value of the inventory, which
is periodically re-appraised in order to re-set such advance rates.
- - The ability of the Company to dispose of assets related to its third party
fulfillment business, to the extent not transferred to other facilities.
- - The 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 on a
timely basis, or at all, actions by any holder in response thereto, if any,
and future interpretations of applicable law and contract.
- - The ability of the Company to maintain the listing of its Common Stock on
the American Stock Exchange.
- - The continued willingness of customers to place and receive mail orders in
light of worries about bio-terrorism.
- - The ability of the Company to sublease, 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.
28
- - The ability of the Company to achieve cross channel synergies, create
successful affiliate programs, effect profitable brand extensions or
establish popular loyalty and buyers' club programs.
- - Uncertainty in the U.S. economy and decreases in consumer confidence
leading to a slowdown in economic growth and spending resulting from the
invasion of, war with and occupation of Iraq, which may result in future
acts of terror. Such activities, either domestically or internationally,
may affect the economy and consumer confidence and spending within the
United States and adversely affect the Company's business.
- - The inability of the Company to continue to source goods from foreign
sources, particularly India and Pakistan, leading to increased costs of
sales.
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 June 28, 2003, outstanding principal balances under these facilities
subject to variable rates of interest were approximately $22.7 million. If
interest rates were to increase by one percent from current levels, the
resulting increase in interest expense, based upon the amount outstanding at
June 28, 2003, would be approximately $0.2 million on an annual basis.
ITEM 4. CONTROLS AND PROCEDURES
DISCLOSURE CONTROLS AND PROCEDURES. The Company's management, with the
participation of the Company's Chief Executive Officer and Chief Financial
Officer, has evaluated the effectiveness of the Company's disclosure controls
and procedures (as such term is detailed in Rules 13a-15(e) and 15d-15(e) under
the Securities Exchange Act of 1934, as amended (the "Exchange Act")) as of the
end of the period covered by this report. Based on such evaluation, the
Company's Chief Executive Officer and Chief Financial Officer have concluded
that, as of the end of such period, the Company's disclosure controls and
procedures are effective in recording, processing, summarizing and reporting, on
a timely basis. Information required to be disclosed by the Company in the
reports it files or submits under the Exchange Act.
INTERNAL CONTROL OVER FINANCIAL REPORTING. There have not been any
changes in the Company's internal control over financial reporting (as such
term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act)
during the fiscal quarter to which this report relates that have materially
affected, or are reasonably likely to materially affect, the Company's internal
control over financial reporting.
29
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
30
untrue, deceptive and misleading advertising in that it was not lawfully
required or permitted to collect insurance, tax and sales tax from customers in
California; and that Brawn has engaged in acts of unfair competition under the
state's Business and Professions Code. Plaintiff seeks (i) restitution and
disgorgement of all monies wrongfully collected and earned by Brawn, including
interest and other gains made on account of these practices, including
reimbursement in the amount of the insurance fee, tax and sales tax collected
unlawfully, together with interest, (ii) an order enjoining Brawn from charging
customers insurance fee and tax on its order forms and/or from charging tax on
the delivery, shipping and insurance charges, (iii) an order directing Brawn to
notify the California State Board of Equalization of the failure to pay the
correct amount of tax to the state and to take appropriate steps to provide the
state with the information needed for audit, and (iv) compensatory damages,
attorneys' fees, pre-judgment interest and costs of the suit. The Plaintiff
alleged that the claims of the individually named plaintiff and for each member
of the class amount to less than $75,000. On April 15, 2002, the Company filed a
Motion to Stay the Wilson action in favor of the previously filed Martin action.
On May 14, 2002, the Court heard the argument in 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
trial commenced on April 14, 2003 and a bench trial took place from April 14
through April 17, 2003. At the bench trial, the 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
conduct a vigorous defense of this action.
A class action lawsuit was commenced on October 28, 2002 entitled John
Morris, individually and on behalf of all other persons & entities similarly
situated v. Hanover Direct, Inc., and Hanover Brands, Inc. (referred to here as
"Hanover"), No. L 8830-02 in the Superior Court of New Jersey, Bergen County --
Law Division. The plaintiff brings the action individually and on behalf of a
class of all persons and entities in New Jersey who purchased merchandise from
Hanover within six years prior to filing of the lawsuit and continuing to the
date of judgment. On the basis of a purchase made by the plaintiff in August
2002 of certain clothing from Hanover (which was from a men's division catalog,
the only one which retained the insurance line item in 2002), the Plaintiff
claims that for at least six years, Hanover maintained a policy and practice of
adding a charge for "insurance" to the orders it received and concealed and
failed to disclose its policy with respect to all class members. Plaintiff
claims that Hanover's conduct was (i) in violation of the New Jersey Consumer
Fraud Act, as otherwise deceptive, misleading and unconscionable; (ii) such as
to constitute Unjust Enrichment of Hanover at the expense and to the detriment
of plaintiff and the class; and (iii) unconscionable per se under the Uniform
Commercial Code for contracts related to the sale of goods. Plaintiff and the
class seek damages equal to the amount of all insurance charges, interest
thereon, treble and punitive damages, injunctive relief, costs and reasonable
attorneys' fees, and such other relief as may be just, necessary, and
appropriate. 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 March 17, 2003, and the Company's reply
brief was filed on March 31, 2003. Hearing on the motion to stay took place on
June 6, 2003 at which time the Court granted the Company's motion to stay until
December 31, 2003, at which time the Court will revisit the issue if the
parties request that it do so. The Company plans to conduct a vigorous defense
of this action.
On June 28, 2001, Rakesh K. Kaul, the Company's former President and
Chief Executive Officer, filed a five-count complaint (the "Complaint") in New
York State Court against the Company, seeking damages and other relief arising
out of his separation of employment from the Company, including severance
payments of $2,531,352 plus the cost of employee benefits, attorneys' fees and
costs incurred in connection with the enforcement of his rights under his
employment agreement with the Company, payment of $298,650 for 13 weeks of
accrued and unused vacation, 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
31
against Mr. Kaul. The counterclaims include (1) breach of contract; (2) breach
of the Non-Competition and Confidentiality Agreement with the Company; (3)
breach of fiduciary duty; (4) unfair competition; and (5) unjust enrichment. The
Company seeks damages, including, without limitation, the $341,803 in severance
pay and car allowance Mr. Kaul received following his resignation, $412,336 for
amounts paid to Mr. Kaul for car allowance and related benefits, the cost of a
long-term disability policy, and certain payments made to personal attorneys and
consultants retained by Mr. Kaul during his employment, $43,847 for certain
services the Company provided and certain expenses the Company incurred,
relating to the renovation and leasing of office space occupied by Mr. Kaul's
spouse at 115 River Road, Edgewater, New Jersey, the Company's current
headquarters, $211,729 on a tax loan to Mr. Kaul outstanding since 1997 and
interest, compensatory and punitive damages and attorneys' fees. The case is
pending. The discovery period has closed, the Company has moved to amend its
counterclaims, and the parties have each moved for summary judgment. The Company
seeks summary judgment: dismissing Mr. Kaul's claim for severance under his
employment agreement on the ground that he failed to provide the Company with a
general release of, among other things, claims for change of control benefits;
dismissing Mr. Kaul's claim for attorneys' fees on the grounds that they are not
authorized under his employment agreement; dismissing Mr. Kaul's claims related
to change in control benefits based on an administrative decision that he is not
entitled to continued participation in the plan or to future benefits
thereunder; dismissing Mr. Kaul's claim for a tandem bonus payment on the ground
that no payment is owing; dismissing Mr. Kaul's claim for vacation payments
based on Company policy regarding carry over vacation; and seeking judgment on
the Company's counterclaim for unjust enrichment based on Mr. Kaul's failure to
pay under a tax note. Mr. Kaul seeks summary judgment: dismissing the Company's
defenses and counterclaims relating to a release on the grounds that he tendered
a release or that the Company is estopped from requiring him to do so;
dismissing the Company's defenses and counterclaims relating to his alleged
violations of his non-compete and confidentiality obligations on the grounds
that he did not breach the obligations as defined in the agreement; and
dismissing the Company's claims based on his alleged breach of fiduciary duty,
including those based on his monthly car allowance payments and the leased space
to his wife, on the grounds that he was entitled to the car payments and did not
involve himself in or make misrepresentations in connection with the leased
space. The Company has concurrently moved to amend its Answer and Counterclaims
to state a claim that it had cause for terminating Mr. Kaul's employment based
on, among other things, after acquired evidence that Mr. Kaul received a monthly
car allowance and other benefits totaling $412,336 that had not been authorized
by the Company's Board of Directors and that his wife's lease and related
expense was not properly authorized by the Company's Board of Directors, and to
clarify or amend the scope of the Company's counterclaims for reimbursement. The
briefing on the motions is completed and the parties are awaiting the decision
of the Court. No trial date has been set. It is too early to determine the
potential outcome, which could have a material impact on the Company's results
of operations when resolved in a future period.
The Company was named as one of 88 defendants in a patent infringement
complaint filed on November 23, 2001 by the Lemelson Medical, Education &
Research Foundation, Limited Partnership (the "Lemelson Foundation"). The
complaint, filed in the U.S. District Court in Arizona, was not served on the
Company until March 2002. In the complaint, the Lemelson Foundation accuses the
named defendants of infringing seven U.S. patents, which allegedly cover
"automatic identification" technology through the defendants' use of methods for
scanning production markings such as bar codes. The Company received a letter
dated November 27, 2001 from attorneys for the Lemelson Foundation notifying the
Company of the complaint and offering a license. The Court entered a stay of the
case on March 20, 2002, requested by the Lemelson Foundation, pending the
outcome of a related case in Nevada being fought by bar code manufacturers. The
trial in the Nevada case began on November 18, 2002 and ended on January 17,
2003. The parties in the Nevada case submitted post trial briefs at the end of
June 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 about $125,000 to $400,000. The Company has decided to gather further
information, but will not agree to a settlement at this time, and has not
established a reserve.
In early March 2003, the Company learned that one of its business units
had engaged in certain travel transactions that may have constituted violations
under the provisions of U.S. government regulations promulgated
32
pursuant to 50 U.S.C. App. 1-44, which proscribe certain transactions related to
travel to certain countries. See Note 12.
On July 17, 2003, the Company filed an action in the Supreme Court of
the State of New York, County of New York (Index No. 03/602269) against
Richemont Finance S.A. ("Richemont"), and Chelsey Direct, LLC, a Delaware
limited liability company ("Chelsey"), seeking a declaratory judgment as to
whether Richemont improperly transferred all of Richemont's securities in the
Company consisting of 29,446,888 shares of Common Stock and 1,622,111 shares of
Series B Participating Preferred Stock (collectively, the "Shares") to Chelsey
on or about May 19, 2003 and whether the Company can properly recognize the
transfer of those Shares from Richemont to Chelsey under federal and/or state
law. The Company believes that Richemont sold the Shares to Chelsey while in the
possession of confidential, material non-public information concerning the
Company that it had received from the Company pursuant to a confidentiality
agreement that barred it from using the information other than in connection
with Richemont's relationship or business with the Company. The Company believes
that Richemont improperly used this information in connection with its sale of
the Shares to Chelsey and that it would be improper for the Company and/or its
transfer agent to register the transfer of the Shares to Richemont without a
court first deciding the issue.
On July 29, 2003, Chelsey answered the Company's complaint, alleged
certain affirmative defenses and raised three counterclaims against the Company,
including Delaware law requiring the registration of the Shares, damages,
including attorney's fees, for the failure to register the Shares, and tortious
interference with contract. Chelsey also moved for a preliminary injunction
directing the Company to register the ownership of the Shares in Chelsey's name.
The parties appeared before the Court on July 29 and July 30, 2003. On
July 30, 2003, an agreement was reached between the parties and read into the
Court record and midday on July 31, 2003 the agreement reached between the
parties and read into the Court record was ordered by the Court. The agreement
includes the following:
1. The Company will register ownership of the Shares in Chelsey's name
on a temporary basis, subject to final resolution of the rights of
the parties in the litigation.
2. Chelsey will have the right to elect as a class two directors of the
Company, after August 31, 2003, on a temporary basis, subject to
final resolution of the rights of the parties in the litigation, if
the Company does not redeem one-half of the Preferred Shares on or
prior to that date, as called for by the Certificate of
Designations.
3. Chelsey will be entitled to select immediately, on a temporary
basis, subject to final resolution of the rights of the parties in
the litigation, an individual reasonably acceptable to the Company
to attend all meeting of the Board of Directors of the Company and
any committee thereof as a non-voting observer (the "Observer"),
subject to certain limitations set forth in the Certificate of
Designations. Both Chelsey and the Observer are required by the
Certificate of Designations to execute and deliver to the Company a
confidentiality agreement in form and substance reasonably
satisfactory to the Company whereby each agrees to hold confidential
all information learned as a result of the attendance by the
Observer at the Board of Director and committee meetings.
4. The Company and Chelsey will use their reasonable best efforts to
prosecute and defend the pending declaratory judgment action as
expeditiously as possible. The Company is serving Richemont with the
complaint pursuant to the Hague Convention and the complaint has
been delivered to the Central Authority in the Grand Duchy of
Luxembourg. It cannot know how soon service of the complaint on
Richemont will be effected by the Central Authority. Richemont will
have 30 days to respond to the complaint after service on it under
the Hague Convention. Discovery is to be concluded 60 days following
Richemont's responsive pleadings and a trial to be held as soon as
may be practicable, subject to the calendar of the Justice.
5. Until the Justice in the pending action renders a decision in the
litigation, if Chelsey has a good faith intention to sell the
Shares, it has agreed to give the Company at least two business
days' prior notice before consummating such a sale.
The parties agreed that none of the foregoing agreements shall give
rise to an adverse inference with respect to the positions of the parties in the
underlying litigation.
In addition, the Company is involved in various routine lawsuits of a
nature, which are deemed customary and incidental to its businesses. In the
opinion of management, the ultimate disposition of these actions will not have a
material adverse effect on the Company's financial position or results of
operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The 2003 annual meeting of stockholders of the Company was held in
Weehawken, New Jersey on May 15, 2003. Holders of 131,267,009 shares of Common
Stock and 1,622,111 shares of Series B Participating Preferred Stock outstanding
and entitled to vote at the meeting, or 95% of the outstanding shares, were
present at the meeting in person or by proxy.
1. The following five directors were elected to a one-year term expiring in
2004:
NAME FOR WITHHELD
---- --- --------
Thomas C. Shull 101,410,935 46,077,184
E. Pendleton James 101,436,905 46,051,214
Kenneth J. Krushel 101,436,567 46,051,552
Robert H. Masson 101,437,197 46,050,922
Basil P. Regan 101,384,030 46,104,089
2. The proposal to delegate to the Audit Committee of the Board of Directors the
authority to select the Company's independent auditors for the fiscal year
ending December 27, 2003 from amongst established national audit firms received
the following votes: 101,492,031 shares voted in favor; 178,786 shares voted
against; and 45,817,302 shares abstained.
ITEM 5. OTHER INFORMATION
On May 19, 2003, the Company issued a Notice of Blackout Period to its
directors and executive officers (the "Notice") announcing a blackout period
commencing on June 13, 2003 and ending the week of August 24, 2003 (the
"Blackout Period") because participants in The Company Store Savings and
Retirement Plan for Union Employees and The Company Store Money Purchase Pension
Plan are prohibited from entering into transactions with respect to Company
securities under such plans due to certain changes under such plans. A copy of
such Notice is furnished as an exhibit to this Quarterly Report on Form 10-Q.
The information contained in this Item 5 is being furnished pursuant to
"Item 11, Temporary Suspension of Trading Under Registrant's Employee Benefit
Plans" of Form 8-K in accordance with Release No. 33-8216 of the Securities and
Exchange Commission.
33
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
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.
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
10.1 Amendment No. 2 to Employment Agreement dated as of June 23, 2003
between Thomas C. Shull and the Company.
10.2 Amendment No. 3 to Employment Agreement effective as of August 3,
2003 between Thomas C. Shull and the Company.
31.1 Certification signed by Thomas C. Shull.
31.2 Certification signed by Edward M. Lambert.
32.1 Certification signed by Thomas C. Shull and Edward M. Lambert.
99.1 Notice of Blackout Period, dated May 19, 2003, to Directors and
Executive Officers of Hanover Direct, Inc. Incorporated by
reference to Exhibit 32.1 to the Company's Current Report on Form
8-K filed with the Securities and Exchange Commission on May 20,
2003.
(b) Reports on Form 8-K:
1.1 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.
1.2 Form 8-K, filed May 13, 2003 -- reporting pursuant to Item 9 of
such Form (information furnished pursuant to Item 12 of such
Form) the issuance of a press release announcing operating
results for the fiscal quarter ended March 29, 2003.
1.3 Form 8-K, filed May 13, 2003 -- reporting pursuant to Item 9 of
such Form an unofficial transcript of its conference call with
management to review the operating results for the fiscal quarter
ended March 29, 2003.
1.4 Form 8-K, filed May 20, 2003 -- reporting pursuant to Item 9 of
such Form (information furnished pursuant to Item 11 of such
Form) the issuance of a Notice of Blackout Period to its
directors and executive officers.
1.5 Form 8-K, filed May 22, 2003 -- reporting pursuant to Item 5 of
such Form that it had learned that Richemont Finance S.A. had
sold its shares in the Company to Chelsey Direct, LLC.
1.6 Form 8-K, filed May 30, 2003 -- reporting pursuant to Item 5 of
such Form certain instructions the Company was giving to its
transfer agent.
1.7 Form 8-K, filed July 15, 2003 -- reporting pursuant to Item 5 of
such Form the exchange of certain correspondence with Chelsey
Direct, LLC.
1.8 Form 8-K, filed July 17, 2003 -- reporting pursuant to Item 5 of
such Form the filing by the Company of an action in the Supreme
Court of the State of New York against Richemont Finance S.A. and
Chelsey Direct, LLC.
1.9 Form 8-K, filed July 30, 2003 -- reporting pursuant to Item 5 of
such Form the increase in the size of the Company's Board of
Directors and the election of Jeffrey A. Sonnenfeld and A. David
Brown as directors.
2.0 Form 8-K, filed August 1, 2003 -- reporting pursuant to Item 5 of
such Form certain agreements of the parties in the matter of
Hanover Direct, Inc. v. Richemont Finance S.A. and Chelsey
Direct, LLC.
2.1 Form 8-K, filed August 5, 2003 -- reporting pursuant to Item 5
of such Form scheduling information
35
regarding its conference call with management to review the
operating results for the fiscal quarter ended June 28, 2003.
36
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HANOVER DIRECT, INC.
Registrant
By: /s/ Edward M. Lambert
---------------------------------------
Edward M. Lambert
Executive Vice President and
Chief Financial Officer
(On behalf of the Registrant and as
principal financial officer)
Date: August 7, 2003
37