PART I

Item 1. Business

Preliminary Statement

This Annual Report on Form10-K contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The use of words such as “anticipates,” “estimates,” “expects,” “projects,” “intends,” “plans,” and “believes,” among others, generally identify forward-looking statements. Forward-looking statements are predictions of future trends and events and as such, there are substantial risks and uncertainties associated with forward-looking statements, many of which are beyond management’s control. Some of the more material risks and uncertainties are identified in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—1A. Risk Factors.” We do not intend, and disclaim any obligation, to update any forward-looking statements.

General

Hanover Direct, Inc. (collectively with its subsidiaries, referred to as the “Company,” “we” or “us” in this Form 10-K) is a direct marketer of quality, branded merchandise through a portfolio of catalogs and websites. We also manufacture comforters and pillows that we sell in twoseveral of our catalogs and our retail outlet stores and manufacture Scandia Down branded comforters, pillows and featherbeds that we sell through specialty retailers. In addition, we provide product fulfillment, telemarketing, information technology and e-commerce services to third party businesses involved in the direct marketing business.

On March 14, 2005, we sold all of the stock of Gump’s Corp. and Gump’s By Mail, Inc. to an unrelated third party. We have treated Gump’s as a discontinued operation for financial accounting purposes (see Notes 1 and 4 to the Consolidated Financial Statements). To provide more meaningful disclosure in this Form 10-K and to focus on our continuing operations, the results of Gump’s and other statistics related to the Gump’s business, such as year-to-year comparisons of the number of catalogs mailed and the percentage of our business conducted over the Internet, have been excluded from the disclosure contained in this Form 10-K except as otherwise indicated herein.

Our direct marketing operations consist of a portfolio of catalogs and associated websites in the home fashions, men’s and women’s apparel and gift categories that included during 2004,2005, Domestications, The Company Store, Company Kids, Silhouettes, International Male and Undergear. Each catalog can be accessed on the Internet individually by name. We also owned and operated the Gump’s retail store in San Francisco and the Gump’s By Mail catalog and website until their sale on March 14, 2005, when we sold them to an unrelated third party.2005. In addition, we manufacture high quality pillows and comforters for sale in The Company Store, Company Kids and Domestications catalogs and websites, through our retail outlet stores and super-premium down comforters, pillows and featherbeds under the Scandia Down brand name, which we sell through third party luxury retailers in North and South America.

Leveraging our in-house expertise in product fulfillment and utilizing our excess capacity, weWe also provide third party, end-to-end, fulfillment, logistics, telemarketing and information technology services to businesses formerly owned by the Company and select third party companies involved in the direct marketing business.

The Company is incorporated in Delaware and our executive offices are located at 1500 Harbor Boulevard, Weehawken, New Jersey 07086. The Company’s telephone number is (201) 863-7300. The Company is the successor of the 1993 merger between The Horn & Hardart Company, a restaurant company that traces its origins to 1888 and Hanover House Industries, Inc., which was founded in 1934.

At the Company’s 2004 Annual Meeting of Shareholders held on August 12, 2004, the Company’s shareholders approved a one-for-ten reverse stock split of the Company’s common stock (“Common Stock”), which became effective at the close of business on September 22, 2004. In this Annual Report on Form 10-K, the number of shares of Common Stock outstanding, per share amounts, stock warrants, stock option and exercise price data relating to the Company’s Common Stock for periods prior to the reverse stock split have been restated to reflect the effect of the reverse stock split. See Note 9 to the accompanying consolidated financial statements for more information regarding the reverse stock split and additional amendments to the Company’s Certificate of Incorporation.

Restatement of Prior Financial InformationSignificant Shareholder; Going Private Proposal and Related MattersLitigation

We have restated the consolidated financial statements for the fiscal years ended December 27, 2003 and December 28, 2002 in this Annual Report on Form 10-K. We have also restated the quarterly financial information for fiscal 2003 and the first two quarters of fiscal 2004. See Note 2 to the accompanying consolidated financial statements (collectively, the “Restatement”). The Restatement also affects periods prior to fiscal 2002. The Restatement’s impact on periods prior to fiscal 2002 have been reflected as an adjustment to accumulated deficit as of December 29, 2001 in the accompanying Consolidated Statements of Shareholders’ Deficiency.

We have also restated the applicable financial information for fiscal 2000, fiscal 2001, fiscal 2002 and fiscal 2003 in “Item 6. Selected Consolidated Financial Data.”

The Restatement corrects a revenue recognition issue that resulted in revenue being recorded in advance of the actual receipt of merchandise by the customer, corrects an error in the accounting treatment of discounts obligations for certain of the Company’s buyers’ club programs, corrects two errors in the accounting treatment of a reserve, including re-establishing a reserve balance prematurely released based on a summary judgment decision which could be and was appealed, and recording legal fees in the proper periods that were inappropriately recorded related to the matter. The Restatement also records certain customer prepayments and credits prematurely released, and records other liabilities relating to certain miscellaneous catalog costs and other miscellaneous costs that were inappropriately not accrued in the appropriate periods. In addition, we have made adjustments to the deferred tax asset and liability to reflect the effect of the Restatement adjustments. We did not amend our previously filed Annual Reports on Form 10-K or Quarterly Reports on Form 10-Q for the Restatement. As previously disclosed in our Current Report on Form 8-K filed with the Securities and Exchange Commission (“SEC”) on November 10, 2004, the consolidated financial statements and related financial information contained in such reports for the fiscal years ended December 25, 1999, December 30, 2000, December 29, 2001, December 28, 2002 and December 27, 2003 and the fiscal quarters ended March 29, 2003, June 28, 2003, September 27, 2003, March 27, 2004 and June 26, 2004 should no longer be relied upon. Throughout this Form 10-K all referenced amounts for prior periods and prior period comparisons reflect the balances and amounts after giving effect to the Restatement.

As a result of the Restatement, we were unable to timely file our Quarterly Report on Form 10-Q for the fiscal quarter ended September 27, 2004 or this Form 10-K. As a result of our not filing our Quarterly Report on Form 10-Q for the fiscal quarter ended September 27, 2004 on a timely basis and our inability to meet the continued listing requirements of the American Stock Exchange (“AMEX”), trading in our Common Stock on the AMEX was halted and ultimately the Common Stock was delisted by the AMEX on February 16, 2005.

In response to the discovery of certain of the matters leading up to the Restatement, the Audit Committee of the Board of Directors launched an investigation in November 2004 relating to the restatement of the Company’s consolidated financial statements and other accounting-related matters and engaged the law firm of Wilmer Cutler Pickering Hale and Dorr LLP (“Wilmer Cutler”) as its independent outside counsel to assist with the investigation. In March 2005, the Audit Committee concluded its investigation and, with the assistance of Wilmer Cutler, reported its findings to the Board of Directors. The Audit Committee, again with the assistance of Wilmer Cutler, formulated a series of recommendations to the Company and the Board of Directors concerning potential improvements in the Company’s internal controls and procedures for financial reporting. The Board of Directors and management have begun implementing these recommendations.

The Company was notified in January 2005 by the SEC that the SEC was conducting an informal inquiry relating to the Company’s financial results and financial reporting since 1998. The SEC indicated in its letter to the Company that the inquiry should not be construed as an indication by the SEC that there has been any violation of the federal securities laws. The Company is cooperating fully with the SEC in connection with the inquiry and Wilmer Cutler has briefed the SEC and the Company’s independent registered public accounting firm, Goldstein Golub Kessler LLP (“GGK”) on the results of its investigation. The Company intends to continue to cooperate with the SEC in connection with its informal inquiry concerning the Company’s financial reporting.

We hired a new Chief Executive Officer in May 2004 who, together with current management, identified the issues leading to the Restatement. Based on recommendations of the Audit Committee concerning potential improvements in the Company’s internal controls and procedures for financial reporting, management has responded to the weaknesses in internal controls exposed by the Restatement by revamping and augmenting the Company’s accounting and finance functions, hiring a new Chief Financial Officer, strengthening the Company’s internal controls, hiring an internal general counsel and replacing the Company’s external counsel, and instituting a corporate culture that demands ethical behavior of all employees, the highest level of compliance and encourages free communication up and down the ranks. See “Controls and Procedures” for more information regarding these and other initiatives.

Significant Shareholder

After its January 10, 2005 purchase of an aggregate of 3,799,735 shares of Common Stock formerly held by Regan Partners, L.P., Regan International Fund Limited and Basil Regan,significant shareholder, Chelsey Direct, LLCLLC. Chelsey and its related affiliates (“Chelsey”) beneficially own approximately 69% of the Company’s issued and outstanding common stock (“Common StockStock”) and approximately 75%76% of theour Common Stock after giving effect to the exercise of all of Chelsey’s outstanding options and warrants to purchase Common Stock beneficially owned by Chelsey.warrants. In addition, Chelsey is holder ofholds all 564,819 shares of the Company’s Series C Participating Preferred Stock (“Series C Preferred”). which has 100 votes per share. Including the Series C Preferred and the outstanding options and warrants beneficially owned by Chelsey, Chelsey maintainsholds approximately 91% of the voting rights of the Company (after giving effectCompany.

While our back-end/fulfillment functions are centralized, we operate merchandising, purchasing and catalog production separately for each of The Company Store/Company Kids, Domestications, Silhouettes and International Male/Undergear catalogs and websites. Previously, we operated The Company Store/Company Kids and Domestications as a single unit. During 2004, after a review of the management structure of the catalogs, we determined that we would better served by having separate management teams to guide each of the catalogs because of the diversity of the target customer base and sales volumes of the catalogs.

Each of our specialty catalogs targets its market by offering a focused assortment of merchandise designed to meet the needs and preferences of each catalog’s customers. Through market research and ongoing testing of new products and concepts, each catalog has its own merchandise strategy, including appropriate price points, mailing plans and presentation of its products. We are continuing our development of exclusive or private label products for a number of our catalogs to further differentiate the catalog’s identities.

Our catalogs range in size from approximately 48 to 108 pages with 9 to 2722 editions per year depending on the seasonality and fashion content of the products offered. Each edition may be mailed several times each season with variations in format and content. The Company employs the services of outside creative agencies or has its own creative staff that is responsible for the designs, layout, copy, feel and theme of the catalogs. Generally, the initial sourcing of new merchandise for a catalog begins six to nine months before the catalog is mailed.

Silhouettes is a moderate-to-better priced fashion catalog dedicated to woman’s styles starting at size 12W. The catalog carries the current trends in fashion along with core classics, seasonal favorites and Silhouettes®Silhouettes exclusives. Silhouettes carries a full range of apparel from boots to bathing suits, sleepwear to swimwear, and everything in between.

Silhouettes core strengths include exclusive designs and manufacturing sourced around the world. Utilizing key manufacturing plants allows Silhouettes to control costs and ensure the quality of these designs, offering the customer a product of style and value.

The Silhouettes catalog and website create a virtual department store, carrying something for every 12W plus-sized woman. The catalog continues to be the primary driver for website orders. In each of the past four years Silhouettes®Silhouettes has enjoyed significant Internet sales growth. Improved on-site search capabilities and navigations have taken the tedium and frustration out of the search and have created a better virtual shopping experience, getting Silhouettes®Silhouettes closer to its goal of being the customer’s best friend.

International Male and Undergear offers contemporary men’s fashions and accessories at reasonable prices. As we celebrate International Male’s 30^th Anniversary, the Company has relocated the business to its headquarters in Weehawken, New Jersey and hired2005 marked a new management teamkey transitional year for the catalog, which is in the process of repositioning International Male to return it to its roots as a young men’s “lifestyle” fashion leader. This merchandising shift will be evident in catalogs commencing in the fourth quarter of 2005.

International Male carries a full line of apparel, from sportswear to swimwear, underwear, shoes and accessories, offering a merchandise mix that is both exciting and eclectic.

Undergear was launched in 1985 as a “handbook of men’s underwear” from around the world. It is a market leader in the men’s underwear catalog and Internet business.

Core strengths include the production of our many exclusive styles, interpreted by our merchandising team using key manufacturing sources, allowing us to control costs and ensure quality. 

Over the years, the names International Male and Undergear. The businesses have become synonymous with our merchandise - from top vendorsrecently relocated to our signature collections -New Jersey headquarters, where new management and a newly formed creative team have been charged with the ultimate goal of re-establishing the unique qualities of both brands and making them well-known to consumers. Fashion offerings have been increased and diversified, while the catalogs have been given a more modern look and feel to accurately reflect our evolving image and solidify our niche in the men's fashion and underwear business.

During November 2002, Amazon.com began to offer Silhouettes, International Male and Undergear merchandise within Amazon.com’s Apparel & Accessories store under a multi-year strategic alliance between the Company and Amazon.com. During 2003, Company Kids, Domestications, The Company Store and Gump’s were also made available on Amazon.com. All orders resulting from this alliance are electronically transferred to and fulfilled by the Company. Amazon.com charges us a commission on orders placed through its website.

We utilize other on-line marketing opportunities by posting our catalog merchandise and accepting orders on third-party websites for which we are charged a commission. We also enter into affiliate marketing agreements with third-party website operators and pay for “click thrus” to our websites. In addition to the Amazon.com arrangements, weWe have entered into third party affiliate marketing agreements with Amazon.com, ArtSelect.com, CatalogCity, Decorative Product Source, Google, MSN, NexTag, Overture, Shopping.com, Linkshare and GiftCertificates.com.

Scandia Down. Scandia Down manufactures luxury European down comforters, pillows and featherbeds from its LaCrosse, Wisconsin facility and distributes these products together with proprietary branded sheeting, towels and related accessories through its network of over 90 high end retailers in North and South America. Scandia Down’s core growth strategy is focused on expanding distribution in select markets with key retailers, expanding product lines and categories, and developing sales and marketing support programs for licensed retailers.

Divestitures.

Improvements. On June 29, 2001, we sold certain assets and liabilities of our Improvements business to HSN, a division of USA Networks, Inc.’s Interactive Group, for approximately $33.0 million. In conjunction with the sale, we agreed to provide telemarketing and fulfillment services for the Improvements business under a services agreement with a three year term that was later extended for an additional two years. To secure our performance, $3.0 million of the purchase price was held in escrow. A portion of the escrow was released in 2002 and the balance was released in 2003. The services agreement for Improvements, which originally expired on June 27, 2006, was extended until August 31, 2007.

Gump’s and Gump’s By Mail. On March 14, 2005, we sold all of the stock of Gump’s Corp. and Gump’s By Mail, Inc. (collectively, “Gump’s”) to Gump’s Holdings, LLC, an unrelated third party (“Purchaser”) for $8.9 million, including a $0.4 million purchase price adjustment pursuant to the terms of a February 11, 2005 Stock Purchase Agreement. The Company recognized a gain of approximately $3.6 million in its quarter ended March 26, 2005. Chelsey, as the holder of all of the Series C Preferred, consented to the application of the sales proceeds to reduce the outstanding balance of the senior secured credit facility (“Wachovia Facility”) provided by Wachovia National Bank, as successor by a merger with Congress Financial Corporation (“Wachovia”), in lieu of using the available proceeds to redeem the Series C Preferred (the number of shares to be redeemed would have been based on the available sales proceeds and the then current redemption price per share of the Series C Preferred). This waiver

Incorporated (now known as “Vertrue”) under which our catalogsWe market and offer a variety of Vertrue membership programs to our catalog customers through our call centers when they call to place an order. VertrueWe also offer membership programs on our websites. The membership programs offer members discounts on a wide variety of goods and services. Vertrue has the exclusive rights to the first up-sell position on all merchandise order calls made to our call centers, after any cross-sells that the catalogs may make for their own primary (or catalog-based) products. Initially, prospective members participate in a thirty-day trial period that, unless canceled, is automatically converted into a full membership term, which is one year in duration.membership. Memberships are automatically renewed at the end of each year unless canceled by the member.

Until March 21, 2006, we marketed membership programs provided by Vertrue. After the expiration of the agreement with Vertrue, pays us commissions that vary based on the actual number of offers and sales made and whether the membership is an initial sale or a renewal. In 2004, we began offering Vertrue programs on our websites. The Vertrue programs are offered to customers when a customer reaches the order confirmation page after placing an order.

The Vertrue agreement expires in March 2006 and we are evaluating proposals from membership program providers to marketsimilar membership programs to our customers after the Vertrue agreement expires. We expect theprovided by Encore Marketing International (“Encore”) under a two year agreement. The economic terms of any new membership marketing agreementthe Encore program are more favorable to be no less favorableus than those under the currentVertrue agreement with Vertrue.

We also received commission revenue related toprovided our solicitation of the Magazine Direct subscription program until the program was discontinued in May 2003. We were paid commissions based on a per-solicitation basis accordingcustomers are as receptive to the number of solicitations made, with additional revenue recognized ifEncore programs as they were to the customer accepted the solicitation.Vertrue programs. There is, however, no assurance on how receptive our customers will be to these new programs.

Buyers’ Club. Customers may purchase memberships in a number of our catalogs’ Buyers’ Club programs for an annual fee. The Buyers’ Clubs offer members merchandise discounts or free delivery and service charge, advance notice of sales and other benefits. We use Buyers’ Club programs to promote catalog loyalty, repeat business and to increase sales.

In the past, certain of the Buyers’ Club programs contained a guarantee whereby the customer would receive discounts or savings, at least equal to the cost of his or her membership or we would refund the difference with a merchandise credit at the end of the membership period. This guarantee was offered during the following periods: Silhouettes from July 1998 through March 2004; Domestications from April 2002 through March 2004; and Men’s Apparel from April 2003 through March 2004. We do not offer the guarantee currently.

In the first quarter of 2004, former management identified a potential issue with the accounting treatment for Buyers’ Club memberships that contained a guarantee related to discount obligations. At that time, an inappropriate conclusion regarding the accounting treatment was reached and during the third quarter of 2004, the issue was re-evaluated and we determined that an error in the accounting treatment had occurred. The cumulative impact of the error for which the Company restated resulted in the overstatement of revenues and the omission of the liability related to the guarantee of these discount obligations that aggregated $2.4 million as of June 26, 2004 (the end of the second quarter of 2004). The Company has developed a plan to satisfy its obligation to those Buyers’ Club members entitled to benefits as a result of the guarantee which will be implemented by the end of the first quarter of 2006. As reflected in the Restatement, for memberships purchased during those periods when the Buyers’ Club memberships contained a guarantee, revenue net of actual cancellations is recognized on a monthly basis over the membership period, commencing after the thirty-day cancellation period, with the revenue recognized equal to the lesser of the cumulative amount determined using the straight-line method or the actual benefit received by each customer as of the end of each period. At the end of the membership period, a liability equal to the residual guarantee is recorded on the Company’s Consolidated Balance Sheets.

For Buyers’ Club memberships that did not contain a guarantee, we recognize revenue net of actual cancellations on a monthly basis commencing after the thirty-day cancellation period, over the membership period using the straight-line method.

Collectively, we reported revenues from membership services of $14.3 million, or 3.5% of net revenues, $10.3 million or 2.8% of net revenues, and $9.3 million or 2.5% of net revenues $9.3 million or 2.2% of net revenues, and $10.3 million or 2.2% of net revenues for fiscal years 2005, 2004 2003 and 2002,2003, respectively. We continue to consider opportunities to offer new and different goods and services to our customers on inbound order calls and on our websites.

Marketing and Database Management. We maintain a proprietary customer list currently containing approximately 5.65.4 million names of customers who have purchased from one of our catalogs or websites within the past thirty-six months (including 0.2 million names relating to Gump’s By Mail).months. Approximately 2.22.4 million of the names on the list represent customers who have made purchases from at least one of our catalogs within the last twelve months (including 0.1 million names relating to Gump’s By Mail).months. We also maintain a proprietary list of e-mail addresses totaling approximately 2.82.9 million addresses (including 0.2 million addresses relating to Gump’s By Mail).addresses. We consider our customer lists one of our most valuable assets.

We utilize modeling and segmentation analysis to devise catalog marketing and circulation strategies that are intended to maximize customer contribution by catalog. This analysis is the basis used by our catalogs to determine which of our catalogs will be mailed and how frequently to a particular customer, as well as the promotional incentive content of the catalog(s) that a customer receives.

We acquire products for resale in our catalogs from numerous domestic and foreign vendors. Over recent years, the Company has trended more towards obtaining goods from foreign as opposed to domestic vendors. No single third party source supplied more than 10.0%10% of our products in 2004.2005. Our vendors are selected based on their ability to reliably meet our production and quality requirements, as well as their financial strength and willingness to meet our needs on an ongoing basis.

At the end of fiscal 2004,2005, we had received approximately $4.7$5.6 million in combined catalog and Internet orders that had not been shipped and were not included in the net revenues of the Company. This amount was a decreasean increase of $1.0$1.6 million compared with the approximately $5.7$4.0 million of unshipped orders existing at the end of fiscal 2003.2004. These amounts consisted mainly of backorders, orders awaiting credit card authorization, open dropship orders and orders physically in the warehouse awaiting shipment to customers. The Company fulfilled substantially all of these orders within the first ninetyseventy-five days of 2005.2006.

Because we import a large portion of our merchandise, we have, in the past, been subject to delays in merchandise availability and shipments due to customs, quotas, duties, inspections and other governmental regulation of international trade. We continue to monitor development in this area in an effort to minimize delays in international merchandise shipments that adversely impact our business.

the consolidation of our fulfillment centers, our Roanoke fulfillment center hasfacility, we have experienced lower productivity and high employee turnover due, in part, to a tight labor market in Roanoke, increases in our own volumes and those of our third party business, that has negatively impactedresulted in higher costs being incurred in the fulfillment costs and the Company’s overall performance.center. We tookcurrently lease 379,800 square feet at a charge of $0.7 million in 2004 because of staff reductions at the LaCrossenearby facility and the costs of relocating inventory to Roanoke. In addition, the Company leases a 302,900 square foot warehouse and fulfillment facility located in Salem, Virginia for additional storage for the Roanoke distribution center. Theunder a lease originally commenced on March 28, 2005 and was amended in June 2005 and again in September 2005 to increase the initial 91,000 square feet of leased space to the current 302,900 square feet. The leasethat expires on September 30, 2006 except2007. We have an option to extend the lease for the portion that pertains to thethree additional 90,900 square feet added in September 2005 which is on a month-to-month basis.terms of six months each. See “Properties.”

Management Information Systems. All of our catalogs are part of our integrated mail order and catalog system operating on mid-range computer systems. Additionally, our fulfillment centers are part of our warehouse management system. These systems have been designed to meet our requirements as a high volume publisher of multiple catalogs and provider of back-end fulfillment services. We continue to devote resources to improving our systems.

Our software system is an on-line, real-time system, which is used in managing all phases of our operations and includes order processing, fulfillment, inventory management, list management and reporting. The software provides us with a flexible system that offers data manipulation and in-depth reporting capabilities. The management information systems are designed to permit us to achieve efficiencies in the way our financial, merchandising, inventory, telemarketing, fulfillment and accounting functions are performed.

As described more fully in Note 7, Debt, to the consolidated financial statements, contained in Part II, we have two credit facilities: the Wachovia Facility and the $20.0 million Chelsey Facility provided by Chelsey Finance. The Wachovia Facility includes a revolving credit facility with a maximum loan amount of $34.5 million and a $5.0 million term loan. The Wachovia Facility expires on July 8, 2007 and bears interest at 0.5% over the Wachovia prime rate. The interest rate on December 25, 200431, 2005 was 5.5%7.5%.

The Chelsey Facility is a $20.0 million junior secured credit facility and has a three-year term. At December 25, 2004,31, 2005, the amount recorded as debt relating to the Chelsey Facility on the Consolidated Balance Sheet is $8.2$11.5 million, net of the remaining, un-accreted debt discount of $11.8$8.5 million. The Chelsey Facility bears interest at 5.0% over the Wachovia prime rate. The stated interest rate on December 25, 200431, 2005 was 10.0%12.0%. TheAs of December 31, 2005, the annual effective interest rate of this debt instrument is approximately 62.7%57.1%, inclusive of the accretion of the debt discount arising from the issuance of common stock warrants to Chelsey Finance in connection with the Chelsey Facility. See Note 7 to the consolidated financial statements for more information regarding the Chelsey Facility and the common stock warrant . We used approximately $4.9 million of the proceeds of the Chelsey Facility to retire a term loan under the Wachovia Facility that bore interest at a 13.0% rate. As a result of this prepayment and the concurrent amendment of the Wachovia Facility, Wachovia provided us with an additional $10.0 million of availability on the Wachovia Facility. There is no additional availability on the Chelsey Facility.warrant.

Employees

As of December 25, 2004,31, 2005, we employed approximately 1,8002,050 full-time employees and approximately 400300 part-time employees. The number of part-time employees at December 25, 200431, 2005 reflects a temporary increase in headcount necessary to fill the increase in orders during the holiday season. Approximately 164 employees employed by oneOne of our subsidiaries has approximately 72 employees who are represented by The Union of Needletrades, Industrial and Textile Employees (UNITE!). We entered into a new union agreement in March 2003 thaton February 25, 2006 which expires on February 26, 2006. The Company and the union are currently negotiating a new agreement.  While the Company believes that a new union agreement can be reached on terms mutually acceptable to the Company and the union, there can be no assurances that such an agreement can be reached before the current agreement expires.   April 25, 2009.

We believe our relations with our employees are good.

During the fiscal year ended December 25, 2004, we eliminated a total of approximately 200 full-time equivalent positions, including approximately eight positions at or above the level of director, which included open positions that were eliminated. All separations were made in accordance with normal pay practices, excluding those individuals who were terminated under a compensation continuation agreement, which provided for payment in the form of a lump sum.

Seasonality

Our business is subject to moderate variations in demand. Historically, a larger portion of our revenues have been realized during the fourth quarter compared to each of the first three quarters of the year. The percentage of annual revenues for the first, second, third and fourth quarters recognized by the Company were as follows: 2005-22.0%, 24.6%, 23.7% and 29.7%, 2004 — 22.4%22.6%, 24.0%24.3%, 23.4%23.7% and 30.2%29.4%; and 2003 — 23.5%23.8%, 25.4%26.0%, 23.4%23.7% and 27.7%; and 2002 — 22.8%, 24.5%, 23.3% and 29.4%26.5%.

Competition

We believe that the principal bases upon which we compete in our direct commerce business are quality, value, service, proprietary product offerings, catalog design, website design, convenience, speed and efficiency. Our catalogs compete with other mail order catalogs, both specialty and general catalogs and bricks and mortar stores. Competitors in each of our catalog specialty areas of home fashions, women’s apparel, and men’s apparel include Linen Source, Pottery Barn and BrylaneHome in the home fashions, Lane Bryant, Roaman’s, Jessica London and Spiegel in the women’s apparel category and J. Crew, Blair and Bachrach, in the men’s apparel category. Our

The Company is subject to Federal Trade Commission regulations governing its advertising and trade practices, Consumer Product Safety Commission regulations governing the safety of the products it sells and other regulations relating to the sale of merchandise to its customers. We are also subject to the Department of Treasury — Customs regulations with respect to any goods we directly import.

The imposition of a sales and use tax collection obligation on out-of-state catalog companies in states to which they ship products was the subject of a case decided in 1994 by the United States Supreme Court. While the Court reaffirmed an earlier decision that allowed direct marketers to make sales into states where they do not have a physical presence without collecting sales taxes with respect to such sales, the Court further noted that Congress has the power to change this law. We believe that we collect sales tax in all jurisdictions where we are currently required to do so.

Listing Information

Current trading information about the Common Stock can be obtained from the Pink Sheets (www.pinksheets.com) under the trading symbol HNVD.PK. The Common Stock washad been listed on the AMEX. Because of the Restatement, we could not file our Form 10-Q for the fiscal quarter ended September 25, 2004, a condition of continued AMEX listing. Trading in our Common Stock on the AMEX was halted on November 16, 2004, formally suspended on February 2, 2005 and delisted effective February 16, 2005. Current trading information about the Common Stock can be obtained from the Pink Sheets (www.pinksheets.com) under the trading symbol HNVD.PK.

Website Access to Information

Our corporate Internet address is www.hanoverdirect.com. Our catalogs operate the following websites:

The website for Keystone Internet Services, LLC (“Keystone”) which provides business to business services is www.keystoneinternet.com and Scandia Down’s is www.scandiadown.com.

junior lender, Chelsey Finance, so that we can support normal operations, purchase inventory, and secure letters of credit and other financial accommodations required to operate our business. Our credit facilities contain financial and other covenants and we have not been in compliance with these covenants at all times. In the past Wachovia and Chelsey Finance have granted us waivers and agreed to amendments to the Wachovia and Chelsey Facilities, though there can be no assurances that they will continue to do so. Our ability to borrow is also limited by the value of our inventory which is reappraised from time to time. Were either Wachovia or Chelsey Finance to deny or curtail the Company’s access to capital, our business would be adversely affected. Both lenders have liens on our assets and were we to default, they could commence foreclosing on our assets.

We are also dependent on our vendors or suppliers providing us with trade credit. If certain trade creditors were to deny us credit or 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, paper, printing and other items essential to its business, our costs would be increased and we might have inadequate liquidity to operate our business or operate profitably.

decline significantly. We must also accurately determine the optimal number of issues to publish for each catalog and the contents thereof and the optimal circulation for each of our catalogs to maximize sales at an appropriate cost level to achieve profitability while growing our customer base. Correctly determining the universe of catalog recipients also directly impacts our results. We can provide no assurance that we will be able to identify and offer merchandise that appeals to our customer-base or that the introduction of new merchandise categories will be successful or profitable or that we will mail the optimal number of catalogs to the appropriate target customer base.

Our catalogs are in highly competitive markets.

Our catalogs are in a highly competitive markets. Many of our competitors are considerably larger and have substantially greater financial, marketing and other resources, and we can provide no assurance that we will be able to compete successfully with them in the future.

result in delays and increased costs. If any significant merchandise vendor or buying agent were to suddenly discontinue its relationship with us, we could experience temporary delivery delays until a substitute supplier could be found.

capitalization, Section 404 would apply to our 2007 financial statements.statements if we remain a public company. There can be no assurance that management will not identify significant deficiencies that would result in one or more material weaknesses in our internal controls over financial reporting. We cannot provide any assurance that testing of our internal controls will not uncover significant deficiencies that would result in a material weakness in our internal controls over financial reporting.

If we fail to comply in a timely manner with the requirements of Section 404 of the Sarbanes-Oxley Act of 2002 or to remedy any material weaknesses in our internal controls that we may identify, such failure could result in material misstatements in our financial statements and cause a default under the Company’s credit facilities, cause investors to lose confidence in our reported financial information and have a negative effect on the trading price of our common stock.

• A 775,000 square foot warehouse and fulfillment facility located in Roanoke, Virginia; • A 48,000 square foot administrative and telemarketing facility located in LaCrosse, Wisconsin; and • A 150,000 square foot home fashion manufacturing facility located in LaCrosse, Wisconsin used to manufacture comforters, pillows and featherbeds for sale under “The Company Store” and “Scandia Down” names.   Each of these properties is subject to a mortgage in favor of Wachovia and a second mortgage in favor of Chelsey Finance.   In addition, the Company or its subsidiaries lease the following properties:   • An 85,000A 50,000 square foot corporate headquarters and administrative offices located in Weehawken, New Jersey. On February 12, 2005, we entered into a 10-year lease extension and modification, effective June 2005, for 50,000 square feet of the 85,000 square feet that was previously leased. All catalog operations are based in the Weehawken facility as of the end of May 2005. In addition, we leased approximately 5,000 square feet in a storage facility in Jersey City, New Jersey under a lease that expiredexpiring in May 2005. We did not renew this lease, however we did secure a new lease expiring May 31, 2010, for aJune 2015. A 6,900 square foot storage facility in Secaucus, New Jersey.Jersey under a lease expiring May 31, 2010; • A 28,700 square foot office formerly used for corporate headquarters, administration and Silhouettes operations located in Edgewater, New Jersey under a lease that expired in May 2005. The Company has vacated this facility and has consolidated these functions into the Weehawken facility. • FiveTwo properties used as outlet stores located in Pennsylvania and Wisconsin having approximately 49,20019,500 square feet of space in the aggregate, with leases running through February 2007. The Company decided to close and not renew the leases of three of these stores. Two of these closures were located in Wisconsin and were vacated by July 31, 2005. The remaining location isAnother outlet store located in Pennsylvania and will be vacated no later thanwas closed at the end of February 28, 2006. • A 65,100 square foot retail and office facility which includes the Gump’s retail store in San Francisco, California under two leases that expire in April 2010, of which approximately 37,800 square feet was occupied by the Company and the remaining 27,300 square feet are subleased. On March 14, 2005, the Company sold its Gump’s retail store operation. After the sale, the Company continued as the guarantor of one of the two leases. The Purchaser is required to use its commercially reasonable efforts to secure the Company’s release from the guarantee within a year of the closing. • A 151,000 square foot warehouse and fulfillment facility located in LaCrosse, Wisconsin under a lease that expired in June 2005. The Company also leased a 34,000 square foot facility, located in LaCrosse, Wisconsin that was used for storage under a lease extension that expired in August 2005. As part of the consolidation of the distribution function to the Roanoke facility, the Company vacated these facilities upon their lease expirations.2006; • A 117,900 square foot telemarketing, customer service and administrative facility located in Hanover, Pennsylvania, under a lease extension expiring on June 30, 2006.2006; • An 11,000 square foot satellite telemarketing facility in York, Pennsylvania under a lease expiring July 31, 2006.2006; • A 30,000 square foot administrative facility in San Diego, California for the men’s apparel business under a lease that expired February 28, 2005. At the end of the lease, the Company vacated this space in conjunction with the relocation of the men’s apparel business to the Weehawken facility. • A 302,900379,800 square foot warehouse and fulfillment facility located in Salem, Virginia for additional storage for the Roanoke distribution center under a lease commencing March 28, 2005. The lease was initially for 91,000 square feet and was amended in June 2005 and September 2005 to increase the leased space to the current 302,900 square feet. The leasethat expires on September 30, 2006 except for2007; and • A 5,100 square foot retail outlet store facility in Roanoke, Virginia under a portion that pertains to an additional 90,900 square feet addedlease expiring in September 2005 which is on a month-to-month basis.February 2009. A 5,100 square foot retail outlet store facility in Roanoke, Virginia under a lease expiring in February 2009.   Item 3. Legal Proceedings   Rakesh K. Kaul v. Hanover Direct, Inc.Litigation Related to Going Private Proposal: Three substantially identical complaints have been filed against the Company, Chelsey and each of the Company’s directors: the first complaint was filed in Delaware Chancery Court by Glenn Friedman and L.I.S.T., No. 04-4410(L)-CV, 2nd Cir.S.D.N.Y.,Inc. as plaintiffs on appeal from 296 F. Supp.2d (S.D. NY 2004). On June 28, 2001, Rakesh K. Kaul,March 1, 2006; the former Presidentsecond complaint was filed in Delaware Chancery Court by Howard Lasker as plaintiff on March 7, 2006; and Chief Executive Officerthe third complaint was filed in Superior Court of New Jersey Chancery Division by Feivel Gottlieb as plaintiff on March 3, 2006. In each complaint, the plaintiffs challenge Chelsey’s going private proposal and allege, among other things, that the consideration to be paid in the going private proposal is unfair and grossly inadequate, that the special committee appointed by the Board of Directors of the Company filed a five-countcannot be expected to act independently, that Chelsey has manipulated the financial statements of the Company and its public statements in order to depress the stock price of the Company and that the proposal would freeze out the purported class members and capture the true value of the Company for Chelsey. In each complaint, plaintiffs seek class action certification, preliminary and permanent injunctive relief, rescission of the transaction if the offer is consummated and unspecified damages. The cases are in the Federal District Court in New York seeking relief stemming from his separationinitial pleadings phase. Based upon a preliminary analysis of employment fromthe complaints, the Company including short-term bonusbelieves that the complaints are without merit and severance payments of $2,531,352, attorneys’ fees and costs, and damages dueintends to the Company’s failure to pay him a “tandem bonus” as well as Kaul’s alleged rights to benefits under a change in control plan and a long-term incentive plan. The Company filed a Motion for Summary Judgment and in July 2004, the Court entered a final judgment dismissing most of Mr. Kaul’s claims with prejudice and awarded Mr. Kaul $45,946 in vacation pay and $14,910 in interest which the Company paid in July 2004. In August 2004, Kaul filed an appeal on three issues: severance and short-term bonus, tandem bonus and legal fees. On June 28, 2005 the Second Circuit Court of Appeals denied Kaul’s appeal, affirming the Summary Judgment decision in the Company’s favor. Mr. Kaul’s rights to appeal the Second Circuit’s decision expired in August 2005. As of December 25, 2004, the Company had accrued $4.5 million related to this matter. This accrual remained on the Company’s Consolidated Balance Sheet until the third fiscal quarter of 2005 when Kaul’s rights to pursue this claim expired.defend its interests vigorously.   SEC Informal Inquiry:   See Note 182 to the consolidated financial statements for a discussion of the informal inquiry being conducted by the SEC relating to the Company’s financial results and financial reporting since 1998.   Class Action Lawsuits:   The Company was a party to four class action/representative lawsuits that all involved allegations that the Company’s charges for insurance were invalid, unfair, deceptive and/or fraudulent.   As described in greater detail below,During the third quarter of 2005, the Company hasfavorably resolved allthree of these class action lawsuits. Jacq Wilson v. Brawnthe cases: one was settled for an aggregate payment of California, Inc. , Case No. CGC-02-404454 (Supp. Ct. San Francisco, CA 2002) (“Wilson Case”). On February 13, 2002, Jacq Wilson, suing on behalf of himself and other similarly situated persons, filed a representative suit$39,500, the Company prevailed in another case which led to the plaintiff in the Superior Court ofthird case voluntarily dismissing his case.  In the State of California, City and County of San Francisco, against the Company alleging that the Company charged an unlawful, unfair, and fraudulent insurance fee on orders, was engaged in untrue, deceptive and misleading advertising and unfair competition under the state’s Business and Professions Code. The plaintiffs sought relief including restitution and disgorgement of all monies wrongfully collected by defendants, including interest, an order enjoining defendants from imposing insurance on its order forms, and compensatory damages, attorneys’ fees, pre-judgment interest and costs of the suit. In November, 2003, the Court, after a trial the previous April, entered judgment for the plaintiffs, requiring defendants to refund insurance charges collected from consumers for the period from February 13, 1998 through January 15, 2003, with interest. In April, 2004, the Court awarded plaintiff’s counsel approximately $445,000 of attorneys’ fees. The Company appealed the Court’s decision and the order to pay attorneys’ fees, which appeals were consolidated. Enforcement of the judgment for insurance fees and the award of attorneys’ fees was stayed pending resolution of the appeal. On September 2, 2005 the California Court of Appeals reversed both the Court’s findings on the merits and its award of attorneys’ fees and awarded the Company its cost on the appeal. Teichman v. Hanover Direct, Inc. et. al., No. 3L641 (Supp. Ct. San Francisco, CA 2001). On August 15, 2001, Randi Teichman filed a summons and four-count complaint in the Superior Court for the City and County of San Francisco seeking damages and other relief for herself and a class of similarly situated persons arising out of the insurance fee charged by catalogs and Internet sites operated by Company subsidiaries. Thisremaining case, had been stayed since May 2002 pending resolution of the Wilson Case. The plaintiffs in both Wilson and Teichman were represented by the same counsel and the plaintiffs in both cases agreed to dismiss the cases with prejudice in exchange for the Company’s agreement to not seek reimbursement of costs in the Wilson case. John Morris, individually and on behalf of all other similarly situated person and entities similarly situated v. Hanover Direct, Inc. and Hanover Brands, Inc., No. L 8830-02 (Sup. Ct. Bergen Co. – Law Div., NJ) October 28, 2002, John Morris, individually and on behalf of other similarly situated persons in New Jersey filed a class action alleging that (1) the Company improperly added a charge for “insurance” and (2) the Company’s conduct was in violation of the New Jersey Consumer Fraud Act as otherwise deceptive, misleading and unconscionable. Morris sought relief including damages equal to the amount of all insurance charges, interest, treble and punitive damages, injunctive relief, costs, and reasonable attorneys’ fees. On February 14, 2005, the Court denied class certification which limited the damages being litigated, absent an appeal of the denial of class certification, to Plaintiff’s individual injury of the $1.48 he paid for insurance which could be trebled pursuant to the New Jersey consumer protection statute plus attorney’s fees. This case was settled effective as of August 29, 2005 and the Company paid $39,500 in the aggregate for a nominal amount of damages and legal fees. Martin v. Hanover Direct, Inc., et. al., No. CJ-2000 (D.C. Sequoyah Co., Ok.) (“Martin Case”). On March 3, 2000, Edwin L. Martin filed a class action lawsuit against the Company claiming breach of contract, unjust enrichment, recovery of money paid absent consideration, fraud and a claim under the New Jersey Consumer Fraud Act. The allegations stem from “insurance charges” paid to the Company by consumers who had placed orders from catalogs published by indirect subsidiaries of the Company over a number of years. Martin sought relief including (i) a declaratory judgment as to the validity of the delivery insurance, (ii) an order directing the Company to return to the plaintiff and class members the “unlawful revenue” derived from the insurance charges, (iii) threefold damages for each class member, and (iv) attorneys’ fees and costs. In July 2001, the Court certified the class and the Company filed anprevailed in its appeal of the class certification. Oncertification in an October 25, 2005 the class certification was reversed.decision.  Martin filed an Application for Rehearing which was denied on January 3, 2006. On January 18, 2006, Martin filedand a Petition for a Writ of Certiorari in the Oklahoma Supreme Court. The Company believes that it is unlikely thatCourt, both of which were denied during the Oklahoma Supreme Court will grant Martin’s petition.first quarter of 2006.   The Company established a $0.5 million reserve during the third quarter of 2004 for the class action lawsuits described above for settlements and the Company’s current estimate of future legal fees to be incurred. The balance of the reserve as of December 25, 2004 remained at $0.5 million.   Claims for Post-Employment Benefits   The Company is involved in four lawsuits instituted by former employees arising from the Company’s denial of change in control (“CIC”) benefits under compensation continuation plans following the termination of employment.    Two of these cases arose from the circumstances surrounding the Restatement:    Charles Blue v. Hanover Direct, Inc., William Wachtel, Stuart Feldman, Wayne Garten and Robert Masson, (Supp. Ct. N.J., Law Div. Hudson Cty, Docket No.: L-5153-05) is an action instituted by the Company’s former Chief Financial Officer who was terminated for cause on March 8, 2005.  The complaint seeks compensatory and punitive damages and attorney’s fees and alleges retaliation, mental anguish and reputational damage, loss of earnings and employment and racial discrimination.  The Company believes that Mr. Blue was properly terminated for cause and that his claims are groundless.    Frank Lengers v. Hanover Direct, Inc., Wayne Garten, William Wachtel, A. David Brown, Stuart Feldman, Paul S. Goodman,  Donald Hecht and Robert Masson, (Supp. Ct. N.J., Law Div. Hudson Cty, Docket No.: L-5795-05) was brought as a result of the Company terminating the employment of its former Vice President, Treasury Operations & Risk Management, on March 8, 2005 for cause.  The complaint seeks compensatory and punitive damages and attorney’s fees and alleges improper denial of CIC benefits, age and disability discrimination, handicap discrimination, aiding and abetting and breach of contract.  The Company believes that Mr. Lengers was properly terminated for cause and that his claims are groundless.   The Company believes that it properly denied CIC benefits with respect to each of the four former employees and that it has meritorious defenses in all of the cases and plans a vigorous defense.   In addition, the Company is involved in various routine lawsuits of a nature that is 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, results of operations, or cash flows.   Item 4. Submission of Matters to a Vote of Security Holders   None.   PART II   Item 5. Market for Registrant’s Common Equity, and Related Stockholder MattersMatter and Issuer Purchases of Equity Securities   Current trading information about our Common Stock can be obtained from the Pink Sheets under the trading symbol “HNVD.PK.” The Common Stock was delisted from the AMEX effective February 16, 2005 as a result of the Company’s inability to timely file its periodic SEC reports and its failure to comply with the AMEX’s continued listing standards. Current trading information about our Common Stock can be obtained from the Pink Sheets under the trading symbol “HNVD.PK.”   The following table sets forth, for the periods shown, the high and low sale prices of our Common Stock (as adjusted for the reverse stock split)split that occurred on September 22, 2004). As of FebruaryMarch 21, 2006, we had 22,426,296 shares of Common Stock outstanding. Of these, 15,380,41315,380,772 shares were held directly or indirectly by Chelsey and its affiliates. As a result, 7,045,8837,045,524 shares of Common Stock were held by other public shareholders. There were approximately 540 holders of record of Common Stock as of January 24,March 23, 2006.     High Low Fiscal 2004 First Quarter (Dec. 28, 2003 to March 27, 2004) $   3.00 $   2.00 Second Quarter (March 28, 2004 to June 26, 2004) $   2.50 $   1.30 Third Quarter (June 27, 2004 to Sept. 25, 2004) $   1.80 $   1.20 Fourth Quarter (Sept. 26, 2004 to Dec. 25, 2004) $   1.59 $   1.26   High Low Fiscal 2005 First Quarter (Dec. 26, 2004 to March 26, 2005) $   1.44 $   0.70 Second Quarter (March 27, 2005 to June 25, 2005) $   1.00 $   0.69 Third Quarter (June 26, 2005 to Sept. 24, 2005) $   1.55 $   0.88 Fourth Quarter (Sept. 25, 2005 to Dec. 31, 2005) $   1.50 $   0.95         Fiscal 2003 First Quarter (Dec. 29, 2002 to March 29, 2003) $   2.70 $   1.90 Second Quarter (March 30, 2003 to June 28, 2003) $   2.80 $   1.80 Third Quarter (June 29, 2003 to Sept. 27, 2003) $   2.90 $   2.20 Fourth Quarter (Sept. 28, 2003 to Dec. 27, 2003) $   3.00 $   2.00       Fiscal 2004 First Quarter (Dec. 28, 2003 to March 27, 2004) $   3.00 $   2.00 Second Quarter (March 28, 2004 to June 26, 2004) $   2.50 $   1.30 Third Quarter (June 27, 2004 to Sept. 25, 2004) $   1.80 $   1.20 Fourth Quarter (Sept. 26, 2004 to Dec. 25, 2004) $   1.59 $   1.26   The Company is restricted from paying dividends on its Common Stock or from acquiring its Common Stock by certain debt covenants contained in the loan agreements for the Wachovia Facility and the Chelsey Facility. See Note 7 to the Notes to the consolidated financial statements for additional information regarding the certain debt covenants and loan agreements.   Reverse Stock Split. At our 2004 Annual Meeting of Shareholders held on August 12, 2004, our shareholders approved a one-for-ten reverse stock split of the Common Stock, which became effective at the close of business on September 22, 2004. In this Annual Report on Form 10-K, the number of shares of Common Stock outstanding, per share amounts, stock warrants, stock option and exercise price data relating to the Company’s Common Stock, for periods prior to the reverse stock split, have been restated to reflect the effect of the reverse stock split.   Amendments to the Company’s Certificate of Incorporation. On September 22, 2004, we filed a Certificate of Amendment to the Company’s Amended and Restated Certificate of Incorporation (1) reducing the par value of the Common Stock from $0.66-2/3 to $0.01 per share and reclassifying the outstanding shares of Common Stock into such lower par value shares; (2) increasing the number of authorized shares of additional Preferred Stock from 5,000,000 shares to 15,000,000 shares and making a corresponding change to the aggregate number of authorized shares of all classes of preferred stock; and (3) after giving effect to the reverse stock split, increasing the authorized number of shares of Common Stock from 30,000,000 shares to 50,000,000 shares and making a corresponding change to the aggregate number of authorized shares of all classes of common stock. Equity Compensation Plan Information Table   The following table provides information about the securities authorized for issuance under the Company’s equity compensation plans as of December 25, 2004:31, 2005:   (a)   (b)   (c)           Plan category   Number of securities to be issued upon exercise of outstanding options, warrants and rights         Weighted-average exercise price of outstanding options, warrants and rights   Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column(a)) Equity compensation plans approved by security holders 899,600   $   5.30   2,020,400 Equity compensation plans not approved by security holders 270,000   2.50   270,000 Total 1,169,600   $   4.65   2,290,400         (a)   (b)   (c)                 Plan category   Number of securities to be issued upon exercise of outstanding options, warrants and rights         Weighted-average exercise price of outstanding options, warrants and rights   Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column(a))       Equity compensation plans approved by security holders 1,048,883   $   6.23   1,871,117 Equity compensation plans not approved by security holders 270,000   2.50   270,000       Total 1,318,883   $   5.47   2,141,117       The equity compensation plan not approved by security holders relates to options granted to Meridian, an affiliate of Mr. Shull who was a former Chief Executive Officer of the Company. See Note 7 of Notes to the consolidated financial statements.   Item 6. Selected Financial Data   The following table presents selected financial data for each of the fiscal years indicated:     2004   2003   2002   2001   2000       As Restated   As Restated   As Restated   As Restated   2005   2004   2003   2002   2001                                 (In thousands of dollars, except per share data )   (In thousands of dollars, except per share data ) Income Statement Data:                                         Net revenues   $    403,160   $   414,283   $    456,990   $       533,630   $    606,430   $       407,442   $        360,526   $        370,096   $       407,920   $      478,880 Special charges   1,536   1,308   4,398   11,277   19,126   (69)   1,684   215   3,678   10,617 Income (loss) from operations   10,742   1,445   (2,211)   (24,926)   (69,686)   17,136   7,313   (143)   (4,866)   (27,200) Gain on sale of Improvements   --   (1,911)   (570)   (23,240)   --   --   --   1,911   570   23,240 Gain on sale of Kindig Lane Property   --   --   --   (1,529)   --   --   --   --   --   1,529 Income (loss) before interest and income taxes   10,742   3,356   (1,641)   (157)   (69,686)   17,136   7,313   1,768   (4,296)   (2,431) Interest expense, net   5,567   12,088   5,477   6,529   10,083   8,146   5,105   11,715   5,072   6,426 Provision for income taxes   174   11,328   3,791   120   165   29   174   11,328   3,791   120 Net income (loss)   5,001   (20,060)   (10,909)   (6,806)   (79,934) Net income (loss) from continuing operations   8,961   2,034   (21,275)   (13,159)   (8,977) Gain from discontinued operations of Gump’s   2,996   2,967   1,215   2,250   2,171 Net income (loss) and comprehensive income (loss)   11,957   5,001   (20,060)   (10,909)   (6,806) Preferred stock dividends and accretion   --   7,922   15,556   10,745   4,015   --   --   7,922   15,556   10,745 Earnings Applicable to Preferred Stock   294   124   --   --   -- Net income (loss) applicable to common stockholders   $         4,877   $     (27,982)   $      (26,465)   $      (17,551)   $   (83,949)   $          11,663   $            4,877   $       (27,982)   $      (26,465)   $     (17,551)                                                   Net Income (Loss) Per Common Share:                                         Basic   $           0.22   $         (1.94)   $          (1.91)   $           (0.83)   $        (3.94)           Diluted   $           0.18   $         (1.94)   $          (1.91)   $           (0.83)   $        (3.94)           From continuing operations – basic   $               0.39   $              0.09   $            (2.02)   $           (2.07)   $         (0.93) From continuing operations – diluted   $               0.27   $              0.07   $            (2.02)   $           (2.07)   $         (0.93) From discontinued operations – basic   $               0.13   $              0.13   $               0.08   $              0.16   $            0.10 From discontinued operations – diluted   $               0.09   $              0.11   $               0.08   $              0.16   $            0.10 Net income (loss) – basic   $               0.52   $              0.22   $            (1.94)   $           (1.91)   $         (0.83) Net income (loss) - diluted   $               0.36   $              0.18   $            (1.94)   $           (1.91)   $         (0.83)                                         Weighted Average Number of Shares                                         Outstanding (in thousands):                                         Basic   22,220   14,439   13,828   21,054   21,325   22,426   22,220   14,439   13,828   21,054           Diluted   27,015   14,439   13,828   21,054   21,325   32,588   27,015   14,439   13,828   21,054                                     2005   2004   2003   2002   2001                           (In thousands of dollars) Balance Sheet Data (End of Period):                     Working capital (deficit)   $         26,007   $          10,622   $        (10,399)   $         (6,200)   $             658 Total assets   122,177   130,499   116,547   145,274   161,032 Total debt, excluding Preferred Stock   22,648   27,886   22,510   25,129   29,710 Series B Participating Preferred Stock   --   --   --   92,379   76,823 Series C Participating Preferred Stock   72,689   72,689   72,689   --   -- Shareholders’ deficiency   (25,548)   (37,652)   (56,339)   (63,011)   (38,119)                               2004   2003   2002   2001   2000         As Restated   As Restated   As Restated   As Restated                 (In thousands of dollars) Balance Sheet Data (End of Period):                     Working capital (deficit)   $ 10,622   $ (10,399)   $ (6,200)   $ 658   $ (5,138) Total assets   130,499   116,547   145,274   161,032   208,379 Total debt, excluding Preferred Stock   27,886   22,510   25,129   29,710   39,036 Series A Participating Preferred Stock   --   --   --   --   71,628 Series B Participating Preferred Stock   --   --   92,379   76,823   -- Series C Participating Preferred Stock   72,689   72,689   --   --   -- Shareholders’ deficiency   (37,652)   (56,339)   (63,011)   (38,119)   (25,882)   There were no cash dividends declared on the Common Stock in any of the periods presented. See Note 2 of Notes to consolidated financial statements for more information regarding the Restatement.   Item 7. Management’s Discussion and Analysis of Consolidated Financial Condition and Results of Operations   The following table sets forth, for the fiscal years indicated, the percentage relationship to net revenues of certain items in the Company’s Consolidated Statements of Income (Loss):. In addition, on March 14, 2005, we sold all of the stock of Gump’s Corp. and Gump’s By Mail, Inc. (collectively, “Gump’s”) to Gump’s Holdings, LLC. The following reflects the Gump’s operating results and gain on sale as discontinued operations.   Fiscal Year 2004     2003 As Restated   2002 As Restated Fiscal Year     2005     2004     2003   Net revenues 100.0%   100.0%   100.0% 100.0%   100.0%   100.0% Cost of sales and operating expenses 60.3   63.1   63.5 62.1   60.2   63.1 Special charges 0.4   0.3   1.0 (0.0)   0.5   0.1 Selling expenses 24.9   24.1   23.1 25.0   25.2   24.2 General and administrative expenses 10.7   11.0   11.7 8.0   11.2   11.5 Depreciation and amortization 1.0   1.1   1.2 0.7   0.9   1.1 Gain on sale of Improvements —   (0.4)   (0.1) —   —   0.5 Income (loss) before interest and income taxes 2.7   0.8   (0.4) Income before interest and income taxes 4.2   2.0   0.5 Interest expense, net 1.4   2.9   1.2 2.0   1.4   3.2 Provision for Federal and state income taxes 0.0   2.7   0.8 0.0   0.0   3.1 Gain from discontinued operations of Gump’s 0.7   0.8   0.3 Net income (loss) 1.2%   (4.8)%   (2.4)% 2.9%   1.4%   (5.4)%   Restatement of Prior Year Financial Information and Related Matters During the second quarter of 2004, the Company identified a revenue recognition cut-off issue that resulted in revenue being recorded in advance of the actual shipment of merchandise to the customer. The practice was stopped immediately. Subsequently, the Company determined that revenue should be recognized when merchandise is received by the customer rather than when shipped because the Company routinely replaces customer merchandise damaged or lost in transit as a customer service matter (even though risk of loss, as a legal matter, passes on shipment). As a consequence, the Company has restated all periods presented to recognize revenue when merchandise is received by the customer. In the first quarter of 2004, former management identified a potential issue with the accounting treatment for Buyers’ Club memberships that contained a guarantee. At that time, an inappropriate conclusion regarding the accounting treatment was reached and during the third quarter of 2004, the issue was re-evaluated and we determined that an error in the accounting treatment had occurred. The impact of the error resulted in an overstatement of revenues and the omission of a liability related to the guarantee for discount obligations. The proper accounting treatment has been applied to all periods impacted including a calculation of the cumulative impact on previously reported periods. Starting in fiscal 2001, the Company inappropriately reduced the liability for certain customer prepayments and credits. The impact of the inappropriate reduction of this liability resulted in the understatement of general and administrative expenses and the omission of the related liability. During the fourth quarter of 2004, the Company re-evaluated the accounting treatment for these customer prepayments and credits. As a consequence, the Company has applied the proper accounting treatment to all periods impacted including recording a liability in each respective previously reported period equivalent to the cumulative impact of the error. The Company also corrected its accounting for an accrual related to a claim for post-employment benefits by a former CEO. See “Legal Proceedings—Rakesh Kaul v. Hanover Direct, Inc.” In addition, the Company has recorded other liabilities relating primarily to certain miscellaneous catalog costs and other miscellaneous costs that were inappropriately not accrued in the necessary periods and has made adjustments to the deferred tax asset and liabilities to reflect the effect the Restatement. The Audit Committee of the Board of Directors conducted an investigation related to these issues (except for the revenue recognition issue based on receipt of merchandise by the customer which was addressed by the Company subsequent to the conclusion of the investigation) and other accounting-related matters with the assistance of independent outside counsel. The Company’s inability to timely file its financial statements as well as its non-compliance with several of the AMEX’s listing criteria resulted in the AMEX halting trading in the Company’s common stock on November 16, 2004 and later delisting the common stock as of February 16, 2005. See Item 9A. “Controls and Procedures” for management’s evaluation and conclusions relating to this investigation. In addition, the SEC is currently conducting an informal inquiry relating to the Company’s financial results and financial reporting since 1998. We intend to continue our cooperation with the SEC with its informal inquiry concerning our financial reporting. See Note 2 to the consolidated financial statements for additional information regarding the Restatement. Executive Summary   Hanover Direct is a direct marketer owning a portfolio of catalogs and associated websites. During the first six months ofIn 2004 the Company operated in a very challenging environment due to our liquidity constraints. The inability to maintain levels of inventory adequate to service demand created increased backorder levels, reduced initial customer order fill rates as well as higher order cancellation rates all of which contributed to lower net revenues. On May 5, 2004, the Board of Directors appointedwe installed a new chief executive officer (“CEO”), Wayne P. Garten, who quickly obtainedmanagement team and secured additional financing that alleviated the Chelsey Facility, a $20.0 million junior secured credit facility. The Company borrowed the entire $20.0 million and paid off the remaining outstanding balance ($4.9 million) of a term loan, which was part of the Wachovia Facility. As part of a concurrent amendment to the Wachovia Facility, the Chelsey Facility freed up $10.0 million of availability under the Wachovia Facilitycapital constraints that had previously been blocked. The increased liquidity enabled ushampered our business. In the last half of 2004, we were able to increase inventory levels to more adequate levels forservice our customer demand and begin increasing our catalog circulation. This led to increased sales and net income of nearly $5 million. In 2004 we decided to relocate our men’s apparel catalogs to our New Jersey headquarters during the second halffirst quarter of 2004,2005 and installed a new team. Consequently, we did not expect growth in those catalogs during the transition period. We also decided to consolidate our catalog operations into one facility located in New Jersey and consolidated our distribution function into our Roanoke Virginia distribution center because of capacity constraints at our LaCrosse facility and lower shipping costs available from the Roanoke facility. In the first nine months of 2005 the Company experienced positive trends in both revenues and profits compared to 2004. We then experienced setbacks starting in the third quarter which resulted in substantial declineslower profits in the fourth quarter. Demand and customer response in the The Company Store catalog, which had been our strongest catalog for the last several years, began a downward trend late in the second fiscal quarter of 2005 that continued throughout the remainder of the year. While we have hired a new President for The Company Store, we expect this trend to continue for some time. The Company Store also suffered from higher merchandise costs and catalog expenses that also adversely affected its results. Domestications saw its demand increase markedly but experienced inventory problems, exacerbated in part by the larger than projected demand, which led to higher backorder levels and higher initial customer order fill rates, reversingcancellations which adversely affected its results. Silhouettes had stronger revenues and profits throughout the trendyear. The men’s business experienced during the first six months of 2004. The improved inventory levels increased the Company’s borrowing availability under the Wachovia Facilitylower revenues and alleviated constraints on vendor credit previously experienced. In addition, the increased working capital allowed the Company to invest in catalog circulation in order to strengthen the customer name file base for the future as well as producing strong fourth quarter revenues of $121.6 million, which were an increase of $6.9 million, or 6.0%, over the comparable prior year period. Income from operations increased $9.3 million to $10.7 millionprofits for the year after it went through a relocation and installation of a completely new management team. We were also adversely affected by diminished productivity in our distribution function brought on by the consolidation of our LaCrosse distribution facility into our Roanoke distribution facility. This reached a head in the fourth quarter, our busiest quarter, when high employee turnover in Roanoke and space constraints brought on by larger than expected inventory levels both in our catalogs and our third party business to business customers, led to diminished productivity. Our 2005 results were also hurt by increasing costs including paper and product shipping costs. We ended December 25, 2004 from $1.4 million in 2003. Although a significant improvement, certain items incurred during 2004 hinderedthe year with income from continuing operations of $9.0 million and net income applicable to common shareholders of $11.7 million on sales of $407.4 million, all which were increases over the prior year. Our 2005 results from achievingcontinuing operations were positively impacted by a greater increasenumber of expense/income items outside of normal operations which provided a net benefit in 2005. As set forth in the table below, in 2004 we had a number of expense items that adversely affected our results in that year by approximately $5.7 million. In 2005, some of these items, principally a $4.5 million reserve we had established for post employment benefits for a former CEO, were reversed and we had a net benefit from these items which improved our 2005 results by over 2003 and 2002.$1.2 million. A summary of these expense / (income) items incurred during 2005, 2004 2003 and 20022003 are as follows (in thousands):     2004   2003   2002     2005   2004   2003 Severance and Termination Costs   $ 2,607   $ 725   $ 356     $   760     $   2,607     $   725 Special Charges     1,536   1,308   4,398     (69)   1,536   1,308 Legal and Audit Fees related to Restatement       2,559     617     -- Class Action Litigation Reserve     535   --     --       --     535       -- Facility Exit Costs   201   --   --     --   201   -- Rakesh Kaul Accrual   196   24   3,648     (4,488)   196   24 Compensation Continuation Agreement Costs       --     --     3,083 Change in Vacation and Sick Policy       --     --     (1,634)   $ (1,238)   $ 5,692   $ 3,506   Compensation Continuation Agreement Costs     --     3,083     -- Change in Vacation and Sick Policy     --     (1,634)     --                   $ 5,075   $ 3,506   $ 8,402               We also began developing and implementing strategies to reduce the infrastructure of the Company. These strategies included the consolidation of the operations of the LaCrosse, Wisconsin fulfillment center and storage facility into the Roanoke, Virginia fulfillment center, which was substantially completed by the end of June 2005; the relocation of the International Male and Undergear catalog operations from San Diego, California to the corporate headquarters in Weehawken, New Jersey, which was completed February 28, 2005; and the consolidation of the Edgewater facility into the Weehawken, New Jersey premises, which was completed by May 31, 2005. Since the consolidation of our fulfillment centers, our Roanoke fulfillment center has experienced lower productivity that has negatively impacted fulfillment costs and the Company’s overall performance. The projected annual savings from the consolidation of the San Diego, California and the Edgewater, New Jersey facilities into the Weehawken, New Jersey facility is approximately $2.1 million, however with this relocation and consolidation, the transition has negatively impacted the performance of the Men’s Apparelcatalogs in 2005. Results of Operations 2005 Compared to 2004 Net Income (Loss). The Company reported net income applicable to common shareholders of $11.7 million, or $0.52 basic and $0.36 diluted income per share, for the year ended December 31, 2005 compared to $4.9 million, or $0.22 basic and $0.18 diluted income per share, in 2004. The Company reported income from continuing operations of $9.0 million, or $0.39 basic and $0.27 diluted income per share, for the year ended December 31, 2005 compared to $2.0 million, or $0.09 basic and $0.07 diluted income per share, in 2004. In addition to improved operating results, the increase in net income applicable to common shareholders was primarily the result of the following: • Improved operating results generated from a $46.9 million increase in net revenues; • A favorable impact of $4.5 million from the reversal of an accrual established in fiscal 2000 due to the expiration of Rakesh Kaul’s rights to pursue his claims against the Company; • A favorable impact of $1.8 million in expense reduction due to Special Charges incurred in 2004 due to restructuring charge; and • A favorable impact of $1.5 million due to the reduction in general and administrative expenses related to severance. Partially offset by: • An unfavorable impact of $3.0 million on net interest expense primarily due to interest costs incurred with the $20.0 million junior secured credit facility with Chelsey Finance (“Chelsey Facility”) which the Company closed on July 8, 2004. See Note 7 of Notes to the consolidated financial statements for additional information regarding the Chelsey Facility; and • An unfavorable impact of $1.9 million related to general and administrative expenses incurred for the investigation conducted by the Audit Committee of the Board of Directors in connection with the restatement of the Company’s consolidated financial statements and other accounting-related matters. Net Revenues. Net revenues increased by approximately $46.9 million (13.0%) for the year ended December 31, 2005 to $407.4 million from $360.5 million in 2004. This increase was primarily driven by an increase in catalog circulation levels and higher response rates supported by deeper inventory positions that enabled higher initial fulfillment rates for customer orders and lower overall cancellation rates. Higher demand was experienced in The Company Store (although on lower customer response rates), Domestications and Silhouettes catalogs, while lower demand was experienced for the International Male catalogs. Revenues recorded from the Company’s business to business services increased by approximately $12.1 million for the year ended December 31, 2005 to $32.9 million from $20.8 million in 2004. In addition, revenue relating to our membership programs increased by approximately $4.0 million for the year ended December 31, 2005 to $14.3 million from $10.3 million in 2004. Internet sales revenue comprised 39.3% of combined Internet and catalog net revenues for the year ended December 31, 2005 compared with 34.7% in 2004, and have increased by approximately $27.3 million, or 23.9%, to $141.3 million for the year ended December 31, 2005 from $114.0 million in 2004. Cost of Sales and Operating Expenses. Cost of sales and operating expenses increased by $36.1 million to $253.0 million for the year ended December 31, 2005 as compared with $216.9 million in 2004. Cost of sales and operating expenses increased to 62.1% of net revenues for the year ended December 31, 2005 as compared with 60.2% of net revenues in 2004. As a percentage of net revenues, this increase was primarily due to increases in product shipping costs, merchandise and fulfillment costs. The Company has more aggressively liquidated slower moving inventory through clearance avenues within its catalogs and websites, thus resulting in lower product margins. In addition, since the consolidation of our fulfillment centers, our Roanoke fulfillment center has experienced high levels of employee turnover and lower productivity which has resulted in higher costs being incurred in the fulfillment center. This trend of high levels of employee turnover and lower productivity started in the third quarter of 2005 and continued through the end of fiscal 2005. This trend is expected to continue during 2006. Special Charges. In December 2000, the Company began a strategic business realignment program that resulted in the recording of special charges for severance, facility exit costs and fixed asset write-offs. The actions related to this strategic business realignment program were taken in an effort to direct our resources primarily towards a loss reduction strategy and a return to profitability. On June 30, 2004, we decided to consolidate the operations of the LaCrosse, Wisconsin fulfillment center and storage facility into the Roanoke Virginia fulfillment center by June 30, 2005. The LaCrosse fulfillment center and the LaCrosse storage facility were closed in June 2005 and August 2005 upon the expiration of their leases. This plan was prompted by excess capacity at our Roanoke facility at that time and the lack of sufficient warehouse space in the leased Wisconsin facilities to support the growth of The Company Store and lower shipping costs available from the Roanoke facility. Since the consolidation of our fulfillment centers, our Roanoke fulfillment center has experienced high levels of employee turnover and lower productivity that has resulted in higher costs being incurred in the fulfillment center. In addition, on November 9, 2004, we decided to relocate the International Male and Undergear catalog operations to our Corporate offices in New Jersey. The relocation was effected to consolidate operations and reduce costs while leveraging our catalog expertise in New Jersey. The relocation was completed on February 28, 2005. However, since the relocation and consolidation of the Men’s apparel catalogs, the transition has negatively impacted the performance of the Men’s apparel catalogs in 2005. Special charges decreased by $1.8 million to ($0.1) million for the year ended December 31, 2005 as compared to $1.7 million in 2004. During the year ended December 25, 2004, the Company recorded $0.5 million and $0.9 million in severance and related costs associated with the consolidation of the LaCrosse operations and the relocation of the International Male and Undergear catalog operations to New Jersey, respectively. In addition, we recorded an additional $0.3 million in severance and related costs during the fourth quarter of 2004 associated with the elimination of 15 full-time company-wide positions. Selling Expenses. Selling expenses increased by $11.1 million to $102.0 million for the year ended December 31, 2005 as compared with $90.9 million in 2004. Selling expenses decreased to 25.0% of net revenues for the year ended December 31, 2005 from 25.2% in 2004. As a percentage of net revenues, this change was primarily due to higher response rates that more than offset the cost of higher catalog circulation and higher paper costs. Postal rate increases effective January 2006 and the continuation of higher paper costs is expected to continue to negatively impact results for 2006. General and Administrative Expenses. General and administrative expenses decreased approximately $7.8 million to $32.6 million for the year ended December 31, 2005 from $40.4 million in 2004. As a percentage of net revenues, general and administrative expenses decreased to 8.0% of net revenues for the year ended December 31, 2005 compared with 11.2% of net revenues in 2004. This decrease of $7.8 million was principally due to the reversal of a $4.5 million (1.1% of net revenues) reserve we had established for post employment benefits for a former CEO. In addition the Company incurred lower severance and termination costs partially offset by higher legal and audit fees related to the Restatement. See “Executive Summary.” Depreciation and Amortization. Depreciation and amortization decreased approximately $0.4 million to $2.9 million for the year ended December 31, 2005 from $3.3 million in 2004. The decrease was primarily due to property and equipment that have become fully depreciated, partially offset by the depreciation of newly purchased property and equipment. Income from Operations. The Company’s income from operations increased by approximately $9.8 million to $17.1 million for the year ended December 31, 2005 from $7.3 million in 2004. Interest Expense, Net. Interest expense, net, increased $3.0 million to $8.1 million for the year ended December 31, 2005 from $5.1 million in 2004. This increase was primarily due to $2.3 million in higher accretion of the debt discount and $1.3 million higher cash interest payments related to the Chelsey Facility which was partially offset by lower borrowings and interest payments under the Wachovia Facility. See Note 7 of Notes to the consolidated financial statements. Income Taxes. The Company’s income tax provision decreased by approximately $0.2 million to $0.0 million for the year ended December 31, 2005 as compared with $0.2 million in 2004. The Company had a tax loss for 2005 for federal income tax purposes and in 2004 the Company had sufficient net operating loss carryovers (“NOLs”) and its taxable income was below its §382 limit to eliminate its entire 2004 regular Federal income tax. The 2004 Federal income tax provision of $0.1 million is comprised of the Federal alternative minimum tax (“AMT”). The Company has AMT net operating loss carryovers for which utilization is limited to a maximum of 90% of AMT taxable income. See Note 12 of Notes to the consolidated financial statements for further discussion of the Company’s income taxes. Gain from discontinued operations of Gump’s. On March 14, 2005, the Company sold all of the stock of Gump’s to Gump’s Holdings, LLC. The Company recognized a gain of $3.0 million for the year ended December 31, 2005 which represents a $3.6 million gain on the sale of Gump’s net of a $0.6 million loss from Gump’s operation’s for the period December 26, 2004 through March 14, 2005. The Company recognized a gain of $3.0 million for the year ended December 25, 2004 which represents Gump’s ongoing operations.   2004 Compared with 2003   Net Income (Loss). The Company reported net income applicable to common shareholders of $4.9 million, or $0.22 basic and $0.18 diluted income per share, for the year ended December 25, 2004 compared with a net loss applicable to common shareholders of $28.0 million, or a loss of $1.94 basic and diluted income per share, in fiscal 2003. The Company reported income from continuing operations of $2.0 million, or $0.09 basic and $0.07 diluted income per share, for the year ended December 25, 2004 compared to a loss of $21.3 million, or $2.02 basic and diluted income per share, in 2003.   In addition to improved operating results, the increase in net income applicable to common shareholders was primarily the result of the following:   • A favorable impact of $11.3 million due to a deferred Federal income tax provision recorded during the year ended December 27, 2003 to increase the valuation allowance and fully reserve the net deferred tax asset; • A favorable impact of $7.9 million on preferred stock dividends recorded in 2003 and none recorded in 2004 due to the June 2003 implementation of SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” (“SFAS 150”). The accretion of the Series B Participating Preferred Stock (“Series B Preferred”) was recorded as dividends through the June 2003 implementation of SFAS 150, and as interest expense thereafter; • A favorable impact of $6.5$6.6 million on net interest expense as the Series C Participating Preferred Stock (“Series C Preferred”) was recorded as of its November 30, 2003 issuance date at its maximum potential cash payments in accordance with SFAS No. 15, “Accounting by Debtors and Creditors for Troubled Debt Restructurings;” thus, we are currently not required to record accretion of the Series C Preferred. In 2003, the Series B Preferred dividends and accretion were recorded as interest expense after the implementation of SFAS 150; and • A favorable impact of $3.1 million due to Compensation Continuation Agreement costs incurred during the year ended December 27, 2003. These costs included payments made to various executives and non-employee directors of the Company.   Partially offset by:   • An unfavorable impact due to the establishment of a $0.5 million reserve for risks of litigation related to all class action lawsuits including the Company’s current estimate of future legal fees to be incurred; • An unfavorable impact of $2.1 million due to severance, termination and facility exit costs associated with the implementation of strategies to reduce the Company’s infrastructure; • An unfavorable impact of $1.9 million due to the recognition of the deferred gain related to the 2001 sale of our Improvements business during the year ended December 27, 2003; • An unfavorable impact of $1.6 million due to a benefit recognized during 2003 from the revision of our vacation and sick policy; and • An unfavorable impact of $0.2 million of special charges due to facility exit costs associated with the consolidation of the LaCrosse and Roanoke operations.   Net Revenues. Net revenues decreased by approximately $11.1$9.6 million (2.7%(2.6%) for the year ended December 25, 2004 to $403.2$360.5 million from $414.3$370.1 million in 2003. The decrease was primarily due to a 15.6% decline in Domestications revenue on a 19.2% reduction in circulation. During 2004, management purposely reduced circulation in Domestications during the first six months due to liquidity restraints and during the final six months due to the newly appointed President of Domestications assembling a team to stabilize and reposition the catalog. The impact of the decline in circulation and demand from Domestications was partially offset by increases in circulation for Silhouettes and The Company Store resulting in an increase in net revenues for these catalogs. Certain catalogs benefited from increased fill rates and reductions in backorders and lower order cancellations due to the additional capital secured through the Chelsey Facility and the amended Wachovia Facility. In addition, revenue relating to our membership programs increased by approximately $1.0 million for the year ended December 25, 2004 to $10.3 million from $9.3 million in 2003. Internet sales revenue comprised 32.0%34.7% of combined Internet and catalog net revenues for the year ended December 25, 2004 compared with 27.9%30.3% in 2003, and have increased by approximately $11.6$10.9 million, or 10.8%10.6%, to $118.7$114.0 million for the year ended December 25, 2004 from $107.1$103.1 million in 2003.   Cost of Sales and Operating Expenses. Cost of sales and operating expenses decreased by $18.1approximately $16.7 million to $243.2$216.9 million for the year ended December 25, 2004 as compared with $261.3$233.6 million in 2003. Cost of sales and operating expenses decreased to 60.3%60.2% of net revenues for the year ended December 25, 2004 as compared with 63.1% of net revenues in 2003. As a percentage of net revenues, this decrease was primarily due to a decline in merchandise costs associated with a shift from domestic to foreign-sourced goods (1.3%).goods. The balance of the decline was attributable to a combination of factors including a decline in inventory write-downs due to reduced slow moving inventory and increased sales of clearance merchandise through the Internet resulting in lower variable costs as compared with utilizing catalogs as the clearance avenue and other cost reductions.   Special Charges. In December 2000, the Company began a strategic business realignment program that resulted in the recording of special charges for severance, facility exit costs and fixed asset write-offs. The actions related to this strategic business realignment program were taken in an effort to direct our resources primarily towards a loss reduction strategy and a return to profitability. On June 30, 2004, we decided to consolidate the operations of the LaCrosse, Wisconsin fulfillment center and storage facility into the Roanoke Virginia fulfillment center by June 30, 2005. The LaCrosse fulfillment center and the LaCrosse storage facility were closed in June 2005 and August 2005 upon the expiration of their leases. This plan was prompted by excess capacity at our Roanoke facility at that time and the lack of sufficient warehouse space in the leased Wisconsin facilities to support the growth of The Company Store and to reducelower shipping costs available from the overall cost structureRoanoke facility. Since the consolidation of our fulfillment centers, our Roanoke fulfillment center has experienced high levels of employee turnover and lower productivity that has resulted in higher costs being incurred in the Company.fulfillment center. In addition, on November 9, 2004, we decided to relocate the International Male and Undergear catalog operations to our Corporate offices in New Jersey. The relocation was effected to consolidate operations and reduce costs while leveraging our catalog expertise in New Jersey. The relocation was completed on February 28, 2005. However, since the relocation and consolidation of the Men’s apparel catalogs, the transition has negatively impacted the performance of the Men’s apparel catalogs in 2005.   Total special charges increased by approximately $0.2$1.5 million to $1.5$1.7 million for the year ended December 25, 2004 as compared with $1.3$0.2 million in 2003. During the year ended December 25, 2004, the Company recorded $0.5 million and $0.9 million in severance and related costs associated with the consolidation of the LaCrosse operations and the relocation of the International Male and Undergear catalog operations to New Jersey, respectively. In addition, we recorded an additional $0.3 million in severance and related costs during the fourth quarter of 2004 associated with the elimination of 15 full-time company-wide positions. These costs were partially offset by $0.1 million of reductions in the special charges reserve primarily due to decreases in estimated losses on the sublease arrangements for the Gump’s office facility in San Francisco, California. During the year ended December 27, 2003, we recorded $1.3$0.2 million of additionalemployee severance costs and charges incurred to revise estimated losses related to the sublease arrangements for the Gump’s office facility in San Francisco. The increase in anticipated losses on the sublease arrangements for the San Francisco office space resulted from the loss of a subtenant, coupled with declining real estate values in that area of the country.costs.   Selling Expenses. Selling expenses increased by $0.5$1.2 million to $100.5$90.9 million for the year ended December 25, 2004 as compared with $100.0$89.7 million in 2003. Selling expenses increased to 24.9%25.2% of net revenues for the year ended December 25, 2004 from 24.1%24.2% in 2003. As a percentage of net revenues, this change was due primarily to an increase in Internet marketing and catalog paper costs, partially offset by reduced circulation during 2004.   General and Administrative Expenses. General and administrative expenses decreased approximately $2.3 million to $43.2$40.4 million for the year ended December 25, 2004 from $45.5$42.7 million in 2003. As a percentage of net revenues, general and administrative expenses decreased to 10.7%11.2% of net revenues for the year ended December 25, 2004 compared with 11.0%11.5% of net revenues in 2003. This decrease of $2.3 million was due primarily to the net impact of certain items during 2004 and 2003, the largest of which was the higher payments for compensation continuation agreements in 2003 offset by items such as the establishment of a reserve of $0.5 million related to class action lawsuits in 2004. See “Executive Summary.”   Depreciation and Amortization. Depreciation and amortization decreased approximately $0.7$0.8 million to $4.0$3.3 million for the year ended December 25, 2004 from $4.7$4.1 million in 2003. The decrease was primarily due to property and equipment that have become fully depreciated, partially offset by the depreciation of newly purchased property and equipment.   Income from Operations. The Company’s income from operations increased by $9.3approximately $7.4 million to $10.7$7.3 million for the year ended December 25, 2004 from incomea loss from operations of $1.4$0.1 million in 2003.   Gain on Sale of the Improvements Business. During the year ended December 27, 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. Effective March 28, 2003, the remaining $2.0 million escrow balance was received by the Company, thus terminating the escrow agreement. See Note 4 of Notes to the consolidated financial statements.   Interest Expense, Net. Interest expense, net, decreased $6.5$6.6 million to $5.6$5.1 million for the year ended December 25, 2004 from $12.1$11.7 million in 2003. The decrease in interest expense, net was due to the recording of $7.6 million of Series B Preferred dividends and accretion as interest expense for the year ended December 27, 2003 based upon the treatment of the Series B Preferred as a liability as a result of the implementation of SFAS 150 and lower average cumulative borrowings relating to the Wachovia Facility. In November 2003, we exchanged the Series B Preferred for the Series C Preferred, which was accounted for in accordance with SFAS No. 15, “Accounting by Debtors and Creditors for Troubled Debt Restructurings.” Accordingly, the Series C Preferred was recorded at its total maximum potential cash payments including dividends and other contingent amounts, and thus no dividends or interest expense on this stock has been recorded for the year ended December 25, 2004. In addition, the decrease was due to lower amortization of deferred costs as a result of the amendments to the Wachovia Facility, which have lengthened the life of the facility and therefore the amortization period. These decreases were partially offset by increases in interest expense and amortization of deferred issuance costs relating to the Chelsey Facility. See Note 7 of Notes to the consolidated financial statements.   Income Taxes. The Company’s income tax provision decreased by approximately $11.1 million to $0.2 million for the year ended December 25, 2004 as compared with $11.3 million in 2003. The Company had sufficient net operating loss carryovers (“NOLs”) and its taxable income was below its §382 limit to eliminate its entire 2004 regular Federal income tax. The 2004 Federal income tax provision of $0.1 million is comprised of the Federal alternative minimum tax (“AMT”). The Company has AMT net operating loss carryovers for which utilization is limited to a maximum of 90% of AMT taxable income. See Note 12 of Notes to the consolidated financial statements for further discussion of the Company’s income taxes. In addition, during the third quarter of 2003, due to a number of factors, management lowered its projections of taxable income for 2003 and 2004, which resulted in a decision to fully reserve the remaining net deferred tax asset and accordingly increased the valuation allowance by $11.3 million.   Gain from discontinued operations of Gump’s. On March 14, 2005, the Company sold all of the stock of to Gump’s Holdings, LLC. The Company recognized a gain representing Gump’s ongoing operations, of $3.0 million and $1.2 million for the years ended December 25, 2004 and December 27, 2003, respectively. Preferred Stock Dividends. Through the end of the second quarter of 2003, the Company recorded preferred stock dividends relating to the Series B Preferred. Upon the implementation of SFAS 150 beginning in the third quarter of 2003, we were required to begin recording the preferred stock dividends as interest expense. Additionally, the Series C Preferred was recorded at the maximum amount of the liquidation preference of $72.7 million, thus no preferred stock dividends were recorded. Therefore, during the year ended December 25, 2004, no preferred stock dividends were recorded. See Note 8 of Notes to the consolidated financial statements for an explanation regarding the Company’s accounting treatment of the Series C Preferred.   2003 Compared with 2002 Net Loss. The Company reported a net loss applicable to common shareholders of $28.0 million, or $1.94 basic and diluted income per share, for the year ended December 27, 2003 compared with a net loss applicable to common shareholders of $26.5 million, or $1.91 basic and diluted income per share, for the comparable period in the 2002. The increase in net loss applicable to common shareholders was primarily the result of the following: • An increase of $7.6 million in the deferred Federal income tax provision incurred to increase the valuation allowance and fully reserve the remaining net deferred tax asset. Due to a number of factors, including the continued softness in the demand for our products, management lowered its projections of future taxable income for fiscal years 2003 and 2004. As a result of lower projections of future taxable income, the future utilization of our net operating losses were no longer “more-likely-than-not” to be achieved; • $7.6 million of additional interest expense incurred on the Series B Preferred as a result of the implementation of SFAS 150. Effective June 29, 2003, SFAS 150 required us to reclassify our Series B Preferred as a liability and reflect the accretion of the preferred stock balance as interest expense. However, this then reduced the preferred stock dividends by $7.6 million; • A favorable impact of $3.1 million due to the reduction of special charges recorded; • An unfavorable impact of $3.1 million due to Compensation Continuation Agreement costs incurred for the year ended December 27, 2003. These costs included payments made to various executives and non-employee directors of the Company; • A favorable impact of $3.6 million due to reduced legal expenses related to the ongoing litigation with Rakesh Kaul; • A favorable impact of $1.3 million due to recognition of the deferred gain related to the 2001 sale of the Company’s Improvements business; and • A favorable impact of $1.6 million due to the implementation of the revised vacation and sick benefit policy. The increase in net loss applicable to common shareholders was partially offset by improved operating results of the Company. Net Revenues. Net revenues decreased $42.7 million, or 9.3% for the year ended December 27, 2003 to $414.3 million from $457.0 million in 2002. The decreases were due to a number of factors including softness in the economy and demand for our products during the first six months of the year. In addition, our strategy of reducing unprofitable circulation contributed to the decline throughout the year. Circulation decreased by 5.9% from the prior year period. Internet sales accounted for 27.9% of combined Internet and catalog revenues and have improved by $20.8 million, or 24.2%, to $107.1 million from $86.3 million in 2002. Catalog sales declined by $53.7 million, or 16.3%, for the year ended December 27, 2003 to $276.9 million from $330.6 million in 2002. Cost of Sales and Operating Expenses. Cost of sales and operating expenses decreased to 63.1% of net revenues for the year ended December 27, 2003 as compared with 63.5% of net revenues in 2002. As a percentage of net revenues, this decrease from the prior year was caused primarily by a reduction of total merchandise cost of 0.9% due to a more cost-efficient merchandise sourcing strategy. This decline was partially offset by increased product shipping costs of 0.5% related to an increase in rates charged by third party shipping companies. Fixed distribution and telemarketing costs as a percentage of net revenues were constant during 2003 and 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 in 2003 and 2002 relating to the strategic business realignment program were $1.3 million and $4.4 million, respectively. The actions related to the strategic business realignment program were taken in an effort to direct our 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 our strategic business realignment program. During the second, third and fourth quarters of 2003, we recorded special charges of $0.2 million, $0.2 million and $0.6 million, respectively. These charges were incurred primarily to revise estimated losses related to sublease arrangements for the Gump’s office facility in San Francisco, California. For 2002, $4.4 million of special charges were recorded relating to the strategic business realignment program. These costs consisted of approximately $1.8 million in severance costs and $2.6 million in facility lease and exit costs. Selling Expenses. Selling expenses decreased $5.5 million to $100.0 million for the year ended December 27, 2003 from $105.5 million in 2002. Selling expenses increased to 24.1% of net revenues for the year ended December 27, 2003 from 23.1% for the comparable period in 2002. This increase was due primarily to a combined increase of 1.1% in postage, catalog preparation and printing costs, which was partially offset by a 0.1% decline in paper prices. General and Administrative Expenses. General and administrative expenses decreased by $7.8 million to $45.5 million for the year ended December 27, 2003 from $53.3 million in 2002. This decrease was primarily due to reductions in incentive compensation programs of $3.5 million, a reduction of legal costs of $3.0 million which had been incurred in the prior year and related to litigation pertaining to the Company’s former Chief Executive Officer, benefits recognized from the implementation of our new vacation and sick policy of $0.8 million, and other payroll related cost reductions. Depreciation and Amortization. Depreciation and amortization decreased to 1.1% of net revenues for the year ended December 27, 2003 from 1.2% in 2002. The decrease was primarily due to capital expenditures that have become fully amortized, partially offset by the depreciation of newly purchased property and equipment. Income from Operations. The Company’s income from operations increased $3.6 million to $1.4 million for the year ended December 27, 2003 from a loss of $2.2 million in 2002. The increase was principally due to reductions in special charges, general and administrative expenses, and depreciation and amortization, which were partially offset by increased costs in selling expenses. Gain on Sale of the Improvements Business. During 2003, the Company recognized the remaining approximately $1.9 million of deferred gain consistent with the terms of the escrow agreement relating to the Improvements sale. Effective March 28, 2003, the remaining $2.0 million escrow balance was received by the Company, thus terminating the agreement (see Note 4 to the Company’s consolidated financial statements). Interest Expense, Net. Interest expense, net increased $6.6 million to $12.1 million for the year ended December 27, 2003 from $5.5 million in 2002. The increase in interest expense was due to the recording of $7.6 million of Series B Preferred dividends and accretion as interest expense based upon the implementation of SFAS 150. Effective June 29, 2003, SFAS 150 required us to reclassify our Series B Preferred as a liability and reflect the accretion as interest expense. The increase in interest expense was partially offset by a decrease in amortization of deferred financing costs relating to our amendments to the Wachovia Facility, which lengthened the facility. Income Taxes. The Company’s income tax provision increased by approximately $7.5 million to $11.3 million for the year ended December 27, 2003 as compared with $3.8 million in 2002. During the year ended December 27, 2003, the Company made a decision to fully reserve the remaining net deferred tax asset by increasing the valuation allowance by recording a $11.3 million deferred Federal income tax provision as compared with a $3.7 million provision incurred in 2002. During the quarter ended September 27, 2003, management lowered its projections of future taxable income for 2003 and 2004 due to a number of factors, including the continued softness in the demand for our products at that time and the impact of the May 19, 2003 change in control (see Note 12 to the Company’s consolidated financial statements). Partially offsetting this $7.6 million increase was a $0.1 million decrease in the provision for state income taxes for the year ended December 27, 2003. Preferred Stock Dividends. Preferred stock dividends decreased by approximately $7.7 million to $7.9 million for the year ended December 27, 2003 as compared with $15.6 million in 2002. Through the end of the second quarter of 2003, the Company recorded Preferred stock dividends relating to the Series B Preferred, however, upon the implementation of SFAS 150 beginning in the third quarter of 2003, we were required to begin recording the preferred stock dividends as interest expense. Additionally, the Series C Preferred, which was exchanged on November 30, 2003 for the Series B Preferred, was recorded at the maximum amount of the liquidation preference of $72.7 million, thus no preferred stock dividends were recorded. Liquidity and Capital Resources   Overview   ByDuring 2005, the endliquidity position of 2004, the Company’s liquidity significantlyCompany strengthened as a result of improved as compared with its position atoperating results, proceeds from the endsale of 2003. Our working capital at December 25, 2004 was $10.6 million,Gump’s and as compared with a working capital deficit of $10.4 million at December 27, 2003. As a result of securing the $20.0 million Chelsey Facility on July 8, 2004 and concurrently amending the terms of the Wachovia Facility, our liquidity increased by approximately $25.0 million.Facility. The additional working capital has providedcontinued to provide us the ability to restore inventory to more adequate levels in order to more effectively fulfill demand, reduce existing backorder levels, and increase initial customer order fill rates. In addition, thesupport higher demand. The funding has eliminated substantially all vendor restrictions involving our credit arrangements. With lower than expected inventory levelsThe $8.9 million in proceeds from the fourth quartersale of 2003 and the interruptions in the flow of merchandise, which prevented inventories from reaching adequate levels in the first half of 2004, we experienced a significant negative impact on revenues and cash flow in the first half of 2004. These lower inventory levels resulted in large part from tighter vendor credit and borrowing restrictions under our Wachovia Facility. This had a compounding effect on the business as a whole; lower levels of inventory reduced the amount of the financing available under the Wachovia Facility as well as the ability to meet customer demand, which resulted in a significant increase in our backorder position and cancellation of customer orders. During the second quarter of 2004, management determined that this inventory position was not sustainable for the long term, as we were experiencing a significant negative impact on second quarter net revenues due to the decreased inventory levels. Management’s primary objective became the formulation and execution of a plan to address the liquidity issue facing the Company. After reviewing available alternatives,Gump’s enabled the Company entered into the Chelsey Facility and concurrently negotiated an amendment of the termsto pay down $8.1 million of the Wachovia Facility.revolving loan facility during the first quarter of 2005. Net cash provided by discontinued operations for December 25, 2004 and December 27, 2003 was $1.8 million and $2.6 million, respectively.   Net cash usedprovided by operating activities. For the year ended December 25, 2004,31, 2005, net cash usedprovided by operating activities was $17.3$1.0 million. This was due primarily to increased inventory levels, payments to vendors to reduce accounts payable and increases in accounts receivable and prepaid catalog costs. These uses of cash were partially offset by $13.0$16.0 million of operating cash provided by net income, when adjusted for the gain on the disposition of Gump’s, depreciation, amortization special charges and other non cash items. These receipts of cash were largely offset by payments made by the Company to increase inventory and prepaid catalog costs and reduce accrued liabilities.   Net cash usedprovided by investing activities. For the year ended December 25, 2004,31, 2005, net cash usedprovided by investing activities was $0.8$7.4 million. This amount comprisedwas due primarily to $8.9 million in proceeds received from the sale of Gump’s, partially offset by capital expenditures, consisting primarily of purchases and upgrades to various information technology hardware and software throughout the Company and purchases of furniture and equipment for the Company’s Lacrosse, Wisconsin and Roanoke, Virginia locations.headquarters in New Jersey.   Net cash providedused by financing activities. For the year ended December 25, 2004,31, 2005, net cash providedused by financing activities was $16.3$8.6 million, which was primarily due to the receipt of $20.0 million from the Chelsey Facility and a $0.3 million refund relating to withholding taxes remitted on behalf of Richemont Finance S.A. for estimated taxes due related to the Series B Preferred. These receipts were partially offset by net payments of $2.1$8.3 million under the Wachovia Facility, debt issuance costs of $1.2 million relating to the Chelsey Facility transaction and the amendment of the Wachovia Facility and payments of $0.7$0.3 million for obligations under capital leases.   Financing Activities   Wachovia Facility. Wachovia and the Company are parties to a Loan and Security Agreement dated November 14, 1995 (as amended by the First through Thirty-FourthThirty-Fifth Amendments, the “Wachovia Loan Agreement”) pursuant to which Wachovia provided the Company with the Wachovia Facility which has included, since inception, one or more term loans and a revolving credit facility (“Revolver”). The Wachovia Facility expires on July 8, 2007.   Prior to obtaining the Chelsey Facility, there were twoThe term loans outstanding, Tranche A and Tranche B,loan under the Wachovia Facility. The Tranche B term loanfacility had a principal balance of approximately $4.9 million and bore interest at 13% when the Company used a portion of the proceeds of the Chelsey Facility to repay this loan on July 8, 2004. The Tranche A term loan had a principal balance of approximately $5.0$3.0 million as of December 25, 2004,31, 2005, of which approximately $2.0 million was classified as short term and approximately $3.0$1.0 million was classified as long term on the Consolidated Balance Sheet. The Tranche A term loan bears interest at 0.5% over the Wachovia prime rate and requires monthly principal payments of approximately $166,000.$0.2 million.   The Revolver has a maximum loan limit of $34.5 million, subject to inventory and accounts receivable sublimits that limit the credit available to the Company’s subsidiaries, that are borrowers under the Revolver. The interest rate on the Revolver is currently 0.5% over the Wachovia prime rate. As of December 25, 2004,31, 2005, the interest rate on the Revolver was 5.5%7.5%.   The Wachovia Facility is secured by substantially all of the assets of the Company and contains certain restrictive covenants, including a restriction against the incurrence of additional indebtedness and the payment of Common Stock dividends. In addition, all of the real estate owned by the Company is subject to a mortgage in favor of Wachovia and a second mortgage in favor of Chelsey Finance. The Wachovia Loan Agreement contains affirmative and negative covenants typical for loan agreements for asset-based lending of this type including financial covenants requiring the Company to maintain specified levels of Consolidated Net Worth, Consolidated Working Capital and EBITDA, as those terms are defined in the Wachovia Loan Agreement.   Due to, among other things, the restatements which resulted in the Company violating several financial covenants and the Company’s inability to timely file its periodic reports with the SEC, the Company was in technical default under the Wachovia and Chelsey Facilities. The Company has obtained waivers from both Wachovia and Chelsey Finance for such defaults. 2004 Amendments2006 Amendment to Wachovia Loan Agreement. AgreementOn - Effective March 25, 2004,28, 2006 the Company and Wachovia amended the Wachovia Loan Agreement to adjust(“Thirty-Fifth Amendment”) which reduced the levels of Consolidated Net Worth and Consolidated Working Capital as defined ininterest rate on the agreement, that the Company must maintain during each month commencing January 2004, and amend the EBITDA covenant to specify minimum levels of EBITDA that the Company must achieve on a quarterly basis during 2004, 2005 and 2006. In addition, the definition of “Event of Default” was amended by changing an Event of Default from the occurrence of a material adverse change in the business, assets, liabilities or condition of the Company and its subsidiariesRevolver to the occurrence ofWachovia prime rate plus 0%, eliminated the annual Revolver fee, reset certain specific events such as a decrease in consolidated net revenues beyondfinancial covenants and consented to certain specified levels or aging of inventory or accounts payable beyond certain specified levels. Concurrent with the closing of the Chelsey Facility on July 8, 2004, the Company and Wachovia amended the Wachovia Loan Agreement in several respects including: (1) releasing certain existing availability reserves and removing the excess loan availability covenant, which increasedtransactions between the Company’s availability by approximately $10.0 million, (2) reducing the amount of the maximum credit, the revolving loan limit and the inventory and accounts sublimits of the borrowers, and (3) permitting Chelsey Finance to have a junior secured lien on the Company’s assets. In addition, Wachovia consented to (a) the Company’s issuance to Chelsey Finance of the Common Stock Warrant and the Common Stock as described below, (b) the proposed reverse stock split of the Common Stock and the Company making cash payments to repurchase fractional shares, (c) certain amendments to the Company’s Certificate of Incorporation, and (d) the issuance by the Company of Common Stock to Chelsey as payment of a waiver fee. The Companysubsidiaries. There were no fees paid Wachovia a $400,000 fee in connection with this amendment. This fee was recorded as a deferred charge on the Company’s Consolidated Balance Sheets and is being amortized over the three-year term of the amended Wachovia Facility. 2005 Amendments to Wachovia Loan Agreement. On March 14, 2005, Wachovia consented to the sale of Gump’s and Gump’s By Mail. On March 11, 2005 the Wachovia Loan Agreement was amended to temporarily increase the amount of letters of credit that the Company could issue from $10.0 million to $13.0 million through June 30, 2005. The Company paid Wachovia a $25,000 fee in connection with this amendment. Effective July 29, 2005 the Company and Wachovia amended the Wachovia Loan Agreement (“Thirty-Fourth Amendment”) to provide the terms under which the Company could enter into the World Financial Network National Bank (“WFNNB”) Credit Card Agreement which, among other things, prohibits the use of the proceeds of the Wachovia Facility to repurchase private label and co-brand accounts created under the WFNNB Credit Card Agreement should the Company become obligated to do so, prohibits the Company from terminating the WFNNB Credit Card Agreement without Wachovia’s consent and restricts the Company from borrowing on receivables generated under the WFNNB Credit Card Agreement. The amendment also waives enumerated defaults, resets the financial covenants, reallocates the availability that was previously allocated to Gump’s among other Company subsidiaries and, retroactive to June 30, 2005, increases the amount of letter of credits that the Company can issue to $15.0 million. The Company paid Wachovia a $60,000 fee in connection with this amendment.   On July 29, 2005March 28, 2006 the Company and Chelsey Finance entered into a similar amendment of the Chelsey Facility. Facility to reset certain financial covenants and consents to certain transactions.   Based on the provisionsThere were $9.2 million in letters of EITF 95-22, “Balance Sheet Classificationcredit outstanding as of Borrowings OutstandingDecember 31, 2005 under Revolving Credit Agreements that Include Both a Subjective Acceleration Clause and a Lock-Box Arrangement,” and certain provisions in the Wachovia Loan Agreement, the Company is required to classify its Revolver as short-term debt. Facility. Remaining availability under the Wachovia Facility was $14.0$13.8 million and the interest rate was 5.5%7.5% as of December 25, 2004.31, 2005.   Chelsey Facility. On July 8, 2004, the Company closed on the Chelsey Facility, the $20.0 million junior secured credit facility with Chelsey Finance that was recorded net of a debt discount at $7.1 million at issuance. The Chelsey Facility has a three-year term, subject to earlier maturity upon the occurrence of a change in control or sale of the Company (as defined), and carries an interest rate of 5.0% above the prime rate publicly announced by Wachovia. The financial and non-financial covenants contained in the Chelsey Facility mirror those in the Wachovia Facility except that the quantitative measures for the consolidated working capital and EBITDA covenants are 10.0% less restrictive and the consolidated net worth covenant is 5.0% less restrictive than the comparable financial covenants in the Wachovia Facility. The Chelsey Facility is secured by a second priority lien on substantially of the assets of the Company. As part of this transaction, Chelsey Finance entered into an intercreditor and subordination agreement with Wachovia. At December 25, 2004,31, 2005, the amount recorded as debt on the Consolidated Balance Sheet is $8.2$11.5 million, net of the un-accreted debt discount of $11.8$8.5 million. Under the original terms of the Chelsey Facility, the Company was obligated to make payments of principal of up to the full outstanding amount of the Chelsey Facility in each quarter, provided, among other things that: (1) the aggregate amount of availability under the Wachovia Facility is at least $7.0 million, (2) the cumulative EBITDA for the four fiscal quarters immediately preceding the quarter in which the payment is made is at least $14.0 million, and (3) the aggregate amount of principal prepayments is no more than $2.0 million in any quarter. Subsequent to the closing of the Chelsey Facility, the Company and Chelsey Finance amended the Chelsey Facility to provide that the Company was not obligated to make principal payments prior to July 8, 2007, except in the event of a change in control or sale of the Company. This resulted in the recorded amount of the Chelsey Facility plus the accreted cost of the debt discount (as described below) being classified as long term on the Company’s Consolidated Balance Sheet as of December 25, 2004.   In consideration for providing the Chelsey Facility to the Company, Chelsey Finance received a closing fee of $200,000$0.2 million and a warrant (the “Common Stock Warrant”) valued at $12.9 million, exercisable immediately and for a period of ten years to purchase 30.0% of the fully diluted shares of Common Stock of the Company (equal to 10,259,366 shares of Common Stock) at an exercise price of $0.01 per share. The closing fee of $200,000 was recorded as a deferred charge within Other Assets on the Company’s Consolidated Balance Sheets and is being amortized over the three-year term of the Chelsey Facility. Because the issuance of the Common Stock Warrant was subject to shareholder approval, the Company initially issued a warrant to Chelsey Finance to purchase newly-issued Series D Participating Preferred Stock (“Series D Preferred”) that was automatically exchanged for the Common Stock Warrant on September 23, 2004 following receipt of shareholder approval. See Note 7 to the Company’s consolidated financial statements for further information on the Chelsey Facility and the Common Stock Warrant.   Other Activities     Consolidation of New Jersey Office Facilities. The Company entered into a 10-year extension of the lease for its Weehawken, New Jersey premises and has relocated its executive offices to that facility in 2005. We consolidated all of our New Jersey operations into the Weehawken facility when the Edgewater, New Jersey facility closed upon the expiration of the lease on May 31, 2005.   Consolidation of Men’s Apparel Business. TheOn February 28, 2005 the Company decided on November 9, 2004 to relocatecompleted the relocation and consolidateconsolidation of all functions of International Male and Undergear from San Diego, California to Weehawken, New Jersey by February 28, 2005. The decision was prompted by the business need to consolidate operations, reduce costs and leverage its catalog expertise in New Jersey. We accrued $0.9 million in severance and related costs during the fourth quarter of 2004 associated with the elimination of 32 California-based full-time equivalent positions. The payment of these costs began in February 2005 and continued throughwere completed by August 2005. Since the relocation and consolidation of the Men’s apparel catalogs, the transition has negatively impacted the performance of the Men’s apparel catalogs in 2005.   The projected annual savings from the consolidation of the San Diego, California and the Edgewater, New Jersey facilities into the Weehawken, New Jersey facility is approximately $2.1 million, however with this relocation and consolidation, the transition has negatively impacted the performance of the Men’s Apparel catalogs in 2005.   Consolidation of Fulfillment Centers. On June 30, 2004 the Company announced plans to consolidate the operations of the LaCrosse, Wisconsin fulfillment center and storage facility into the Roanoke, Virginia fulfillment center by June 30, 2005. The LaCrosse fulfillment center and the LaCrosse storage facility were closed in June 2005 and August 2005 upon the expiration of their respective leases. TheThis plan to consolidate operations was prompted by excess capacity at theour Roanoke facility at that time and the lack of sufficient warehouse space in the leased Wisconsin facilities to support the growth of The Company Store and reduce the overall cost structure of the Company. The Company substantially completed the consolidation intolower shipping costs available from the Roanoke Virginia fulfillment center by the end of June 2005. Since the consolidation of our fulfillment centers, our Roanoke fulfillment center has experienced lower productivity that has negatively impacted fulfillment costs and the Company’s overall performance.facility. We accrued $0.5 million in severance and related costs and incurred $0.2 million of facility exit costs during 2004 associated with the consolidation of the LaCrosse operations and the elimination of 149 full and part-time positions. The payment of these costs began in January 2005 and is expected to continue intocontinued through the fourth quarter of 2005. Since the consolidation of our fulfillment centers, our Roanoke fulfillment center has experienced high levels of employee turnover and lower productivity that has resulted in higher costs being incurred in the fulfillment center. This trend of high levels of employee turnover and lower productivity continued through the end of fiscal 2005 and is expected to continue during 2006.   Pursuant to and in conjunction with the above actions to reduce overhead costs, the Company eliminated an additional 15 full-time positions Company-wide, for which we accrued $0.3 million in severance and related costs during the fourth quarter of 2004. Sale of Improvements Business. On March 27, 2003, the Company and HSN, a division of USA Networks, Inc.’s Interactive Group and purchaser of certain assets and liabilities of the Company’s Improvements business on June 29, 2001, 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. The asset purchase agreement had provided that if Keystone failed to perform its obligations during the first two years of the services contract, HSN could receive a reduction in the original purchase price of up to $2.0 million. By agreeing to the terms of the amendment, HSN forfeited its ability to receive a reduction in the original purchase price. In consideration for the release, Keystone issued a credit to HSN for $100,000, which could be applied by HSN against any invoices of Keystone to HSN. This credit was utilized by HSN in March 2003. On March 28, 2003, the remaining $2.0 million escrow balance was received by the Company, thus terminating the escrow agreement. During 2002, the Company recognized approximately $0.6 million of the deferred gain consistent with the terms of the escrow agreement. Proceeds related to the deferred gain were received on July 2, 2002 and December 30, 2002 for $0.3 million and $0.3 million, respectively. We recognized the remaining net deferred gain of $1.9 million upon 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.   Delisting of Common Stock. The Common Stock was delisted from the AMEX on February 16, 2005 ultimately because of the Restatement that prevented us from filing our Form 10-Q for the fiscal quarter ended September 25, 2004, a condition of continued AMEX listing. Trading in our Common Stock on the AMEX was halted on November 16, 2004 and formally suspended on February 2, 2005.   Initially the Company was notified by the AMEX on May 21, 2004 that the Company was not in compliance with the continued listing standards as set forth in Part 10 of the AMEX’s Company Guide because of insufficient shareholders equity and a series of losses from continuing operations. The Company submitted a plan to the AMEX to regain compliance with the continued listing standards which the AMEX accepted and granted the Company an extension until November 21, 2005 to regain compliance with the continued listing standards. Because the Company could not timely file its Form 10-Q for the fiscal quarter ended September 25, 2004, a condition for the Company’s continued listing on the AMEX, the AMEX began the delisting proceedings that culminated in the February 16, 2005 delisting. Current trading information about the Company’s Common Stock can be obtained from the Pink Sheets (www.pinksheets.com) under the trading symbol HNVD.PK.     General. At December 25, 2004,31, 2005, the Company had $0.5$0.3 million in cash and cash equivalents compared with $2.3$0.5 million at December 27, 2003.25, 2004. Working capital and current ratio at December 25, 200431, 2005 were $26.0 million and 1.42 to 1, respectively, compared with $10.6 million and 1.13 to 1, respectively.respectively at December 25, 2004. Total recorded borrowings, net of the un-accreted debt discount of $11.8$8.5 million and the Series C Preferred, as of December 25, 2004,31, 2005, aggregated $27.9$22.6 million, $11.2$12.5 million of which is classified as long term. Remaining availability under the Revolver as of December 25, 200431, 2005 was $14.0$13.8 million.   At December 25, 2004,31, 2005, the aggregate annual principal payments required on debt instruments (including capital lease obligations) are as follows (in thousands): 2005 — $16,690; 2006 — $2,039;$10,105; 2007 — $20,998.   Management believes that the Company has sufficient liquidity and availability under its credit agreements to fund its planned operations through at least the next twelve months. See “Risk Factors” below.in Item 1A above.   Use of Estimates and Other Critical Accounting Policies   The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and revenues and expenses during the period. Significant accounting policies employed by the Company, including the use of estimates, are presented in the Notes to consolidated financial statements.   Critical accounting policies are those that are most important to the portrayal of the Company’s financial condition and results of operations, and require management’s most difficult, subjective or complex judgments, as a result of the need to make estimates about the effect of matters that are inherently uncertain. The Company’s most critical accounting policies, discussed below, pertain to revenue recognition, inventory valuation, catalog costs, reserves related to the Company’s strategic business realignment program and other accrued liabilities, reserves related to employee health, welfare and benefit plans, and the net deferred tax asset.   Revenue Recognition   Direct Commerce — The Company recognizes revenue for catalog and Internet sales at the time merchandise is received by the customer, net of estimated returns. Delivery and service charges billed to customers are also recognized as revenue at the time merchandise is received by the customer. The Company’s revenue recognition policy includes the use of estimates for the time period between shipment of merchandise by the Company and receipt of merchandise by the customer and the future amount of returns to be received on the current period’s sales. These estimates of future returns are determined using historical measures including the amount of time between the shipment of a product and its return, the overall rate of return, and the average product margin associated with the returned products. The Company’s total returns reserve at the end of 2005 and 2004 was $2.2 million and 2003 was $2.0 million. For the year ended December 25, 2004, themillion, respectively. The Company’s return rate decreased 0.6% to 10.5% from 11.1% in 2003. A contributing factor to this decrease wasremained constant at 10.8% at the modificationend of our return policy in October 2003, which previously allowed unlimited returns, to limit returns to a maximum of 90 days after the sale of the merchandise.2005 and 2004.   Membership Services — Customers may purchase memberships in a number of the Company’s Buyers’ Club programs for an annual fee. For memberships purchased during the following periods, certain of the Buyers’ Club programs contained a guarantee that the customer would receive discounts or savings, at least equal to the cost of his or her membership or the Company would refund the difference with a merchandise credit at the end of the membership period: Silhouettes from July 1998 through March 2004; Domestications from April 2002 through March 2004; and Men’s Apparel from April 2003 through March 2004. For memberships purchased during the periods in which the Buyers’ Club memberships contained a guarantee, revenue net of actual cancellations was recognized on a monthly basis over the membership period subsequent to the end of the thirty-day cancellation period, with the revenue recognized equal to the lesser of the cumulative amount determined using the straight-line method or the actual benefit received by each customer as of the end of each period. For the Buyers’ Club memberships that did not contain a guarantee, revenue net of actual cancellations was recognized on a monthly basis over the membership period subsequent to the end of the thirty-day cancellation period, using the straight-line method. We receive commission revenue related to our solicitation of the Vertrue membership programs. The Company receives a monthly commission based on the number of memberships sold with additional revenue recognized if certain program performance levels are attained for each fiscal year. Through May 2003, we received commission revenue from the Magazine Direct magazine subscription program. The commission revenue we recognized for the Magazine Direct magazine program was on a per-solicitation basis according to the number of solicitations made, with additional revenue recognized if the customer accepted the solicitation. Collectively, the amount of revenues the Company received from these sources was $14.3 million, or 3.5% of net revenues, $10.3 million or 2.8% of net revenues, and $9.3 million, or 2.5% of net revenues $9.3 million or 2.2% of net revenues,for 2005, 2004 and $10.3 million, or 2.2% of net revenues for 2004, 2003, and 2002, respectively. In May 2003, we discontinued our solicitation of the Magazine Direct program.   Inventory Valuation — The Company’s inventory valuation policy includes the use of estimates regarding the future loss on in-transit and on-hand inventory that will be sold at a price less than the cost of the inventory (inventory write-downs), plus the amount of freight-in expense associated with the inventory on-hand (capitalized freight). These amounts are included in Inventories, as recorded on the Company’s Consolidated Balance Sheets. Our inventory write-downs are determined for each individual catalog using the estimated amount of overstock inventory that will need to be sold below cost and an estimate of the method of liquidating this inventory (each method generates a different level of cost recovery). Any incremental gross margin that would result in inventory being sold at a higher amount after a write-down is recorded is not realized until that inventory is ultimately sold. The estimated amount of overstock inventory is determined using current and historical sales trends for each category of inventory as well as the content of future merchandise offers that will be produced by the Company. An estimate of the percentage of freight-in expense associated with each dollar of inventory received is used in calculating the amount of freight-in expense to include in our inventory value. Different percentage estimates are developed for each catalog and for inventory purchased from foreign and domestic sources. The estimates used to determine our inventory valuation affect the balance of Inventories on the Company’s Consolidated Balance Sheets and Cost of sales and operating expenses on the Company’s Consolidated Statements of Income (Loss).   Prepaid Catalog Costs — Prepaid catalog costs consist of direct response advertising costs related to catalog production and mailing. In accordance with Statement of Position 93-7, “Reporting on Advertising Costs,” catalogthese costs are deferred and amortized as selling expenses over the estimated period in which the sales related to such advertising are generated. An estimate of the future sales dollars to be generated from each individual catalog drop is used in the implementation of the Company’s catalog cost amortization policy. The estimate of future sales is calculated for each catalog drop using historical trends for similar catalog drops mailed in prior periods as well as the overall current sales trend for the catalog. On a monthly basis, this estimate is evaluated and adjusted as necessary and then is compared with the actual sales generated to-date for the catalog drop to determine the percentage of total catalog costs to be classified as prepaid catalog costs on the Company’s Consolidated Balance Sheets. The costs for each catalog drop are completely amortized, regardless of actual sales generated by the catalog drop, when the catalog has been in circulation for six months or the amount of the costs remaining to be amortized decreases below 3.0% of the catalog drop’s total cost. OurTotal selling expenses which includes both the amortization of catalog costs and other advertising expenses in the Company’s Consolidated Statements of Income (Loss) was $102.0 million, $90.9 million and $89.7 million for 2005, 2004 and 2003, respectively. Prepaid catalog costs at the end of 2005 and 2004 2003were $17.6 million and 2002 were $15.6 million, $12.5 million and $14.3 million, respectively. Prepaid catalog costs on the Consolidated Balance Sheets and Selling expenses on the Consolidated Statements of Income (Loss) are affected by these estimates.   Reserves related to the Company’s strategic business realignment program and other Accrued Liabilities — Generally, the Company records severance in accordance with the Financial Accounting Standards Board (“FASB”) Statement No. 112, “Employers’ Accounting for Postemployment Benefits,” (“SFAS 112”) and reserves for leased properties were accounted in accordance with Emerging Issues Task Force No. 94-3 (“EITF 94-3”), “Liability Recognition for Certain Employee Termination Benefits & Other Costs to Exit an Activity (Including Certain Costs Incurred in Restructuring).” The Company has not recorded any reserves under FASB Statement No. 146, “Accounting for Costs Associated with Exit or Disposal Activities”. The reserves established by the Company related to its strategic business realignment program include employee severance and related costs, facility exit costs and estimates primarily associated with the potential subleasing of leased properties that have been vacated by the Company. Subsequent to December 25, 2004,On March 14, 2005, the Gump’s business was sold as described in Part I of this Form 10-K. The overall reserves for leased properties that have been vacated by the Company are developed using estimates that include the potential ability to sublet leased but unoccupied properties, the length of time needed to obtain suitable tenants and the amount of rent to be received for the sublet. Real estate broker representations regarding current and future market conditions are sometimes used in estimating these items. Accrued liabilities and Other Non-current liabilities on the Company’s Consolidated Balance Sheets and Special charges on the Company’s Consolidated Statements of Income (Loss) are impacted by these estimates. See Note 5 and Note 6 to the Company’s consolidated financial statements.   The most significant estimates involved in evaluating our accrued liabilities are used in the determination of the accrual for legal liabilities or those liabilities that will be resolved through litigation. We accrue for potential litigation losses when management determines that it is probable that an unfavorable outcome will result and the loss is reasonably estimable. Our policy is to accrue an amount equal to the estimated potential loss and associated legal fees. For the year ended December 30, 2000, the Company used estimates to determine the liability related to Rakesh Kaul’s claims regarding benefits as a result of his resignation on December 5, 2000. As part of the Restatement, the Company corrected two accounting errors related to the Rakesh Kaul liability. The first error identified was the premature reversal of the reserve in the fourth quarter of 2003 based upon the summary judgment decision in January 2004. As noted above, this decision could be, and subsequently was, appealed. Due to this fact, management has now determined that the reversal was premature. The second error identified was the accounting for legal fees associated with litigating this claim. Due to the fact that the Kaul reserve was recorded prior to the initiation of litigation,31, 2005, the Company has determined that the appropriate basis of accounting for the legal fees related to the litigation would have been to treat such fees as period costs and, therefore, expensed as incurred. However, the Company had inappropriately recorded certain of these fees against the reserve as opposed to recording them as an expense in the income statement. See Note 2 of Notes to the consolidated financial statements for additional information pertaining to this restatement adjustment. In addition, the Company recorded a $0.5$0.1 million reserve during the third quarter of 2004accrued for estimated costs associated with the Class Action Lawsuits the Company is currently litigating. See Note 15 of Notes to the consolidated financial statements for additional information pertaining to this reserve.   Reserves related to employee health, welfare and benefit plans — The Company maintains a self-insurance program related to losses and liabilities associated with employee health and welfare claims. Stop-loss coverage is held on both an aggregate and individual claim basis thereby limiting the amount of losses we will experience. Losses are accrued based upon estimates of the aggregate liability for claims incurred using our experience patterns. General and administrative expenses on the Consolidated Statement of Income (Loss) and Accrued liabilities on the Consolidated Balance Sheets are affected by these estimates. At December 25, 200431, 2005 and December 27, 2003,25, 2004, the Company had an accrued liability recorded in the amount of $0.6 million.   Deferred Tax Asset - In determining the Company’s net deferred tax asset (gross deferred tax asset net of a valuation allowance and the deferred tax liability), projections concerning the future utilization of the Company’s net operating loss carryforwards are employed. These projections involve evaluations of our future operating plans and ability to generate taxable income, as well as future economic conditions and our future competitive environment. For the year ended December 27, 2003, the carrying value of the deferred tax asset was adjusted based on a reassessment of the Company’s ability to utilize certain net operating losses prior to their expiration and our history of losses. The deferred tax asset and deferred tax liability on the Company’s Consolidated Balance Sheets and the Provision for deferred income taxes on the Company’s Consolidated Statements of Income (Loss) are impacted by these projections.   New Accounting Pronouncements   On March 31, 2004, the Financial Accounting Standards Board (“FASB”) issued Emerging Issues Task Force Issue No. 03-6 (“EITF 03-6”), “Participating Securities and the Two-Class Method under FASB Statement No. 128.” SFAS 128 defines earnings per share (“EPS”) as “the amount of earnings attributable to each share of common stock” and indicates that the objective of EPS is to measure the performance of an entity over the reporting period. SFAS 128 addresses conditions under which a participating security requires the use of the two-class method of computing EPS. The two-class method is an earnings allocation formula that treats a participating security as having rights to earnings that otherwise would have been available to common shareholders, but does not require the presentation of basic and diluted EPS for securities other than common stock. The Company’s Series C Preferred is a participating security and, therefore, we calculate EPS utilizing the two-class method, however, have chosen not to present basic and diluted EPS for its preferred stock. In November 2004, the FASB issued SFAS No. 151, “Inventory Costs, an Amendment of ARB No. 43, Chapter 4” (“SFAS 151”), which clarifies the accounting for abnormal amounts of idle facility expense, freight, handling costs and spoilage. We are required to adoptThe Company has adopted the provisions of SFAS 151 effective January 1, 2006; however, early2006 and does not expect that such adoption is permitted. We are currently inwill have a material effect on the processCompany’s results of determining the impact of the adoption of this Statement on ouroperations or financial statements.position.   In December 2004, the FASB issued SFAS No. 123R, “Share Based Payment” (“SFAS 123R”). SFAS 123R requires measurement and recording of compensation expense for all employee share-based compensation awards using a fair value method. The Company currently accounts for its stock-based compensation to employees using the fair value-based methodology under SFAS 123. We are currently assessingThe Company has adopted the impactprovisions of SFAS 123R effective January 1, 2006 and does not expect that such adoption will have a material effect on the adoptionCompany’s results of this Statement.operations or financial position.   In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Correction”Corrections” (“SFAS 154”), which changes the requirements for the accounting for and reporting of a change in accounting principle. We are required to adopt the provisions of SFAS 154 effective January 1, 2006; however, early adoption is permitted.2006. The Company is currently assessinghas adopted the impactprovisions of the adoption of this Statement.SFAS 154 and does not expect any current impact.   Off-Balance Sheet Arrangements and Contractual Obligations   The Company has entered into no “off-balance"off-balance sheet arrangements”arrangements" within the meaning of the Securities Exchange Act of 1934, as amended, and the rules thereunder other than operating leases, which are in the normal course of business.business and the warrants issued in conjunction with the Chelsey debt facility. These warrants are equity linked derivatives and accordingly represent off balance sheet arrangements. The warrants meet the scope exception in paragraph 11 (a) of FAS 133 and are accordingly not accounted for as derivatives for purposes of FAS 133, but instead are accounted for as equity. See Note 7 to the Company’s consolidated financial statements for more information.   Provided below is a tabular disclosure of contractual obligations as of December 25, 2004,31, 2005, as required by Item 303(a)(5) of SEC Regulation S-K. In addition to obligations recorded on the Company’sCompany's Consolidated Balance Sheets as of December 25, 2004,31, 2005, the schedule includes purchase obligations, which are defined as legally binding and enforceable agreements to purchase goods or services that specify all significant terms (quantity, price, and timing of transaction).   Payment Due by Period (in thousands)     Contractual Obligations   Total   Less Than 1 Year     1-3 Years     3-5 Years   More Than 5 Years   Debt Obligations, excluding the Series C Participating Preferred Stock (a) $    39,384   $  16,400   $ 22,984   $        —   $           —   Total Minimum Lease Payments Under Capital Lease Obligations (Including interest) 358   304   54   —   —   Operating Lease Obligations- excluding Gump’s (e) 2,164   1,735   421   8   —   Operating Lease Obligations- Gump’s (e) 8,680   1,659   3,383   3,360   278   Operating Lease Obligations — Restructuring/ Discontinued Operations- excluding Gump’s (e) 1,051   979   72   —   —   Operating Lease Obligations — Restructuring/ Discontinued Operations- Gump’s (e) 5,179   1,002   2,004   2,006   167   Contractual Obligations (b) 1,478   1,289   189   —   —   Purchase Obligations- excluding Gump’s (c) (e) 27,661   27,661   —   —   —   Purchase Obligations- Gump’s (c) (e) 1,088   1,088   —   —   —   Other Long-Term Liabilities Reflected on the Registrant’s Balance Sheet under GAAP (d) 72,689   —   —   72,689   —             Total $  159,732   $  52,117   $ 29,107   $ 78,063   $         445                 Less Than           More Than Contractual Obligations Total   1 Year   1-3 Years   3-5 Years   5 Years   Debt Obligations, excluding the Series C Participating Preferred Stock (a) $  31,050   $         10,056   $  20,994   $         —   $              —   Total Minimum Lease Payments Under Capital Lease Obligations 53   49   4   —   —   Operating Lease Obligations 12,528   2,410   2,637   2,299   5,182   Operating Lease Obligations —Discontinued Operations 72   72   —   —   — Contractual Obligations (b) 424   424   —   —   — Purchase Obligations(c) 26,856   26,856   —   —   —   Other Long-Term Liabilities Reflected on the Registrant's Balance Sheet under GAAP (d) 72,689   —   —   72,689   —   Total $143,672   $         39,867   $  23,635   $  74,988   $         5,182   (a) Represents the Company’s debt obligations, including the $20.0 million Chelsey Facility principal amount due Chelsey Finance, recorded as $8.2$11.5 million on the Consolidated Balance Sheet. See Note 7 of Notes to the Company’s consolidated financial statements for additional detail regarding the Chelsey Facility.   (b) The Company’s contractual obligations consist primarily of a total commitment of $2,000,000 to purchase telecommunication services during the period from May 1, 2004 through April 30, 2006, of which approximately $1,246,000 had been fulfilled as of December 25, 2004, and of which the remaining $754,000 has been fulfilled as of February 6, 2006; a total commitment of approximately $487,000 to purchase catalog photography services during the period from September 11, 2003 through September 10, 2005, of which approximately $265,000 had been fulfilled as of December 25, 2004, and of which an additional $161,000 had been fulfilled by September 10, 2005, and of which the remaining $61,000 was offset by an extension of the original agreement by an amendment dated January 10, 2006; a total commitment of $375,000commitments for list processing and photography services representing the maximum exposureand purchases for a service contract that requires a three-month notice of termination for services costing $125,000 per month; and several commitments totaling approximately $127,000 to purchase various packaging materials from several vendors during the next 12 months, under contracts wherein the vendors warehouse varying minimum and maximum levels of materials to ensure immediate availability.materials.   (c) The Company’s purchase obligations represent the estimated commitments at year-end to purchase inventory and raw materials in the normal course of business to meet operational requirements. The Company’s purchase orders are not unconditional commitments, but rather represent executory contracts requiring performance by vendors/suppliers. As such the Company has an absolute and unconditional right to cancel the Purchase Order if the vendor/supplier is unable to arrange for the products listed thereon to be delivered to the destination by the date shown. The purchase obligations presented above include all such open orders and agreed upon raw material commitments that are not otherwise included in the Company’s recorded liabilities.   (d) Represents Series C Participating Preferred Stock as disclosed in Note 8 to the Company’s consolidated financial statements. In March 2005 at the Company’s request, Chelsey agreed to permit the Company to apply the sales proceeds from the sale of Gump’s to reduce the Wachovia Facility. Chelsey retained the right to require redemption of approximately $6.9 million (the Gump’s sales proceeds available for redemption) of the Series C Preferred subject to Wachovia’s approval. Since the redemption of approximately $6.9 million is subject to Wachovia’s approval the payment due period is presented as January 1, 2009.   (e) Operating lease and purchase obligation amounts for Gump’s are being shown separately due to the Company’s sale of Gump’s on March 14, 2005. Item 7A. Quantitative and Qualitative Disclosures about Market Risk   Interest Rates: The Company’s exposure to market risk relates to interest rate fluctuations for borrowings under the Wachovia Facility, including the term loans, which bear interest at variable rates, and the Chelsey Facility, which bears interest at 5.0% above the prime rate publicly announced by Wachovia. At December 25, 2004,31, 2005, outstanding principal balances under the Wachovia Facility and Chelsey Facility subject to variable rates of interest were approximately $19.4$11.1 million and $20.0 million, respectively. If interest rates were to increase by one percent from current levels, the resulting increase in interest expense, based upon the amount outstanding at December 25, 2004,31, 2005, would be approximately $0.4$0.3 million on an annual basis.   In addition, the Company’s exposure to market risk relates to 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, fluctuations in foreign currency exchange rates, and the ability of the Company to reduce unprofitable circulation and effectively manage its customer lists.       Item 8. Financial Statements and Supplementary Data — Report of the Independent Registered Accounting Firm   REPORT OF THE INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM   To the Board of Directors Hanover Direct, Inc.   We have audited the accompanying consolidated balance sheets of Hanover Direct, Inc. as of December 25, 200431, 2005 and December 27, 2003,25, 2004, and the related consolidated statements of income (loss), cash flows and shareholders’ deficiency for each of the three fiscal years in the period ended December 25, 2004.31, 2005. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.   We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.   In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Hanover Direct, Inc. as of December 25, 200431, 2005 and December 27, 200325, 2004 and the results of its operations and its cash flows for each of the three years in the period ended December 25, 200431, 2005 in conformity with accounting principlesUnited States generally accepted in the United States of America.accounting principles.   The information included on Schedule II is the responsibility of management, and although not considered necessary for a fair presentation of financial position, results of operations, and cash flows, it is presented for additional analysis and has been subjected to the auditing procedures applied in the audit of the basic consolidated financial statements. In our opinion, the information included on Schedule II relating to each of the three years in the period ended December 25, 2004, December 27, 2003 and December 28, 200231, 2005 is fairly stated in all material respects, in relation to the basic consolidated financial statements taken as a whole. Also, such schedule presents fairly the information set forth therein in compliance with the applicable accounting regulations of the Securities and Exchange Commission.     /s/ GOLDSTEIN GOLUB KESSLER LLP     New York, NY February 8,March 9, 2006       HANOVER DIRECT, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS As of December 25, 200431, 2005 and December 27, 200325, 2004         December 25, 2004       December 27, 2003 As Restated       (In thousands of dollars,   Except share amounts) ASSETS CURRENT ASSETS: Cash and cash equivalents $                 510 $         2,282 Accounts receivable, net of allowance for doubtful accounts of $1,367 in 2004 and $1,105 in 2003 17,819 14,335 Inventories, principally finished goods 53,147 42,806 Prepaid catalog costs 15,644 12,485 Other current assets 4,482 4,239 Total Current Assets 91,602 76,147 PROPERTY AND EQUIPMENT, AT COST: Land 4,361 4,361 Buildings and building improvements 18,221 18,210 Leasehold improvements 10,156 10,108 Furniture, fixtures and equipment 53,792 53,212   86,530 85,891 Accumulated depreciation and amortization (61,906) (58,113) Property and equipment, net 24,624 27,778 Goodwill 9,278 9,278 Deferred tax asset 2,179 1,769 Other non-current assets 2,816 1,575 Total Assets $         130,499 $     116,547   LIABILITIES AND SHAREHOLDERS’ DEFICIENCY CURRENT LIABILITIES: Short-term debt and capital lease obligations $           16,690 $       13,468 Accounts payable 29,544 42,742 Accrued liabilities 20,535 17,088 Customer prepayments and credits 12,032 11,479 Deferred tax liability 2,179 1,769 Total Current Liabilities 80,980 86,546 NON-CURRENT LIABILITIES: Long-term debt, including $8,159 to a related party as of December 25, 2004 (see note 7) 11,196 9,042 Series C Participating Preferred Stock, authorized, issued and outstanding 564,819 shares at December 25, 2004 and December 27, 2003; liquidation preference was $56,482 at December 25, 2004 and December 27, 2003 72,689 72,689 Other 3,286 4,609 Total Non-current Liabilities 87,171 86,340 Total Liabilities 168,151 172,886 SHAREHOLDERS’ DEFICIENCY: Common Stock, $0.01 par value, authorized 50,000,000 shares at December 25, 2004 and 30,000,000 shares at December 27, 2003; 22,426,296 shares issued and outstanding at December 25, 2004; 22,229,456 shares issued and 22,017,363 shares outstanding at December 27, 2003 225 222 Capital in excess of par value 460,744 450,407 Accumulated deficit (498,621) (503,622)   (37,652) (52,993) Less: Treasury stock, at cost (0 shares at December 25, 2004 and 212,093 shares at December 27, 2003) -- (2,996) Notes receivable from sale of Common Stock -- (350) Total Shareholders’ Deficiency (37,652) (56,339) Total Liabilities and Shareholders’ Deficiency $         130,499 $     116,547             December 31, 2005       December 25, 2004   (In thousands of dollars,   Except share amounts) ASSETS   CURRENT ASSETS:   Cash and cash equivalents $                 275   $            510 Accounts receivable, net of allowance for doubtful accounts of $916 in 2005 and $1,367 in 2004 16,518   17,819 Inventories 51,356   53,147 Prepaid catalog costs 17,567   15,644 Other current assets 2,744   4,482 Total Current Assets 88,460   91,602 PROPERTY AND EQUIPMENT, AT COST:   Land 4,378   4,361 Buildings and building improvements 18,194   18,221 Leasehold improvements 1,115   10,156 Furniture, fixtures and equipment 51,532   53,792   75,219   86,530 Accumulated depreciation and amortization (55,030)   (61,906) Property and equipment, net 20,189   24,624 Goodwill 8,649   9,278 Deferred tax asset 2,890   2,179 Other non-current assets 1,989   2,816 Total Assets $         122,177   $     130,499 LIABILITIES AND SHAREHOLDERS’ DEFICIENCY   CURRENT LIABILITIES:   Short-term debt and capital lease obligations $           10,105   $       16,690 Accounts payable 27,043   29,544 Accrued liabilities 12,341   20,535 Customer prepayments and credits 10,074   12,032 Deferred tax liability 2,890   2,179 Total Current Liabilities 62,453   80,980 NON-CURRENT LIABILITIES:   Long-term debt (including $11,545 and $8,159 to a related party as of December 31, 2005 and December 25, 2004, respectively, see note 7) 12,543   11,196 Series C Participating Preferred Stock, authorized, issued and outstanding 564,819 shares at December 31, 2005 and December 25, 2004; liquidation preference was $56,482 at December 31, 2005 and December 25, 2004 72,689   72,689 Other 40   3,286 Total Non-current Liabilities 85,272   87,171 Total Liabilities 147,725   168,151 SHAREHOLDERS’ DEFICIENCY:   Common Stock, $0.01 par value, authorized 50,000,000 shares; 22,426,296 shares issued and outstanding at December 31, 2005 and December 25, 2004 225   225 Capital in excess of par value 460,891   460,744 Accumulated deficit (486,664)   (498,621) Total Shareholders’ Deficiency (25,548)   (37,652) Total Liabilities and Shareholders’ Deficiency $         122,177   $     130,499 See notes to Consolidated Financial Statements.     HANOVER DIRECT, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (LOSS) For the Years Ended December 31, 2005, December 25, 2004 and December 27, 2003 and December 28, 2002             2004   2003 As Restated   2002 As Restated           ��     2005     2004     2003 (In thousands of dollars, except (In thousands of dollars, except per share amounts)   per share amounts)   NET REVENUES $     403,160   $      414,283   $        456,990 $     407,442   $        360,526   $          370,096                         OPERATING COSTS AND EXPENSES:                     Cost of sales and operating expenses 243,215   261,297   290,383 252,991   216,940   233,552 Special charges 1,536   1,308   4,398 (69)   1,684   215 Selling expenses 100,460   99,971   105,448 101,956   90,903   89,722 General and administrative expenses 43,213   45,543   53,322 32,562   40,374   42,657 Depreciation and amortization 3,994   4,719   5,650 2,866   3,312   4,093     390,306   353,213   370,239 392,418   412,838   459,201           INCOME (LOSS) FROM OPERATIONS 17,136   7,313   (143) Gain on sale of Improvements, net --   --   1,911                         INCOME (LOSS) FROM OPERATIONS 10,742   1,445   (2,211) Gain on sale of Improvements, net --   (1,911)   (570)               INCOME (LOSS) BEFORE INTEREST AND INCOME TAXES 10,742   3,356   (1,641) Interest expense, net (including interest expense to a related party see note 7) 5,567   12,088   5,477     INCOME BEFORE INTEREST AND INCOME TAXES 17,136   7,313   1,768 Interest expense, net (including interest expense to a related party; see note 7) 8,146   5,105   11,715                     INCOME (LOSS) BEFORE INCOME TAXES 5,175   (8,732)   (7,118) 8,990   2,208   (9,947)           Provision for Federal income taxes 146   11,300   3,700 21   146   11,300 Provision for state income taxes 28   28   91 8   28   28     Provision for income taxes 174   11,328   3,791 29   174   11,328               INCOME (LOSS) FROM CONTINUING OPERATIONS 8,961   2,034   (21,275) Gain from discontinued operations of Gump’s, net of $22 of income tax benefit, including a gain on disposal of $3,576 at December 31, 2005 2,996   2,967   1,215                     NET INCOME (LOSS) AND COMPREHENSIVE INCOME (LOSS) 5,001   (20,060)   (10,909) 11,957   5,001   (20,060) Preferred stock dividends --   7,922   15,556 --   --   7,922 Earnings Applicable to Preferred Stock 124   --   -- 294   124   --                         NET INCOME (LOSS) APPLICABLE TO COMMON SHAREHOLDERS $         4,877   $     (27,982)   $       (26,465) $       11,663   $             4,877   $         (27,982)     NET INCOME (LOSS) PER COMMON SHARE:                     From continuing operations – basic $            0.39   $               0.09   $             (2.02) From continuing operations – diluted $            0.27   $               0.07   $             (2.02) From discontinued operations – basic $            0.13   $               0.13   $                0.08 From discontinued operations – diluted $            0.09   $               0.11   $                0.08 Net income (loss) per common share – basic $           0.22   $          (1.94)   $           (1.91) $            0.52   $               0.22   $             (1.94) Net income (loss) per common share – diluted $           0.18   $          (1.94)   $           (1.91)           Net income (loss) per common share - diluted $            0.36   $               0.18   $             (1.94)               Weighted average common shares outstanding – basic (thousands) 22,220   14,439   13,828 22,426   22,220   14,439     Weighted average common shares outstanding – diluted (thousands) 27,015   14,439   13,828 32,588   27,015   14,439         See notes to Consolidated Financial Statements.       HANOVER DIRECT, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS For the Years Ended December 31, 2005, December 25, 2004 and December 27, 2003 and December 28, 2002     2004       2003 As Restated     2002 As Restated     2005   2004   2003 (In thousands of dollars) (In thousands of dollars) CASH FLOWS FROM OPERATING ACTIVITIES:     Net income (loss) $        5,001 $     (20,060) $       (10,909) $       11,957   $      5,001   $     (20,060) Adjustments to reconcile net income (loss) to net cash provided (used) by operating activities:           Depreciation and amortization, including deferred fees 4,538 5,715 7,203 3,685   4,538   5,715 Provision for doubtful accounts 609 378 304 518   609   378 Special charges 1,536 1,308 4,398 Special charges (income) (69)   1,536   1,308 Provision for deferred tax — 11,300 3,700 —   —   11,300 Gain on the sale of Improvements — (1,911) (570) —   —   (1,911) Gain on disposal of Gump’s (3,576)   —   — Gain on the sale of property and equipment (11) (4) (167) (97)   (11)   (4) Interest expense related to Series B Participating Preferred Stock redemption price increase — 7,235 — —   —   7,235 Compensation expense related to stock options 184 1,141 1,332 147   184   1,141 Accretion of debt discount 1,098 — — 3,386   1,098   — Changes in assets and liabilities: Accounts receivable (4,093) 2,232 2,207 (1,292)   (4,093)   2,232 Inventories (10,341) 11,700 5,997 (4,197)   (10,341)   11,700 Prepaid catalog costs (3,159) 1,801 1,075 (2,806)   (3,159)   1,801 Accounts payable (13,198) (666) (3,151) (1)   (13,198)   (666) Accrued liabilities 1,911 (11,434) (2,345) (6,832)   1,911   (11,434) Customer prepayments and credits 553 1,478 433 (1,409)   553   1,478 Other, net (1,893) (2,140) (4,848) 1,612   (1,893)   (2,140) Net cash (used) provided by operating activities (17,265) 8,073 4,659 Net cash provided (used) by operating activities 1,026   (17,265)   8,073 CASH FLOWS FROM INVESTING ACTIVITIES:     Acquisitions of property and equipment (840) (1,895) (639) (1,664)   (840)   (1,895) Proceeds from sale of Improvements — 2,000 570 —   —   2,000 Proceeds from disposal of Gump’s 8,921   —   — Costs related to early release of escrow funds — (89) — —   —   (89) Proceeds from sale of property and equipment 14 78 169 106   14   78 Net cash (used) provided by investing activities (826) 94 100 Net cash provided (used) by investing activities 7,363   (826)   94 CASH FLOWS FROM FINANCING ACTIVITIES:     Net borrowings (payments) under Wachovia revolving loan facility 5,411 179 (4,704) Borrowings under Wachovia Tranche B term loan facility — — 3,500 Net (payments) borrowings under Wachovia revolving loan facility (6,342)   5,411   179 Payments under Wachovia Tranche A term loan facility (1,493) (1,991) (1,991) (1,991)   (1,493)   (1,991) Payments under Wachovia Tranche B term loan facility (6,011) (1,800) (1,314) —   (6,011)   (1,800) Borrowings under the Chelsey Facility 7,061 — — —   7,061   — Issuance of Common Stock Warrant to related party 12,939 — — —   12,939   — Payments of capital lease obligations (690) (466) (104) (291)   (690)   (466) Payments of Series C Participating Preferred Stock financing costs — (1,334) — —   —   (1,334) Payments of debt issuance costs (1,045) (910) (722) —   (1,045)   (910) Payment of debt issuance costs to related party (200) — — —   (200)   — Refund (payment) of estimated Richemont tax obligation on Series B Participating Preferred Stock accretion 347 (347) — —   347   (347) Proceeds from issuance of common stock — — 25 Series B Participating Preferred Stock transaction cost adjustment — — 215 Other, net — (1) — —   —   (1) Net cash provided (used) by financing activities 16,319 (6,670) (5,095) Net cash (used) provided by financing activities (8,624)   16,319   (6,670) Net (decrease) increase in cash and cash equivalents (1,772) 1,497 (336) (235)   (1,772)   1,497 Cash and cash equivalents at the beginning of the year 2,282 785 1,121 510   2,282   785 Cash and cash equivalents at the end of the year $           510 $         2,282 $              785 $           275   $         510   $        2,282         Supplemental Disclosures of Cash Flow Information Cash paid during the year for: Interest $        3,340 $         3,325 $           3,405 $        4,256 $         3,340 $           3,325 Income taxes $               9 $            705 $              193 $           314 $                 9 $              705 Non-cash investing and financing activities:             Issuance of Common Stock to related party as payment of waiver fee $           563 $              — $                — $             — $            563 $                — Series B Participating Preferred Stock redemption price increase $             — $         7,575 $         15,556 $             — $              — $           7,575 Redemption of Series B Participating Preferred Stock $             — $     107,536 $                — $             — $              — $       107,536 Issuance of Series C Participating Preferred Stock $             — $       72,689 $                — $             — $              — $         72,689 Issuance of Common Stock in conjunction with Recapitalization $             — $       19,646 $                — $             — $              — $         19,646 Gain on issuance of Series C Participating Preferred Stock $             — $       13,867 $                — $             — $              — $         13,867 Tandem share expirations $           350 $              — $                 54 $             — $            350 $                — Retirement of Treasury Stock $        3,346 $              — $                — $             — $         3,346 $                — Capital lease obligations $             — $         1,459 $                 32 $             — $              — $           1,459   See notes to Consolidated Financial Statements.     HANOVER DIRECT, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ DEFICIENCY For the Years Ended December 31, 2005, December 25, 2004 and December 27, 2003 and December 28, 2002           Notes Receivable from Sale of Common Stock           Notes Receivable from Sale of Common Stock     Capital in Excess of Par Value         Capital in Excess of Par Value       Common Stock     Notes Receivable from Sale of Common Stock Common Stock     Notes Receivable from Sale of Common Stock $0.01 Par Value Accumulated Deficit Treasury Stock $0.01 Par Value Accumulated Deficit Treasury Stock Shares Amount Shares Amount Shares Amount Shares Amount (In thousands of dollars and shares) (In thousands of dollars and shares)                             Restated Balance at December 29, 2001 14,033 $    140 $ 444,976 $(479,888) (210) $ (2,942) $      (405) $(38,119)                 Net loss applicable to common shareholders (26,465)       (26,465) Series B Participating Preferred stock liquidation preference accrual (15,556) 15,556       — Stock options expensed 1,332       1,332 Issuance of Common Stock for employee stock plan 10 25       25 Tandem share expirations (2) (54) 54 — Series B Preferred Stock issuance cost adjustment 215 1 216                 Restated Balance at December 28, 2002 14,043 $    140 $ 430,992 $(490,797) (212) $ (2,996) $      (350) $(63,011) Balance at December 28, 2002 14,043 $    140 $ 430,992 $(490,797) (212) $ (2,996) $      (350) $(63,011)                                 Net loss applicable to common shareholders (27,982)       (27,982) (27,982)       (27,982) Series B Participating Preferred Stock liquidation preference accrual (15,157) 15,157       — (15,157) 15,157       — Stock options expensed 1,141         1,141   1,141         1,141 Gain on Recapitalization, net of issuance costs of $1,334 13,867         13,867 13,867         13,867 Issuance of Common Stock in conjunction with Recapitalization 8,186 82 19,564 19,646 8,186 82 19,564 19,646                                 Restated Balance at December 27, 2003 22,229 $    222 $ 450,407 $(503,622) (212) $ (2,996) $      (350) $(56,339) Balance at December 27, 2003 22,229 $    222 $ 450,407 $(503,622) (212) $ (2,996) $     (350) $(56,339)                                 Net income applicable to common shareholders 4,877       4,877 4,877       4,877 Earnings applicable to Series C Preferred Stock   124       124   124       124 Stock options expensed   184         184   184         184 Issuance of Common Stock for Chelsey Facility waiver fee 434 4 559         563 434 4 559         563 Issuance of Chelsey Common Stock Warrants     12,939         12,939     12,939         12,939 Tandem share expirations (14)       (11) (350) 350 — (14)       (11) (350) 350 — Retirement of Treasury Stock (223) (1) (3,345) 223   3,346 — (223) (1) (3,345) 223 3,346 —                                 Balance at December 25, 2004 22,426 $    225 $460,744 $(498,621) — — — $(37,652) 22,426 $    225 $460,744 $(498,621) — — — $(37,652)                 Net income applicable to common shareholders 11,663       11,663 Earnings applicable to Series C Preferred Stock   294       294 Stock options expensed   147         147                 Balance at December 31, 2005 22,426 $    225 $460,891 $(486,664) — — — $(25,548)   See notes to Consolidated Financial Statements.       HANOVER DIRECT, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years Ended December 31, 2005, December 25, 2004 and December 27, 2003 and December 28, 2002   1. BACKGROUND OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES   Nature of Operations — Hanover Direct, Inc., (the “Company” or we), a Delaware corporation, is a specialty direct marketer that markets a diverse portfolio of home fashions as well as men’s and women’s apparel, and gift products, through mail-order catalogs retail stores and connected Internet websites directly to the consumer (“direct commerce”). The Company also manufactures super-premium down comforters, pillows and featherbeds under the Scandia Down brand name, which are sold through third party luxury retailers in North and South America. In addition, as excess capacity exists within its operating centers,We provide third party, end-to-end, fulfillment, logistics, telemarketing and information technology services to businesses formerly owned by the Company providesand select third party clients with business-to-business (B-to-B) e-commerce transaction services including a full range of order processing, customer care, customer information, and shipping and distribution services. The Company utilizes these services provided to third party clients as a mechanism to absorb certain fixed costs ofcompanies involved in the Company.direct marketing business.   Basis of Presentation — The consolidated financial statements include all subsidiaries of the Company, and all intercompany transactions and balances have been eliminated. The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. All references in these consolidated financial statements to the number of shares outstanding, per share amounts, stock warrants, and stock option data relating to the Company’s common stock have been restated, as appropriate, to reflect the one-for-ten reverse stock split occurring at the close of business on September 22, 2004. See On March 14, 2005, the Company sold all of the stock of Gump’s Corp. and Gump’s By Mail, Inc. (collectively, “Gump’s”) (See Note 94). The Consolidated Statements of Income reflects the Gump’s operating results and gain on sale as discontinued operations. In addition, in the Consolidated Statement of Cash Flows for more information regarding the reverse stock splityear ended December 31, 2005, the change in assets and additional amendments to the Company’s Certificate of Incorporation.liabilities reflects Gump’s as discontinued operations.   Fiscal Year — The Company operates on a 52 or 53-week fiscal year, ending on the last Saturday in December. The year ending December 31, 2005 was reported as a 53-week year, while the years ended December 25, 2004 and December 27, 2003 and December 28, 2002 were reported as 52-week years.   Cash and Cash Equivalents — Cash includes cash equivalents consisting of highly liquid investments with an original maturity of ninety days or less.   Allowance for Doubtful Accounts — An allowance for doubtful accounts is calculated for the Company’s accounts receivable. A combination of historical and rolling bad debt rates are applied to the various receivables maintained by the Company to determine the amount of the allowance to be recorded. The Company also records additional specific allowances deemed necessary by management, based on known circumstances related to the overall receivable portfolio.   Inventories — Inventories consist principally of merchandise held for resale and are stated at the lower of cost or market. Cost, which is determined using the first-in, first-out (FIFO) method, includes the cost of the product as well as capitalized freight-in charges. Raw materials and work in process represented approximately 7%5% and 5%7% of the inventory balance as of December 25, 200431, 2005 and December 27, 2003,25, 2004, respectively. The Company considers slow moving inventory to be surplus and calculates a loss on the impairment as the difference between an individual item’s cost and the net proceeds anticipated to be received upon disposal. The Company utilizes various liquidation vehicles to dispose of aged inventory including special sale catalogs, sale sections within main catalogs, sale sections on the Company’s Internet websites, outlet stores and liquidations through off-price merchants. Such inventory is written down to its net realizable value if the expected proceeds of disposal are less than the cost of the merchandise.   Prepaid Catalog Costs — Prepaid catalog costs consist of direct response advertising costs related to catalog production and mailing. In accordance with Statement of Position 93-7, “Reporting on Advertising Costs,” these costs are deferred and amortized as selling expenses over the estimated period in which the sales related to such advertising are generated. Total selling expenses which includes both the amortization of catalog expense was $99.4 million, $99.0 millioncosts and $104.3 million for 2004, 2003 and 2002, respectively. These costs are included in Sellingother advertising expenses in the Company’s Consolidated Statements of Income (Loss). was $102.0 million, $90.9 million and $89.7 million for 2005, 2004 and 2003, respectively. Prepaid catalog costs at the end of 2005 and 2004 were $17.6 million and $15.6 million, respectively.   Depreciation and Amortization — Depreciation and amortization of property and equipment is computed on the straight-line method over the following lives: buildings and building improvements, 30-40 years; furniture, fixtures and equipment, 3-10 years; and leasehold improvements, over the estimated useful lives or the terms of the related leases, whichever is shorter. Repairs and maintenance are expensed as incurred.   Assets Held under Capital Leases — Assets held under capital leases are recorded at the lower of the net present value of the minimum lease payments or the fair value of the leased asset at the inception of the lease. Amortization expense is computed using the straight-line method over the shorter of the estimated useful lives of the assets or the period of the related lease.   Goodwill — The Company accounts for goodwill in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” which requires that goodwill no longer be amortized but reviewed for impairment if impairment indicators arise and, at a minimum, annually. The Company performs its annual impairment review during its second quarter each fiscal year. The Company performs a review, at a total company-wide level since the Company is viewed as one segment, of long-lived assets using a fair-value approach utilizing appraisals to determine if impairment exists. The fair value is determined using a combination of market and discounted cash flow approaches.   Impairment of Long-lived Assets — In accordance with SFAS No.144, “Accounting for the Impairment or Disposal of Long-lived Assets” (“SFAS 144”), the Company reviews long-lived assets, other than goodwill, for impairment whenever events indicate that the carrying amount of such assets may not be fully recoverable. The Company performs a review, at a total company-wide level since the Company is viewed as one segment, of long-lived assets using a fair-value approach utilizing appraisals to determine if impairment exists. If impairment is determined to exist, any related impairment loss is calculated based on fair value, which is generally based on discounted future cash flows.   Reserves and accruals related to loss contingencies, litigation and legal expenses — The Company accrues for potential litigation losses when management determines that it is probable that an unfavorable outcome will result and the loss is reasonably estimable in accordance with SFAS No. 5, “Accounting for Contingencies.” In addition, when a loss contingency is accrued pursuant to SFAS 5, the Company’s policy is to accrue for all of the related legal fees as contemplated in EITF D-77, “Accounting for Legal Costs Expected to Be Incurred in Connection with a Loss Contingency.” For the year ended December 30, 2000, the Company used estimates to determine the liability related to Rakesh Kaul’s claims regarding benefits to which he was entitled as a result of his resignation as CEO on December 5, 2000, which resulted in an accrual of $5.0 million. As part of the restatement as discussed in Note 2, the Company corrected two accounting errors related to the Rakesh Kaul liability.   Reserves related to the Company’s strategic business realignment program — The reserves established by the Company related to its strategic business realignment program include employee severance and related costs, facility exit costs and estimates primarily associated with the potential subleasing of leased properties which have been vacated by the Company. The overall reserves for leased properties that have been vacated by the Company are developed using estimates that include the potential ability to sublet leased but unoccupied properties, the length of time needed to obtain suitable tenants and the amount of rent to be received for the sublet. Real estate broker representations regarding current and future market conditions are sometimes used in estimating these items. See Note 5 for additional information regarding the reserves.   Reserves related to employee health and welfare claims — The Company maintains a self-insurance program related to losses and liabilities associated with employee health and welfare claims. Stop-loss coverage is held on both an aggregate and individual claim basis; thereby, limiting the amount of losses the Company will experience. Losses are accrued based upon estimates of the aggregate liability for claims incurred using the Company’s experience patterns. At December 25, 200431, 2005 and December 27, 2003,25, 2004, the Company had an accrued liability recorded in the amount of $0.6 million.   Employee Benefits — Vacation and Sick Compensation — 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 and sick benefits. Under the new policy, vacation and sick benefits are deemed earned and thus accrued ratably throughout the fiscal year and employees must utilize all vacation and sick earned by the end of the same year. Generally, any unused vacation and sick benefits not utilized by the end of a fiscal year will be forfeited. Before the establishment of this new policy, employees earned vacation and sick in the twelve months prior to the year that it would be utilized. The policy has been modified in certain locations to comply with state and local laws or written agreements. As a result of the transition to this new policy, the Company recognized a benefit of approximately $1.6 million in 2003. Approximately $0.8 million of both general and administrative expenses and operating expenses was reduced as a result of the recognition of this benefit for the year ended December 27, 2003.   Cost of Sales and operating expenses — Cost of sales and operating expenses in the Consolidated Statements of Income (Loss) include the cost of merchandise sold and merchandise delivery expenses in addition to fulfillment, telemarketing and information technology expenses. Merchandise delivery expenses consist of the cost to ship packages to the customer utilizing a variety of shipping services, as well as the cost of packaging the merchandise for shipment. Total merchandise postage expense for 2005, 2004 and 2003 and 2002 was $36.5$45.0 million, $39.9$34.8 million and $41.6$37.6 million, respectively. These costs are recognized upon receipt of delivery by the customer and are included in Cost of sales and operating expenses in the Company’s Consolidated Statements of Income (Loss). The total costscost of merchandise sold and merchandise postage expense deferred for shipments in transit for 2005 and 2004 and 2003 were $1.8$1.6 million and $1.3$1.7 million, respectively.   General and administrative expenses — General and administrative expenses in the Consolidated Statements of Income (Loss) reflect payroll and benefit expenses for the catalog and corporate management personnel, costs associated with the New Jersey facilities as well as professional fees and other corporate expenses.   Stock-Based Compensation — The Company accounts for its stock-based compensation to employees using the fair value-based methodology under SFAS No. 123, “Accounting for Stock-Based Compensation.”   Income Taxes — The Company accounts for income taxes in accordance with SFAS No. 109, “Accounting for Income Taxes.” SFAS No. 109 requires an asset and liability approach for financial accounting and reporting of income taxes. The provision for income taxes is based on income after adjustment for those temporary and permanent items that are not considered in the determination of taxable income. The gross deferred tax asset is the total tax benefit available from net operating loss carryovers and temporary differences. A valuation allowance is calculated, based on the Company’s projections of its future taxable income, to establish the amount of deferred tax asset that the Company is expected to utilize on a “more-likely-than-not” basis. A deferred tax liability represents future taxes that may be due arising from the reversal of temporary differences. In 2003, due to a number of factors, including the annual limitation on utilization of net operating losses caused by the Chelsey Direct, LLC (“Chelsey”) purchase of Richemont Finance, S.A.’s (“Richemont”) stockholdings in the Company during the year (see Note 8)9), and lower projections of taxable income for future years, the Company made a decision to fully reserve the remaining net deferred tax asset (the gross deferred tax asset net of the then existing valuation allowance and deferred tax liability) by increasing the valuation allowance and recorded an $11.3 million deferred income tax provision. At December 25, 2004,31, 2005, the Company’s net deferred tax asset remains fully reserved with no additional deferred income tax provision required.   Net Income (Loss) Per Share — Net income (loss) per share is computed using the weighted average number of common shares outstanding in accordance with the provisions of SFAS No. 128, “Earnings Per Share.” Basic net income (loss) per common share is calculated by dividing net income (loss) available to common shareholders, reduced for participatory interests, by the weighted average number of common shares outstanding during the period. Diluted net income (loss) per common share is calculated using the weighted average number of common shares outstanding adjusted to include the potentially dilutive effect of stock options and stock warrants. The computations of basic and diluted net income (loss) per common share are as follows (in thousands except per share amounts):             December 31, 2005     December 25, 2004     December 27, 2003               Net income (loss)   $            11,957   $              5,001   $          (20,060) Less:             Preferred stock dividends   --   --   7,922 Earnings applicable to preferred stock   294   124   -- Net income (loss) applicable to common shareholders     $            11,663     $              4,877     $          (27,982) Basic net income (loss) per common share   $                0.52   $                0.22   $              (1.94)               Weighted-average common shares outstanding     22,426     22,220     14,439               Diluted net income (loss)   $            11,663   $               4,877   $          (27,982) Diluted net income (loss) per common share     $                0.36     $                 0.18     $              (1.94)               Weighted-average common shares outstanding     22,426     22,220     14,439 Effect of Dilution:             Stock options   2   9   -- Stock warrants   10,160   4,786   -- Weighted-average common shares outstanding assuming dilution     32,588     27,015     14,439       December 25, 2004   December 27, 2003 As Restated   December 28, 2002 As Restated                     Net income (loss)   $              5,001   $    (20,060)   $       (10,909) Less:             Preferred stock dividends   --   7,922   15,556 Earnings applicable to preferred stock   124   --   --         Net income (loss) applicable to common shareholders   $              4,877   $    (27,982)   $       (26,465)         Basic net income (loss) per common share   $                0.22   $        (1.94)   $           (1.91)                       Weighted-average common shares outstanding   22,220   14,439   13,828                       Diluted net income (loss)   $              4,877   $    (27,982)   $       (26,465)         Diluted net income (loss) per common share   $                0.18   $        (1.94)   $           (1.91)                       Weighted-average common shares outstanding   22,220   14,439   13,828 Effect of Dilution:             Stock options   9   --   -- Stock warrants   4,786   --   --         Weighted-average common shares outstanding assuming dilution     27,015     14,439     13,828           Diluted net loss per common share excluded incremental weighted-average shares of 20,979 and 93,318 for the yearsyear ended December 27, 2003 and December 28, 2002, respectively.2003. These incremental weighted-average shares were related to employee stock options and were excluded due to their anti-dilutive effect. Options for which the exercise price was greater than the average market price of common shares as of the fiscal years ended 2005, 2004 and 2003 were not included in the computation of diluted earnings per share as the effect would be antidilutive. These consisted of options totaling 1,069,600 shares, 1,270,883 shares and 1,388,145 shares, respectively.   Revenue Recognition   — Direct Commerce: The Company recognizes revenue for catalog and Internet sales at the time merchandise is received by the customer, net of estimated returns in accordance with the provisions of Staff Accounting Bulletin (“SAB”) No. 101, “Revenue Recognition in Financial Statements,” as amended by SAB No. 104, “Revenue Recognition.” Delivery and service charges billed to customers are also recognized as revenue at the time merchandise is received by the customer. The Company’s revenue recognition policy includes the use of estimates for the time period between shipment of merchandise by the Company and receipt of merchandise by the customer and the future amount of returns to be received on the current period’s sales. The Company accrues for expected future returns that relate to sales prior to the balance sheet date utilizing a combination of historical and current trends. During October 2003, the Company modified its returns policy, which previously allowed unlimited returns, by adopting a policy that limits returns to a maximum of ninety days after the sale of the merchandise.   — Membership Services: Customers may purchase memberships in a number of the Company’s Buyers’ Club programs for an annual fee. For memberships purchased during the following periods, certain of the Buyers’ Club programs contained a guarantee that the customer would receive discounts or savings, at least equal to the cost of his or her membership or we would refund the difference with a merchandise credit at the end of the membership period period: Silhouettes from July 1998 through March 2004; Domestications from April 2002 through March 2004; and Men’s Apparel from April 2003 through March 2004. In the first quarter of 2004, we identified a potential issue with the accounting treatment for Buyers’ Club memberships that contained a guarantee. At that time, an inappropriate conclusion was reached and during the third quarter of 2004, the issue was re-evaluated and we determined an error in the accounting treatment had occurred. The Company identified guarantee obligations to members of certain of the Company’s Buyers’ Club programs for its catalogs. The impact of the error resulted in the overstatement of revenues and the omission of the related liability for guarantee obligations. The proper accounting treatment was applied to all periods impacted including a calculation of the cumulative impact of the error on previously reported periods. See Note 2 for further explanation and amounts. Currently, and as reflected by the restatement of the Company’s consolidated financial statements, for memberships purchased during the periods in which the Buyers’ Club memberships contained a guarantee, revenue net of actual cancellations was recognized on a monthly basis over the membership period subsequent to the end of the thirty-day cancellation period, with the revenue recognized equal to the lesser of the cumulative amount determined using the straight-line method or the actual benefit received by each customer as of the end of each period. For the Buyers’ Club memberships that did not contain a guarantee, revenue net of actual cancellations was recognized on a monthly basis over the membership period subsequent to the end of the thirty-day cancellation period, using the straight-line method. We also receive commission revenue related to our solicitation of the Vertrue membership programs. The Company receives a monthly commission based on the number of memberships sold with additional revenue recognized if certain program performance levels are attained for each fiscal year. The additional revenue is not recognized until the performance level is attained. Until March 21, 2006, we marketed membership programs under an agreement with MemberWorks, Incorporated (now known as “Vertrue”). After the expiration of the agreement with Vertrue, we began offering membership programs provided by Encore Marketing International (“Encore”) under a two year agreement. Under our agreement with Encore, we are paid a commission for each customer who places an order for a membership program and a renewal commission for each member who is still a member at the end of the member’s then current membership year. We received commission revenue from the Magazine Direct magazine subscription program through May 2003 when the program was discontinued. The commission revenue recognized by the Company for the Magazine Direct magazine program was on a per-solicitation basis according to the number of solicitations made, with additional revenue recognized if the customer accepted the solicitation. Collectively, the amount of revenues the Company received from these sources was $14.3 million, or 3.5% of net revenues, $10.3 million, or 2.8% of net revenues, and $9.3 million, or 2.5% of net revenues $9.3 million, or 2.2% of net revenues,in 2005, 2004 and $10.3 million, or 2.2% of net revenues in 2004, 2003, and 2002, respectively.   — B-to-B Services: Revenues from the Company’s e-commerce transaction services are recognized as the related services are provided. Customers are charged on an activity unit basis, which applies a contractually specified rate according to the type of transaction service performed. Revenues recorded from the Company’s B-to-B services were $32.9 million, or 8.1% of net revenues, $20.8 million, or 5.2% of net revenues, $20.0 million, or 4.8%5.8% of net revenues, and $20.1$20.0 million, or 4.4%5.4% of net revenues, for 2005, 2004 2003 and 2002,2003, respectively.   — Financial Instruments: The carrying amounts for cash and cash equivalents, accounts receivable, accounts payable, short- and long-term debt (including the Wachovia Facility and excluding the Chelsey Facility) and capital lease obligations approximate fair value due to the short maturities of these instruments. The carrying amounts for long-term debt related to the Chelsey Facility are net of the remaining un-accreted debt discount of $11.8$8.5 million. The fair value of the long-term debt related to the Chelsey Facility is approximately equal to the gross amount outstanding under the facility of $20.0 million since the interest rate on this loan is a floating rate of 5.0% above the prime rate publicly announced by Wachovia.   In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” (“SFAS 150”). SFAS 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability, many of which had been previously classified as equity or between the liabilities and equity sections of the Consolidated Balance Sheet. The provisions of SFAS 150 were effective for financial instruments entered into or modified after May 31, 2003, and otherwise were effective at the beginning of the first interim period beginning after June 15, 2003. The Company adopted the provisions of SFAS 150, which resulted in the reclassification of its Series B Participating Preferred Stock (“Series B Preferred”) to a liability rather than between the liabilities and equity sections of the Consolidated Balance Sheet. Based upon the requirements set forth by SFAS 150, this reclassification was subject to implementation beginning on June 29, 2003. Upon implementation of SFAS 150, the Company reflected subsequent increases in liquidation preference of the Series B Preferred as an increase in Total Liabilities with a corresponding reduction in capital in excess of par value, because the Company has an accumulated deficit. Accretion was recorded as interest expense. Net Income (Loss) Applicable to Common Shareholders and Net Income (Loss) Per Common Share remains unchanged in comparison with the Company’s classification of the instrument prior to June 29, 2003. On November 30, 2003, the Company and Chelsey consummated the transactions contemplated by a Recapitalization Agreement, dated as of November 18, 2003 under which the Company recapitalized, completed the reconstitution of its Board of Directors and outstanding litigation between the Company and Chelsey was settled (the “Recapitalization”). As part of the Recapitalization, the Company exchanged the Series B Preferred for Series C Preferred Stock, which was recorded at its maximum amount of the liquidation preference. Therefore, there have been no preferred stock dividends recorded since November 30, 2003. See Note 8 for additional information regarding the Recapitalization. New Accounting Pronouncements On March 31, 2004, the Financial Accounting Standards Board (“FASB”) issued Emerging Issues Task Force Issue No. 03-6 (“EITF 03-6”), “Participating Securities and the Two-Class Method under FASB Statement No. 128.” SFAS 128 defines earnings per share (“EPS”) as “the amount of earnings attributable to each share of common stock” and indicates that the objective of EPS is to measure the performance of an entity over the reporting period. SFAS 128 addresses conditions under which a participating security requires the use of the two-class method of computing EPS. The two-class method is an earnings allocation formula that treats a participating security as having rights to earnings that otherwise would have been available to common shareholders, but does not require the presentation of basic and diluted EPS for securities other than common stock. The Company’s Series C Preferred is a participating security and, therefore, we calculate EPS utilizing the two-class method, however, have chosen not to present basic and diluted EPS for its preferred stock.   In November 2004, the FASB issued SFAS No. 151, “Inventory Costs, an Amendment of ARB No. 43, Chapter 4” (“SFAS 151”), which clarifies the accounting for abnormal amounts of idle facility expense, freight, handling costs and spoilage. We are required to adoptThe Company has adopted the provisions of SFAS 151 effective January 1, 2006; however, early2006 and does not expect that such adoption is permitted. We are currently inwill have a material effect on the processCompany’s results of determining the impact of the adoption of this Statement on ouroperations or financial statements.position.   In December 2004, the FASB issued SFAS No. 123R, “Share Based Payment” (“SFAS 123R”). SFAS 123R requires measurement and recording of compensation expense for all employee share-based compensation awards using a fair value method. The Company currently accounts for its stock-based compensation to employees using the fair value-based methodology under SFAS 123. We are currently assessingThe Company has adopted the impactprovisions of SFAS 123R effective January 1, 2006 and does not expect that such adoption will have a material effect on the adoptionCompany’s results of this Statement.operations or financial position.   In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections” (“SFAS 154”), which changes the requirements for the accounting for and reporting of a change in accounting principle. We are required to adopt the provisions of SFAS 154 effective January 1, 2006; however, early adoption is permitted.2006. The Company is currently assessinghas adopted the impactprovisions of the adoption of this Statement.SFAS 154 and does not expect any current impact.   2. PRIOR RESTATEMENT OF FINANCIAL STATEMENTS AND OTHER RELATED MATTERS   We have restated the consolidated financial statements for the fiscal years ended December 27, 2003 and December 28, 2002 which were included in thisthe Annual Report on Form 10-K.10-K filed for the 2004 fiscal year filed on February 21, 2006. We have also restated the quarterly financial information for fiscal 2003 and the first two quarters of fiscal 2004 (collectively, the “Restatement”). Buyers’ Club Program. In The Restatement corrected errors in the first quarter of 2004, former management identified a potential issue with the accountingaccount treatment of discount obligations due(i) a guarantee related to members of certain of the Company’s buyers’ clubour Buyer’s Club programs, and at that time, an inappropriate conclusion regarding the accounting treatment was reached. During the third quarter of 2004, the issue was re-evaluated and we determined that an error in the accounting treatment had occurred. The impact of the error resulted in the overstatement of revenues and the omission of a liability related to the guarantee for discount obligations. The proper accounting treatment has been applied to all periods impacted including a calculation of the cumulative impact of the error on previously reported periods. Revenue Recognition Issues. During the second quarter of 2004, the Company identified a(ii) our revenue recognition cut-off issue that resulted in revenue being recorded in advance of the actual shipment ofpolicies on shipped merchandise, (iii) a reserve relating to the customer.claims for post employment benefits, (iv) customer prepayments and credits, and (v) certain other accruals. The practice was stopped immediately. Subsequently, the Company determined that revenue should be recognized when merchandise is received by the customer rather than when shipped because the Company routinely replaces customer merchandise damaged or lost in transit as a customer service matter (even though risk of loss, as a legal matter, passes on shipment). As a consequence, the Company has restated all periods presented to recognize revenue when merchandise is received by the customer. Kaul Accrual. During the year ended December 30, 2000, the Company estimated its liability related to Rakesh Kaul’s claims regarding benefits to which he was entitled as a result of his resignation as CEO on December 5, 2000. The accompanying consolidated financial statements contain a restatement related to the Kaul reserve that corrects two errors in the accounting treatment of the reserve. The first error identified was the premature reversal of the reserve in the fourth quarter of 2003 based upon the summary judgment decision in January 2004. As noted above, because this decision could be, and subsequently was, appealed, management has determined that the reversal was premature. The second error identified was the accounting for legal fees associated with litigating this claim. Due to the fact that the Kaul reserve was recorded prior to the initiation of litigation, the Company has determined that the appropriate basis of accounting for the legal fees related to the litigation would have been to treat such fees as period costs and, therefore, expensed as incurred. However, the Company had inappropriately recorded certain of these fees against the reserve as opposed to recording them as an expense in the income statement. As of December 25, 2004, the Company had accrued $4.5 million related to this matter. This accrual remained on the Company’s Consolidated Balance Sheet until the third quarter of 2005 when Kaul’s rights to pursue this claim expired. Customer Prepayments and Credits. Starting in fiscal 2001, the Company inappropriately reduced the liability for certain customer prepayments and credits. The impact of the inappropriate reduction of this liability resulted in the understatement of general and administrative expenses and the omission of the related liability. During the fourth quarter of 2004, the Company re-evaluated the accounting treatment for these customer prepayments and credits. As a consequence, the Company has applied the proper accounting treatment to all periods impacted including recording a liability in each respective previously reported period equivalent to the cumulative impact of the error. Other Accruals. The Company has recorded other liabilities relating primarily to certain miscellaneous catalog costs and other miscellaneous costs that were inappropriately not accrued in the appropriate periods. The summary ofreflect the effects of the Restatement, inclusive of any tax implications, on the Company’s annual consolidated financial statements is as follows:     Year ended December 27, 2003       As Previously Reported   Buyers’ Club Adjustment   Revenue Recognition Adjustments   Kaul Accrual Adjustment Customer Prepayments and Credit Adjustments   Other Accrual Adjustments       As Restated         (In thousands, except per share amounts) Inventories   $      41,576 -- 1,230 -- -- -- $        42,806 Prepaid catalog costs   $      11,808 -- 677 -- -- -- $        12,485 Other current assets   $        3,951 -- 288 -- -- -- $          4,239 Total current assets   $      73,952 -- 2,195 -- -- -- $        76,147 Deferred tax asset   $        1,453 -- 316 -- -- -- $          1,769 Accounts payable   $      41,880 -- -- -- -- 862 $        42,742 Accrued liabilities   $      12,918 -- (184) 4,354 -- -- $        17,088 Customer prepayments and credits   $        5,485 1,897 3,230 -- 867 -- $        11,479 Deferred tax liability   $        1,453 -- 316 -- -- -- $          1,769 Total current liabilities   $      75,204 1,897 3,362 4,354 867 862 $        86,546 Accumulated deficit   $ ( 494,791) (1,897) (851) (4,354) (867) (862) $    (503,622) Total shareholders’ deficiency   $    (47,508) (1,897) (851) (4,354) (867) (862) $      (56,339) Net revenues   $    414,874 (899) 308 -- -- -- $      414,283 Cost of sales and operating expenses   $    261,118 -- 179 -- -- -- $      261,297 Selling expenses   $      99,543 -- 150 -- -- 278 $        99,971 General and administrative expenses   $      42,080 -- 4 3,297 114 48 $        45,543 Income before interest and income taxes   $        8,017 (899) (25) (3,297) (114) (326) $          3,356 Net loss and comprehensive loss   $    (15,399) (899) (25) (3,297) (114) (326) $      (20,060) Net loss applicable to common shareholders   $    (23,321) (899) (25) (3,297) (114) (326) $      (27,982) Net loss per share-basic and diluted   $       (1.62) (0.06) (0.00) (0.23) (0.01) (0.02) $         (1.94)     Year ended December 28, 2002       As Previously Reported   Buyers’ Club Adjustment   Revenue Recognition Adjustments   Kaul Accrual Adjustment Customer Prepayments and Credit Adjustments   Other Accrual Adjustments       As Restated         (In thousands, except per share amounts) Accumulated deficit   $   (486,627) (998) (826) (1,057) (753) (536) $      (490,797) Total shareholders’ deficiency   $     (58,841) (998) (826) (1,057) (753) (536) $        (63,011) Net revenues   $      457,644 (306) (348) -- -- -- $        456,990 Cost of sales and operating expenses   $      290,531 -- (148) -- -- -- $        290,383 Selling expenses   $      105,239 -- (86) -- -- 295 $        105,448 General and administrative expenses   $       52,258 -- (4) 777 261 30 $          53,322 Income (loss) before interest and income taxes   $           138 (306) (110) (777) (261) (325) $         (1,641) Net loss and comprehensive loss   $       (9,130) (306) (110) (777) (261) (325) $        (10,909) Net loss applicable to common shareholders   $     (24,686) (306) (110) (777) (261) (325) $        (26,465) Net loss per share-basic and diluted   $        (1.79) (0.02) (0.01) (0.05) (0.02) (0.02) $           (1.91)     Year ended December 29, 2001       As Previously Reported   Buyers’ Club Adjustment   Revenue Recognition Adjustments   Kaul Accrual Adjustment Customer Prepayments and Credit Adjustments   Other Accrual Adjustments       As Restated         (In thousands) Accumulated deficit   $    (477,497) (692) (716) (280) (492) (211) $    (479,888) Total shareholders’ deficiency   $      (35,728) (692) (716) (280) (492) (211) $      (38,119) The Restatement did not result in a change to the Company’s cash flows during the restated periods.Restatement.   As further discussed below in Note 18, as a result of the Restatement, the Audit Committee of the Board of Directors hired independent outside counsel to assist with an investigation of certain of the matters relating to the restatements of the Company’s consolidated financial statementsRestatement and other accounting-related matters. The Securities and Exchange Commission (“SEC”) also informed the Company that it was conducting an informal inquiry.inquiry which is ongoing. The Company’s common stock was formally suspended from trading on the American Stock Exchange (the “AMEX”) on February 2, 2005 as a result of the Company’s inability to comply with the AMEX’s continued listing standards and because the Company did not file on a timely basis its Form 10-Q for the fiscal quarter ended September 25, 2004 which in turn was attributable to the Restatement. The Common Stock was removed from listing and registration on the AMEX effective February 16, 2005. Current trading information about the Company’s common stock can be obtained from the Pink Sheets (www.pinksheets.com) under the trading symbol HNVD.PK.   3. DIVIDEND RESTRICTIONS   The Company is restricted from paying dividends on its Common Stock or from acquiring its Common Stock by covenants contained in loan agreements to which the Company is a party.   4. DIVESTITURES Sale of Gump’s On March 14, 2005, the Company sold all of the stock of Gump’s to Gump’s Holdings, LLC (“Purchaser”) for $8.9 million, including a purchase price adjustment of $0.4 million, pursuant to the terms of a February 11, 2005 Stock Purchase Agreement. The Company recognized a gain of approximately $3.6 million in the quarter ended March 26, 2005. Chelsey Direct, LLC (“Chelsey”), as the holder of all of the Series C Participating Preferred Stock (“Series C Preferred”), consented to the application of the sales proceeds to reduce the outstanding balance of the credit facility provided by Wachovia National Bank (“Wachovia”) in lieu of the current redemption of a portion of the Series C Preferred. Chelsey expressly retained its right to require redemption of approximately $6.9 million of the Series C Preferred subject to Wachovia’s approval. After the sale, the Company continued as the guarantor of one of the two leases for the San Francisco building where the store is located (the Company was released from liability on the other lease). The Purchaser is required to use its commercially reasonable efforts to secure the Company’s release from the guarantee within a year of the closing. If the Purchaser cannot secure the Company’s release within a year of the closing, an affiliate of the Purchaser will either (i) transfer a percentage interest in its business so that the Company will own, indirectly, 5% interest of the Purchaser’s common stock, or (ii) provide the Company with a $2.5 million stand-by letter of credit or other form of compensation acceptable to the Company to reimburse the Company for any liabilities the Company may incur under the guarantee until the Company is released from the guarantee or the lease is terminated. As of March 6, 2006 there are $6.8 million (net of $0.5 million in expected sublease income) in lease commitments for which the Company is the guarantor. Based on its evaluation, the Company has concluded it is unlikely any payments will be required under the guarantee, thus had not established a guarantee liability as of the March 14, 2005 sale date or as of December 31, 2005. To date the Purchaser has not secured the Company’s release from the guarantee and the Company has started negotiations with the Purchaser on an acceptable form of compensation. The Company entered into a Direct Marketing Services Agreement with the Purchaser to provide telemarketing and fulfillment services for the Gump’s catalog and direct marketing businesses for 18 months. We have the option to extend the term for an additional 18 months. Listed below are the carrying values of the major classes of assets and liabilities of Gump’s included in the Consolidated Balance Sheets: In thousands (000’s) December 25, 2004 Total current assets $          10,842 Total non-current assets $            3,221 Total assets $          14,063 Total current liabilities $            6,727 Total non-current liabilities $            3,283 Total liabilities $          10,010 Listed below are the revenues and income before income taxes included in the Consolidated Statements of Income (these results exclude certain corporate overhead charges allocated to Gump’s for services provided by the Company to run the business):     In thousands (000’s) For the Year Ended December 31, 2005 For the Year Ended December 25, 2004 For the Year Ended December 27, 2003 Net revenues $                     7,241 $                   42,634 $                 44,188 Income before income taxes   $                   2,974a   $                     2,967   $                   1,215 a) Includes a gain on disposal of $3,576 at December 31, 2005 Sale of Improvements Catalog   On March 27, 2003, the Company and HSN, a division of USA Networks, Inc.’s Interactive Group and purchaser of certain assets and liabilities of the Company’s Improvements business on June 29, 2001, 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. The asset purchase agreement had provided that if the Company’s subsidiary, Keystone Internet Services LLC (“Keystone”) failed to perform its obligations during the first two years of the services contract, HSN could receive a reduction in the original purchase price of up to $2.0 million. By agreeing to the termsAs part of the amendment, HSN forfeited its ability to receive a reduction in the original purchase price. In consideration for the release,price and Keystone issued a credit to HSN for $100,000, which could be applied by HSN against any invoices of Keystone to HSN.$0.1 million. This credit was utilized by HSN during March 2003. On March 28, 2003, the remaining $2.0 million escrow balance was received by the Company, thus terminating the escrow agreement.   During 2002, the Company recognized approximately $0.6 million of the deferred gain consistent with the terms of the escrow agreement. Proceeds related to the deferred gain were received on July 2, 2002 and December 30, 2002 for $0.3 million and $0.3 million, respectively. The Company recognized the remaining net deferred gain of $1.9 million upon 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.   5. SPECIAL CHARGES   2004 Plan     On June 30, 2004 the Company announced its plan to consolidate the operations of the LaCrosse, Wisconsin fulfillment center and storage facility into the Roanoke, Virginia fulfillment center by June 30, 2005. The LaCrosse fulfillment center and the storage facility were closed in June 2005 and August 2005, upon the expiration of their respective leases. The plan to consolidate operations was prompted by excess capacity at the Roanoke facility and the lack of sufficient warehouse space in the leased Wisconsin facilities to support the growth of The Company Store and reduce the overall cost structure of the Company. The Company substantially completed the consolidation ofinto the Roanoke, Virginia fulfillment center by the end of June 2005. The Company has incurred approximately $0.6$0.8 million in facility exit costs from the date of the announcement through June 25,December 31, 2005. The Company accrued $0.5 million in severance and related costs during 2004 associated with the LaCrosse operations and the elimination of 149 full and part-time positions, of which 96 employees will behave been or are being provided severance benefits by the Company. Since the consolidation of our fulfillment centers, our Roanoke fulfillment center has experienced high levels of employee turnover and lower productivity that has negatively impactedresulted in higher costs being incurred in the fulfillment costscenter. This trend of high levels of employee turnover and lower productivity continued through the Company’s overall performance.end of fiscal 2005 and is expected to continue during 2006.   On November 9, 2004, the Company decided to relocate its International Male and Undergear catalog operations to its offices in New Jersey. The Company completed the relocation on February 28, 2005. The relocation was done primarily to consolidate operations, reduce costs, and leverage its catalog expertise in New Jersey. The Company accrued $0.9 million in severance and related costs during the fourth quarter 2004 associated with the elimination of 32 California-basedCalifornia based full-time equivalent positions. Since the relocation and consolidation of the Men’s apparel catalogs, the transition has negatively impacted the performance of the Men’s apparel catalogs in 2005.   Pursuant toDuring 2005, the reserve activity represents the utilization of the severance reserves established in 2004 for the LaCrosse fulfillment center and in conjunction withstorage facility and the above actions to reduce overhead costs, the Company eliminated anInternational Male and Undergear catalog operations as well as additional 15 full-time positions Company-wide, for which the Company accrued $0.3 million innet severance and related costs during the fourth quarterreductions of 2004.less than $0.1 million.   2000 Plan   In December 2000, the Company began a strategic business realignment program that resulted in the recording of special charges for severance, facility exit costs and fixed asset write-offs. 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 return to profitability.   In May 2002, the Company entered into an agreement with the landlord and the sublandlord to terminate its sublease of the Company’s closed 746,000 square foot warehouse and telemarketing facility located in Maumelle, Arkansas. The agreement provided for the payment by the Company to the sublandlord of $1.8 million. The Company’s previously established reserves for Maumelle, Arkansas were adequate based upon the terms of the final settlement agreement. In 2002, special charges relating to the strategic business realignment program were recorded in the amount of $4.4 million. These charges consisted of $1.8 million of severance costs related to the Company’s strategic business realignment program, and $1.3 million of additional facility exit costs resulting from the integration of The Company Store and Domestications divisions. The remaining $1.3 million consisted primarily of a $0.4 million credit reflecting the reduction of the deferred rental liabilities applicable to the portions of the facilities previously included in the Company’s strategic business realignment program, and a $1.7 million charge in order to properly reflect the current marketability of such facilities in the rental markets. In 2003, special charges were recorded in the amount of $1.3$0.2 million primarily for additional severance costs associated with the Company’s strategic business realignment program and to revise estimated losses related to sublease arrangements for Gump’s office facility in San Francisco, California, as a result of the loss of a subtenant, coupled with declining market values in that area of the country. During 2004, special charge credits were recorded in the amount of $0.1 million. These credits consisted principally of reductions of estimated losses on the sublease arrangements for the office facility in San Francisco due to the acquisition of additional subtenants for the vacant space.program.   Plan Summary   At December 25, 2004,31, 2005, a current liability of approximately $2.5less than $0.1 million was included within Accrued Liabilities and a long-term liability of approximately $2.4 million was included within Other Non-Current Liabilities relating to future payments in connection with the Company’s 2000 and 2004 plans. They are expected to be satisfied no later than February 2010 and consistIt consists of the following (in thousands):     Severance & Personnel Costs   Real Estate Lease & Exit Costs   Information Technology Leases               2004 Plan 2000 Plan   2000 Plan   2000 Plan   Total                     Balance at December 28, 2002   $              -- $       1,452   $        6,417   $             163   $          8,032 2003 expenses Gump’s 2003 charges Gump’s Paid in 2003   -- -- -- 149 142 --   62 951 (513)   -- -- --   211 1,093 (513) Paid in 2003   -- (1,538)   (1,328)   (163)   (3,029) Balance at December 27, 2003   $              -- $          205   $        5,589   $                --   $          5,794 2004 expenses (reductions) Gump’s 2004 (reductions) Gump’s Paid in 2004   1,664 -- -- -- (31) --   20 (117) (786)   -- -- --   1,684 (148) (786) Paid in 2004   (146) ( 174)   (1,346)   --   (1,666) Balance at December 25, 2004   $       1,518 $              --   $        3,360   $                --   $          4,878 2005 expenses (reductions) Gump’s Paid in 2005   (69) -- -- --   -- (63)   -- --   (69) (63) Paid in 2005   (1,428) --   (475)   --   (1,903) Reductions due to sale of Gump’s     --   --     (2,822)     --     (2,822) Balance at December 31, 2005   $            21 $              --   $                 --   $                --   $             21                           Severance & Personnel Costs   Real Estate Lease & Exit Costs   Information Technology Leases               2004 Plan 2000 Plan   2000 Plan   2000 Plan   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   -- 291   1,013   --   1,304 Paid in 2003   -- (1,538)   (1,841)   (163)   (3,542)           Balance at December 27, 2003   $              -- $          205   $          5,589   $                --   $          5,794 2004 expenses   1,664 --   --   --   1,664 2004 revisions of previous estimate   -- (31)   (97)   --   (128) Paid in 2004   (146) (174)   (2,132)   --   (2,452)           Balance at December 25, 2004   $       1,518 $              --   $          3,360   $                --   $          4,878                                 The following is a summary of the liability related to real estate lease and exit costs, by location, as of December 25, 2004 and December 27, 2003 and includes lease and exit costs related to the Gump’s operations that were sold on March 14, 2005 (in thousands):         December 25, 2004     December 27, 2003                 Gump’s facility, San Francisco, CA   $              2,885   $            3,788 Corporate facility, Weehawken, NJ   386   1,447 Corporate facility, Edgewater, NJ   68   261 Administrative and telemarketing facility, San Diego, CA   21   93       Total Real Estate Lease and Exit Costs   $             3,360   $             5,589       December 25, 2004 Gump’s facility, San Francisco, CA $              2,885 Corporate facility, Weehawken, NJ 386 Corporate facility, Edgewater, NJ 68 Administrative and telemarketing facility, San Diego, CA 21 Total Real Estate Lease and Exit Costs $              3,360   6. ACCRUED LIABILITIES   Accrued liabilities consist of the following (in thousands):   December 25, 2004     December 27, 2003 As Restated     December 31, 2005     December 25, 2004 Special charges $        2,460   $         2,362 $              21   $         2,460 Reserve for future sales returns 1,985   1,981 2,240   1,985 Compensation and benefits 5,670   4,341 4,836   5,670 Income and other taxes 470   258 149   470 Litigation and other related accruals 5,023   4,554 78   5,023 Other 4,927   3,592   Other (1) 5,017   4,927 Total $      20,535   $       17,088 $      12,341   $       20,535   (1) Other consists of items that are individually less than 5% of current liabilities.   7. DEBT   The Company has two credit facilities: a senior secured credit facility (the “Wachovia Facility”) provided by Wachovia National Bank, as successor by merger to Congress Financial Corporation (“Wachovia”) and a $20.0 million junior secured facility (the “Chelsey Facility”), provided by Chelsey Finance, LLC (“Chelsey Finance”), of which the entire $20.0 million was borrowed by the Company. Chelsey Finance is an affiliate of Chelsey, the Company’s principal shareholder.   Debt consists of the following (in thousands):     December 25,   December 27,   2004   2003   December 31,   December 25,       2005   2004 Wachovia facility:                 Tranche A term loans – Current portion, interest rate of 5.5% in 2004 and 4.75% in 2003   $       1,992   $         1,992 Tranche B term loan – Current portion, interest rate of 13.0% in 2003   --   1,800 Revolver, interest rate of 5.5% in 2004 and 4.5% in 2003   14,408   8,997 Tranche A term loans – Current portion, interest rate of 7.5% in 2005 and 5.5% in 2004     $         1,992     $         1,992 Revolver, interest rate of 7.5% in 2005 and 5.5% in 2004   8,066   14,408 Capital lease obligations – Current portion   290   679   47   290     Short-term debt   $     16,690   $       13,468   $       10,105   $       16,690                 Wachovia facility:                 Tranche A term loans – interest rate of 5.5% in 2004 and 4.75% in 2003   $       2,985   $         4,478 Tranche B term loan – interest rate of 13.0% in 2003   --   4,211 Chelsey facility – stated interest rate of 10.0% (5.0% above prime rate) in 2004   8,159   -- Tranche A term loans – interest rate of 7.5% in 2005 and 5.5% in 2004   $            994   $         2,985 Chelsey facility – stated interest rate of 12.0% in 2005 and 10.0% in 2004 (5% above prime rate)     11,545     8,159 Capital lease obligations   52   353   4   52     Long-term debt   $     11,196   $         9,042   $       12,543   $       11,196     Total debt   $     27,886   $       22,510   $       22,648   $       27,886       Wachovia Facility   Wachovia and the Company are parties to a Loan and Security Agreement dated November 14, 1995 (as amended by the First through Thirty-FourthThirty-Fifth Amendments, the “Wachovia Loan Agreement”) pursuant to which Wachovia provided the Company with the Wachovia Facility which has included, since inception, one or more term loans and a revolving credit facility (“Revolver”). The Wachovia Facility expires on July 8, 2007.   Prior to the Chelsey Facility, there were two term loans outstanding, Tranche A and Tranche B, under the Wachovia Facility. The Tranche B term loan had a principal balance of approximately $4.9 million and bore interest at 13.0% when the Company used a portion of the proceeds of the Chelsey Facility to repay this loan on July 8, 2004. The Tranche A term loan had a principal balance of approximately $5.0$3.0 million as of December 25, 2004,31, 2005, of which approximately $2.0 million is classified as short term and approximately $3.0$1.0 million is classified as long term on the Consolidated Balance Sheet. The Tranche A term loan bears interest at 0.5% over the Wachovia prime rate and requires monthly principal payments of approximately $166,000.$0.2 million.   The Revolver has a maximum loan limit of $34.5 million, subject to inventory and accounts receivable sublimits that limit the credit available to the Company’s subsidiaries, which are borrowers under the Revolver. The interest rate on the Revolver is currently 0.5% over the Wachovia prime rate. As of December 25, 2004,31, 2005, the interest rate on the Revolver was 5.5%7.5%.   The Wachovia Facility is secured by substantially all of the assets of the Company and contains certain restrictive covenants, including a restriction against the incurrence of additional indebtedness and the payment of Common Stock dividends. In addition, all of the real estate owned by the Company is subject to a mortgage in favor of Wachovia and a second mortgage in favor of Chelsey Finance. The Wachovia Loan Agreement contains affirmative and negative covenants typical for loan agreements for asset-based lending of this type including financial covenants requiring the Company to maintain specified levels of Consolidated Net Worth, Consolidated Working Capital and EBITDA, as those terms are defined in the Wachovia Loan Agreement.   Due to, among other things, the Restatement which resulted in the Company violating several financial covenants and the Company’s inability to timely file its periodic reports with the SEC, the Company was in technical default under the Wachovia and Chelsey Facilities. The Company has obtained waivers from both Wachovia and Chelsey Finance for such defaults. 2004 Amendments2006 Amendment to Wachovia Loan Agreement   OnEffective March 25, 2004,28, 2006 the Company and Wachovia amended the Wachovia Loan Agreement (“Thirty-Fifth Amendment”) which adjustedreduced the levels of Consolidated Net Worthinterest rate on the Revolver to the Wachovia prime rate plus 0%, eliminated the annual Revolver fee, reset certain financial covenants and Consolidated Working Capital thatconsented to certain transactions between the Company had to maintain during each month commencing January 2004, and amended the EBITDA covenant to specify minimum levels of EBITDA that the Company had to achieve on a quarterly basis during 2004, 2005 and 2006. In addition, the definition of “Event of Default” was amended by changing an Event of Default from the occurrence of a material adverse changeCompany’s subsidiaries. There were no fees paid in the business, assets, liabilities or condition ofconnection with this amendment. On March 28, 2006 the Company and its subsidiaries to the occurrence of certain specific events such asChelsey Finance entered into a decrease in consolidated net revenues beyond certain specified levels or aging of inventory or accounts payable beyond certain specified levels. Concurrent with the closingsimilar amendment of the Chelsey Facility on July 8, 2004, the Companyto reset certain financial covenants and Wachovia amended the Wachovia Loan Agreement in several respects including: (1) releasingconsents to certain existing availability reserves and removing the excess loan availability covenant that increased the Company’s availability by approximately $10.0 million, (2) reducing the amount of the maximum credit, the revolving loan limit and the inventory and accounts sublimits of the borrowers, and (3) permitting Chelsey Finance to have a junior secured lien on the Company’s assets. In addition, Wachovia consented to (a) the Company’s issuance to Chelsey Finance of the Common Stock Warrant and the Common Stock as described below, (b) the proposed reverse stock split of the Common Stock and the Company making cash payments to repurchase fractional shares, (c) certain amendments to the Company’s Certificate of Incorporation, and (d) the issuance by the Company of Common Stock to Chelsey as payment of a waiver fee. The Company paid Wachovia a $400,000 fee in connection with this amendment. This fee was recorded as a deferred charge on the Company’s Consolidated Balance Sheets and is being amortized over the three-year term of the amended Wachovia Facility.transactions.   2005 Amendments to Wachovia Loan Agreement   On March 11, 2005, Wachovia consented to the sale of Gump’s and Gump’s By Mail (collectively “Gump’s”). On March 11, 2005 the Wachovia Loan Agreement was amended to temporarily increase the amount of letters of credits that the Company could issue from $10.0 million to $13.0 million through June 30, 2005. The Company paid Wachovia a $25,000 fee in connection with this amendment.   On July 29, 2005 the Company and Wachovia amended the Wachovia Loan Agreement to provide the terms under which the Company could enter into the World Financial Network National Bank (“WFNNB”) Credit Card Agreement which, among other things, prohibits the use of the proceeds of the Wachovia Facility to repurchase private label and co-brand accounts created under the WFNNB Credit Card Agreement should the Company become obligated to do so, prohibits the Company from terminating the WFNNB Credit Card Agreement without Wachovia’s consent and restricts the Company from borrowing on receivables generated under the WFNNB Credit Card Agreement. The amendment also waives enumerated defaults, resets the financial covenants, reallocates the availability that was previously allocated to Gump’s among other Company subsidiaries and, retroactive to June 30, 2005, increases the amount of letter of credits that the Company can issue to $15.0 million. The Company paid Wachovia a $60,000 fee in connection with this amendment.   On July 29, 2005 the Company and Chelsey Finance entered into a similar amendment of the Chelsey Facility.   Based on the provisions of EITF 95-22, “Balance Sheet Classification of Borrowings Outstanding under Revolving Credit Agreements that Include Both a Subjective Acceleration Clause and a Lock-Box Arrangement,” and certain provisions in the Wachovia Loan Agreement, the Company is required to classify the Revolver as short-term debt.   There were $9.2 million in letters of credit outstanding as of December 31, 2005 under the Wachovia Facility. Remaining availability under the Wachovia Facility as of December 25, 200431, 2005 was $14.0$13.8 million.   Chelsey Facility   On July 8, 2004, the Company closed on the Chelsey Facility, a $20.0 million junior secured credit facility with Chelsey Finance that was recorded net of a debt discount, at $7.1 million at issuance. The Chelsey Facility has a three-year term, subject to earlier maturity upon the occurrence of a change in control or sale of the Company (as defined), and carries a stated interest rate of 5.0% above the prime rate publicly announced by Wachovia. The financial and non-financial covenants contained in the Chelsey Facility mirror those in the Wachovia Facility except that the quantitative measures for the consolidated working capital and EBITDA covenants are 10.0% less restrictive and the consolidated net worth covenant is 5.0% less restrictive than the comparable financial covenants in the Wachovia Facility. The Chelsey Facility is secured by a second priority lien on substantially all of the assets of the Company. As part of this transaction, Chelsey Finance entered into an intercreditor and subordination agreement with Wachovia. At December 25, 2004,31, 2005, the amount recorded as debt on the Consolidated Balance Sheet is $8.2$11.5 million, net of the un-accreted debt discount of $11.8$8.5 million.   Under the original terms of the Chelsey Facility, the Company was obligated to make payments of principal of up to the full outstanding amount of the Chelsey Facility in each quarter, provided, among other things: (1) the aggregate amount of availability under the Wachovia Facility is at least $7.0 million, (2) the cumulative EBITDA for the four fiscal quarters immediately preceding the quarter in which the payment is made is at least $14.0 million, and (3) the aggregate amount of principal prepayments is no more than $2.0 million in any quarter. Subsequent to the closing of the Chelsey Facility, the Company and Chelsey Finance amended the Chelsey Facility to provide that the Company was not obligated to make principal payments prior to the July 8, 2007, except in the event of a change in control or sale of the Company. This resulted in the recorded amount of the Chelsey Facility plus the accreted cost of the debt discount (as described below) being classified as long term on the Company’s Consolidated Balance Sheets as of December 31, 2005 and December 25, 2004.   In consideration for providing the Chelsey Facility to the Company, Chelsey Finance received a closing fee of $200,000$0.2 million and a warrant (the “Common Stock Warrant”) with a fair value of $12.9 million, exercisable immediately and for a period of ten years to purchase 30.0% of the fully diluted shares of Common Stock of the Company (equal to 10,259,366 shares of Common Stock) at an exercise price of $0.01 per share. The closing fee of $200,000$0.2 million was recorded as a deferred charge in other assets on the Company’s Consolidated Balance Sheets and is being amortized over the three-year term of the Chelsey Facility utilizing the interest-method. Because the issuance of the Common Stock Warrant was subject to shareholder approval, the Company initially issued a warrant to Chelsey Finance to purchase newly-issued Series D Participating Preferred Stock (“Series D Preferred”) that was automatically exchanged for the Common Stock Warrant on September 23, 2004 following receipt of shareholder approval.   In connection with the closing of the Chelsey Facility, Chelsey waived its blockage rights over the issuance of senior securities and received in consideration a waiver fee equal to 1.0% of the liquidation preference of the Series C Preferred, payable in 434,476 shares of Common Stock (calculated based upon the fair market value thereof two business days prior to the closing date). The $0.6 million waiver fee was recorded as a deferred charge within other assets on the Company’s Consolidated Balance Sheets and is being amortized over the remaining redemption period of the Series C Preferred utilizing the interest-method. After consideration of the waiver fee paid in Common Stock and the change in the par value of Common Stock (see Notenote 9), the Company’s Common Stock increased by less than $0.1 million and Capital in excess of par value increased by $0.6 million. Both the shares underlying the Common Stock Warrant and the shares issued in payment of the waiver fee are subject to an existing Registration Rights Agreement between the Company and Chelsey. The Company has assessed whether the warrants should be classified as either a liability or equity in accordance with EITF 00-19 “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock” and concluded that since the requirements are only a “best efforts” registration requirement, the warrants should be classified as equity.   As part of the Chelsey Facility, the Company and its subsidiaries agreed to indemnify Chelsey Finance and its affiliates, which includes Chelsey, from any losses suffered arising out of the Chelsey Facility other than liabilities resulting from Chelsey Finance and its affiliates’ gross negligence or willful misconduct. The indemnification agreement is not limited as to term and does not include any limitations on maximum future payments thereunder.   The terms of the Chelsey Facility were approved by the Company’s Audit Committee, all of whose members are independent, and the Company’s Board of Directors.   On July 8, 2004, approximately $4.9 million of the proceeds from the Chelsey Facility were used to repay the Tranche B Term Loan with the balance used to provide ongoing working capital for the Company, which has been used to reduce outstanding payables and increase inventory. The Chelsey Facility, together with the concurrent amendment of the Wachovia Facility, increased the Company’s liquidity by approximately $25.0 million.   In accordance with Accounting Principles Board Opinion No. 14, “Accounting for Convertible Debt and Debt Issued with Stock Purchase Warrants” (“APB 14”), proceeds received from the sale of debt with detachable stock purchase warrants should be allocated to both the debt and warrants, with the portion allocable to the warrants to be accounted for as Capital in excess of par value of $7.1 million with the remaining portion of $7.1 million classified as debt. The fair value of the Common Stock Warrant of $12.9 million was determined using the Black-Scholes option pricing model and is being treated as debt discount, which will be accreted as interest expense utilizing the interest method over the 36-month term of the Chelsey Facility. The assumptions used for the Black-Scholes option pricing model were as follows: risk-free interest rate of 4.5%, expected volatility of 80.59%, an expected life of ten years and no expected dividends. A summary of the debt relating to the Chelsey Facility is as follows (in thousands):   Amount Borrowed Under the Chelsey Facility $    20,000 Fair Value of Common Stock Warrant (Recorded as Capital in excess of par value) (12,939) Accretion of Debt Discount (Recorded as Interest Expense) 1,098 Balance at December 25, 2004 $      8,159     December 31, 2005   December 25, 2004 Amount Borrowed Under the Chelsey Facility   $             20,000   $              20,000 Fair Value of Common Stock Warrant (Recorded as Capital in excess of par value)     (12,939)     (12,939) Accretion of Debt Discount (Recorded as Interest Expense)     4,484     1,098               $             11,545   $                8,159   The annual effective interest rate ofFor the Chelsey Facility is approximately 62.7%. For53- weeks ending December 31, 2005 and the 52- weeks ended December 25, 2004, the Company has incurred approximately $0.9$5.9 million and $2.1 million of interest expense (including the accretion of debt discount and haveamortization of debts costs), respectively, and has made interest payments of approximately $2.2 million and $0.8 million, respectively, related to the Chelsey Facility.   General   At December 25, 2004,31, 2005, the aggregate future annual principal payments required on debt instruments (including capital lease obligations) are as follows (in thousands): 2005 — $16,690; 2006 — $2,039;$10,105; 2007 — $20,998.   8. PREFERRED STOCK   Currently, the Company has one series of preferred stock outstanding, Series C Preferred. Chelsey holds all 564,819 outstanding shares of Series C Preferred which it acquired after a series of transactions that began with its May 19, 2003 acquisition of all of the Series B Participating Preferred Stock (“Series B Preferred”) from Richemont. The transactions leading up Prior to Chelsey’s acquisition, of the Series C Preferred and the terms of the Series C Preferred are summarized below. Series A Cumulative Participating Preferred Stock and Series B Participating Preferred Stock On August 24, 2000, the Company issued 1.4 million shares of newly created Series A Cumulative Participating Preferred Stock (“Series A Preferred”) to Richemont the then holder of approximately 47.9% of the Company’s Common Stock, for $70.0 million. On December 19, 2001, the Company and Richemont agreed to exchangeheld all of the outstanding shares of the Series A Preferred and 7,409,876 shares of the Common Stock held by Richemont for 1,622,111 shares of newly-created Series B Preferred. The effect of the exchange was to reflect the elimination of the Series A Preferred for the then $82.4 million carrying amount and the issuance of Series B Preferred, in the amount of $76.8 million, which was equal to the aggregate liquidation preference of the Series B Preferred on December 19, 2001. In addition, the Common Stock’s $0.7 million par value repurchased by the Company and subsequently retired was reflected as a reduction of Common Stock, with an offsetting increase to capital in excess of par value. The Company recorded a net decrease in shareholders’ deficiency of $5.6 million as a result of the Richemont transaction. The shares of the Series A Preferred repurchased from Richemont represented all of the outstanding Series A Preferred. The Company filed a certificate in Delaware eliminating the Series A Preferred. only preferred stock then outstanding. The Series B Preferred had a par value of $0.01 per share and a liquidation preference initially of $47.36 per share, increasing thereafter to a maximum of $86.85 per share in 2005.   The Company learned from filings made with the SEC that on On May 19, 2003 Richemont sold to Chelsey all of its securities in the Company consisting of 2,944,688 shares of Common Stock and 1,622,111 shares of Series B Preferred for $40.0 million. The Company was not a party to the transaction and did not provide Chelsey with any material non-public information nor did the Company’s Board of Directors endorse the transaction. As a result of the transaction, Chelsey succeeded to Richemont’s rights in the Common Stock and the Series B Preferred, including the rights of the Series B Preferred holder to a liquidation preference that was equal to approximately $98.2 million on May 19, 2003, the date of the sale by Richemont, and that could have increased to a maximum of approximately $146.2 million on August 23, 2005, the final Series B Preferred redemption date. Recapitalization Agreement   On November 30, 2003, the Company and Chelsey consummated the transactions contemplated by a Recapitalization Agreement, dated as of November 18, 2003 under which the Company recapitalized, the Company completed the reconstitution of its Board of Directors and outstanding litigation between the Company and Chelsey was settled. As part of the Recapitalization, the Company exchanged all of Chelsey’s Series B Preferred for 564,819 shares of newly created $0.01 par value Series C Preferred and 8,185,783 shares of Common Stock. The Company filed a certificate in Delaware eliminating the Series B Preferred.   Effective upon the closing of the transactions contemplated by the Recapitalization Agreement, the size of the Board of Directors was increased to nine members. For a period of two years from the closing of the Recapitalization, five of the nine directors of the Company were to be designated by Chelsey and one was to be designated by Regan Partners, L.P. Effective July 30, 2004, Basil Regan, the general partner of Regan Partners, L.P. and its designee to the Board of Directors, resigned from the Board of Directors. Regan Partners, L.P. held the right to appoint a designee to the Company’s Board of Directors until the January 10, 2005 sale of Common Stock held by Regan Partners, L.P., Regan International Fund Limited and Basil Regan to Chelsey.   Because the Series B Preferred was mandatorily redeemable and thus accounted for as a liability pursuant to SFAS 150, the Company accounted for the exchange of the 1,622,111 shares of Series B Preferred for the 564,819 shares of Series C Preferred and the 8,185,783 shares of Common Stock in accordance with SFAS No. 15, “Accounting by Debtors and Creditors for Troubled Debt Restructurings.” As such, the $107.5 million carrying value of the Series B Preferred as of the consummation date of the exchange was compared with the fair value of the Common Stock of approximately $19.6 million issued to Chelsey as of the consummation date and the total maximum potential cash payments of approximately $72.7 million that could be made pursuant to the terms of the Series C Preferred. Since the carrying value, net of issuance costs of approximately $1.3 million, exceeded these amounts by approximately $13.9 million, pursuant to SFAS No. 15, such excess was determined to be a “gain” and the Series C Preferred was recorded at the amount of total potential cash payments (including dividends and other contingent amounts) that could be required pursuant to its terms. Because Chelsey was a significant stockholder at the time of the exchange and, as a result, a related party, the “gain” was recorded to “Capital in Excess of Par Value” within “Shareholders’ Deficiency” on the accompanying Consolidated Balance Sheets.   Series C Preferred   The Series C Preferred holders are entitled to one hundred votes per share on any matter on which the Common Stock votes and are entitled to one hundred votes per share plus that number of votes equal to the dollar value of any accrued, unpaid and compounded dividends with respect to such share. The holders of the Series C Preferred are also entitled to vote as a class on any matter that would adversely affect such Series C Preferred. In addition, if the Company defaults on its obligations under the Certificate of Designations, the Recapitalization Agreement or the Wachovia Facility, then the holders of the Series C Preferred, voting as a class, shall be entitled to elect twice the number of directors as comprised the Board of Directors on the default date, and such additional directors shall be elected by the holders of record of Series C Preferred as set forth in the Certificate of Designations.   If the Company liquidates, dissolves or is wound up, the holders of the Series C Preferred are entitled to a liquidation preference of $100 per share, or an aggregate of approximately $56.5 million based on the shares of Series C Preferred currently owned by Chelsey, plus all accrued and unpaid dividends on the Series C Preferred. As described further below, commencing January 1, 2006, dividends will beare payable quarterly on the Series C Preferred at the rate of 6% per annum, but such dividends may be accrued at the Company’s option. Effective October 1, 2008 and assuming the Company has electedCompany’s election to accrue all dividends from January 1, 2006 through such date, the maximum aggregate amount of the liquidation preference plus accrued and unpaid dividends on the Series C Preferred will be approximately $72.7 million.   Commencing January 1, 2006, dividends will beare payable quarterly on the Series C Preferred at the rate of 6.0% per annum, with the preferred dividend rate increasing by 1 1/2% per annum on each anniversary of the dividend commencement date until redeemed. At the Company’s option, in lieu of cash dividends, the Company may accrue dividends that will compound at a rate 1.0% higher than the applicable cash dividend rate. The Series C Preferred is entitled to participate ratably with the Common Stock on a share for share basis in any dividends or distributions on the Common Stock. The right to participate has anti-dilution protection. The Wachovia Loan Agreement currently prohibits the payment of dividends.   The Series C Preferred may be redeemed in whole and not in part, except as set forth below, at the option of the Company at any time for the liquidation preference and any accrued and unpaid dividends (the “Redemption Price”). The Series C Preferred, if not redeemed earlier, must be redeemed by the Company on January 1, 2009 (the “Mandatory Redemption Date”) for the Redemption Price. If the Series C Preferred is not redeemed on or before the Mandatory Redemption Date, or if other mandatory redemptions are not made, the Series C Preferred will be entitled to elect one-half of the Company’s Board of Directors. Notwithstanding the foregoing, the Company will redeem the maximum number of shares of Series C Preferred as possible with the net proceeds of certain asset and equity sales not required to be used to repay Wachovia pursuant to the terms of the Wachovia Loan Agreement, and Chelsey will be required to accept such redemptions. At the Company’s request, Chelsey agreed to permit the Company to apply the sales proceeds from the sale of Gump’s to reduce the Wachovia Facility. Chelsey retained the right to require redemption of approximately $6.9 million (the Gump’s sales proceeds available for redemption) of the Series C Preferred subject to Wachovia’s approval.   9. CAPITAL STOCK   General — At December 25, 200431, 2005 there were 22,426,296 shares of Common Stock issued and outstanding. Additionally, an aggregate of 1,318,8831,169,600 and 10,259,366 shares of Common Stock were reserved for issuance pursuant to the exercise of outstanding options and common stock warrants, respectively, at December 25, 2004.31, 2005. After its January 10, 2005 purchase of an aggregate of 3,799,735 shares of Common Stock formerly held by Regan Partners, L.P., Regan International Fund Limited and Basil Regan, which was reported in an SEC filing, Chelsey and related affiliates beneficially owned approximately 69% of the issued and outstanding Common Stock and approximately 75%76% of the Common Stock after giving effect to the exercise of all outstanding options and warrants to purchase Common Stock beneficially owned by Chelsey. In addition, Chelsey is holder of all of the Company’s Series C Preferred. Including the Series C Preferred and outstanding options and warrants (after giving effect to the exercise of all outstanding options and warrants) beneficially owned by Chelsey, Chelsey maintains approximately 91% of the voting rights of the Company. Effective July 30, 2004, Basil Regan resigned from the Board of Directors and continued to hold the right to appoint a designee to the Company’s Board of Directors until the January 10, 2005 sale of Common Stock held by Regan Partners, L.P., Regan International Fund Limited and Basil Regan to Chelsey.   Recapitalization — On November 30, 2003 as part of the Recapitalization, the Company issued 8,185,783 shares of Common Stock to Chelsey.   Reverse Stock Split — At the 2004 Annual Meeting of Shareholders of the Company held on August 12, 2004, the Company’s shareholders approved a one-for-ten reverse stock split of the Common Stock that became effective at the close of business on September 22, 2004. The number of shares of Common Stock in these consolidated financial statements and footnotes have been adjusted to take into account the effect of the reverse stock split.   Amendment to the Company’s Certificate of Incorporation — On September 22, 2004, the Company filed a Certificate of Amendment to the Company’s Amended and Restated Certificate of Incorporation (1) reducing the par value of the Common Stock from $0.66-2/3 to $0.01 per share and reclassifying the outstanding shares of Common Stock into such lower par value shares; (2) increasing the number of authorized shares of additional Preferred Stock from 5,000,000 shares to 15,000,000 shares and making a corresponding change to the aggregate number of authorized shares of all classes of preferred stock; and (3) after giving effect to the reverse split, increasing the authorized number of shares of Common Stock from 30,000,000 shares to 50,000,000 shares and making a corresponding change to the aggregate number of authorized shares of all classes of common stock.   Retirement of Treasury Stock — The Company approved the retirement of the Company’s 212,093 treasury shares on November 16, 2004. Pursuant to the Delaware General Corporation Law, such shares will assume the status of authorized and unissued shares of Common Stock of the Company.   Dividend Restrictions — The Company is restricted from paying dividends on its Common Stock or from acquiring its Common Stock under the Wachovia and Chelsey Facilities.   10. MANAGEMENT AND COMPENSATION   Chief Executive Officer Garten Employment Agreement. On May 6, 2004, Wayne P. Garten became the Company’s Chief Executive Officer and President. Mr. Garten is employed pursuant to the terms of a May 6, 2004 Employment Agreement. Under Mr. Garten’s Employment Agreement he will be paid an annual salary of $600,000 over a term expiring on May 6, 2006. The Company also granted Mr. Garten options to acquire 200,000 shares of the Company’s common stock, half pursuant to its 2000 Management Stock Option Plan and half outside the plan. All of the options have an exercise price of $1.95 per share, the Common Stock’s average closing price for the ten trading days preceding the grant date and the ten trading days after the grant date. One third of each of the options vested upon execution of the Employment Agreement and the balance will vest in two equal installments over a two-year period, vesting on the anniversary of the original grant date, subject to earlier vesting in the event of a change in control of the Company (as that term is defined in the Employment Agreement). Mr. Garten is entitled to participate in the Company’s bonus plan for executives, as established by the Board of Directors. The Employment Agreement provides for a lump sum change in control payment equal to 200% of Mr. Garten’s annual salary if a change in control occurs during the term. The Employment Agreement also provides for eighteen months of severance payments if Mr. Garten is not otherwise entitled to change in control benefits and (i) is terminated without cause or terminates hishas employment for good reason (as both terms are defined in the Employment Agreement) during the term or (ii) his Employment Agreement is not renewed. Shull Employment and Severance Agreement. Thomas Shull, the Company’s prior Chief Executive Officer, resigned from the Company on May 5, 2004. Mr. Shull and the Company executed a General Release and Separation Agreement dated effective as of May 5, 2004 which provided for the Company to pay Mr. Shull $900,000 of severance in lieu of any other benefits provided for in the Employment Agreement dated September 1, 2002, as amended (the “Shull Employment Agreement”). The severance was paid with a $300,000 lump sum on execution and the balance in biweekly installments that were completed in 2004. The Company also agreed to pay for eighteen months of COBRA coverage for Mr. Shull. Prior to his resignation, Mr. Shull was employed pursuant to the Shull Employment Agreement which provided for an $855,000 base salary and had term expiring on March 31, 2006. Mr. Shull was a participant in the Company’s Key Executive Eighteen Month Compensation Continuation Plan (the “Change of Control Plan”) and its transaction bonus program. The Recapitalization was a change in control under the Change in Control Plan and therefore the Company paid Mr. Shull $1,350,000 in 2003. The Company also paid Mr. Shull $450,000 under the transaction bonus program in 2003. Mr. Shull received $450,000 in 2002 related to the terms of his agreement. Chief Operating Officer Michael Contino, the Company’s Executive Vice President and Chief Operating Officer, is employed pursuant to a October 29, 2002 letter agreement. Under the letter agreement, Mr. Contino is to receive an annual salary of $387,000 and is entitled to participate in the Company’s bonus plan for executives, as established by the Board of Directors. Mr. Contino was awarded options to purchase 100,000 shares under the 2000 Management Stock Option Plan. Under the agreement, if Mr. Contino is terminated other than “for cause” or terminates his employment for “good reason” (as those terms are defined in the agreement), he is entitled to eighteen months of severance pay and health benefits. Mr. Contino was a participant in the Company’s 18 month change in control plan and was entitled to a Transaction Bonus equal to half of his base salary on a change in control. Mr. Contino was paid the Transaction Bonus following the Recapitalization in 2003. In addition, in January 1998, the Company made a $75,000 non interest-bearing loan to Mr. Contino for the purchase by Mr. Contino of a new principal residence. The terms of the loan agreement, as amended, included a provision for the Company to forgive the original amount of the loan on the fifth anniversary of the loan. The Company forgave the loan in accordanceagreements with its terms in January 2003CEO and paid the applicable withholding taxes of $64,063. Chief Financial Officer On April 4, 2005 John W. Swatek joined the Company as its Senior Vice President, Chief Financial Officer and Treasurer. Mr. Swatek will report directly to the Company’s Chief Executive Officer. Under the March 15, 2005 Employment Agreement between the Company and Mr. Swatek, Mr. Swatek will be paid an annual salary of $270,000CFO and has been granted options to acquire 50,000 shares ofletter agreements with other officers.  In general, the Company’s common stock pursuant to its 2000 Management Stock Option Plan. All of the optionsagreements have an exercise price of $0.81 per share, the Common Stock’s average closing price for the ten trading days preceding the grant date and the ten trading days after the grant date. One third of the options vested upon execution of the Employment Agreement and the balance will vest in two equal annual installments over the next two years on the anniversary of the original grant date, subject to earlier vesting in the event of a change in control of the Company (as that term is defined in the Employment Agreement). Mr. Swatek will be entitled to participate in the Company’s bonus plan for executives. The Employment Agreement expires on May 6, 2006 and provides for a sign-on bonusterms of up to $25,000two years and provide severance payments of up to the extent his bonus from his prior employer was reduced as a result18 months of his decision to join the Company. The Company paid Mr. Swatek $17,208 under this provision.salary.   The Employment Agreement provides for a lump sum change in control payment equal to Mr. Swatek’s annual salary if his employment is terminated due to a change in control during the term of the agreement. The Employment Agreement also provides for one year of severance payments if Mr. Swatek is not otherwise entitled to change in control benefits and (i) is terminated without cause or terminates his employment for good reason (as both terms are defined in the Employment Agreement) or (ii) if his agreement is not renewed at the end of the term. Charles E. Blue had been appointed Chief Financial Officer of the Company effective November 11, 2003, replacing Edward M. Lambert. Mr. Blue joined the Company in 1999 and prior to his appointment had most recently served as Senior Vice President, Finance. Mr. Lambert continued to serve as Executive Vice President of the Company until his January 2, 2004 resignation. Mr. Lambert and the Company entered into a severance agreement dated November 4, 2003 providing for payments of $640,000, as well as other benefits that were accrued and paid in the fourth quarter of 2003. Mr. Lambert received a payment of $72,512 under the Company’s 2003 Management Incentive Plan. Mr. Blue’s employment with the Company was terminated effective March 8, 2005 and the Company reported in a Current Report on Form 8-K that he had resigned voluntarily. The Company and Mr. Blue were unable to agree on the terms of his voluntary resignation and the Company notified Mr. Blue that his employment had been terminated for cause. General Counsel On January 31, 2005, the Company appointed Daniel J. Barsky as its Senior Vice President and General Counsel. Under a letter agreement with the Company, Mr. Barsky will be paid an annual salary of $265,000 and was granted options to purchase 50,000 shares of Common Stock. One third of the options vested on February 17, 2005 and the balance will vest in two equal annual installments over the next two years on the anniversary of the original grant date, subject to earlier vesting in the event of a change in control of the Company. All of the options have an exercise price of $1.03 per share, the Common Stock’s average closing price for the ten trading days preceding the grant date and the ten trading days after the grant date. Mr. Barsky will be entitled to participate in the Company’s bonus plan for executives. The agreement also provides for six months of severance payments if Mr. Barsky is terminated without cause or terminates his employment for good reason. Mr. Barsky was appointed as the Company’s Secretary on March 7, 2005. Other Severance and Compensation Related Agreements Charles F. Messina. During September 2002, Charles F. Messina resigned as Executive Vice President, Chief Administrative Officer and Secretary of the Company. In connection with his resignation, the Company and Mr. Messina entered into a September 30, 2002 severance agreement providing for payments of $884,500 and other benefits which were accrued in the fourth quarter of 2002. Brian C. Harriss. Effective February 15, 2004, the Company eliminated Mr. Harriss’ position as Executive Vice President, Finance and Administration, as part of its ongoing strategic business realignment program. Mr. Harriss and the Company entered into a severance agreement providing for payments of $545,000, as well as other benefits that were accrued and paid in the first quarter of 2004. Mr. Harriss also received a payment of $61,091 under the Company’s 2003 Management Incentive Plan. William C. Kingsford. William C. Kingsford, the Company’s Senior Vice President Treasury and Control (Corporate Controller) resigned from the Company effective September 22, 2004. In connection with his resignation, the Company and Mr. Kingsford entered into a Separation Agreement and General Release under which the Company agreed to pay him severance at his then current salary of $200,000, payable over the shorter of one year following resignation or the date Mr. Kingsford secured a new job. The Company paid Mr. Kingsford one year of severance payments. Compensation Continuation Agreements. The Company has entered into severance and established a number of compensation continuation agreements and programs (some of which were included in employment agreements and transaction bonus letters) for its executives and its non-employee directors. In general, the plans provided that a plan participant whose employment is terminated other than for cause or for a resignation without good reason within two years of a change in control is entitled toagreements with various officers and other senior employees over the years.  In 2005, the Company incurred an aggregate of $0.6 million in costs for severance; in 2004 and 2003 the Company incurred an aggregate of $2.6 million and $2.1 million, respectively costs for severance and change in control benefits. These benefits for the plans applicable to employees included payments equal to eighteen months, twelve months or six months (depending on the level of the plan participant) of salary and COBRA benefits and outplacement services.payments.   The Board of Directors determined that the November 30, 2003 recapitalization was aCompany is currently involved in litigation with four former employees who were denied change in control for purposes of the plans and that the plans would be maintained solely for persons who were plan participants on that date and who became eligible for plan benefits within two years thereafter. As of December 25, 2004, the potential maximum salary payout was $6.5 million. During 2005 and before the November 30, 2005 termination of the plans, the Company terminated the employment of three plan participants but denied them benefits because the terminations had been “for cause.” A fourth plan participant resigned and sought plan benefits on the grounds that she had resigned for good reason. The Company denied her benefits as well. Each of the former employees has commenced an action against the Company seeking post employment benefits and/or compensatory and punitive damages and legal fees. As of December 1, 2005, the plans were terminated and no further benefits were available. In December 2003, Messrs. Shull, Harriss and Contino received payments of $450,000, $168,500 and $193,500, respectively, under their “single trigger” change in control plans. On December 18, 2003, each of the eight non-employee directors (Messrs. Brown, James, Krushel, Sonnenfeld, Masson, Regan, Garten and Edelman) received an $87,000 payment under the terms of the Directors Change of Control Plan. No other plan participants received change in control payments in 2003 and five triggered change in control benefits in 2004 totaling $1,194,257 (excluding the Shull Severance Agreement). Of these five, three received payments in 2004 totaling $772,257 and two in 2005 totaling $422,000. Salary Reduction. The Company effected salary reductions of 5.0% of base pay for participants in its 2003 Management Incentive Plan, including Executive Officers, effective with the pay period starting August 3, 2003. These salary reductions were restored at or below the Vice-President levels on March 28, 2004 and levels above Vice-President on August 1, 2004. Summary of Severance Costs. For the year ended December 25, 2004, the Company agreed to pay termination benefits to eight director level and above positions (including the Shull Severance Agreement and five change in control benefits, excluding positions eliminated due to the International Male and Undergear relocation). These costs totaled $2.6 million, of which $0.8 million was recorded during the 1st quarter of 2004, $0.9 million recorded during the 2nd quarter of 2004, $0.3 million during the third quarter of 2004 and $0.6 million in the fourth quarter of 2004. The Company recorded costs relating to termination benefits for director level and above positions of $1.5 million and $1.6 million for the years ended December 27, 2003 and December 28, 2002, respectively.payments.       11. EMPLOYEE BENEFIT PLANS   The Company maintains two defined contribution 401(k) plans that are available to all employees of the Company. The Company matches a percentage of employee contributions to the plans up to $13,000. Matching contributions for both plans was $0.4 million for fiscal year 2005 and $0.5 million for each of the fiscal years 2004 2003 and 2002.2003.   12. INCOME TAXES   On May 19, 2003 the Company had a change in control, as defined by Internal Revenue Code Section 382, which places an annual limit of $3.0 million on the utilization of the Company’s Federal income tax net operating loss (“NOLs”NOL”) carryovers and alternative minimum tax net operating loss (“AMT NOLs”NOL”) carryovers that existed prior to the change in control date. The unused portion of the $3.0 million annual limitation for any year may be carried forward to succeeding years to increase the annual limitation for those succeeding years. In addition to the Section 382 annual limit, the utilization of AMT NOLs in any year is further limited to 90% of that year’s Federal alternative minimum taxable income. The annual Section 382 limit, discussed above, may be increased, under certain circumstances, up to the amount of net unrealized built-in gains that existed on the change in control date, which are recognized within five years of that date. The Company does not have any transactions, in the foreseeable future, that would enable it to realize any net built-in gains within the requisite period.   At December 25, 2004,31, 2005, the Company’s NOLs and AMT NOLs significantly exceeded the maximum utilizable pursuant to the above limits. The Company estimates that maximum utilizable carryforwards consist of $54.3$55.7 million of NOLs and AMT NOLs, expiring between 2019 and 2023, subject to a $3.0 million annual limitation under Section 382 and $1.1$1.9 million of NOLs and $1.2$2.2 million of AMT NOLs, both expiring inbetween 2023 and 2025, not subject to such limitation. As a result of differences between financial and tax accounting rules, the Company recognized a long-term capital loss carryover (“LTCL”) of $27.5 million from the disposal of Gump’s (see Note 4) that expires in 2010. The Company may be unable to utilize its LTCL before it expires without the sale of core assets. No such transactions are currently contemplated. The Company has charitable contribution carryovers totaling $0.9 million; $0.6 million, expiring between 2006 and 2008, is subject to the same $3.0 million annual Section 382 limit discussed above and $0.3 million, expiring between 2008 and 2010, is not subject to such limit. The deduction for charitable contribution carryovers in any future year within the carryover period is limited, however, to the excess of 10% of taxable income, computed without the deduction for contributions, over the amount contributed in that year.     SFAS 109 requires management to assess the realizability of the Company’s deferred tax assets. Realization of the future tax benefits is dependent, in part, on the Company’s ability to generate taxable income within the carry forward period and the periods in which net temporary differences reverse. Future levels of operating income and taxable income are dependent upon general economic conditions, competitive pressures on sales and margins, postal and other delivery rates, and other factors beyond the Company’s control. Accordingly, no assurance can be given that sufficient taxable income will be generated for utilization of NOLsthe carryovers described above and reversals of temporary differences. Management believes that the $5.5$3.6 million deferred tax asset (excluding the $5.5$3.6 million deferred tax liability), as of December 25, 2004,31, 2005, represents a “more-likely-than-not” estimate of the future utilization of the NOLsabove-mentioned carryovers and the reversal of temporary differences. The valuation allowance increased by $5.7 million in 2005 and decreased by $1.3$0.1 million in 2004 and increased by $108.6 million in 2003.2004. Management will continue to routinely evaluate the likelihood of future profits and the necessity of future adjustments to the valuation allowance.   The Company’s Federal income tax provision consists of $0.1current income taxes of $21,000 in 2005 and $146,000 in 2004 and deferred income taxes of $11.3 million in 2003. The Company’s state income tax provision consists of current income taxes for 2004, $11.3 million of deferred income tax for 2003 and $3.7 million of deferred income tax for 2002. The Company’s current state income tax provision was$8,000 in 2005, $28,000 in 2004 and $28,000 in 2003 and $91,000 in 2002.2003. The Company has adjusted the calculation of its deferred tax assets and liabilities as of December 27, 2003 to also consider the effect of deferred state income taxes as of that date, in addition to calculating deferred taxes on only those NOL carryforwards that may be utilizable in the future. These adjustments resulted in a decrease of the deferred tax assets and liabilities by $0.8 million and $0.8 million, respectively, as of December 27, 2003. As the Company’s net deferred tax asset had a full valuation allowance at that date, there was no impact on the Company’s financial position, cash flows or operating results for this change. The components of the net deferred tax asset at December 25, 200431, 2005 and December 27, 200325, 2004 are as follows (in millions):   2004   2003 As Restated 2005   2004   Current Non- Current   Total   Current Non- Current   Total Current   Non Current   Total   Current   Non Current   Total Deferred Tax Assets Federal and state tax NOL, alternative minimum tax and business tax credit carry forwards $    1.4 $    20.1 $    21.5 $    2.4 $    21.0 $    23.4 Deferred Tax Assets                       Federal and state tax NOL, capital loss, alternative minimum tax and business tax credit carry forwards $       0.9   $     31.6   $     32.5   $       1.4   $     20.1   $      21.5 Allowance for doubtful accounts 0.5 — 0.5 0.4 — 0.4 0.3   —   0.3   0.5   —   0.5 Property and equipment — 4.0 — 4.0 4.0 —   2.0   2.0   —   4.0   4.0 Mailing lists and trademarks — 0.3 — 0.4 0.4 —   0.2   0.2   —   0.3   0.3 Accrued liabilities 4.7 — 4.7 3.2 — 3.2 2.4   —   2.4   4.7   —   4.7 Customer prepayments and credits 4.6 — 4.6 3.8 — 3.8 4.3   —   4.3   4.6   —   4.6 Deferred rent credits 0.7 1.3 2.0 1.0 1.8 2.8 —   —   —   0.7   1.3   2.0 Stock option compensation —   1.0   1.0   —   1.2   1.2 Total 11.9 25.7 37.6 10.8 27.2 38.0 7.9   34.8   42.7   11.9   26.9   38.8 Valuation allowance 10.2 21.9 32.1 9.5 23.9 33.4 7.3   31.8   39.1   10.2   23.1   33.3 Deferred tax asset, net of valuation allowance 1.7 3.8 5.5 1.3 3.3 4.6 0.6   3.0   3.6   1.7   3.8   5.5 Deferred Tax Liabilities Inventories (0.3) — (0.3) (0.2) — (0.2) Deferred Tax Liabilities                       Inventories (0.2)   —   (0.2)   (0.3)   —   (0.3) Prepaid catalog costs (3.5) — (3.5) (2.7) — (2.7) (3.2)   —   (3.2)   (3.5)   —   (3.5) Other current assets (0.1) — (0.1) (0.1) — (0.1) (0.1)   —   (0.1)   (0.1)   —   (0.1) Excess of net assets of acquired business — (1.5) — (1.5) (1.5) —   —   —   —   (1.5)   (1.5) Other — (0.1) (0.1) — (0.1) —   (0.1)   (0.1)   —   (0.1)   (0.1) Deferred tax liability (3.9) (1.6) (5.5) (3.1) (1.5) (4.6) (3.5)   (0.1)   (3.6)   (3.9)   (1.6)   (5.5) Net deferred tax (liability) asset $  (2.2) $      2.2 $      0.0 $  (1.8) $      1.8 $      0.0 $      (2.9)   $       2.9   $       0.0   $     (2.2)   $       2.2   $       0.0       The Company’s effective tax rate for the three fiscal years presented differs from the Federal statutory income tax rate due to the following:   2004 Percent of Pre-tax Income 2003 Percent of Pre-tax Loss As Restated 2002 Percent of Pre-tax Loss As Restated   2005 Percent of Pre-tax Income   2004 Percent of Pre-tax Income   2003 Percent of Pre-tax Loss   Tax expense (benefit) at Federal statutory rate 35.0% (35.0)% (35.0)%   35.0 % 35.0 % (35.0 )% State and local taxes, net of Federal benefit 0.3 0.2 0.8   0.1   0.8   0.2   Permanent differences:               $1 million salary limit and stock option compensation 1.2 16.0 15.0 $1million salary limit and stock option compensation   —   —   9.7   Non-deductible interest expense on Series B Preferred Stock — 29.0 —   —   —   25.5   Other permanent differences 0.8 (1.0) 2.0   (0.6 ) 1.7   (0.9 ) Change in valuation allowance (33.9) 120.5 70.5   (34.2 ) (29.6 ) 114.4   Tax expense at effective tax rate 3.4 % 129.7% 53.3%   0.3 % 7.9 % 113.9 %   13. LEASES   The Company is the lessee under certain leases that require it to pay real estate taxes and common area maintenance by the Company. Most leases are accounted for as operating leases and include various renewal options with specified minimum rentals. Rental expense for operating leases net of sublease income, was as follows (in thousands):   Year Ended   2004 2003 2002 Rent expense by lease type: Land and building $   4,626 $   4,798 $   4,682 Computer equipment 362 1,359 3,516 Plant, office and other 336 548 446   Rent expense $   5,324 $   6,705 $   8,644 Sublease income — — (53)   Net rent expense $   5,324 $   6,705 $   8,591     Year Ended   2005 2004 2003 Rent expense by lease type: Land and building $   2,842 $   3,207 $   3,310 Computer equipment 142 362 1,359 Plant, office and other 286 327 510 Rent expense $   3,270 $   3,896 $   5,179   The amounts above includeexclude the net minimum rentals for the Gump’s operations of (in thousands) $1,428, $1,526$0.2 million, $1.4 million and $1,567$1.5 million for 2005, 2004 2003 and 2002,2003, respectively.   Future minimum lease payments as of December 25, 200431, 2005 under non-cancelable operating leases, by lease type are as follows (in thousands):   Year Ending Land and Buildings   Computer Equipment   Plant, Office and Other     Total   Land and Buildings   Computer Equipment   Plant, Office and Other     Total 2005 $     3,056 $   130 $   208 $     3,394 2006 1,963 9 74 2,046 $     2,094 $          71 $          245 $     2,410 2007 1,720 — 38 1,758 1,157 62 146 1,365 2008 1,676 — 24 1,700 1,138 46 88 1,272 2009 1,668 — — 1,668 1,140 — 2 1,142 2010 1,157 — — 1,157 Thereafter (extending to 2015) 278 — — 278 5,182 — — 5,182 Total future minimum lease payments $   10,361 $   139 $   344 $   10,844 $   11,868 $        179 $          481 $   12,528   The amounts above include the future commitments of non-cancelable operating leases for the Gump’s operations of (in thousands) $8,585 for Land and Buildings and $95 for Plant, Office and Other. On February 12, 2005, the Company entered into a ten-year lease extension and modification for 50,000 square feet of the 85,000 square feet previously leased for our corporate headquarters and administrative offices located in Weehawken, New Jersey. Effective June 2005, the annual rent is approximately $1,075,000 for the first five years of the extension, and increases to an annual rent of approximately $1,175,000 during the final five years. These amounts are not reflected in the table above. Effective October 1, 2005, the Company entered into a one-year lease for auxiliary warehouse storage space in Salem, Virginia. The lease provides for an annual rental of $477,000 for 212,000 square feet of space. An   additional 90,880 square feet of space in the same facility is being leased on a month-to-month basis at a monthly rental of $15,147. These amounts are not reflected in the table above.   The Company leases certain machinery and equipment under agreements that are classified as capital leases. The cost of equipment under capital leases is included in the Balance Sheet in Furniture, fixtures and equipment and was $1,506,512$1.5 million at both December 25, 200431, 2005 and December 27, 2003.25 2004. Accumulated amortization of the leased equipment at December 31, 2005 and December 25, 2004 was $1.4 million and December 27, 2003 was $1,139,155 and $434,509,$1.1 million, respectively. The future minimum lease payments as of December 25, 200431, 2005 are as follows (in thousands):   Year Ending Total 2005 $      305 2006 49 2007 4   Total minimum lease payments $      358 Less: Amount representing interest computed at annual   rates ranging from 7.5% to 9.0% (16)   Present value of net minimum lease payments 342 Less: Current maturities of capital lease obligations (290)   Long-term capital lease obligations $        52   The Company has established reserves for certain future minimum lease payments under noncancelable operating leases due to the restructuring of business operations which previously utilized such leased space. The future commitments under such leases, net of related sublease income under noncancelable subleases, as of December 25, 2004 are as follows (in thousands):     Year Ending Minimum Lease Commitments   Sublease Income   Net Lease Commitments 2005 $   1,624 $      (785) $      839 2006 1,002 (581) 421 2007 1,002 (469) 533 2008 1,003 (292) 711 2009 1,003 (296) 707 Thereafter (extending to 2010) 167 (49) 118   Total minimum lease payments $   5,801 $   (2,472) $   3,329   The amounts above include the future commitments under noncancelable operating leases, net of related sublease income under noncancelable subleases, for the Gump’s operations of (in thousands) $5,179 of minimum lease commitments less $2,275 of sublease income for a net lease commitment of $2,904. Year Ending Total 2006 $         49 2007 4     Total minimum lease payments $         53 Less: Amount representing interest computed at annual   rates ranging from 7.5% to 8.5% (2) Present value of net minimum lease payments 51 Less: Current maturities of capital lease obligations (47) Long-term capital lease obligations $           4   The future minimum lease payments under non-cancelable leases that remain from the Company’s discontinued restaurant operations as of December 25, 200431, 2005 are as follows (in thousands):       Year Ending Minimum Lease Payments   Sublease Income 2005 357 (329) 2006 72 (100)   Total minimum lease payments $   429 $   (429)       Year Ending Minimum Lease Payments   Sublease Income       2006 $     72 $   (100) Total minimum lease payments $     72 $   (100)   14. STOCK-BASED COMPENSATION PLANS   The Company has established several stock-based compensation plans for the benefit of its officers and employees. As discussed in the Summary of Significant Accounting Policies, the Company applies the fair-value-based methodology of SFAS No. 123 and, accordingly, has recorded stock compensation expense of $0.1 million, $0.2 million and $1.1 million for 2005, 2004 and $1.3 million for 2004, 2003, and 2002, respectively. The information below details each of the Company’s stock compensation plans, including any changes during the years presented.   1999 Stock Option Plan for Directors — In August 1999, the Board of Directors adopted the 1999 Stock Option Plan for Directors providing options to purchase shares of Common Stock to certain non-employee directors (the “Directors’ Option Plan”). The Company’s shareholders ratified the Directors’ Option Plan at the 2000 Annual Meeting of Shareholders. Under the Directors’ Option Plan, the Company may grant stock options to purchase up to 70,000 shares of Common Stock to eligible directors at an exercise price equal to the fair market value as of the grant date. An eligible director received an initial stock option grant to purchase 5,000 shares of Common Stock as of the effective date of his/her initial appointment or election to the Board of Directors. Furthermore, on each Award Date, defined as August 4, 2000 or August 3, 2001, eligible directors were granted options to purchase an additional 1,000 shares of Common Stock. Stock options granted have terms not to exceed ten years and shall be exercisable in accordance with the terms and conditions specified in each option agreement. In addition, options became exercisable over three years from the grant date. Option holders may pay for shares purchased on exercise in cash or Common Stock. As of December 31, 2005, no stock options remained outstanding or exercisable related to the 1999 Stock Option Plan for Directors.   The following table summarizes information concerning the options outstanding, granted and the weighted average exercise prices of options granted under the Directors’ Option Plan:   1999 Stock Option Plan for Directors     2004   2003   2002               Shares   Weighted Average Exercise Price         Shares   Weighted Average Exercise Price         Shares   Weighted Average Exercise Price           Options outstanding, beginning of period 42,000   $     16.15   42,000   $     16.15   37,000   $    17.82 Granted —   —   —   —   5,000   3.80 Exercised —   —   —   —   —   — Forfeited (35,000)   $     15.68   —   —   —   —                   Options outstanding, end of period 7,000   $     18.50   42,000   $     16.15   42,000   $    16.15             Options exercisable, end of period 7,000   $     18.50   36,667   $     17.98   31,667   $    20.15             Weighted average fair value of options granted $            —     $        —     $       2.90                     The fair value of each option granted is estimated on the grant date using the Black-Scholes option-pricing model. The weighted average assumptions for grants in 2002 under the Directors’ Option Plan were as follows: risk-free interest rate of 4.70%, expected volatility of 89.28%, expected life of six years, and no expected dividends. The following table summarizes information about stock options outstanding at December 25, 2004 under the 1999 Stock Option Plan for Directors: 1999 Stock Option Plan for Directors     Options Outstanding   Options Exercisable       Exercise Prices   Number Outstanding Weighted Average Remaining Contractual Life   Weighted Average Exercise Price   Number Exercisable Weighted Average Exercise Price     $         2.00   1,000 0.25 $   2.00   1,000 $     2.00 $       10.00   1,000 0.25 $ 10.00   1,000 $   10.00 $       23.50   5,000 0.25 $ 23.50   5,000 $   23.50                 7,000 0.25 $ 18.50   7,000 $   18.50         2005   2004   2003               Shares   Weighted Average Exercise Price         Shares   Weighted Average Exercise Price         Shares   Weighted Average Exercise Price Options outstanding, beginning of period 7,000   $        18.50   42,000   $       16.15   42,000   $    16.15 Granted —   —   —   —   —   — Exercised —   —   —   —   —   — Forfeited (7,000)   $        18.50   (35,000)   $       15.68   —   — Options outstanding, end of period —   $             —   7,000   $       18.50   42,000   $    16.15 Options exercisable, end of period —   $             —   7,000   $       18.50   36,667   $    17.98 Weighted average fair value of options granted $            —     $           —     $            —     2002 Stock Option Plan for Directors — In 2002, the Board of Directors adopted the 2002 Stock Option Plan for Directors providing options to purchase shares of Common Stock of the Company to certain non-employee directors (the “2002 Directors’ Option Plan”). Under the 2002 Directors’ Option Plan, the Company may issue options to eligible directors to purchase up to 90,000 shares of Common Stock at an exercise price equal to the fair market value as of the grant date. An eligible director received an initial option grant to purchase 5,000 shares of Common Stock as of the effective date of his/her initial appointment or election to the Board of Directors. On each Award Date, defined as August 2, 2002, August 1, 2003, or August 3, 2004, eligible directors were granted options to purchase additional shares of Common Stock. On August 2, 2002, each eligible director was granted options to purchase an additional 2,500 shares of Common Stock. For the August 1, 2003 and August 3, 2004 Award Dates, each eligible director was granted options to purchase an additional 3,500 shares of Common Stock. Stock options granted have terms of ten years and shall vest and become exercisable over three years from the grant date; however, due to the Recapitalization on November 30, 2003, certain options vested and became exercisable immediately. Option holders may pay for shares purchased on exercise in cash or Common Stock.   The following table summarizes information concerning the options outstanding, granted, forfeited and the weighted average exercise prices of options granted under the 2002 Directors’ Option Plan:   2002 Stock Option Plan for Directors   2004   2003   2002       Shares Weighted Average Exercise Price         Shares Weighted Average Exercise Price         Shares Weighted Average Exercise Price 2005   2004   2003           Shares Weighted Average Exercise Price         Shares Weighted Average Exercise Price         Shares Weighted Average Exercise Price Options outstanding, beginning of period 71,000 $2.40   10,000 $       2.30   — $        — 65,500 $2.04   71,000 $2.40   10,000 $   2.30 Granted 26,000 1.60   61,000 2.41   10,000 2.30 — —   26,000 1.60   61,000 2.41 Exercised — —   — —   — — — —   — —   — — Forfeited (31,500) 2.49   — —   — — (2,500) 2.30   (31,500) 2.49   — —           Options outstanding, end of period 65,500 $2.04   71,000 $       2.40   10,000 $     2.30 63,000 $2.03   65,500 $2.04   71,000 $   2.40     Options exercisable, end of period 36,167 $2.35   47,167 $       2.39   — $        — 44,000 $2.20   36,167 $2.35   47,167 $   2.39     Weighted average fair value of options granted   $      1.11     $   1.83     $     1.56   $        —     $     1.11     $   1.83             The fair value of each option granted is estimated on the grant date using the Black-Scholes option-pricing model. The weighted average assumptions for grants in 2004 2003 and 20022003 under the 2002 Directors’ Option Plan were as follows: risk-free interest rate of 3.30%, and 3.64% and 3.76%, respectively, expected volatility of 99.68%, and 90.74% and 89.36%, respectively, expected life of four six, and six years, respectively, and no expected dividends.   The following table summarizes information about stock options outstanding at December 25, 200431, 2005 under the 2002 Directors’ Option Plan: 2002 Stock Option Plan for Directors     Options Outstanding Options Exercisable         Exercise Price       Number Outstanding Weighted Average Remaining Contractual Life   Weighted Average Exercise Price       Number Exercisable   Weighted Average Exercise Price $1.43 21,000 9.6 $1.43 -- $1.43 $1.95 5,000 8.0 $1.95 5,000 $1.95 $2.20 15,000 8.9 $2.20 11,667 $2.20 $2.30 7,500 6.3 $2.30 2,500 $2.30 $2.51 7,000 8.6 $2.51 7,000 $2.51 $2.54 5,000 8.6 $2.54 5,000 $2.54 $2.69 5,000 8.8 $2.69 5,000 $2.69           65,500 8.7 $2.04 36,167 $2.35     Options Outstanding Options Exercisable         Exercise Price       Number Outstanding Weighted Average Remaining Contractual Life   Weighted Average Exercise Price       Number Exercisable   Weighted Average Exercise Price $ 1.43 21,000 8.6 $1.43 7,000 $1.43 $ 1.95 5,000 7.0 $1.95 5,000 $1.95 $ 2.20 15,000 7.9 $2.20 13,333 $2.20 $ 2.30 5,000 8.3 $2.30 1,667 $2.30 $ 2.51 7,000 7.6 $2.51 7,000 $2.51 $ 2.54 5,000 7.6 $2.54 5,000 $2.54 $ 2.69 5,000 7.8 $2.69 5,000 $2.69   63,000 8.0 $2.03 44,000 $2.20   2004 Stock Option Plan for Directors – During 2004, the Board of Directors adopted the 2004 Stock Option Plan for Directors providing stock options to purchase shares of Common Stock of the Company to certain non-employee directors (the “2004 Directors’ Option Plan”). The Company’s shareholders ratified the 2004 Directors’ Option Plan at the 2004 Annual Meeting of Shareholders. The Company may grant options to purchase up to 100,000 shares of Common Stock to eligible directors at an exercise price equal to the fair market value as of the grant date. An eligible director will receive an initial option grant to purchase 5,000 shares of Common Stock as of the effective date of his/her appointment or election to the Board of Directors. On each Award Date, defined as August 3, 2004, August 3, 2005 and August 3, 2006, eligible directors are to be granted options to purchase additional shares of Common Stock (to the extent the 2002 Stock Option Plan for Directors did not have enough remaining shares). Stock options granted have terms of 10 years and vest over three years from the grant date; however, if there is a Change in Control (as defined in the Hanover Direct, Inc. Directors Change of Control Plan), the participant has the cumulative right to purchase up to 100% of the option shares. Option holders may pay for shares purchased on exercise in cash or Common Stock. As of December 25, 200431, 2005 no options have been granted under the 2004 Directors’ Option Plan. In addition,Plan, as the automatic grant of options that wereon August 3, 2004 was made under the 2002 Stock Option Plan for Directors, and the non-employee directors waived their right to the automatic grant of options to be granted on the August 3, 2005 Award Date have been deferred until the Company issues its December 25, 2004 audited financial statements.2005.   1993 Executive Equity Incentive Plan — In December 1992, the Board of Directors adopted the 1993 Executive Equity Incentive Plan (the “Incentive Plan”) under which executives were given options to purchase shares of Common Stock with up to 80% of the purchase price financed with a six-year full recourse loan from the Company. As of December 25, 2004 and December 27, 2003, no stock options remained outstanding or exercisable related to the Incentive Plan. Changes to the notes receivable balances related to the Incentive Plan are as follows: 1993 Executive Equity Incentive Plan   2004 2003 2002 Notes Receivable, beginning of period $   269,400 $   269,400 $   313,400 Payments — — — Forfeitures (269,400) — (44,000)   Notes Receivable, end of period $              -- $   269,400 $   269,400   The Common Stock issued under the Incentive Plan was held in escrow as collateral security for the loans extended to each remaining plan participant. During 2004, the Company transferred and retired the Common Stock held in escrow to satisfy the outstanding notes receivable and the participants forfeited their initial 20% cash down payment. Management Stock Option Plans — The Company approved for issuance to employees 2,000,000 shares of the Company’s Common Stock pursuant to the Company’s 2000 Management Stock Option Plan and 700,000 shares of the Company’s Common Stock pursuant the Company’s 1996 Stock Option Plan. Under both plans, the option exercise price is equal to the fair market value as of the grant date. However, for stock options granted to an employee owning more than 10.0%10% of the total combined voting power of all classes of Company stock, the exercise price is equal to 110.0%110% of the fair market value of the Company’s Common Stock as of the grant date. Stock options granted to an individual employee under the 2000 Management Stock Option Plan may not exceed 100,000 shares of the Company’s Common Stock. Stock options granted to an individual employee under the 1996 Stock Option Plan may not exceed 50,000 shares of the Company’s Common Stock and may be performance-based. All options granted must be specifically identified as incentive stock options or non-qualified stock options, as defined in the Internal Revenue Code. Furthermore, the aggregate fair market value of Common Stock for which an employee is granted incentive stock options that first became exercisable during any given calendar year shall be limited to $100,000. To the extent this limitation is exceeded, the option shall be treated as a non-qualified stock option. Stock options may be granted for terms not to exceed ten years and shall be exercisable in accordance with the terms and conditions specified in each option agreement. In the case of an employee who owns common stock possessing more than 10.0%10% of the total combined voting power of all classes of common stock, the options must become exercisable within five years. Due to the change in control that occurred on November 30, 2003, certain options became fully vested. Option holders may pay for shares purchased on exercise in cash or Common Stock.   The following table summarizes information concerning the options outstanding, granted and the weighted average exercise prices of options granted under the 1996 and 2000 Management Stock Option Plans:   1996 and 2000 Management Stock Option Plans   2004   2003   2002           Shares Weighted Average Exercise Price         Shares Weighted Average Exercise Price         Shares Weighted Average Exercise Price 2005   2004   2003           Shares Weighted Average Exercise Price         Shares Weighted Average Exercise Price         Shares Weighted Average Exercise Price Options outstanding, beginning of period 822,145 $     8.08   923,027 $     8.13   396,278 $   24.59 776,383 $     7.44   822,145 $     8.08   923,027 $     8.13 Granted 127,000 1.84   6,500 2.32   676,100 2.43 100,000 0.92   127,000 1.84   6,500 2.32 Exercised — —   — —   — — — —   — —   — — Forfeited (172,762) 6.39   (107,382) 8.13   (149,351) 25.98 (239,783) 7.74   (172,762) 6.39   (107,382) 8.13           Options outstanding, end of period 776,383 $     7.44   822,145 $     8.08   923,027 $     8.13 636,600 $     6.31   776,383 $     7.44   822,145 $     8.08     Options exercisable, end of period 671,216 $     8.32   802,920 $     8.21   191,327 $   21.81 513,426 $��    7.50   671,216 $     8.32   802,920 $     8.21     Weighted average fair value of options granted $      1.34   $     1.62   $       1.84 $      0.51   $     1.34   $       1.62             The fair value of each option granted is estimated on the grant date using the Black-Scholes option-pricing model. The weighted average assumptions for grants in 2005, 2004 2003 and 20022003 are as follows: risk-free interest rate of 3.44%3.96%, 3.58%3.44% and 3.81%3.58%, respectively, expected volatility of 103.78%87.55%, 90.96%103.78% and 89.58%90.96%, respectively, expected lives of four, sixfour and six years, respectively, for 2005, 2004 2003 and 2002,2003, and no expected dividends.   The following table summarizes information about stock options outstanding at December 25, 200431, 2005 under both the 1996 and 2000 Management Stock Option Plans:   1996 and 2000 Management Stock Option Plans     Options Outstanding   Options Exercisable         Weighted             Average Weighted   Weighted     Remaining Average   Average   Number Contractual Exercise Number Exercise Range of Exercise Prices Outstanding Life Price Exercisable Price     $ 1.44 to $2.10 127,000 9.4 $       1.84   33,333 $       1.95 $ 2.40 to $2.70 500,000 7.6 $       2.44   488,500 $       2.44 $ 10.10 to $14.38 12,000 2.5 $     13.67   12,000 $     13.67 $ 17.30 to $23.80 17,500 2.1 $     22.87   17,500 $     22.87 $ 26.61 to $31.88 119,883 3.9 $     31.38   119,883 $     31.38             776,383 7.1 $       7.44   671,216 $       8.32       Options Outstanding   Options Exercisable     Weighted             Average Weighted   Weighted     Remaining Average   Average   Number Contractual Exercise Number Exercise Range of Exercise Prices Outstanding Life Price exercisable Price $ 0.81 to $1.03 100,000 9.2 $       0.92   33,334 $       0.92 $ 1.44 to $2.10 127,000 8.4 $       1.84   73,417 $       1.90 $ 2.40 to $2.70 305,400 6.6 $       2.40   302,475 $       2.40 $ 10.10 to $14.38 10,000 0.8 $     14.38   10,000 $     14.38 $ 17.30 to $23.80 16,500 0.9 $     23.21   16,500 $     23.21 $ 26.61 to $31.88 77,700 3.3 $     31.26   77,700 $     31.26   636,600 6.7 $       6.31   513,426 $       7.50   Wayne P. Garten Stock Option Agreement – During 2004, the Company granted Mr. Garten an option (the “Garten Option”) to purchase up to 100,000 shares of the Company’s Common Stock for an exercise price of $1.95 per share. The Garten Option was not issued pursuant to any of the Company’s plans and Mr. Garten has registration rights for these options. The options vest over a two year period: one-third upon execution of the Garten Employment Agreement, one-third on May 5, 2005 and the final one-third on May 5, 2006; provided that all of the options vest and become fully exercisable upon the earliest to occur of (i) Mr. Garten’s resignation “For Good Reason” (ii) a “Change of Control” or (iii) the Company’s termination of Mr. Garten’s employment other than “For Cause” (as defined in the Garten Employment Agreement). The options expire on May 4, 2014.   The fair value of the options was estimated to be $1.45 per share at the grant date based on the following assumptions: risk-free interest rate of 3.45%, expected life of four years, expected volatility of 103.71%, and no expected dividends. As of December 31, 2005, 66,667 options are exercisable and 100,000 shares are outstanding.   Meridian Options — In December 2000, the Company granted options (the “2000 Meridian Options”) for the purchase of an aggregate of 400,000 shares of Common Stock with an exercise price of $2.50 per share to Meridian, an affiliate of Mr. Shull.Shull who was a former Chief Executive Officer of the Company. These options were allocated as follows: Thomas C. Shull, 270,000 shares; Paul Jen, 50,000 shares; John F. Shull, 50,000 shares; Evan M. Dudik, 20,000 shares; and Peter Schweinfurth, 10,000 shares. All of the remaining 2000 Meridian Options are vested and are due to expire on March 31, 2006.   The fair value of the 2000 Meridian Options was estimated to be $0.70 per share at the grant date based on the following assumptions: risk-free interest rate of 6.0%, expected life of 1.5 years, expected volatility of 54.0%, and no expected dividends.   During December 2001, the Company granted to Meridian, and the Company’s Board of Directors approved, options to Meridian (the “2001 Meridian Options”) for the purchase of an additional 100,000 shares of Common Stock with an exercise price of $3.00. These options were allocated as follows: Thomas C. Shull, 50,000 shares; Edward M. Lambert, 30,000 shares; Paul Jen, 10,000 shares; and John F. Shull, 10,000 shares. The 2001 Meridian Options vested and became exercisable on March 31, 2003, and are due to expire on March 31, 2006.   The fair value of the 2001 Meridian Options was estimated to be $1.60 per share at the grant date based on the following assumptions: risk-free interest rate of 2.82%, expected life of 1.25 years, expected volatility of 129.73%, and no expected dividends.   The following table summarizes information concerning the options outstanding, granted and the weighted average exercise prices of options granted for the 2000 Meridian Options and the 2001 Meridian Options:   Meridian Option Plans   2004   2003   2002           Weighted     Weighted     Weighted     Average     Average     Average     Exercise     Exercise     Exercise   Shares Price   Shares Price   Shares Price       Options outstanding, beginning of period 490,000 $2.60   490,000 $2.60   500,000 $2.60 Granted — —   — —   — — Exercised — —   — —   (10,000) 2.50 Forfeited (120,000) 2.50   — —   — —             Options outstanding, end of period 370,000 $2.64   490,000 $2.60   490,000 $2.60       Options exercisable, end of period 370,000 $2.64   490,000 $2.60   390,000 $2.50         2005   2004   2003     Weighted     Weighted     Weighted     Average     Average     Average     Exercise     Exercise     Exercise   Shares Price   Shares Price   Shares Price Options outstanding, beginning of period 370,000 $2.64   490,000 $2.60   490,000 $2.60 Granted — —   — —   — — Exercised — —   — —   — — Forfeited — —   (120,000) 2.50   — — Options outstanding, end of period 370,000 $2.64   370,000 $2.64   490,000 $2.60 Options exercisable, end of period 370,000 $2.64   370,000 $2.64   490,000 $2.60   The following table summarizes information about stock options outstanding and exercisable at December 25, 200431, 2005 for the 2000 Meridian Options and the 2001 Meridian Options:   Meridian Option Plans   Options Outstanding   Options Exercisable Options Outstanding   Options Exercisable Exercise Prices       Number Outstanding Weighted Average Remaining Contractual Life   Weighted Average Exercise Price         Number Exercisable   Weighted Average Exercise Price       Number Outstanding Weighted Average Remaining Contractual Life   Weighted Average Exercise Price         Number Exercisable   Weighted Average Exercise Price   $ 2.50 270,000 2.3 $ 2.50   270,000 $    2.50 270,000 0.3 $ 2.50   270,000 $    2.50 $ 3.00 100,000 2.3 $ 3.00   100,000 $    3.00 100,000 0.3 $ 3.00   100,000 $    3.00         370,000 0.3 $ 2.64   370,000 $    2.64 370,000 2.3 $ 2.64   370,000 $    2.64     15. CONTINGENICES   Rakesh K. Kaul v. Hanover Direct, Inc., No. 04-4410(L)-CV, 2nd Cir.S.D.N.Y., on appeal from 296 F. Supp.2d (S.D. NY 2004). On June 28, 2001, Rakesh K. Kaul, the former President and Chief Executive Officer of the Company, filed a five-count complaint in the Federal District Court in the Southern District of New York seeking relief stemming from his separation ofpost employment from the Company including short-term bonus and severance payments of $2,531,352, attorneys’ fees and costs, and damages due to thebenefits. The Company’s failure to pay him a “tandem bonus” as well as Kaul’s alleged rights to benefits under a change in control plan and a long-term incentive plan. The Company filed a Motion for Summary Judgment andwas granted in July 2004, the Court entered a final judgmentlarge part, dismissing most of Mr. Kaul’s claims with prejudice and awarded Mr. Kaul $45,946 in vacation pay and $14,910 in interest which the Company paid in July 2004. In August 2004,claims. Kaul filed an appeal on three issues: severance and short-term bonus, tandem bonus and legal fees. Onon June 28, 2005 the Second Circuit Court of Appeals denied Kaul’s appeal, affirming the Summary Judgment decision in the Company’s favor. Mr.appeal. Kaul’s rightsright to appeal the Second Circuit’s decision expired in August 2005.   AsDue to the expiration of December 25, 2004, the Company had accrued $4.5 million related to this matter. This accrual remained on the Company’s Consolidated Balance Sheet until the third fiscal quarter of 2005 when Kaul’s rights to pursue this claim, expired.the Company reversed the $4.5 million accrual related to this matter during the third fiscal quarter of 2005. This reversal reduced general and administrative expenses in the Consolidated Statements of Income (Loss) and accrued liabilities in the Consolidated Balance Sheet. Litigation Related to Going Private Proposal: Three substantially identical complaints have been filed against the Company, Chelsey and each of the Company’s directors: the first complaint was filed in Delaware Chancery Court by Glenn Friedman and L.I.S.T., Inc. as plaintiffs on March 1, 2006; the second complaint was filed in Delaware Chancery Court by Howard Lasker as plaintiff on March 7, 2006; and the third complaint was filed in Superior Court of New Jersey Chancery Division by Feivel Gottlieb as plaintiff on March 3, 2006. In each complaint, the plaintiffs challenge Chelsey’s going private proposal and allege, among other things, that the consideration to be paid in the going private proposal is unfair and grossly inadequate, that the special committee appointed by the Board of Directors of the Company cannot be expected to act independently, that Chelsey has manipulated the financial statements of the Company and its public statements in order to depress the stock price of the Company and that the proposal would freeze out the purported class members and capture the true value of the Company for Chelsey. In each complaint, plaintiffs seek class action certification, preliminary and permanent injunctive relief, rescission of the transaction if the offer is consummated and unspecified damages. The cases are in the initial pleadings phase. Based upon a preliminary analysis of the complaints, the Company believes that the complaints are without merit and intends to defend its interests vigorously.   SEC Informal Inquiry:   See Note 182 to the consolidated financial statements for a discussion of the informal inquiry being conducted by the SEC relating to the Company’s financial results and financial reporting since 1998.   Class Action Lawsuits:   The Company was a party to four class action/representative lawsuits that all involved allegations that the Company’s charges for insurance were invalid, unfair, deceptive and/or fraudulent.   As described in greater detail below,During the third quarter of 2005, the Company hasfavorably resolved allthree of these class action lawsuits. Jacq Wilson v. Brawnthe cases: one was settled for an aggregate payment of California, Inc. , Case No. CGC-02-404454 (Supp. Ct. San Francisco, CA 2002) (“Wilson Case”). On February 13, 2002, Jacq Wilson, suing on behalf of himself and other similarly situated persons, filed a representative suit$39,500, the Company prevailed in another case which led to the plaintiff in the Superior Court ofthird case voluntarily dismissing his case.  In the State of California, City and County of San Francisco, against the Company alleging that the Company charged an unlawful, unfair, and fraudulent insurance fee on orders, was engaged in untrue, deceptive and misleading advertising and unfair competition under the state’s Business and Professions Code. The plaintiffs sought relief including restitution and disgorgement of all monies wrongfully collected by defendants, including interest, an order enjoining defendants from imposing insurance on its order forms, and compensatory damages, attorneys’ fees, pre-judgment interest and costs of the suit. In November, 2003, the Court, after a trial the previous April, entered judgment for the plaintiffs, requiring defendants to refund insurance charges collected from consumers for the period from February 13, 1998 through January 15, 2003, with interest. In April, 2004, the Court awarded plaintiff’s counsel approximately $445,000 of attorneys’ fees. The Company appealed the Court’s decision and the order to pay attorneys’ fees, which appeals were consolidated. Enforcement of the judgment for insurance fees and the award of attorneys’ fees was stayed pending resolution of the appeal. On September 2, 2005 the California Court of Appeals reversed both the Court’s findings on the merits and its award of attorneys’ fees and awarded the Company its cost on the appeal. Teichman v. Hanover Direct, Inc. et. al., No. 3L641 (Supp. Ct. San Francisco, CA 2001). On August 15, 2001, Randi Teichman filed a summons and four-count complaint in the Superior Court for the City and County of San Francisco seeking damages and other relief for herself and a class of similarly situated persons arising out of the insurance fee charged by catalogs and Internet sites operated by Company subsidiaries. Thisremaining case, had been stayed since May 2002 pending resolution of the Wilson Case. The plaintiffs in both Wilson and Teichman were represented by the same counsel and the plaintiffs in both cases agreed to dismiss the cases with prejudice in exchange for the Company’s agreement to not seek reimbursement of costs in the Wilson case. John Morris, individually and on behalf of all other similarly situated person and entities similarly situated v. Hanover Direct, Inc. and Hanover Brands, Inc., No. L 8830-02 (Sup. Ct. Bergen Co. – Law Div., NJ) October 28, 2002, John Morris, individually and on behalf of other similarly situated persons in New Jersey filed a class action alleging that (1) the Company improperly added a charge for “insurance” and (2) the Company’s conduct was in violation of the New Jersey Consumer Fraud Act as otherwise deceptive, misleading and unconscionable. Morris sought relief including damages equal to the amount of all insurance charges, interest, treble and punitive damages, injunctive relief, costs, and reasonable attorneys’ fees. On February 14, 2005, the Court denied class certification which limited the damages being litigated, absent an appeal of the denial of class certification, to Plaintiff’s individual injury of the $1.48 he paid for insurance which could be trebled pursuant to the New Jersey consumer protection statute plus attorney’s fees. This case was settled effective as of August 29, 2005 and the Company paid $39,500 in the aggregate for a nominal amount of damages and legal fees. Martin v. Hanover Direct, Inc., et. al., No. CJ-2000 (D.C. Sequoyah Co., Ok.) (“Martin Case”). On March 3, 2000, Edwin L. Martin filed a class action lawsuit against the Company claiming breach of contract, unjust enrichment, recovery of money paid absent consideration, fraud and a claim under the New Jersey Consumer Fraud Act. The allegations stem from “insurance charges” paid to the Company by consumers who had placed orders from catalogs published by indirect subsidiaries of the Company over a number of years. Martin sought relief including (i) a declaratory judgment as to the validity of the delivery insurance, (ii) an order directing the Company to return to the plaintiff and class members the “unlawful revenue” derived from the insurance charges, (iii) threefold damages for each class member, and (iv) attorneys’ fees and costs. In July 2001, the Court certified the class and the Company filed anprevailed in its appeal of the class certification. Oncertification in an October 25, 2005 the class certification was reversed.decision.  Martin filed an Application for Rehearing which was denied on January 3, 2006. On January 18, 2006, Martin filedand a Petition for a Writ of Certiorari in the Oklahoma Supreme Court. The Company believes that it is unlikely thatCourt, both of which were denied during the Oklahoma Supreme Court will grant Martin’s petition.first quarter of 2006.   The Company established a $0.5 million reserve during the third quarter of 2004 for the class action lawsuits described above for settlements and the Company’s current estimate of future legal fees to be incurred. The balance of the reserve as of December 25, 2004 remained at $0.531, 2005 is $0.1 million.   Claims for Post-Employment Benefits   The Company is involved in four lawsuits instituted by former employees arising from the Company’s denial of change in control (“CIC”) benefits under compensation continuation plans following the termination of employment.    Two of these cases arose from the circumstances surrounding the Restatement:    Charles Blue v. Hanover Direct, Inc., William Wachtel, Stuart Feldman, Wayne Garten and Robert Masson, (Supp. Ct. N.J., Law Div. Hudson Cty, Docket No.: L-5153-05) is an action instituted by the Company’s former Chief Financial Officer who was terminated for cause on March 8, 2005.  The complaint seeks compensatory and punitive damages and attorney’s fees and alleges retaliation, mental anguish and reputational damage, loss of earnings and employment and racial discrimination.  The Company believes that Mr. Blue was properly terminated for cause and that his claims are groundless.    Frank Lengers v. Hanover Direct, Inc., Wayne Garten, William Wachtel, A. David Brown, Stuart Feldman, Paul S. Goodman,  Donald Hecht and Robert Masson, (Supp. Ct. N.J., Law Div. Hudson Cty, Docket No.: L-5795-05) was brought as a result of the Company terminating the employment of its former Vice President, Treasury Operations & Risk Management, on March 8, 2005 for cause.  The complaint seeks compensatory and punitive damages and attorney’s fees and alleges improper denial of CIC benefits, age and disability discrimination, handicap discrimination, aiding and abetting and breach of contract.  The Company believes that Mr. Lengers was properly terminated for cause and that his claims are groundless.   The Company believes that it properly denied CIC benefits with respect to each of the four former employees and that it has meritorious defenses in all of the cases and plans a vigorous defense.   In addition, the Company is involved in various routine lawsuits of a nature that is 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, results of operations, or cash flows.   16. DELISTING OF COMMON STOCK The Company’s Common Stock was delisted from the American Stock Exchange (the “AMEX”) on February 16, 2005 as a result of the Company’s inability to comply with the AMEX’s continued listing standards and because the Company did not file on a timely basis its Form 10-Q for the fiscal quarter ended September 25, 2004 as a result of the Restatement. Initially the Company received a May 21, 2004 letter from the AMEX advising that a review of the Company’s Form 10-K for the fiscal period ended December 27, 2003 indicated that the Company did not meet the following continued listing standards as set forth in Part 10 of the AMEX’s Company Guide: (i) Section 1003(a)(i) with shareholders’ equity of less than $2.0 million and losses from continuing operations and/or net losses in two out of its three most recent fiscal years; and (ii) Section 1003(a)(ii) with shareholders’ equity of less than $4 million 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 $6.0 million and losses from continuing operations and/or net losses in its five most recent fiscal years. To maintain its AMEX listing, the Company was required to submit a plan to the AMEX by June 22, 2004, advising the AMEX of action that would bring it into compliance with the continued listing standards of the AMEX by November 21, 2005 (18 months of receipt of the original letter from the AMEX). The Company submitted a plan to the AMEX on June 22, 2004 and on August 3, 2004 the AMEX notified the Company that it accepted the Company’s plan and granted the Company an extension until November 21, 2005 to regain compliance with the continued listing standards. The Company received a December 9, 2004 letter from the AMEX notifying the Company that it had failed to satisfy an additional continued listing standard because the Company had yet to file its Quarterly Report on Form 10-Q for the fiscal quarter ended September 25, 2004, a condition for the Company’s continued listing on the AMEX under Sections 234 and 1101 of the Company Guide. The AMEX advised that if the Company did not file the Form 10-Q by December 31, 2004, the AMEX staff would initiate delisting proceedings as appropriate. The Company received a January 24, 2005 letter from the AMEX notifying it that the AMEX had determined to proceed with the filing of an application with the SEC to strike the Common Stock of the Company from listing and registration on the AMEX based on the Company’s failure to regain compliance with the AMEX’s filing requirements as set forth in Section 134 and 1101 of the Company Guide by December 31, 2004 and the fact that the Company was not in compliance with Sections 1003(a)(i), 1003(a)(ii) and 1003(a)(iii) of the Company Guide. The Company had a limited right to appeal the AMEX’s determination which it did not because, in addition to its continued inability to file its Quarterly Report on Form 10-Q for the fiscal quarter ended September 25, 2004 and its inability to satisfy the requirements for minimum stockholders’ equity, the Company did not meet the alternative financial standards set forth in Section 1003 of the Company Guide. The Company’s common stock was formally suspended from trading on the AMEX on February 2, 2005 and removed from listing and registration effective February 16, 2005. Current trading information about the Company’s common stock can be obtained from the Pink Sheets (www.pinksheets.com) under the trading symbol HNVD.PK. 17. SELECTED QUARTERLY FINANCIAL INFORMATION (UNAUDITED)   First Quarter   Second Quarter   Third Quarter   Fourth Quarter     As Reported As Restated   As Reported As Restated                           (in thousands, except per share amounts)   2004                         Net revenues $       95,312 $     90,184   $      96,545 $ 96,886   $     94,443   $  121,647   Income before interest and income taxes 1,445 10   1,276 933   2,476   7,323   Net income (loss) and comprehensive income (loss) 418 (796)   586 33   711   5,053   Net income (loss) applicable to common shareholders $            417 $       (796)   $           585 $ 33   $         711   $       4,929   Net income (loss) per share – basic $           0.02 $      (0.04)   $          0.03 $ 0.00   $        0.03   $        0.22             Net income (loss) per share – diluted $           0.02 $      (0.04)   $          0.03 $ 0.00   $        0.02   $        0.15                                         First Quarter   Second Quarter   Third Quarter   Fourth Quarter     As Reported As Restated   As Reported As Restated   As Reported As Restated   As Reported As Restated           (in thousands, except per share amounts)   2003                         Net revenues $     102,474 $     97,311   $   105,765 $   105,317   $     96,633 $     96,925   $    110,002 $  114,730   Income (loss) before interest and income taxes 1,655 245   1,805 1,235   (64) (219)   4,621 2,095   Net income (loss) and comprehensive income (loss) 192 (1,209)   690 115   (16,645) (16,810)   364 (2,156)   Preferred stock dividends and accretion 3,632 3,632   4,290 4,290   -- --   -- --   Net income (loss) applicable to common shareholders $      (3,440) $    (4,841)   $    (3,600) $     (4,175)   $   (16,645) $   (16,810)   $          364 $   (2,156)   Net income (loss) per share – basic and diluted $        (0.25) $      (0.35)   $      (0.26) $      (0.30)   $      (1.20) $      (1.22)   $         0.00 $     (0.13)             The quarterly amounts above include the impact of the Restatement identified in Note 2. 18. SUBSEQUENT EVENTS Gump’s Business On March 14, 2005, the Company sold all of the stock of Gump’s to Gump’s Holdings, LLC, an unrelated third party (“Purchaser”) for $8.9 million, including a purchase price adjustment of $0.4 million, pursuant to the terms of a February 11, 2005 Stock Purchase Agreement. The Company will recognize a gain on the sale of approximately $3.6 million in the quarter ended March 26, 2005. Chelsey, as the holder of all of the Series C Preferred, consented to the application of the sales proceeds to reduce the outstanding balance of the Wachovia Facility in lieu of the current redemption of a portion of the Series C Preferred. Chelsey expressly retained its right to require redemption of approximately $6.9 million (the Gump’s sales proceeds available for redemption) of the Series C Preferred subject to Wachovia’s approval. After the sale, the Company continues as the guarantor of one of the two leases for the San Francisco building where the store is located (the Company was released from liability on the other lease). The Purchaser is required to use its commercially reasonable efforts to secure the Company’s release from the guarantee within a year of the closing. If the Purchaser cannot secure the Company’s release within a year of the closing, an affiliate of the Purchaser will either (i) transfer a percentage interest in its business so that the Company will own, indirectly, 5% interest of the Purchaser’s common stock, or (ii) provide the Company with a $2.5 million stand-by letter of credit or other form of compensation acceptable to the Company to reimburse the Company for any liabilities the Company may incur under the guarantee until the Company is released from the guarantee or the lease is terminated. As of February 6, 2006 there are $7.1 million (net of $0.5 million of expected sublease income) in lease commitments for which the Company is the guarantor. Based on its evaluation, the Company has concluded it is unlikely any payments will be required under the guarantee. The Company entered into a Direct Marketing Services Agreement with the Purchaser to provide telemarketing and fulfillment services for the Gump’s catalog and direct marketing businesses for eighteen months. We have the option to extend the term for an additional eighteen months. Listed below are the carrying values of the major classes of assets and liabilities of Gump’s included in the Consolidated Balance Sheets: In thousands (000’s) December 25, 2004   December 27, 2003       Total current assets   $       10,842     $       10,995 Total non-current assets $         3,221   $         3,801 Total assets $       14,063   $       14,796 Total current liabilities $         6,727   $         7,980 Total non-current liabilities $         3,283   $         3,995 Total liabilities $       10,010   $       11,975 Listed below are the revenues and income before income taxes included in the Consolidated Statements of Income (Loss) (these results exclude certain corporate overhead charges allocated to Gump’s for services provided by the Company to run the business): In thousands (000’s) For the Year Ended December 25, 2004   For the Year Ended December 27, 2003       Net revenues   $          42,634     $                     44,188 Income before income taxes $            2,967   $                       1,215 Private Label and Co-Brand Credit Card Agreement PRIVATE LABEL AND COBRAND CREDIT CARD AGREEMENT   On February 22, 2005, the Company entered into a seven year co-brand and private label credit card agreement (as amended by Amendment Number One on March 30, 2005, the “Credit Card Agreement”) with WFNNBWorld Financial Network National Bank (“WFNNB”) under which WFNNB will provide private label (branded) and co-brand credit cards to the Company’s customers. The Company began offering the private label credit card to its customers in April 2005. The program extends credit to our customers at no credit risk to the Company and is expected to lead to increased sales and lower expenses. WFNNB will provide a fixed dollar amount as marketing funds in the first year of which 25% of any unused amount can be utilized in the first six months of the second year and a percentage of the lesser of private label net sales or average accounts receivable balance in later years to support the Company’s promotion of the program. In general, WFNNB will pay the Company proceeds from sales of Company merchandise using the cards issued under the program with no discount. In addition, WFNNB paid the Company an up-front fee when the private label plan commenced and will pay a per card fee for each card issued under the co-brand program and a percentage of the net finance charges on co-brand accounts.   If the Credit Card Agreement is terminated or expires other than as a result of a default by WFNNB, the Company will be obligated to purchase any outstanding private label accounts at their fair market value. The Company will have the option of purchasing any outstanding co-brand accounts at their fair market value when the Credit Card Agreement terminates unless the termination is attributable to the Company’s default. Under the 34th Amendment to the Loan & Security Agreement executed by the Company and Wachovia on July 29, 2005, the Company is prohibited from using the Wachovia Facility to fund the purchase of the private label and co-brand accounts. As a consequence, should the Company become obligated to purchase the accounts and should it not have secured a replacement credit card program with a new credit card issuer, the Company will be forced to seek financing from a different source which financing will be subject to Wachovia’s and Chelsey’s approval.   Audit Committee Investigation; SEC Inquiry17. SELECTED QUARTERLY FINANCIAL INFORMATION (UNAUDITED)     First Quarter   Second Quarter   Third Quarter   Fourth Quarter         (in thousands, except per share amounts)     2005                 Net revenues   $                    89,682   $                  100,231   $                    96,839   $                  120,690 Income before interest and income taxes   2,072   3,411   8,994   2,659 Income from continuing operations   239   1,444   6,796   482 Net income and comprehensive income   3,227   1,452   6,796   482 Net income applicable to common shareholders   $                      3,148   $                      1,416   $                      6,629   $                        470 Net Income Per Common Share:                 From continuing operations – basic   $                       0.01   $                       0.06   $                       0.30   $                       0.02 From continuing operations – diluted   $                       0.01   $                       0.04   $                       0.20   $                       0.01 From discontinued operations – basic   $                       0.13   $                       0.00   $                       0.00   $                       0.00 From discontinued operations – diluted   $                       0.09   $                       0.00   $                       0.00   $                       0.00 Net income – basic   $                       0.14   $                       0.06   $                       0.30   $                       0.02 Net income – diluted   $                       0.10   $                       0.04   $                       0.20   $                       0.01                       First Quarter   Second Quarter   Third Quarter   Fourth Quarter         (in thousands, except per share amounts)     2004                 Net revenues   $                    81,281   $                    87,744   $                    85,443   $                  106,058 Income before interest and income taxes   109   624   2,081   4,499 Income (loss) from continuing operations   (600)   (186)   444   2,376 Net income (loss) and comprehensive income (loss)   (796)   33   711   5,053 Net income (loss) applicable to common shareholders   $                      (796)   $                          33   $                        711   $                      4,929 Net Income (Loss) Per Common Share:                 From continuing operations – basic   $                     (0.03)   $                     (0.01)   $                       0.02   $                       0.10 From continuing operations – diluted   $                     (0.03)   $                     (0.01)   $                       0.01   $                       0.07 From discontinued operations – basic   $                     (0.01)   $                       0.01   $                       0.01   $                       0.12 From discontinued operations – diluted   $                     (0.01)   $                       0.01   $                       0.01   $                       0.08 Net income (loss) – basic   $                     (0.04)   $                       0.00   $                       0.03   $                       0.22 Net income (loss) – diluted   $                     (0.04)   $                       0.00   $                       0.02   $                       0.15       The Audit Committee of the Board of Directors began an investigation of matters relating to restatements of the Company’s financial statements and other accounting-related matters with the assistance of independent outside counsel Wilmer Cutler Pickering Hale and Dorr LLP (“Wilmer Cutler”). The Audit Committee concluded its investigation and, with the assistance of Wilmer Cutler, reported its findings to the Board of Directors. The Audit Committee, again with the assistance of Wilmer Cutler, formulated a series of recommendations to the Company and the Board of Directors concerning potential improvements in the Company’s internal controls and procedures for financial reporting. The Board of Directors and management have begun implementing these recommendations. The Company was notified by the SEC that it was conducting an informal inquiry relating to the Company’s financial results and financial reporting since 1998. The SEC indicated in its letter to the Company that the inquiry should not be construed as an indication by the SEC that there has been any violation of the federal securities laws. The Company is cooperating fully with the SEC in connection with the inquiry and Wilmer Cutler has briefed the SEC and the Company’s independent registered public accounting firm, Goldstein Golub Kessler LLP (“GGK”) on the results of its investigation. The Company intends to continue to cooperate with the SEC in connection with its informal inquiry concerning the Company’s financial reporting. SCHEDULE II   HANOVER DIRECT, INC. VALUATION AND QUALIFYING ACCOUNTS Years Ended December 31, 2005, December 25, 2004 December 27, 2003 and December 28, 200227, 2003 (In thousands of dollars)   Column A Column B Column C Column D Column E Column B Column C Column D Column E   Additions       Additions     Description     Restated Balance at Beginning of Period       Charged to Costs and Expenses     Charged to Other Accounts (Describe)         Deductions (Describe)       Balance at End of Period     Restated Balance at Beginning of Period       Charged to Costs and Expenses     Charged to Other Accounts (Describe)         Deductions (Describe)       Balance at End of Period 2005: Allowance for Doubtful Accounts Receivable $          1,367 $             518 - $ 969(4) $        916 Reserve for Closed Restaurant Operations 21 30 - 41(5) 10 Special Charges Reserve 4,878 - - 4,857(5) 21 Reserves for Sales Returns 1,985 9,037 - 8,782(6) 2,240 Deferred Tax Asset Valuation Allowance 33,349 - 15,333(1) 9,612(7) 39,070 2004: Allowance for Doubtful Accounts Receivable $     1,105 $    609 - $ 347(4) $     1,367 1,105 609 - 347(4) 1,367 Reserve for Closed Restaurant Operations 69 42 - 90(5) 21 69 42 - 90(5) 21 Special Charges Reserve 5,794 1,536 - 2,452(5) 4,878 5,794 1,536 - 2,452(5) 4,878 Reserves for Sales Returns 1,981 3,549 - 3,545(6) 1,985 1,981 3,549 - 3,545(6) 1,985 Deferred Tax Asset Valuation Allowance 33,414 - 618(1) 1,921(7) 32,111 33,414 - 1,858(2) 1,923(8) 33,349 2003 (As Restated): 2003: Allowance for Doubtful Accounts Receivable 1,560 378 - 833(4) 1,105 1,560 378 - 833(4) 1,105 Reserve for Closed Restaurant Operations 322 40 - 293(5) 69 322 40 - 293(5) 69 Special Charges Reserve 8,032 1,304 - 3,542(6) 5,794 8,032 1,304 - 3,542(6) 5,794 Reserves for Sales Returns 1,710 2,551 - 2,280(6) 1,981 1,710 2,551 - 2,280(6) 1,981 Deferred Tax Asset Valuation Allowance 142,054 - 11,300(2) 119,940(8) 33,414 142,054 - 11,300(3) 119,940(9) 33,414 2002 (As Restated): Allowance for Doubtful Accounts Receivable 2,117 304 - 861(4) 1,560 Reserve for Closed Restaurant Operations 737 40 - 455(5) 322 Special Charges Reserve 11,056 4,769 - 7,793(6) 8,032 Reserves for Sales Returns 2,547 345 - 1,182(6) 1,710 Deferred Tax Asset Valuation Allowance 137,252 - 4,802(3) - 142,054   (1) $61810,460 is attributable to the long-term capital loss carryover and $4,873 is attributable to an increase in estimated utilizable NOLs. (2) $1,858 represents the increase in the valuation allowance used to offset net increases in temporary differences. (2)(3) $11,300 increase in the valuation allowance charged to deferred income tax provision. (3) $3,700 charged to deferred income tax provision, $1,102 increase in the valuation allowance used to offset net increase in temporary differences. (4) Written-off. (5) Utilization and reversal of reserves. (6) Utilization of reserves. (7) $5,455 represents the decrease in the allowance attributable to loss carryovers and the reversal of temporary differences caused by the sale of Gump’s and $4,157 represents the reversal of temporary differences in continuing operations. (8) Represents the utilization and expiration of NOLs. (8)(9) $117,671 represents the expiration of NOL and tax credit carryovers and $2,269 is attributable to the net reversal of temporary differences.   Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure   There were no disagreements with accountants on accounting and financial disclosure.   Item 9A. Controls and ProceduresProcedures.   Disclosure Controls and Procedures   Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has completed an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) pursuant to Item 307 of Regulation S-K for the fiscal quarter covered by this quarterly report.as of December 31, 2005. This evaluation has allowed management to make conclusions, as set forth below, regarding the state of the Company’s disclosure controls and procedures as of December 25, 2004. While31, 2005. It should be noted that as a result of the Restatement of our prior period financial statements, the change in our auditors and the attendant delay in the completion of the 2004 audit and reviews of our quarterly financial statements, we were unable to file our Form 10-K for fiscal year 2004 and the Form 10-Q’s for the third fiscal quarter of 2004 and the first three fiscal quarters of 2005 until February 21, 2006. During the last year and half, management has made significant improvements in itsour disclosure controls and procedures and has completed various action plans to remedy identified weaknesses in these controls (as more fully discussed below), based on management’s evaluation, managementwhich has concluded that the Company’s disclosure controls and procedures were not effective in alerting managementenabled us to file this Annual Report on a timely basis to material information relating to the Company required to be included in the Company’s periodic filings under the Exchange Act. In coming to this conclusion, management considered, among other things, the control deficiency related to periodic review of the application of generally accepted accounting principles, which resulted in the Restatement as disclosed in Note 2 to the accompanying consolidated financial statements included in this Form 10-K. As background, the following occurred during 2004 and 2005: • During the second quarter of 2004, the Company identified a revenue recognition cut-off issue that resulted in revenue being recorded in advance of the actual shipment of merchandise to the customer. The practice was stopped immediately. Subsequently, the Company determined that revenue should be recognized when merchandise is received by the customer rather than when shipped because the Company routinely replaces customer merchandise damaged or lost in transit as a customer service matter (even though risk of loss, as a legal matter, passes on shipment). As a consequence, the Company has restated all affected periods presented to recognize revenue when merchandise is received by the customer. • In the first quarter of 2004, former management identified a potential issue with the accounting treatment of discount obligations due to members of certain of the Company’s buyers’ club programs, and at that time, an inappropriate conclusion regarding the accounting treatment was reached. During the third quarter of 2004, the issue was re-evaluated and it was determined that an error in the accounting treatment had occurred. The cumulative impact of the error for which the Company restated resulted in the overstatement of revenues and the omission of the related liability to the guarantee of these discount obligations that aggregated $2.4 million as of June 26, 2004 (the end of the second quarter of 2004). The Company immediately implemented accounting policies to appropriately account for all obligations due to members of the buyers’ club programs. • On November 9, 2004, the Company’s Audit Committee discussed the two matters noted above with the Company’s former independent registered public accounting firm, KPMG LLP (“KPMG”) and then on November 17, 2004, the Audit Committee launched an investigation relating to the restatement of the Company’s consolidated financial statements and other accounting-related matters and engaged Wilmer Cutler as its independent outside counsel to assist with the investigation. • The Company was notified on January 11, 2005 by the SEC that the SEC was conducting an informal inquiry relating to the Company’s financial results and financial statements since 1998. The Audit Committee, the Board of Directors and the Company’s management have been cooperating fully with the SEC in connection with the inquiry. • On February 3, 2005, the Company reported that its Common Stock was being delisted by the AMEX as a consequence, among other reasons, of the Company’s inability to meet the AMEX’s continued listing requirements and its inability to timely file its Form 10-Q for the fiscal quarter ended September 25, 2004. • On March 14, 2005, the Audit Committee reported that it had concluded its investigation and, with the assistance of Wilmer Cutler, reported its findings to the Board of Directors. The Audit Committee, with Wilmer Cutler’s assistance, formulated recommendations to the Company and the Board of Directors concerning ways of improving the Company’s internal controls and procedures for financial reporting which the Board of Directors and the Company began to implement. • The Audit Committee subsequently instructed Wilmer Cutler to cooperate fully with the SEC in connection with its inquiry and share the results of its investigation with the SEC, KPMG and Goldstein Golub Kessler LLP (“GGK”), whom had been engaged by the Audit Committee on November 2, 2005 as the Company’s new auditors after the dismissal of KPMG on October 20, 2005. Wilmer Cutler has presented the results of its investigation to the SEC, KPMG and GGK. • During the course of preparing its 2004 consolidated financial statements, the Company evaluated a previously reversed litigation reserve relating to post employment benefits allegedly owed to its former CEO. In the course of evaluating the accounting treatment of the restoration of the reserve, the Company identified that the original reserve had been improperly established as a litigation reserve rather than an accrual for post employment benefits and that legal expenses had been improperly charged against the reserve rather than treated as period expenses. Management corrected these errors and restated all affected periods presented in accordance with the corrected treatment of the reserve. • During the course of preparing its 2004 consolidated financial statements, the Company determined that an accrual related to certain customer prepayments and credits had been inappropriately released and that other liabilities relating primarily to certain miscellaneous catalog costs and other miscellaneous costs had not been appropriately accrued in the appropriate periods. The Company re-established the improperly released accrual and accrued certain miscellaneous catalog costs in the appropriate periods and restated all affected periods presented in accordance with the corrected treatment of these items. Internal Control Over Financing Reporting KPMG, the Company’s former auditors, identified material weaknesses in internal control over financial reporting based upon its audit of the 2004 consolidated financial statements which it did not complete. After their engagement, we informed GGK of the identified material weaknesses in internal control over financial reporting and other matters relating to the Company’s internal controls based upon KPMG’s incomplete audit of the 2004 consolidated financial statements. Upon completion of their audit of fiscal 2004, GGK has not brought to our attention any material weaknesses. Our management considered the material weaknesses identified by KPMG in evaluating the adequacy of the Company’s internal controls. A control deficiency exists when the design or operation of a control does not allow management or employees, in the normal course of performing their assigned functions, to detect or prevent misstatements on a timely basis. A deficiency in design exists when (a) a control necessary to meet the control objective is missing, or (b) an existing control is not properly designed so that even if the control operates as designed, the control objective is not always met. A deficiency in operation exists when a properly designed control does not operate as designed, or when the person performing the control does not posses the necessary authority or qualification to perform the control effectively. A material weakness is a significant deficiency, or combination of significant deficiencies, that result in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. The following material weaknesses had been identified: • The Company lacks a sufficient number of financial and tax personnel with the appropriate level of expertise to independently monitor, interpret and implement the application of financial accounting standards in accordance with generally accepted accounting principles, • The environment of the Company was such that members of management were not encouraged to discuss transactions and events that could impact the appropriate financial reporting of the Company, and • The Company does not have adequate policies and procedures relating to the origination and maintenance of contemporaneous documentation to support key accounting judgments or to effectively document the terms of all significant contracts and agreements and the related accounting treatment for these contracts and agreements. The Company has strengthened and replaced its senior management commencing with the May 5, 2004 appointment of a new Chief Executive Officer. Under new management, the Company is committed to meeting and enhancing its internal control obligations as part of the Company’s overall commitment to establishing a new corporate culture that focuses on ethics, unfettered communication within the organization and compliance, and sets a new standard for corporate behavior within the Company. Toward this end during 2004, the Company has: • Appointed a new Chief Executive Officer; • Replaced its Corporate Controller and Director of Internal Audit;  • Instituted a policy of open channels of communication including regularly scheduled meetings of and with senior management; • Instituted weekly meetings between the CEO and Director of Internal Audit to review the status of internal audits and assess internal controls; and • Instituted periodic trips by senior management to the Company’s remote facilities to foster communication and ensure compliance with the Company’s reporting, internal control and ethics policies. The Company continued to implement changes to its internal controls during 2005 and has: • Replaced its Chief Financial Officer, and filled other open finance positions which resulted from earlier terminations and other departures;  • Hired a General Counsel and replaced its outside counsel;   • Instituted weekly reviews of financial results with the Chief Financial Officer and senior management to enhance transparency and accountability; • Instituted a policy that requires review and approval of all material agreements and marketing plans by the legal and financial departments; • Instituted a policy that requires all systems changes that could impact financial reporting be subject to approval by the financial department; • Revised the Company’s reporting structure to have the catalog finance directors report to the CFO; • Documented the Company’s significant accounting policies and implemented a procedure to periodically review and update these policies; and • Implemented a policy that requires the preparation of contemporaneous memoranda and related documentation to support key accounting judgments and to maintain and document the significant terms of material contracts and the accounting treatment thereof. As a result of the restatement of our prior period financial statements and the delay in the completion of the audits and reviews of those statements and the change in our auditors, the burden on our accounting and financial staff has been greatly increased and has thus far caused us to be unable to file our periodic SEC reports on a timely basis. While management believes that current practices and procedures are sufficient to bring to its attention items required to be disclosed in our periodic SEC filings, after an evaluation of those practices, we have determined to institute procedures to enhance the effectiveness of our disclosure controls. Subject to the foregoing, management believes that our disclosure controls are effective for purposes of Item 307 of Regulation S-K.   Changes in Internal Control Over Financial Reporting There has been no change in internal control over financial reporting that occurred during the fourth fiscal quarter of 2005 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.   Item 9B. Other Information.   None.   PART III   Item 10. Directors and Executive Officers of the Registrant   (a) Identification of Directors The following sets forth certain information regarding the current directors of the Company as of the date hereof:   Name Age   Title and Other Information Director Since Robert H. Masson 70 Mr. Masson served as Senior Vice President, Finance and Administration and Vice President and Chief Financial Officer of Parsons & Whittemore, Inc., a global pulp and paper manufacturer, from May 1990 until his retirement June 30, 2002. Prior thereto, Mr. Masson held various executive, financial and treasury roles with The Ford Motor Company, Knutson Construction Company, Ellerbe, PepsiCo, Inc. and Combustion Engineering (now part of the ABB Group). Mr. Masson currently serves as a Trustee and as the Chairman of the Finance Committee of The Naval Aviation Museum Foundation, Inc. in Pensacola, Florida. Mr. Masson was elected a director of the Company effective January 1, 2003. Mr. Masson is the Chairman of the Audit Committee and a member of the Corporate Governance and Nominating Committees.   2003 A. David Brown 63 Mr. Brown joined Linens ‘n Things, Inc., a retail chain specializing in home furnishings, as its Senior Vice President, Human Resources on March 20, 2006. Prior to joining Linens ‘n Things, Inc., Mr. Brown was the co-founder of Bridge Partners LLC, a consumer financial services and diversity headhunting firm. Prior to co-founding Bridge Partners, Mr. Brown served as a Managing Director of Whitehead Mann after having served as Vice President of the Worldwide Retail/Fashion Specialty Practice at Korn/Ferry International, an executive search and recruiting firm. Previously, Mr. Brown served for 12 years as Senior Vice President for Human Resources at R.H. Macy & Co., a nationwide chain of department stores. He was responsible for human resources and labor relations for 50,000 employees in five U.S. divisions and 17 foreign buying offices around the world. He serves on the Board of Directors of Selective Insurance Group, Inc. He is a member of the Board of Trustees of Morristown Memorial Hospital, Drew University and the Jackie Robinson Foundation. Mr. Brown was elected a director of the Company effective July 29, 2003 and is the Chairman of the Corporate Governance and Transaction Committees and a member of the Audit Committee.   2003 Wayne P. Garten 53 Mr. Garten was elected a director of the Company by Chelsey effective September 29, 2003 and appointed President and Chief Executive Officer of the Company on May 5, 2004. Mr. Garten is a member of the Executive and Nominating Committees. Prior to his appointment, Mr. Garten served as the President of Caswell-Massey Ltd., Inc., a retailer and direct marketer of fragrance and other personal care products, from January 2004. Prior thereto, Mr. Garten was a financial consultant specializing in the direct marketing industry. He was Chief Executive Officer and President of Popular Club, Inc., a direct selling, catalog marketer of apparel and general merchandise products, from 2001 to 2003. From 1997 to 2000, he was Executive Vice President and Chief Financial Officer of Micro Warehouse, Inc., an international catalog reseller of computer products. From 1983 to 1996, Mr. Garten held various financial positions at Hanover Direct and its predecessor, The Horn & Hardart Company, including Executive Vice President and Chief Financial Officer from 1989 to 1996. Mr. Garten is a Certified Public Accountant.   2003 William B. Wachtel 51 Mr. Wachtel has been a managing partner of Wachtel & Masyr, LLP, or its predecessor law firm (Gold & Wachtel, LLP), since its founding in August 1984. He is the co-founder of the Drum Major Institute, a not-for-profit organization carrying forth the legacy of Dr. Martin Luther King, Jr. Mr. Wachtel is the Manager of Chelsey. Mr. Wachtel was elected a director of the Company effective November 18, 2003, the date of the Recapitalization Agreement. Mr. Wachtel was appointed the Chairman of the Board of Directors on May 5, 2004 and is Chairman of the Nominating Committee and is a member of the Executive and Corporate Governance Committees. Mr. Wachtel is the Manager of Chelsey and Chelsey Finance and the trustee of Chelsey Capital Profit Sharing Plan which is the sole member of Chelsey and Chelsey Finance.   2003 Stuart Feldman 46 Mr. Feldman has been a principal of Chelsey Capital, LLC, a private hedge fund, for more than the past five years. Mr. Feldman is the principal beneficiary of Chelsey Capital Profit Sharing Plan, which is the sole member of Chelsey. Mr. Feldman was elected a director of the Company effective November 18, 2003, the date of the Recapitalization Agreement and is Chairman of the Executive Committee and a member of the Compensation Committee. Mr. Feldman is the principal beneficiary of the Chelsey Capital Profit Sharing Plan, which is the sole member of Chelsey and Chelsey Finance and the sole officer and director of DSJ International Resources Ltd., the sole sponsor of the Chelsey Capital Profit Sharing Plan. Mr. Feldman was elected a director of the Company effective November 18, 2003, the date of the Recapitalization and is Chairman of the Executive Committee and a member of the Compensation Committee.   2003 Donald Hecht 72 Mr. Hecht has, since 1966, together with his brother Michael Hecht, managed Hecht & Company, an accounting firm. Mr. Hecht was elected a director of the Company effective November 18, 2003, the date of the closing of the Recapitalization and is a member of the Audit and Compensation Committees.   2003 Paul S. Goodman 51 Mr. Goodman is the Chief Executive Officer of Billybey Ferry Company, LLC, a ferry company that provides commuter ferry service between Manhattan and New Jersey and also provides ferry cruise services. Since 2003, Mr. Goodman has been CEO of Chelsey Broadcasting Company, LLC, which owns middle market network-affiliated television stations. Until October 2002, Mr. Goodman had served as a director of Benedek Broadcasting Corporation from November 1994 and as a director of Benedek Communications Corporation from its inception. From 1983 until October 2002, Mr. Goodman was also corporate counsel to Benedek Broadcasting and Benedek Communications since its formation in 1996 until October 2002. From April 1993 to December 2002, Mr. Goodman was a member of the law firm of Shack Siegel Katz Flaherty & Goodman, P.C. From January 1990 to April 1993, Mr. Goodman was a member of the law firm of Whitman & Ransom. Mr. Goodman became a director of the Company effective April 12, 2004. Mr. Goodman is a member of the Corporate Governance Committee. 2004   As provided in the Company’s Certificate of Incorporation and Bylaws, Directors hold office until the next annual meeting or until their successors have been elected or until their earlier death, resignation, retirement, disqualification or removal.   Pursuant to the Corporate Governance Agreement, dated as of November 30, 2003, by and among the Company, Chelsey, Stuart Feldman and the Regan Entities, for two years from the closing of the Recapitalization, five of the nine directors of the Company were to have been designated by Chelsey and one by the Regan Entities. The Corporate Governance Agreement was terminated when Basil Regan resigned from the Board of Directors on July 31, 2004. The following sets forth certain information regarding the current directors of the Company as of the date hereof:   Name Age   Title and Other Information Director Since Robert H. Masson 70 Robert H. Masson served as Senior Vice President, Finance and Administration and Vice President and Chief Financial Officer of Parsons & Whittemore, Inc., a global pulp and paper manufacturer, from May 1990 until his retirement June 30, 2002. Prior thereto, Mr. Masson held various executive, financial and treasury roles with The Ford Motor Company, Knutson Construction Company, Ellerbe, PepsiCo, Inc. and Combustion Engineering (now part of the ABB Group). Mr. Masson currently serves as a Trustee and as the Chairman of the Finance Committee of The Naval Aviation Museum Foundation, Inc. in Pensacola, Florida. Mr. Masson was elected a director of the Company effective January 1, 2003. Mr. Masson is the Chairman of the Audit Committee and a member of the Corporate Governance and Nominating Committees. 2003 A. David Brown 63 Mr. Brown is the co-founder of Bridge Partners LLC, a consumer financial services and diversity headhunting firm. Prior to co-founding Bridge Partners, Mr. Brown served as a Managing Director of Whitehead Mann after having served as Vice President of the Worldwide Retail/Fashion Specialty Practice at Korn/Ferry International. Previously, Mr. Brown served for 12 years as Senior Vice President for Human Resources at R.H. Macy & Co. He was responsible for human resources and labor relations for 50,000 employees in five U.S. divisions and 17 foreign buying offices around the world. He serves on the Boards of Zale Corporation and Selective Insurance Group, Inc. He is a member of the Board of Trustees of Morristown Memorial Hospital, Drew University and the Jackie Robinson Foundation. Mr. Brown was elected a director of the Company effective July 29, 2003 and is the Chairman of the Corporate Governance and Transaction Committees and a member of the Audit Committee. 2003     Wayne P. Garten 53 Mr. Garten was elected a director of the Company by Chelsey effective September 29, 2003 and appointed President and Chief Executive Officer of the Company on May 5, 2004. Mr. Garten is a member of the Executive and Nominating Committees. Prior to his appointment, Mr. Garten served as the President of Caswell-Massey Ltd., Inc., a retailer and direct marketer of fragrance and other personal care products, from January 2004. Prior thereto, Mr. Garten was a financial consultant specializing in the direct marketing industry. He was Chief Executive Officer and President of Popular Club, Inc., a direct selling, catalog marketer of apparel and general merchandise products, from 2001 to 2003. From 1997 to 2000, he was Executive Vice President and Chief Financial Officer of Micro Warehouse, Inc., an international catalog reseller of computer products. From 1983 to 1996, Mr. Garten held various financial positions at Hanover Direct and its predecessor, The Horn & Hardart Company, including Executive Vice President and Chief Financial Officer from 1989 to 1996. Mr. Garten is a Certified Public Accountant. 2003 William B. Wachtel 51 Mr. Wachtel has been a managing partner of Wachtel & Masyr, LLP, or its predecessor law firm (Gold & Wachtel, LLP), since its founding in August 1984. He is the co-founder of the Drum Major Institute, a not-for-profit organization carrying forth the legacy of Dr. Martin Luther King, Jr. Mr. Wachtel is the Manager of Chelsey. Mr. Wachtel was elected a director of the Company effective November 18, 2003, the date of the Recapitalization Agreement. Mr. Wachtel was appointed the Chairman of the Board of Directors on May 5, 2004 and is Chairman of the Nominating Committee and is a member of the Executive and Corporate Governance Committees. Mr. Wachtel is the Manager of Chelsey and Chelsey Finance and the trustee of Chelsey Capital Profit Sharing Plan which is the sole member of Chelsey and Chelsey Finance. 2003 Stuart Feldman 46 Mr. Feldman has been a principal of Chelsey Capital, LLC, a private hedge fund, for more than the past five years. Mr. Feldman is the principal beneficiary of Chelsey Capital Profit Sharing Plan, which is the sole member of Chelsey. Mr. Feldman was elected a director of the Company effective November 18, 2003, the date of the Recapitalization Agreement and is Chairman of the Executive Committee and a member of the Compensation Committee. Mr. Feldman is the principal beneficiary of the Chelsey Capital Profit Sharing Plan, which is the sole member of Chelsey and Chelsey Finance and the sole officer and director of DSJ International Resources Ltd., the sole sponsor of the Chelsey Capital Profit Sharing Plan. Mr. Feldman was elected a director of the Company effective November 18, 2003, the date of the Recapitalization and is Chairman of the Executive Committee and a member of the Compensation Committee. 2003 Donald Hecht 72 Mr. Hecht has, since 1966, together with his brother Michael Hecht, managed Hecht & Company, an accounting firm. Mr. Hecht was elected a director of the Company effective November 18, 2003, the date of the closing of the Recapitalization and is a member of the Audit and Compensation Committees. 2003 Paul S. Goodman 51 Mr. Goodman is the Chief Executive Officer of Billybey Ferry Company, LLC, a ferry company that provides commuter ferry service between Manhattan and New Jersey and also provides ferry cruise services. Since 2003, Mr. Goodman has been CEO of Chelsey Broadcasting Company, LLC, which owns middle market network-affiliated television stations. Until October 2002, Mr. Goodman had served as a director of Benedek Broadcasting Corporation from November 1994 and as a director of Benedek Communications Corporation from its inception. From 1983 until October 2002, Mr. Goodman was also corporate counsel to Benedek Broadcasting and Benedek Communications since its formation in 1996 until October 2002. From April 1993 to December 2002, Mr. Goodman was a member of the law firm of Shack Siegel Katz Flaherty & Goodman, P.C. From January 1990 to April 1993, Mr. Goodman was a member of the law firm of Whitman & Ransom. Mr. Goodman became a director of the Company effective April 12, 2004. Mr. Goodman is a member of the Corporate Governance Committee. 2004   (b) Identification of Executive Officers   Pursuant to the Company’s Bylaws, the Company’s officers are chosen annually by the Board of Directors and hold office until their respective successors are chosen and qualified.   On May 5, 2004, Thomas C. Shull was replaced asSet forth below is certain information regarding the current executive officers of the Company:   Name   Age   Title and Other Information Office Held Since Wayne P. Garten 53 Chief Executive Officer, President and Director. Information concerning Mr. Garten appears above under Directors.   2004 Michael D. Contino 44 Executive Vice President and Chief Operating Officer since April 25, 2001. Senior Vice President and Chief Information Officer from December 1996 to April 25, 2001 and President of Keystone since November 2000. Mr. Contino joined the Company in 1995 as Director of Computer Operations and Telecommunications. Prior to 1995, Mr. Contino was the Senior Manager of IS Operations at New Hampton, Inc., a subsidiary of Spiegel, Inc., which operated several catalogs.   2001 John W. Swatek 41 Senior Vice President, Chief Financial Officer and Treasurer. Prior to joining the Company, Mr. Swatek was Vice President and Controller of Linens ‘n Things, Inc., a retail chain specializing in home furnishings. Before joining Linens ‘n Things, Inc. in 2001, Mr. Swatek held various positions with Micro Warehouse, Inc., an international catalog reseller of computer products, including serving as its Senior Vice President, Finance from 2000 to 2001.   2005 Daniel J. Barsky 50 Senior Vice President, General Counsel and Secretary. Prior to joining the Company, Mr. Barsky was an independent legal consultant. Mr. Barsky served as acting General Counsel to Directrix, Inc., a provider of network origination and digital video asset management and distribution services, from 2001 to 2003. From 1999 to 2001, he served as Executive Vice President, General Counsel and Secretary to American Interactive Media, Inc., which developed multi media content. From 1994 to 1999, Mr. Barsky served as Executive Vice President, General Counsel and Secretary to Spice Entertainment Companies, Inc., an operator of pay-per-view television networks.   2005 Jordan Vargas 54 Senior Vice President, Human Resources since February 2006. Prior to joining the Company, from April 1999 to February 2006, Mr. Vargas served as the Vice President Human Resources at Publisher’s Clearing House, a sweepstakes and direct marketing company. Prior thereto, Mr. Vargas served as the Human Resource Business Partner for PSE&G`s Fossil Generation Business unit from 1996 to 1999.   2006 Steven Lipner 57 Vice President, Taxation since October 2000. Mr. Lipner served as Director of Taxes from February 1984 to October 2000. He holds a license as a Certified Public Accountant in New York.   2000 Pursuant to the Company’s Chief Executive OfficerBylaws, the Company’s officers are chosen annually by Wayne P. Garten. Onthe Board of Directors and hold office until their respective successors are chosen and qualified. Effective November 3,11, 2003 Charles E. Blue washad been appointed Chief Financial Officer of the Company. Mr. Blue’s employment with the Company was terminated effective November 11, 2003, replacing Edward M. Lambert. Mr. Blue resigned as Chief Financial Officer and Secretary on March 8, 2005 and the Company reported in a Current Report on Form 8-K that he had resigned voluntarily. The Company and Mr. Blue were unable to agree on the terms of his voluntary resignation and the Company notified Mr. Blue that his employment had been terminated for cause. John W. Swatek was appointed as Chief Financial Officer and Treasurer effective on April 4, 2005. During the interim period, Mr. Garten served as the Chief Financial Officer. Daniel J. Barsky was appointed as Senior Vice President and General Counsel on January 31, 2005 and Secretary on March 8, 2005. Jordan Vargas was appointed as Senior Vice President, Human Resources on February 7, 2006. Senior Vice President and General Counsel on January 31, 2005 and Secretary on March 8, 2005. Set forth below is certain information regarding the current executive officers of the Company   Name   Age   Title and Other Information Office Held Since Wayne P. Garten 53 Chief Executive Officer, President and Director. Information concerning Mr. Garten appears above under Directors.   2004 Michael D. Contino 44 Executive Vice President and Chief Operating Officer since April 25, 2001. Senior Vice President and Chief Information Officer from December 1996 to April 25, 2001 and President of Keystone since November 2000. Mr. Contino joined the Company in 1995 as Director of Computer Operations and Telecommunications. Prior to 1995, Mr. Contino was the Senior Manager of IS Operations at New Hampton, Inc., a subsidiary of Spiegel, Inc.   2001 John W. Swatek 41 Senior Vice President, Chief Financial Officer and Treasurer. Prior to joining the Company Mr. Swatek was Vice President and Controller of Linens ‘n Things, Inc. Before joining Linens ‘n Things, Inc. in 2001, Mr. Swatek held various positions with Micro Warehouse, Inc. including serving as its Senior Vice President, Finance from 2000 to 2001.   2005 Daniel J. Barsky 50 Senior Vice President, General Counsel and Secretary. Prior to joining the Company, Mr. Barsky was an independent legal consultant. Mr. Barsky served as acting General Counsel to Directrix, Inc. from 2001 to 2003, Executive Vice President, General Counsel and Secretary to American Interactive Media, Inc. from 1999 to 2001 and Executive Vice President, General Counsel and Secretary to Spice Entertainment Companies, Inc. from 1994 to 1999.   2005 Steven Lipner 57 Vice President, Taxation since October 2000. Mr. Lipner served as Director of Taxes from February 1984 to October 2000. Prior thereto, he served as Director of Taxes at Avnet, Inc. and held various positions in public accounting. He holds a license as a Certified Public Accountant in New York.   2000   (c) Audit Committee Financial Expert   While the Common Stock is no longer listed on the AMEX, the Company is providing this information with regard to its compliance with the AMEX listing standards. The Company’s Board of Directors has determined that the Company has at least one “audit committee financial expert” serving on the Audit Committee of the Board of Directors who is “independent” of management within the definition of such term under Rule Section 121A of the AMEX listing standards. Robert H. Masson, a member of the Board of Directors and the Chairman of its Audit Committee, is the “audit committee financial expert” serving on the Company’s Audit Committee. Mr. Masson meets the AMEX requirements that at least one member of the Audit Committee be an “audit committee financial expert.”   The current Audit Committee members are Messrs. Masson (Chairman), Brown and Hecht. Mr. Garten was an Audit Committee member until he became CEO and resigned from the Audit Committee.   (d) Code of Ethics   The Company has adopted a code of ethics that applies to the Company’s principal executive officer, principal financial officer and principal accounting officer and other persons performing similar functions. A copy of the code of ethics has been filed as an Exhibit to the Company’s 2002 Annual Report on Form 10-K. The Company has also adopted a code of conduct that applies to the Company’s directors, officers and employees. A copy of the code of conduct was filed as an Exhibit to the 2003 Annual Report on Form 10-K.   (e) Section 16(a) Beneficial Ownership Reporting Compliance   Section 16(a) of the Securities Exchange Act of 1934 requires officers, directors and beneficial owners of more than 10% of the Company’s shares to file reports with the Securities and Exchange Commission and the American Stock Exchange. Based solely on a review of the reports and representations furnished to the Company during the last fiscal year by such persons, the Company believes that each of these persons is in compliance with all applicable filing requirements.   Item 11. Executive Compensation   The following table shows salaries, bonuses, and long-term compensation paid during the last three years for the Chief Executive Officer (including Mr. Shull who resigned during 2004) and the Company’s four next most highly compensated executive officers who were serving as executive officers at the end of the Company’s 20042005 fiscal year.         Long Term Compensation                 Awards                     Securities           Underlying   Name and   Annual Compensation Other Annual Options/ All Other Principal Position Year Salary Bonus Compensation SARs Compensation               Wayne P. Garten(1) 2004 $    380,769 (2) $  300,000 (6) $ 14,500 (11) 200,000 (16) $ 4,846 (18) President and Chief 2003 — — $ 101,500 (11) 5,000 (16) — Executive Officer                         Michael D. Contino(1) 2004 $          375,837 — — — $ 13,083 (19) Executive Vice President 2003 $          393,698 $  263,656 (7) — — $ 151,282 (20) And Chief Operating Officer 2002 $          382,270 $  565,988 (7) $ 4,000 (12) 100,000 (17) $  9,873 (21)               John DiFrancesco(1) 2004 $          309,300 $  253,500 (8) — — $ 11,442 (22) President, The Company 2003 $          317,400 $   55,180 (8) — — $ 10,531 (23) Store Group, LLC 2002 $          307,846 $  412,000 (8) $ 4,000 (13) 40,000 (17) $ 8,237 (24)               Steven Lipner(1) 2004 $          175,520 $   10,000 (9) — — $ 3,927 (25) Vice President 2003 $          172,924 $   7,768 (9) — — $ 4,220 (26) Taxation 2002 $          163,900 $   78,877 (9) — 5,000 (17) $ 3,849 (27)               Thomas C. Shull(1) 2004 $    295,962 (3) — — — $ 906,776 (28) Former President and Chief 2003 $    915,588 (4) $2,250,000 (4)   — $ 12,369 (29) Executive Officer 2002 $    905,923 (5) $1,327,500 (5) $ 165,000 (14) — $ 2,116 (30)               Charles E. Blue(1) 2004 $          271,029 — — — $ 13,608 (31) Former Senior Vice 2003 $          231,096 $  47,133 (10)   — $ 12,218 (32) President and Chief 2002 $          197,000 $  206,938 (10) $ 4,000 (15) 25,000 (17) $ 10,212 (33) Financial Officer                     Long Term Compensation           Awards             Securities             Underlying   Name and   Annual Compensation   Other Annual Options/ All Other Principal Position Year Salary   Bonus Compensation SARs Compensation                 Wayne P. Garten (1) 2005 $         600,000   $      250,000 (3) — — $     11,652 (12) President and Chief 2004 $         380,769 (2) $      300,000 (3) $         14,500 (8) 200,000 (9) $       4,846 (13) Executive Officer 2003 —   — $       101,500 (8) 5,000 (9) —                 Michael D. Contino (1) 2005 $         387,000   $        25,000 (4) — — $     13,630 (14) Executive Vice President 2004 $         375,837   — — — $     13,083 (15) & Chief Operating Officer 2003 $         393,698   $      263,656 (4) — — $   151,282 (16)                     John W. Swatek (1) 2005 $         202,500   $        42,208 (5) — 50,000 (10) $       8,476 (17) Senior Vice President,               Chief Financial Officer &               Treasurer                               Daniel J. Barsky (1) 2005 $         244,615   $        50,000 (6) — 50,000 (11) $       1,314 (18) Senior Vice President,               General Counsel &               Secretary                               Steven Lipner (1) 2005 $         177,520   $        11,000 (7) — — $       4,014 (19) Vice President 2004 $         175,520   $        10,000 (7) — — $       3,927 (20) Taxation 2003 $         172,924   $          7,768 (7) — — $       4,220 (21)                 __________       (1) Thomas C. Shull was named President and Chief Executive Officer and was elected to the Company’s Board of Directors on December 5, 2000. He resigned on May 5, 2004. Wayne P. Garten was appointed to the Board of Directors on September 30, 2003 and was named President and Chief Executive Officer on May 5, 2004. Charles E. Blue was appointed Senior Vice President and Chief Financial Officer on November 11, 2003. Mr. Blue’s employment was terminated on March 7, 2005. Mr. Garten served as interim Chief Financial Officer until April 4, 2005 when Mr. Swatek became Chief Financial Officer. Mr. Contino was appointed Executive Vice President and Chief Operating Officer on April 25, 2001. Mr. DiFrancescoJohn W. Swatek was appointed asSenior Vice President of The Company Store Group in September 2001 and resignedChief Financial Officer on December 8,April 4, 2005. Daniel J. Barsky was appointed Senior Vice President, General Counsel and Secretary on January 31, 2005. Mr. Lipner was appointed Vice President of Taxation in 2000. (2) $380,769 of salary under the May 5, 2004 Employment Agreement between Mr. Garten and the Company (“Garten Employment Agreement”). (3) Salary until resignation on May 5, 2004. (4) $915,588 of salary,Includes the following payments for Mr. Garten: for 2005 a $450,000 stay bonus and a $1,350,000 change of control payment was paid to Mr. Shull under an Employment Agreement between Mr. Shull and the Company, dated as of September 1, 2002 (as amended, the “Shull Employment Agreement”). An additional $450,000 transaction bonus was paid to Mr. Shull under the Shull Transaction Bonus Letter (as defined below). (5) $276,923 of salary and a $450,000 stay bonus was paid to Mr. Shull under the Shull Employment Agreement. Includes an $877,500$250,000 2005 performance bonus for 2002scheduled to be paid in 2003 under the Shull Employment Agreement. The remaining $629,000 of salary and bonus was paid to Meridian Ventures, LLC, a limited liability company controlled by Mr. Shull (“Meridian”) pursuant to an agreement (“Meridian Services Agreement”) that predated the Shull Employment Agreement. See “Employment Contracts, Termination of Employment and Change-in-Control Arrangements.” (6) Includesduring 2006; for 2004, a $300,000 2004 performance bonus scheduled to be paid during 2005. (7)(4) Includes the following payments made to Mr. Contino: for 2005 a $25,000 2005 performance bonus scheduled to be paid during 2006; for 2003 a $193,500 transaction bonus and a $70,156 2003 performance bonus paid in 2004; for 2002, a $565,988 2002 performance bonus paid in 2003.2004. (8)(5) Includes the following payments made to Mr. DiFrancesco: for 20042005, a $253,500 2004$25,000 2005 performance bonus scheduled to be paid during 2005; for 2003 a $55,180 2003 performance2006 and $17,208 bonus per the Swatek Employment Agreement paid in 2004; for 2002, a $412,000 2002 performance bonus paid in 2003.2005. (9)(6) Includes for 2005, a $50,000 2005 performance bonus scheduled to be paid during 2006. (7) Includes the following payments made to Mr. Lipner: for 2005, a $11,000 2005 performance bonus scheduled to be paid during 2006; for 2004 a $10,000 performance bonus scheduled to be paid during 2005; for 2003 a $7,768 performance bonus paid in 2004; for 2002, a $78,877 2002 paid in 2003.2004. (10) Includes the following payments made by the Company to Mr. Blue: for 2003, a $47,133 performance bonus for 2003 paid in 2004; for 2002, a $206,938 performance bonus for 2002 paid in 2003. (11)(8) Mr. Garten received the following payments as a member of the Board of Directors: for 2004 $14,500 prior to his employment as President and Chief Executive Officer of the Company; for 2003 $101,500. He was granted options to purchase 5,000 shares of Common Stock in 2003. (12) Includes the following payments made by the Company on behalf of Mr. Contino: $4,000 in car allowance and related benefits in 2002. (13) Includes the following payments made by the Company on behalf of Mr. DiFrancesco: $4,000 in car allowance and related benefits in 2002. (14) Paid to Meridian pursuant to the Meridian Services Agreements for Meridian’s over-head (including legal and accounting), health care costs, payroll costs, and other expenses relating to Mr. Shull. See “Employment Contracts, Termination of Employment and Change in Control Arrangements.” (15) Includes the following payments made by the Company on behalf of Mr. Blue: $4,000 in car allowance and related benefits in 2002. (16)(9) 200,000 options granted per the Garten Employment Agreement, half under the 2000 Management Stock Option Plan and half outside the 2000 Management Stock Option Plan. 5,000 options granted under the 2002 Stock Option Plan for directors. (17)(10) Granted by50,000 options granted per the Company pursuant toSwatek Employment Agreement, under the Company’s 2000 Management Stock Option Plan. See “Report of (11) 50,000 options granted per the Stock Option and Executive Compensation Committee on Executive Compensation—Barsky Letter Agreement, under the 2000 Management Stock Option Plan.” (18)(12) Includes the following payments made by the Company on behalf of Mr. Garten in 2005: $276 in group term life insurance premiums; $40 in accidental death and disability insurance premiums; $213 in core life insurance premiums; $168 in dental insurance premiums; $127 in long-term disability premiums; $7,344 in health care insurance premiums and $3,484 in matching contributions under the Company’s 401(k) Savings Plan. (13) Includes the following payments made by the Company on behalf of Mr. Garten in 2004: $170 in group term life insurance premiums; $24 in accidental death and disability insurance premiums; $119 in core life insurance premiums; $103 in dental insurance premiums; $85 in long-term disability premiums; $4,345 in health care insurance premiums. (19)(14) Includes payments made by the Company on behalf of Mr. Contino in 2005: $120 in group term life insurance premiums; $40 in accidental death and disability insurance premiums; $213 in core life insurance premiums; $216 in dental insurance premiums; $127 in long-term disability premiums; $9,414 in health care insurance premiums; and $3,500 in matching contributions under the Company’s 401(k) Savings Plan. (15) Includes payments made by the Company on behalf of Mr. Contino in 2004: $120 in group term life insurance premiums; $40 in accidental death and disability insurance premiums; $182 in core life insurance premiums; $219 in dental insurance premiums; $146 in long-term disability premiums; $8,959 in health care insurance premiums; and $3,417 in matching contributions under the Company’s 401(k) Savings Plan. (20)(16) Includes payments made on behalf of Mr. Contino in 2003; $125 in group term life insurance premiums; $40 in accidental death and disability insurance premiums; $162 in core life insurance premiums; $205 in dental insurance premiums; $159 in long-term disability premiums; $8,195 in health care insurance premiums; $3,333 in matching contributions under the Company’s 401 (k) Savings Plan. Also includes forgiveness of a $75,000 non-interest-bearing loan made by the Company to Mr. Contino in January 1998. The loan was forgiven in full in accordance with its terms during January 2003. In addition to the loan forgiveness, the Company paid all applicable withholding taxes totaling $64,063. (21) Includes payments made on behalf of Mr. Contino in 2002; $120 in group term life insurance premiums; $40 in accidental death and disability insurance premiums; $162 in core life insurance premiums; $143 in dental insurance premiums; $484 in long-term disability premiums; $5,589 in health care insurance premiums; $2 in vision assistance; $3,333 in matching contributions under the Company’s 401(k) Savings Plan. (22)(17) Includes the following payments made by the Company on behalf of Mr. DiFrancescoSwatek in 2004:2005: $88 in group term life insurance premiums; $30 in accidental death and disability insurance premiums; $164 in core life insurance premiums; $166 in dental insurance premiums; $97 in long-term disability premiums; $7,241 in health care insurance premiums; and $690 in matching contributions under the Company’s 401(k) Savings Plan. (18) Includes the following payments made by the Company on behalf of Mr. Barsky in 2005: $255 in group term life insurance premiums; $36 in accidental death and disability insurance premiums; $197 in core life insurance premiums; $199 in dental insurance premiums; $117 in long-term disability premiums; and $510 in matching contributions under the Company’s 401(k) Savings Plan. (19) Includes the following payments made by the Company on behalf of Mr. Lipner in 2005: $516 in group term life insurance premiums; $40 in accidental death and disability insurance premiums; $182$213 in core life insurance premiums; $170 in dental insurance premiums; $146$127 in long-term disability premiums; $6,990 in health care insurance premiums; and $3,398$3,118 in matching contributions under the Company’s 401(k) Savings Plan. (23) Includes the following payments made by the Company on behalf of Mr. DiFrancesco in 2003: $287 in group term life insurance premiums; $40 in accidental death and disability insurance premiums; $162 in core life insurance premiums; $160 in dental insurance premiums; $158 in long-term disability premiums; $6,391 in health care insurance premiums; and $3,333 in matching contributions under the Company’s 401(k) Savings Plan. (24) Includes the following payments made by the Company on behalf of Mr. DiFrancesco in 2002: $276 in group term life insurance premiums; $40 in accidental death and disability insurance premiums; $162 in core life insurance premiums; $116 in dental insurance premiums; $407 in long-term disability premiums; $4,601 in health care insurance premiums; $2 in vision assistance, $2,633 in matching contributions under the Company’s 401(k) Savings Plan. (25)(20) Includes the following payments made by the Company on behalf of Mr. Lipner in 2004: $516 in group term life insurance premiums; $40 in accidental death and disability insurance premiums; $182 in core life insurance premiums; $146 in long-term disability premiums; and $3,043 in matching contributions under the Company’s 401(k) Savings Plan. (26)(21) Includes the following payments made by the Company on behalf of Mr. Lipner in 2003: $527 in group term life insurance premiums; $40 in accidental death and disability insurance premiums; $162 in core life insurance premiums; $158 in long-term disability premiums; and $3,333 in matching contributions under the Company’s 401(k) Savings Plan. (27) Includes the following payments made by the Company on behalf of Mr. Lipner in 2002: $276 in group term life insurance premiums; $40 in accidental death and disability insurance premiums; $162 in core life insurance premiums; $38 in dental insurance premiums; $260 in long-term disability premiums; and $3,073 in matching contributions under the Company’s 401(k) Savings Plan. (28) Includes the following payments made by the Company on behalf of Mr. Shull in 2004: $900,000 in severance payments; $96 in group term life insurance premiums; $14 in accidental death and disability insurance premiums; $56 in core life insurance premiums; $78 in dental insurance premiums; $55 in long-term disability premiums; $3,060 in health care insurance premiums; $3,417 in matching contributions under the Company’s 401(k) Savings Plan;         (29) Includes the following payments made by the Company on behalf of Mr. Shull in 2003: $276 in group term life insurance premiums; $40 in accidental death and disability insurance premiums; $162 in core life insurance premiums; $205 in dental insurance premiums; $158 in long-term disability premiums; $8,195 in health care insurance premiums; and $3,333 in matching contributions under the Company’s 401(k) Savings Plan. (30) Includes the following payments made by the Company on behalf of Mr. Shull in 2002: $85 in group term life insurance premiums; $12 in accidental death and disability insurance premiums; $50 in core life insurance premiums; $44 in dental insurance premiums; $49 in long-term disability premiums; $1,876 in health care insurance premiums. (31) Includes the following payments made by the Company on behalf of Mr. Blue in 2004: $120 in group term life insurance premiums; $40 in accidental death and disability insurance premiums; $182 in core life insurance premiums; $219 in dental insurance premiums; $146 in long-term disability premiums; $8,959 in health care insurance premiums; and $3,402 in matching contributions under the Company’s 401(k) Savings Plan. (32) Includes the following payments made by the Company on behalf of Mr. Blue in 2003: $125 in group term life insurance premiums; $40 in accidental death and disability insurance premiums; $162 in core life insurance premiums; $205 in dental insurance premiums; $158 in long-term disability premiums; $8,195 in health care insurance premiums; and $3,333 in matching contributions under the Company’s 401(k) Savings Plan. (33) Includes the following payments made by the Company on behalf of Mr. Blue in 2002: $120 in group term life insurance premiums; $40 in accidental death and disability insurance premiums; $162 in core life insurance premiums; $143 in dental insurance premiums; $285 in long-term disability premiums; $6,195 in health care insurance premiums; and $3,265 in matching contributions under the Company’s 401(k) Savings Plan; and $2 in vision plan premiums. Stock Options and Stock Appreciation Rights   The following table contains information concerning options granted to the Chief Executive Officer and the Company’s four next most highly compensated executive officers who were serving as executive officers at the end of the Company’s 20042005 fiscal year. There were no stock appreciation rights (“SARs”) granted during fiscal 2004.2005.   Option/SAR Grants in Fiscal 20042005   Individual Grants   Individual Grants   Number of         Number of         Securities Percentage of         Securities Percentage of         Underlying Total Options/         Underlying Total Options/         Options/ SARs Granted Exercise Market Price   Options/ SARs Granted Exercise Market Price   SARs to Employees in or Base on Date of   Grant Date SARs to Employees in or Base on Date of   Grant Date Name Granted Fiscal Year 2004 Price Grant Expiration Date Value($) Granted Fiscal Year 2005 Price Grant Expiration Date Value($)                         Wayne P. Garten 200,000 88.1% $1.95 $2.00 5/5/2014 289,600 Daniel J. Barsky 50,000 50.0% $1.03 $0.80 2/17/2015 24,195 John W. Swatek 50,000 50.0% $0.81 $0.83 4/4/2015 26,915   The following table contains information concerning the fiscal 20042005 year-end values of all options and SARs granted to the Chief Executive Officer and the Company’s four (4) next most highly compensated executive officers who were serving as executive officers at the end of the Company’s 20042005 fiscal year.   Aggregated Option/SAR Exercises in 20042005 Fiscal Year and December 25, 200431, 2005 Option/SAR Values                           Number of Securities Underlying Unexercised Options/SARs at December 25, 200431, 2005 Value of Unexercised In-the-Money Options/SARs at December 25, 200431, 2005   Name Shares Acquired on Exercise(#) Value Realized($) Exercisable/ Unexercisable Exercisable/ Unexercisable           Wayne P. Garten -- -- 71,666138,334 exercisable $0/$0       133,33466,666 unexercisable Michael D. Contino -- -- 125,000 exercisable $0/$0 0 unexercisable Daniel J. Barsky -- -- 16,667 exercisable $7,834/$15,667 33,333 unexercisable John W. Swatek -- -- 16,667 exercisable $11,500/$23,000 33,333 unexercisable Steven Lipner -- -- 7,000 exercisable $0/$0 0 unexercisable     Director Compensation   Standard Arrangements. The Company pays its non-employee directors a $58,000 annual fee; no supplemental fees are paid for serving as Chairman of a Board committee or for attending Board meetings. Non-employee directors also participated in the 1999 Stock Option Plan for Directors (“1999 Directors’ Plan”) and the 2002 Stock Option Plan for Directors (“2002 Directors’ Plan”) and may in the future participate in the 2004 Stock Option Plan for Directors (the “2004 Directors’ Option Plan”). See “Employment Contracts, Termination of Employment and Change-in-Control Arrangements.” The Company does not compensate its employees, or employees of its subsidiaries, who serve as directors. During fiscal 2004,2005, the Company also provided $50,000 of term life insurance for each director.   Effective January 1, 2003, the 2002 Directors’ Plan was amended to increase the annual award for non-employee directors from options to purchase 2,500 shares to 3,500 shares of Common Stock. In November 2003, the 2002 Directors’ Plan was amended to increase the pool of options to purchase shares of Common Stock from 50,000 to 90,000 shares of Common Stock. During 2004, No options to purchase 5,000 shares of Common Stock were granted to a new non-employee director under the 2002 Directors’ Plan and options to purchase 21,000 shares of Common Stock were granted to the six non-employee directors under the automatic annual grant on August 3, 2004 under the 2002 Directors’ Plan. No options wereor exercised by Directors during 2004.2005. As of December 25, 2004, 7,000 options to purchase Common Stock under the 1999 Directors’ Plan were outstanding and exercisable. As of December 25, 2004, 65,50031, 2005, 63,000 options to purchase Common Stock under the 2002 Stock Option Plan for Directors were outstanding, 36,16744,000 of which were exercisable.   2004 Stock Option Plan for Directors – During 2004, the Board of Directors adopted the 2004 Directors’ Option Plan, pursuant to which stock options to purchase shares of Common Stock may be granted to certain non-employee directors. The Company’s shareholders ratified the 2004 Directors’ Option Plan at the 2004 Annual Meeting of Shareholders. The Company may grant options to purchase up to 100,000 shares of Common Stock to eligible directors at an exercise price equal to the fair market value as of the grant date. An eligible director will receive an initial option grant to purchase 5,000 shares of Common Stock as of the effective date of his/her appointment or election to the Board of Directors. On each Award Date, defined as August 3, 2004, August 3, 2005 and August 3, 2006, eligible directors are to be granted options to purchase additional shares of Common Stock (to the extent the 2002 Stock Option Plan for Directors did not have enough remaining shares). Stock options granted have terms of ten years and vest over three years from the grant date; however, if there is a Change in Control (as defined in the Hanover Direct, Inc. Directors Change of Control Plan), the participant has the cumulative right to purchase up to 100% of the option shares. Option holders may pay for shares purchased on exercise in cash or Common Stock. As of December 25, 2004 no options have been granted under the 2004 Directors’ Option Plan. The non-employee directors waived their right to the automatic grant of options to be granted on August 3, 2005. Director Compensation Continuation Agreement. Effective May 3, 2001, the Company’s Board As of Directors established the Hanover Direct, Inc. Directors Change of Control Plan (the “Director Compensation Continuation Agreement”) for all non-employee Directors of the Company. A participant in the Director Compensation Continuation Agreements is entitled to receive a Change of Control Payment if a Change of Control occurs while a director on the effective date of the Change of Control. The Change of Control PaymentDecember 31, 2005 no options have been granted under the Director Compensation Continuation Agreement is the greater of (i) $40,000 or (ii) 150% of the sum of the annual retainer fee, meeting fees and per diem fees paid to a Director for his/her service on the Board of Directors of the Company during the twelve month period immediately preceding the Change of Control. The Recapitalization was a “Change of Control” for purposes of the Director Compensation Continuation Agreement and on December 18, 2003, each of the then eight non-employee directors (Messrs. Brown, James, Krushel, Sonnenfeld, Masson, Regan, Garten and Edelman) received an $87,000 payment.2004 Directors’ Option Plan.   Employment Contracts, Termination of Employment and Change-in-Control Arrangements   Garten Employment Agreement. On May 6, 2004, Wayne P. Garten became the Company’s Chief Executive Officer and President. Mr. Garten is employed pursuant to the terms of a May 6, 2004 Employment Agreement. Under Mr. Garten’s Employment Agreement, he will be paid an annual salary of $600,000 over a term expiring on May 6, 2006. The Company also granted Mr. Garten options to acquire 200,000 shares of the Company’s common stock, half pursuant to its 2000 Management Stock Option Plan (“2000 Management Option Plan”) and half outside the plan. All of the options have an exercise price of $1.95 per share, the Common Stock’s average closing price for the ten trading days preceding the grant date and the ten trading days after the grant date. One third of each of the options vested upon execution of the Employment Agreement and the balance will vest in two equal annual installments on the anniversary of the original grant date, subject to earlier vesting in the event of a change in control of the Company (as that term is defined in the Employment Agreement). Mr. Garten is entitled to participate in the Company’s bonus plan for executives, as established by the Board of Directors.   The Employment Agreement provides for a lump sum change in control payment equal to 200% of Mr. Garten’s annual salary if a change in control occurs during the term. The Employment Agreement also provides for eighteen months of severance payments if Mr. Garten is not otherwise entitled to change in control benefits and (i) is terminated without cause or terminates his employment for good reason (as both terms are defined in the Employment Agreement) during the term or (ii) his Employment Agreement is not renewed at the end of the term.   Contino Letter Agreement. Michael Contino, the Company’s Chief Operating Officer, is employed pursuant to a October 29, 2002 letter agreement. Under the letter agreement, Mr. Contino was to receive an annual salary of $387,000 and is entitled to participate in the Company’s bonus plan for executives, as established by the Board of Directors. Mr. Contino was awarded options to purchase 100,000 shares under the 2000 Management Stock Option Plan. Under the agreement, if Mr. Contino is terminated other than “for cause” or terminates his employment for “good reason” (as those terms are defined in the agreement), he is entitled to eighteen months of severance pay and health benefits. Mr. Contino was a participant in the Company’s eighteen month change in control plan and was entitled to a Transaction Bonus equal to half of his base salary on a change in control. Mr. Contino was paid the Transaction Bonus following the Recapitalization in 2003.   Shull Employment and Severance Agreement. Thomas Shull, the Company’s prior Chief Executive Officer resigned from the Company on May 5, 2004. Mr. Shull and the Company executed a General Release and Separation Agreement dated effective as of May 5, 2004 which provided for the Company to pay Mr. Shull $900,000 of severance in lieu of any other benefits provided for in the Employment Agreement dated September 1, 2002, as amended (the “Shull Employment Agreement”). The severance was paid with a $300,000 lump sum on execution and the balance in biweekly installments that were completed in 2004. The Company also agreed to pay for eighteen months of COBRA coverage for Mr. Shull. Prior to his resignation, Mr. Shull was employed pursuant to the Shull Employment Agreement which provided for an $855,000 base salary and had a term expiring on March 31, 2006. Mr. Shull was a participant in the Company’s Key Executive Eighteen Month Compensation Continuation Plan (the “Change of Control Plan”) and its transaction bonus program. The Recapitalization was a change in control under the Change in Control Plan and the Company paid Mr. Shull $1,350,000 in 2003. The Company also paid Mr. Shull $450,000 under the transaction bonus program in 2003. Charles E. Blue had been appointed Chief Financial Officer of the Company effective November 11, 2003, replacing Edward M. Lambert. Mr. Blue joined the Company in 1999 and prior to his appointment had most recently served as Senior Vice President, Finance. Mr. Lambert continued to serve as Executive Vice President of the Company until his January 2, 2004 resignation. Mr. Lambert and the Company entered into a severance agreement dated November 4, 2003 providing for $640,000 of cash payments, as well as other benefits that were accrued and paid in the fourth quarter of 2003. Mr. Blue’s employment with the Company was terminated effective March 8, 2005 and the Company reported in a Current Report on Form 8-K that he had resigned voluntarily. The Company and Mr. Blue were unable to agree on the terms of his voluntary resignation and the Company notified Mr. Blue that his employment had been terminated for cause.     Mr. DiFrancesco resigned on December 8, 2005. The Company agreed to pay Mr. DiFrancesco $312,000 in severance benefits payable in installments over a 12 month period and an additional $156,000 payable in installments over a 6 month period if Mr. DiFrancesco was employed by a competitor of The Company Store business at the end of the initial 12 month severance period. The Company also agreed to pay his COBRA health care continuation premiums during the same period over which he receives severance payments.   Barsky Letter Agreement. On January 31, 2005, the Company appointed Daniel J. Barsky as its Senior Vice President and General Counsel. Under a letter agreement with the Company, Mr. Barsky will be paid an annual salary of $265,000 and was granted options to purchase 50,000 shares of Common Stock. One third of the options vested on February 17, 2005 and the balance will vest in two equal annual installments over the next two years on the anniversary of the original grant date, subject to earlier vesting in the event of a change in control of the Company. All of the options have an exercise price of $1.03 per share, the Common Stock’s average closing price for the ten trading days preceding the grant date and the ten trading days after the grant date. Mr. Barsky will be entitled to participate in the Company’s bonus plan for executives. The agreement also provides for six months of severance payments if Mr. Barsky is terminated without cause or terminates his employment for good reason. Mr. Barsky was appointed as the Company’s Secretary on March 7, 2005.   Swatek Employment Agreement. On April 4, 2005, John W. Swatek became Senior Vice President, Chief Financial Officer and Treasurer of the Company under a March 15, 2005 Employment Agreement. Under the agreement, Mr. Swatek will be paid an annual salary of $270,000 and was granted options to acquire 50,000 shares of the Company’s common stock pursuant to its 2000 Management Stock Option Plan. The options have an exercise price of $0.81 per share, the Common Stock’s average closing price for the ten trading days preceding the grant date and the ten trading days after the grant date. One third of the options vested on execution of the agreement and the balance will vest in two equal annual installments over the next two years on the anniversary of the original grant date, subject to earlier vesting in the event of a change in control of the Company (as that term is defined in the Employment Agreement). The Employment Agreement has a term expiring on May 6, 2006 and provides for a sign-on bonus of up to $25,000 to the extent his bonus from his prior employer was reduced as a result of his agreeing to join the Company. The Company paid Mr. Swatek $17,208 under this provision.   The Employment Agreement provides for a lump sum change in control payment equal to Mr. Swatek’s annual compensation if his employment is terminated during the term and a change in control occurs during that time. The Employment Agreement also provides for one year’s severance if Mr. Swatek is terminated without cause or terminates his employment for good reason (as both terms are defined in the Employment Agreement) during the term and he is not otherwise entitled to change in control benefits. Mr. Swatek will also be entitled to one year of severance payments equal to his annual base salary if his agreement is not renewed at the end of the term.   Stuart Feldman	46	Mr. Feldman has been a principal of Chelsey Capital, LLC, a private hedge fund, for more than the past five years. Mr. Feldman is the principal beneficiary of Chelsey Capital Profit Sharing Plan, which is the sole member of Chelsey. Mr. Feldman was elected a director of the Company effective November 18, 2003, the date of the Recapitalization Agreement and is Chairman of the Executive Committee and a member of the Compensation Committee. Mr. Feldman is the principal beneficiary of the Chelsey Capital Profit Sharing Plan, which is the sole member of Chelsey and Chelsey Finance and the sole officer and director of DSJ International Resources Ltd., the sole sponsor of the Chelsey Capital Profit Sharing Plan. Mr. Feldman was elected a director of the Company effective November 18, 2003, the date of the Recapitalization and is Chairman of the Executive Committee Interlocks and Insider Participationa member of the Compensation Committee.	2003
Donald Hecht	72	Mr. Garten,Hecht has, since 1966, together with his brother Michael Hecht, managed Hecht & Company, an accounting firm. Mr. Hecht was elected a director of the currentCompany effective November 18, 2003, the date of the closing of the Recapitalization and is a member of the Audit and Compensation Committees.	2003
Paul S. Goodman	51	Mr. Goodman is the Chief Executive Officer of Billybey Ferry Company, LLC, a ferry company that provides commuter ferry service between Manhattan and New Jersey and also provides ferry cruise services. Since 2003, Mr. Goodman has been CEO of Chelsey Broadcasting Company, LLC, which owns middle market network-affiliated television stations. Until October 2002, Mr. Goodman had served as a director of Benedek Broadcasting Corporation from November 1994 and as a director of Benedek Communications Corporation from its inception. From 1983 until October 2002, Mr. Goodman was also corporate counsel to Benedek Broadcasting and Benedek Communications since its formation in 1996 until October 2002. From April 1993 to December 2002, Mr. Goodman was a member of the Compensation Committee until hislaw firm of Shack Siegel Katz Flaherty & Goodman, P.C. From January 1990 to April 29, 2004 resignation before becoming CEO. Stuart Feldman,1993, Mr. Goodman was a Compensation Committee member during 2004, is a principal of Chelsey and Chelsey Finance. Report of the Compensation Committee The reportlaw firm of the Stock Option and Executive Compensation Committee (the “Compensation Committee”) for the fiscal year ended December 25, 2004, is as follows: The Compensation Committee, whose members are A. David Brown (Chairman), Donald B. Hecht and Stuart Feldman as of the date of this report and for the fiscal year ended December 25, 2004, has the responsibility, under delegated authority from the Company’s Board of Directors, for developing, administering and monitoring the executive compensation policiesWhitman & Ransom. Mr. Goodman became a director of the Company and making recommendations to the Company’s Board of Directors with respect to these policies. The Board of Directors has accepted the Compensation Committee’s recommendations for 2004 compensation. Executive Compensation Philosophy The Compensation Committee’s executive compensation philosophy supports the Company’s overall business strategy and has at its coreeffective April 12, 2004. Mr. Goodman is a strong link between pay, performance and retention. The philosophy emphasizes recognition of achievement at both the Company and individual level. A significant portion of compensation delivered to executives to reflect such achievement is intended to be in the form of annual bonuses tied to Company performance. In addition, executives are encouraged to hold an ownership stake in the Company so that their interests are closely aligned with thosemember of the stockholders in terms of both risk and reward.Corporate Governance Committee.	2004