<PAGE>   1
 
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                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                            ------------------------
 
                                  FORM 10-K/A1
 
                 ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
                     OF THE SECURITIES EXCHANGE ACT OF 1934
                  FOR THE FISCAL YEAR ENDED DECEMBER 26, 1998
 
                         COMMISSION FILE NUMBER 1-12082
 
                            ------------------------
 
                              HANOVER DIRECT, INC.
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
 
                                    DELAWARE
                 (STATE OR OTHER JURISDICTION OF INCORPORATION
                                OR ORGANIZATION)
 
                  1500 HARBOR BOULEVARD, WEEHAWKEN, NEW JERSEY
                    (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
 
                                   13-0853260
                       (IRS EMPLOYER IDENTIFICATION NO.)
 
                                     07087
                                   (ZIP CODE)
 
                                 (201) 863-7300
              (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
 
          SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
 
<TABLE>
<CAPTION>
                                                           NAME OF EACH EXCHANGE
             TITLE OF EACH CLASS                            ON WHICH REGISTERED
             -------------------                           ---------------------
<S>                                            <C>
       COMMON STOCK, $.66 2/3 PAR VALUE                   AMERICAN STOCK EXCHANGE
</TABLE>
 
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: None
 
     Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No []
 
     Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
 
     As of March 17, 1999, the aggregate market value of the voting and
non-voting common equity held by non-affiliates of the registrant was
$242,954,538 (based on the closing price of the Common Stock on the American
Stock Exchange on March 17, 1999; shares of Common Stock owned by directors and
officers of the Company are excluded from this calculation; such exclusion does
not represent a conclusion by the Company that all of such directors and
officers are affiliates of the Company).
 
     As of March 17, 1999, the registrant had 210,827,854 shares of Common Stock
outstanding.
 
                      DOCUMENTS INCORPORATED BY REFERENCE
 
     The Company's definitive proxy statement to be filed by the Company
pursuant to Regulation 14A is incorporated into items 10, 11, 12 and 13 of Part
III of this Form 10-K.
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<PAGE>   2
 
                                     PART I
 
ITEM 1.  BUSINESS
 
GENERAL
 
     Hanover Direct, Inc. (the "Company") is a leading specialty direct marketer
with a diverse branded portfolio of home fashions, general merchandise, men's
and women's apparel and gift catalogs delivered via direct mail and electronic
commerce. The Company's catalog titles are organized into six brand groups --
Home Fashions -- Mid-Market brands, Home Fashions-Upscale brands, General
Merchandise brands, Women's Apparel brands, Men's Apparel brands and Gift brands
groups -- each consisting of one or more catalog titles. All of these brand
groups utilize the Company's common systems platform and central purchasing,
telemarketing, fulfillment, distribution and administrative functions.
 
     The Company's Home Fashions-Mid-Market brands includes Domestications(R), a
leading specialty home fashions catalog, and Colonial Garden Kitchens(R),
featuring work saving and lifestyle enhancing items for the kitchen and home.
The Home Fashions-Upscale brands includes The Company Store(R), an upscale home
fashions catalog focusing on high quality down comforters and other down and
related products for the home including sheets and towels, and Kitchen &
Home(R), an upscale kitchen and home product catalog. The General Merchandise
brands includes Improvements(R), a do-it-yourself home improvements catalog, and
The Safety Zone(R), offering safety, prevention and protection products. The
Women's Apparel brands includes Silhouettes(R), featuring everyday, workout,
special occasion and career fashions for larger sized women, and Tweeds(R), the
European-inspired women's fashion catalog. The Men's Apparel brands includes
International Male(R), offering unique men's fashions with an international
flair, Austad's(R), featuring golf equipment, apparel and accessories, and
Undergear(R), a leader in activewear, workout wear and fashion underwear for
men. The Gift brands includes Gump's By Mail(R), a leading upscale catalog of
jewelry and luxury gifts, and Gump's, the well known retail store based in San
Francisco.
 
     The Company reviews its portfolio of catalogs as well as new opportunities
to acquire or develop catalogs from time to time. No catalog brands were
discontinued during the 1996, 1997 or 1998 fiscal years. However, in the fourth
quarter of 1998, the Company selected Austad's, Tweeds and Colonial Garden
Kitchens for repositioning away from traditional catalog operations.
 
     Early in 1999, the Company began the repositioning efforts for Austad's,
Tweeds and Colonial Garden Kitchens primarily as e-commerce brands. If these
repositioning efforts are unsuccessful, these brands are likely to be sold or
discontinued.
 
     During 1998, the Company mailed approximately 242 million catalogs. The
Company maintains a proprietary customer list currently containing approximately
12 million names of customers (the same as in 1997 but down from approximately
14 million names in 1996) who have made purchases from at least one of the
Company's catalogs within the past 36 months. Approximately 4 million of the
names on the list represent customers who have made purchases from at least one
of the Company's catalogs within the last 12 months (the same as in 1997 but
down from approximately 6 million names in 1996).
 
     The Company is incorporated in Delaware with its principal executive office
at 1500 Harbor Boulevard, Weehawken, New Jersey 07087. The Company's telephone
number is (201) 863-7300. Richemont Finance S.A. ("Richemont"), a Luxembourg
company, owns approximately 49% of the Company's common stock on a fully diluted
basis. Additionally, on June 1, 1998 Richemont entered into an agreement with a
third party, whereby Richemont was granted an irrevocable proxy to vote
approximately 9.3 million shares currently held by the third party. Richemont is
a wholly owned subsidiary of Compagnie Financiere Richemont, A.G., a Swiss
public company engaged in luxury goods, tobacco and other business. The Company
is a successor in interest to The Horn & Hardart Company, a restaurant company
founded in 1911, and Hanover House Industries, Inc., founded in 1934.
 
                                        1
<PAGE>   3
 
STRATEGIC REALIGNMENT
 
     The Company recently adopted plans for a strategic realignment of the
Company pursuant to which it will create two separate business units, a brand
marketing division and a web services division.
 
     The brand marketing division will be a marketing/merchandising organization
comprised of the Company's branded portfolio of home fashions, apparel and gift
catalogs and associated e-commerce sites as well as all related inventory. It
will also contain customer lists, databases and trademarks/intellectual
property. Credit marketing agreements as well as internet strategic partnerships
and alliances, such as those already in effect with Excite, ArtSelect and Xoom,
will also fall within the business unit's responsibility.
 
     The web services division will offer the full range of back-end services
required by companies wanting to conduct e-commerce including a comprehensive
range of fulfillment, order management and web marketing services as well as web
site development, system platform interface, and the back-end services of
Keystone Fulfillment, a Company affiliate launched last year, which currently
provides services to a growing portfolio of customers. In addition to its
existing contracts, the web services division has the warehouses and telephone
centers as well as the means to flexibly add capacity as needed. Its system
platform performs the high volume logistical services required by e-commerce
companies and is supported by a state-of-the-art MACS II system, a warehouse
management system and data warehouse applications. Its Internet Management Group
is equipped to provide services both to the Hanover portfolio as well as others
wanting to sell on-line.
 
     Inter-company agreements will be put in place whereby the brand marketing
division will utilize the services of the web services division for web hosting,
system interface, fulfillment and corporate services. Rakesh K. Kaul will
continue as President and Chief Executive Officer of the Company, overseeing
both of the newly created business units.
 
THE COMPANY'S CATALOGS
 
     Each of the Company's specialty catalogs targets distinct market segments
offering a focused assortment of merchandise designed to meet the needs and
preferences of its target customers. Each catalog's merchandise strategy,
including the appropriate price points, mailing plans and presentation of its
products is determined through market research and ongoing testing of new
products and concepts. The Company is continuing its development of exclusive or
private label products for a number of its catalogs, including Domestications,
The Company Store and Improvements, to further enhance the brand identity of the
catalogs.
 
     The Company's specialty catalogs typically range in size from 32 to 132
pages with six to 12 new 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. Each catalog employs
the services of an outside creative agency or has its own creative staff which
is responsible for the design, layout, copy, feel and theme of the book.
Generally, the initial sourcing of new merchandise for a catalog begins two to
six months before the catalog is mailed.
 
     The following is a description of the Company's catalogs in each of the
Company's six brand groups:
 
  Home Fashions -- Mid-Market Brands:
 
     Domestications is a leading specialty home fashions catalog and a fashion
decorating source book for today's value-oriented and style-conscious consumer.
Domestications features sheets, towels, comforters, tablecloths, draperies and
other items for the home, and offers coordinated decorating ideas for the home
at value prices.
 
     Colonial Garden Kitchens features work saving and lifestyle enhancing items
for the kitchen and home.
 
  Home Fashions -- Upscale Brands:
 
     The Company Store is an upscale home fashions catalog focusing on high
quality down comforters and other down and related products for the home
including sheets and towels. The Company Store also features designer brand name
sheets, towels and other bedding accessories.
                                        2
<PAGE>   4
 
     Kitchen & Home features distinctive and highly functional kitchen and home
products for entertaining and decorating.
 
  General Merchandise Brands:
 
     Improvements is a leading do-it-yourself home improvement catalog featuring
home improvement accessories.
 
     The Safety Zone offers safety, protection and prevention products.
 
  Women's Apparel Brands:
 
     Silhouettes is a leading fashion authority for larger sized women
specializing in casual, career and special occasion apparel for this customer's
lifestyle needs.
 
     Tweeds features apparel with a European flair for contemporary women.
 
  Men's Apparel Brands:
 
     International Male is positioned as an authority for unique men's fashion
with an international flair.
 
     Undergear is a leader in activewear, workout wear and fashion underwear for
men.
 
     Austad's features golf equipment and related apparel and accessories.
 
  Gift Brands:
 
     Gump's By Mail is a leading upscale catalog featuring jewelry, luxury
gifts, specialized housewares and other unique items.
 
     Gump's is the well-known San Francisco retailer.
 
MARKETING AND DATABASE MANAGEMENT
 
     The Company maintains a proprietary customer list currently containing
approximately 12 million names of customers who have purchased from one of the
Company's catalogs within the past 36 months. The list contains name, gender,
residence and historical transaction data. This database is selectively enhanced
with demographic, socioeconomic, lifestyle and purchase behavior overlays from
other sources.
 
     The Company utilizes 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 for the Company's
determination of which of the Company's catalogs will be mailed and how
frequently to a particular customer, as well as the promotional incentive
content of the catalog(s) such customer receives.
 
     The primary source of new customers for the Company's catalogs is lists
rented from other mailers and compilers. Prior to mailing these lists, the lists
are edited using statistical segmentation tools to enhance their probable
performance. Other sources of new customers include traditional print space
advertisements and promotional inserts in outbound merchandise packages. In
addition, many of the catalogs participate in a consortium database of catalog
buyers whereby new customers are obtained by the periodic submission of desired
customer buying behavior and interests to the consortium and the subsequent
rental of non-duplicative names from the consortium. The Internet as a source of
new customers continues to grow in importance. The Websites for each brand are
promoted within each catalog, at Hanover's partner websites, in traditional
print media advertising and most recently in TV commercials for several of the
Company's brands.
 
     The Company maintains an active presence on the Internet by having a
commerce-enabled Web site for each one of its catalogs which offers its
merchandise, takes catalog requests, and accepts orders for not only Web site
merchandise but also from any print catalog already mailed. The Company also
utilizes commissionable marketing opportunities available to it by posting its
catalog merchandise and accepting orders on third party Web sites. Publicly
announced alliances include with WebTV as well as Excite.
 
                                        3
<PAGE>   5
 
     The Company continues to use direct response television marketing, having
taken advantage of the opportunity to offer a particular catalog's merchandise
on a 24-hour television shopping channel and on long-form television
infomercials. In addition, the Company has entered into an agreement to post
some of its catalog merchandise offerings on electronic marketing channels which
are not directed to residences but to airport lounges, hotel rooms and airplane
electronic networks.
 
TELEMARKETING
 
     The Company receives approximately 84% of its orders through its toll-free
telephone service which offers customer access seven days per week, 24 hours per
day. The Company has created a telephone network to link its three primary
telemarketing facilities in Hanover, Pennsylvania, LaCrosse, Wisconsin and San
Diego, California. The Company's telemarketing facilities utilize
state-of-the-art telephone switching equipment which enables the Company to
route calls between telemarketing centers and thus provide prompt customer
service. The Company handled approximately 9 million telephone order and
customer service calls in 1998. As part of its December 1996 plan to reduce
operating costs, the Company shut down its telemarketing capacity in its
Roanoke, Virginia facility in February 1997. In the first quarter of 1997, the
Company entered into a call center services agreement with MCI Communications
Corp. which resulted in significant cost savings for such services. See
"Purchasing."
 
     The Company trains its telemarketing service representatives to be
courteous, efficient and knowledgeable about the Company's products.
Telemarketing service representatives generally receive 40 hours of training in
selling products, services, systems and communication skills through simulated
as well as actual phone calls. A substantial portion of the evaluation of
telemarketing service representatives' performance is based on how well the
representative meets customer service standards. While primarily trained with
product knowledge to serve customers of one or more specific catalogs,
telemarketing service representatives also receive cross-training that enables
them to take overflow calls from other catalogs. The Company utilizes customer
surveys as an important measure of customer satisfaction.
 
DISTRIBUTION
 
     The Company presently operates three distribution centers in three
principal locations: one in Roanoke, Virginia, one in Hanover, Pennsylvania, and
one in LaCrosse, Wisconsin. The Company's facilities processed approximately 7
million packages in 1998. As part of its 1996 plan to reduce annual operating
costs, the Company developed a plan to consolidate certain of its operations in
Roanoke, VA and its Hanover, PA operations into its distribution center in
Roanoke, VA. The apparel operations and two of the six catalogs located in
Hanover, PA were consolidated into the Roanoke distribution center in the second
half of 1997. Two other catalogs were consolidated into the Roanoke distribution
center in 1998.
 
     The Company mails its catalogs through the United States Postal Service
("USPS") utilizing pre-sort, bulk mail and other discounts. Most of the
Company's packages are shipped through the USPS. Overall, catalog mailing and
package shipping costs approximated 15% of the Company's net revenues in 1998.
The Company obtains rate discounts from the USPS by automatically weighing each
parcel and sorting and trucking packages to a number of USPS drop points
throughout the country. Some packages are shipped using a consolidator for less
frequently used drop points. The USPS increased mailing rates effective January
1999 (see Item 7. Management's Discussion and Analysis of Consolidated Financial
Condition and Results of Operations). The Company also utilizes United Parcel
Service, Federal Express and other delivery services. United Parcel Service
raised its rates for domestic deliveries by 3.6% for ground rates and 3.3% for
air rates effective February 7, 1998.
 
PURCHASING
 
     The Company's large sales volume permits it to achieve a variety of
purchasing efficiencies, including the ability to obtain prices and terms that
are more favorable than those available to smaller companies or than would be
available to the Company's individual catalogs were they to operate
independently. Major goods and services used by the Company are purchased or
leased from selected suppliers by its central buying staff.
 
                                        4
<PAGE>   6
 
These goods and services include: paper, catalog printing and printing related
services such as order forms and color separations, communication systems
including telephone time and switching devices, packaging materials, expedited
delivery services, computers and associated network software and hardware.
 
     The Company's telephone telemarketing costs (both inbound and outbound
calls) are typically contracted for a three-year period. In the first quarter of
1997, the Company entered into a three-year call center services agreement with
MCI Communications Corp. under which it obtained a material reduction in the
rate which it had been paying pursuant to its then current telecommunications
contract and savings with respect to certain database services which are
provided to it. See "Telemarketing."
 
     The Company generally enters into annual arrangements for paper and
printing with a limited number of suppliers. These arrangements permit periodic
price increases or decreases based on prevailing market conditions, changes in
supplier costs and continuous productivity improvements. For 1998, paper costs
approximated 7% of the Company's net revenues.
 
MANAGEMENT INFORMATION SYSTEMS
 
     The Company has successfully converted all catalogs to its integrated mail
order and catalog system operating on its mid-range computer systems.
Additionally, the remaining fulfillment center migrated to the newly developed
warehouse management system. The migration of the Company's business
applications to mid-range computers was an important part of the Company's
overall systems plan which defined the long-term systems and computing strategy
for the Company. The Company modified and installed, on a catalog by catalog
basis, these new integrated systems for use in managing all phases of the
Company's operations. These systems have been designed to meet the Company's
requirements as a high volume publisher of multiple catalogs. The Company is
continuing to devote resources to improving its systems.
 
     The new software system is an on-line, real-time system which includes
order processing, fulfillment, inventory management, list management and
reporting. The software provides the Company with a flexible system that offers
data manipulation and in-depth reporting capabilities. The new management
information systems are designed to permit the Company to achieve substantial
improvements in the way its financial, merchandising, inventory, telemarketing,
fulfillment and accounting functions are performed. Two catalogs were brought
onto the Company's common systems platform in 1994. The Company brought eight
additional catalogs onto the Company's common systems platform in 1995, one in
1996 and the balance of the catalogs onto the Company's common systems platform
in 1997. As of December 26, 1998, the Company had invested capitalized costs of
approximately $18.6 million in such systems.
 
     Based on its identification and assessment of year 2000 issues, the Company
estimates it will incur total expenditures of $3.6 million to modify its
computer information systems enabling proper processing of transactions relating
to the year 2000 and beyond. The Company continues to take appropriate courses
of corrective action, including replacement of certain systems and contracting
with a consultant to develop contingency plans. The Company does not expect the
amounts required to be expensed over the next year related to the year 2000
modifications to have a material effect on its financial position or results of
operations. The Company has contacted vendors and others on whom it relies to
assure that their systems will be timely converted. However, there can be no
assurance that the systems of other companies on which the Company relies also
will be timely converted or that any such failure to convert by another company
would not have an adverse effect on the Company's operations.
 
CREDIT MANAGEMENT
 
     Several of the Company's catalogs, including Domestications, International
Male and Gump's by Mail, offer their own private label credit cards. The Company
has a five year $75 million credit facility with General Electric Credit
Corporation ("GECC") expiring in the year 2000 which provides for the sale and
servicing of accounts receivable originating from the Company's revolving credit
cards. GECC's servicing responsibilities include credit processing, collections,
billing/payment processing, reporting and credit card issuance. The
 
                                        5
<PAGE>   7
 
Company is required to maintain certain financial covenants related to this
agreement which the Company failed to maintain, but has received a waiver for
the event of default at December 26, 1998. In March 1999, the Company entered
into an account purchase and credit card marketing and services agreement with
Capital One Services, Inc. and Capital One Bank establishing that Capital One
will provide services generally of a type provided previously by GECC with
respect to the Company's private label credit card program. Capital One will do
this by purchasing from the Company the existing portfolio of credit card
accounts on terms which will create neither a gain or loss to the Company on the
closing date. The purchase is currently scheduled for July 1999.
 
INVENTORY MANAGEMENT
 
     The Company's inventory management strategy is designed to maintain
inventory levels that provide optimum in-stock positions while maximizing
inventory turnover rates and minimizing the amount of unsold merchandise at the
end of each season. The Company manages inventory levels by monitoring sales and
fashion trends, making purchasing adjustments as necessary and by promotional
sales. Additionally, the Company sells excess inventory in its special sale
catalogs, its outlet stores and to jobbers.
 
     The Company acquires products for resale in its catalogs from numerous
domestic and foreign vendors. No single source supplied more than 5% of the
Company's products in 1998. The Company's vendors are selected based on their
ability to reliably meet the Company's production and quality requirements, as
well as their financial strength and willingness to meet the Company's needs on
an ongoing basis.
 
FINANCING
 
     Credit Facility.  The Congress Credit Facility is comprised of a revolving
line of credit of up to $65 million and term loans aggregating $14.0 million at
December 26, 1998. The Congress Facility is secured by all assets of the Company
and places limitations on the incurrence of additional indebtedness. The amount
that can be borrowed under the Congress Facility is based on percentages of
eligible inventory and accounts receivable as reported to Congress from time to
time. An inventory appraisal was completed in March 1997 and the advance rate
remained the same through the balance of 1997. In November 1997, a new inventory
appraisal was completed and advance rates were increased along with other
modifications that increased the Company's availability under the Facility. At
that time, negotiations for the refinancing of the Revolving Credit Facility
commenced. Under the terms of the renegotiated Credit Facility, effective March
1998, the facility was extended to January 31, 2001.
 
     The Congress Revolving Credit Facility, prior to the amendment, bore
interest at 1.25% above the prime rate and the Revolving Term Note bore interest
at 1.5% above prime rate. As amended, the Revolving Credit Facility bears
interest at prime plus .5% or Eurodollar plus 2.5% and the Revolving Term Note
bears interest at prime plus .75% or Eurodollar plus 2.75%. The Company is
required to maintain minimum net worth and working capital throughout the terms
of the agreement. The Company was in compliance with such covenants at December
26, 1998. At December 26, 1998, the Company had no revolving indebtedness and
$14.0 million outstanding in Revolving Term Notes, respectively. As of December
27, 1997, the Company also had no revolving indebtedness and $7.9 million
outstanding in Revolving Term Notes, respectively. The face amount of unexpired
documentary letters of credit at December 26, 1998 and December 27, 1997 were
$2.8 million and $3.0 million, respectively. At December 26, 1998, availability
under the Congress Facility was approximately $49 million, including cash on
hand. The Congress Facility financial covenant requirements are as follows:
 
<TABLE>
<CAPTION>
WORKING CAPITAL (AS DEFINED)                                     AMOUNT
----------------------------                                  ------------
<S>                                                           <C>
  December 1997 and forward.................................  $(10,000,000)
</TABLE>
 
<TABLE>
<CAPTION>
NET WORTH                                                        AMOUNT
---------                                                     ------------
<S>                                                           <C>
  June 1997 and thereafter..................................  $ 21,500,000
</TABLE>
 
                                        6
<PAGE>   8
 
     Reimbursement Agreement.  In December 1996, the Company finalized its
agreement (the "Reimbursement Agreement") with Richemont Finance S.A.
("Richemont") that provided the Company with up to approximately $28 million of
letters of credit through Swiss Bank Corporation, New York Branch. The three
letters of credit, which were to expire on February 18, 1998, carry an interest
rate of 3.5% above the prime rate, payable to Swiss Bank Corporation quarterly
on amounts drawn under the letters of credit. The Company also agreed to pay a
facility fee to Richemont equal to 5% of the principal amount of the letters of
credit as well as other fees incurred in connection with providing the facility.
In the event that the Company has not paid in full, by the expiration date, any
outstanding balances under the letters of credit, Richemont shall have the
option, exercisable at any time prior to payment in full of all amounts
outstanding under the letters of credit to convert such amount into Common Stock
of the Company at the mean of the bid and ask prices of the Company's Common
Stock on November 8, 1996, or the mean of the bid and ask prices of the
Company's Common Stock on each of the thirty days immediately prior to the date
of exercise of the conversion privilege. The Reimbursement Agreement is
subordinate to the Credit Facility.
 
     In November 1997, Richemont definitively agreed to extend its guarantee
under the Reimbursement Agreement to March 30, 1999. As consideration for this
transaction, the Company agreed to pay to Richemont a fee of 4% of the principal
amount of each letter of credit, which fee aggregated $1,073,483.28. The
extension required the approval of Congress and Swiss Bank which approvals were
obtained in February 1998, and was subject to certain other conditions. On
February 18, 1998, the extension of the Richemont guarantee and the closing of
this transaction were consummated. Accordingly, the expiration dates of two of
the letters of credit were extended through March 30, 1999, and the letters of
credit were amended to reflect the assignment of all obligations thereon from
Swiss Bank, New York Branch to Swiss Bank, Stamford Branch. A substitute letter
of credit having an expiration date of March 30, 1999 was issued to replace the
third letter of credit. On each of October 1, 1997 and October 1, 1998 the
Company paid down approximately $1 million of the underlying debt thus reducing
the principal amount of the letters of credit to $25.8 million.
 
     In the first quarter of 1999, Richemont agreed to extend its guarantee
under the Reimbursement Agreement to March 31, 2000. As consideration for this
transaction, the Company agreed to pay to Richemont a facility fee of 9.5% of
the principal amount of each letter of credit. The extension required the
approval of Congress and UBS AG which approvals were obtained in March 1999, and
was subject to certain other conditions. In March 1999, the extension of the
Richemont guarantee and the closing of this transaction will be consummated.
Accordingly, the expiration dates of the letters of credit will be extended
through March 31, 2000.
 
     1997 Rights Offering.  The Company commenced a $50 million rights offering
(the "1997 Rights Offering") on April 29, 1997. Holders of record of the
Company's Common Stock, par value $.66 2/3 per share (the "Common Stock"), and
Series B Convertible Additional Preferred Stock, par value $.01 and stated value
$10.00 per share (the "Series B Preferred"), as of April 28, 1997, the record
date, were eligible to participate in the 1997 Rights Offering. The rights were
exercisable at a price of $.90 per share. Shareholders received .38 rights for
each share of Common Stock held and .57 rights for each share of Series B
Preferred held as of the record date. The 1997 Rights Offering expired on May
30, 1997, with 55,654,623 rights to purchase shares exercised, and it closed on
June 6, 1997.
 
     Richemont entered into a standby purchase agreement (the "Richemont Standby
Purchase Agreement") to purchase all shares in the 1997 Rights Offering not
subscribed to by shareholders of record at the subscription price. Richemont
purchased 40,687,970 shares in the 1997 Rights Offering and, as a result, then
owned approximately 20.3% of the Company. The Company paid in cash, from the
proceeds of the 1997 Rights Offering, to Richemont on the closing date, a
standby purchase fee of approximately $1.8 million which represented an amount
equal to 1% of the aggregate offering price of the aggregate number of shares
issuable upon closing of the 1997 Rights Offering other than with respect to the
shares of Common Stock held by NAR Group Limited ("NAR") or its affiliates plus
an amount equal to one-half of one percent of the aggregate number of shares
acquired by NAR upon exercise of their rights (Standby Fee) plus an amount equal
to 4% of the aggregate offering price in respect to all unsubscribed shares
(Take-Up Fee). In connection with the entering of the Richemont Standby Purchase
Agreement, the Company named two Richemont representatives, Messrs. Jan P.
DuPlessis and Howard M.S. Tanner, to its Board of Directors.
                                        7
<PAGE>   9
 
     On April 26, 1997, NAR irrevocably agreed with the Company, subject to and
upon the consummation of the 1997 Rights Offering, to exercise certain of the
rights distributed to it for the purchase of 11,111,111 shares of Common Stock
that had an aggregate purchase price of approximately $10 million. NAR agreed to
pay for and the Company agreed to accept as payment for the exercise of such
rights the surrender by NAR of the principal amount due under a subordinated
promissory note dated September 1996 due by the Company to Intercontinental
Mining & Resources Incorporated, an affiliate of NAR ("IMR"), in the principal
amount of $10 million the ("IMR Promissory Note") and cancellation thereof.
 
     In order to facilitate vendor shipments and to permit the commencement of
the Company's plan to consolidate certain of its warehouse facilities, Richemont
advanced $30 million as of April 23, 1997 against its commitment to purchase all
of the unsubscribed shares pursuant to the Richemont Standby Purchase Agreement.
The Company then executed a subordinated promissory note in the amount of $30
million to evidence this indebtedness (the "Richemont Promissory Note") which
was repaid out of the proceeds of the 1997 Rights Offering.
 
     The Company issued 55,654,623 shares as a result of the 1997 Rights
Offering which generated gross cash proceeds of approximately $40 million (after
giving effect to the acquisition and exercise by NAR of rights having an
aggregate purchase price of $10 million which were paid for by the surrender and
cancellation of the IMR Promissory Note). The proceeds of the 1997 Rights
Offering were used by the Company: (i) to repay the $30 million principal amount
outstanding under the Richemont Promissory Note, and (ii) for working capital
and general corporate purposes including repayment of amounts outstanding under
the Credit Facility with Congress.
 
ADDITIONAL INVESTMENTS
 
     In November 1997, SMALLCAP World Fund, Inc. ("SMALLCAP"), a mutual fund and
substantial investor in the Company, agreed to purchase 3.7 million shares of
the Company's Common Stock at $1.41 per share for an aggregate purchase price of
approximately $5.2 million in a private placement. This transaction was
consummated on November 6, 1997. These shares were restricted and were
subsequently registered under the Securities Act of 1933, as amended, pursuant
to a registration rights agreement with SMALLCAP that called for the Company to
use its best efforts to effect the registration of such shares as soon as
practicable after April 1, 1998.
 
     On July 31, 1998, Richemont acquired 5,646,490 additional shares of Common
Stock of the Company pursuant to the exercise of certain common stock purchase
warrants with exercise prices from $1.95 to $2.59 per share and an aggregate
total exercise price of $13.6 million. The Company used the proceeds of the
warrant exercise to reduce the amounts outstanding under the Congress Credit
Facility.
 
EMPLOYEES
 
     The Company currently employs approximately 2,700 persons on a full time
basis and approximately 600 persons on a part time basis. Approximately 300
employees at one of the Company's subsidiaries are represented by a union. The
Company believes its relations with its employees are good.
 
SEASONALITY
 
     The Company has experienced substantially increased sales in the fourth
quarter of each year as compared to the first three quarters, due in part to the
Company mailing more catalogs in the second part of the year, holiday season
purchases and decreasing apparel sales as a percentage of total sales.
 
COMPETITION
 
     The Company believes that the principal bases upon which it competes are
quality, value, service, product offerings, catalog design, convenience and
efficiency. The Company's catalogs compete with other mail order catalogs, both
specialty and general, and retail stores, including department stores, specialty
stores and discount stores. Competitors also exist in each of the Company's
catalog specialty areas of women's
 
                                        8
<PAGE>   10
 
apparel, home fashions, general merchandise, men's apparel and gifts. A number
of the Company's competitors have substantially greater financial, distribution
and marketing resources than the Company.
 
     The Company is maintaining an active commerce-enabled Internet Web site
presence for all of its catalogs. A substantial number of each of the Company's
catalog competitors maintain an active commerce-enabled Internet Web site
presence as well. A number of such competitors have substantially greater
financial, distribution and marketing resources than the Company. Sales from the
Internet for Web site merchandisers have grown in 1998. The Company believes
strongly in the future of the Internet and online commerce, including the speed
at which marketing opportunities are evolving in this medium, and is adjusting
its marketing focus, resources, and manpower to that end.
 
TRADEMARKS
 
     Each of the Company's catalogs has its own federally registered trademark.
The Company also owns numerous trademarks, copyrights and service marks on its
logos, products and catalog offerings. The Company has also protected various
trademarks internationally. The Company vigorously protects such marks and
believes there is substantial goodwill associated with them.
 
GOVERNMENT REGULATION
 
     The Company is subject to Federal Trade Commission regulations governing
its advertising and trade practices, Consumer Product Safety Commission and Food
and Drug Administration regulations governing the safety of the products it
sells in its catalogs and other regulations relating to the sale of merchandise
to its customers. The Company is also subject to the Department of
Treasury-Customs regulations with respect to any goods it directly imports.
 
     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. The Company believes that it collects sales tax in all
jurisdictions where it is currently required to do so.
 
ITEM 2.  PROPERTIES
 
     The Company's corporate headquarters are located in a modern
85,000-square-foot office in Weehawken, New Jersey. The facility houses
merchandising and marketing personnel, catalog production personnel and
corporate and administrative offices. The Weehawken facility is leased for a
15-year term expiring in 2005. The Company has subleased a portion of these
premises effective April 1998 as part of its plan to further reduce costs. In
addition to this office facility, the Company leases administrative facilities
for men's apparel in San Diego, California, maintains 15,000 square feet of
administrative facilities for the Gump's retail business in its store facility
in San Francisco, California discussed below and maintains administrative
facilities for the Improvements business in Beachwood, Ohio.
 
     The Company currently operates three warehouses and fulfillment facilities
in three principal locations: one in Roanoke, Virginia for home fashions,
apparel and general merchandise, one in Hanover, Pennsylvania for hardgoods,
including sporting goods and giftware, and one in LaCrosse, Wisconsin for
upscale home fashions.
 
     In Roanoke, Virginia, the Company owns a 633,000 square-foot home fashions
distribution center. The facility became operational in the second half of 1995
and handled all of Domestications' fulfillment processing. As a result of the
Company's cost reduction plan, the Company transferred during 1997 the
fulfillment functions for two of the six catalogs previously fulfilled from the
Hanover, Pennsylvania distribution facility as well as all the fulfillment
functions handled by the apparel distribution facility located in Roanoke,
Virginia to the home fashions distribution center in Roanoke, Virginia. See
"Distribution." The apparel distribution center in Roanoke, Virginia is a
175,000 square-foot facility which the Company leases from a
 
                                        9
<PAGE>   11
 
partnership in which it owns a 50% interest. The Company and the partnership are
currently looking for a sublessee for this facility.
 
     In Hanover, Pennsylvania, the Company owns a distribution center of
approximately 265,000 square feet which handles hardgoods, including sporting
goods and giftware. Two of the six catalogs serviced by such facility were
consolidated with and into the home fashions distribution center in Roanoke,
Virginia in 1997. Two other catalogs were consolidated into the Roanoke,
Virginia distribution center in 1998. During 1999, the Company intends to use
the Hanover, Pennsylvania distribution center for third-party fulfillment and
processing.
 
     In LaCrosse, Wisconsin, the Company leases a warehouse and fulfillment
center of 185,000 square feet under a short-term lease. The Company also owns a
150,000 square-foot home fashions manufacturing and assembly facility and a
58,000 square-foot telemarketing and customer service facility in LaCrosse,
Wisconsin.
 
     In addition to the LaCrosse, Wisconsin facility, the Company utilizes
portions of facilities in San Diego, California and Hanover, Pennsylvania as
telemarketing and customer service facilities. Specifically, in Hanover,
Pennsylvania, the Company leases a telemarketing and administrative office
facility of 123,000 square feet. Renewal terms on this telemarketing center
extend through 2009.
 
     The Company's principal retail operations consist of the Gump's retail
store, which occupies approximately 43,000 square feet in a building in downtown
San Francisco, California which is leased pursuant to a 15-year lease. A portion
of the Gump's facility is subleased and a portion is used for administrative
offices. The Company also operates and leases 10 other retail and outlet stores
at various locations.
 
     The Company leases premises in Edgewater, New Jersey which it vacated in
1995. The Company has sublet a portion of the Edgewater facility and is actively
seeking to sub-lease the remainder. The Company sold its interest in a Cleveland
facility in May 1997.
 
<TABLE>
<CAPTION>
                                                                         APPROXIMATE
LOCATION                                                   STATUS       SQUARE FOOTAGE
--------                                                   ------       --------------
<S>                                                     <C>             <C>
WAREHOUSE AND FULFILLMENT CENTERS:
Roanoke, VA                                             Owned              633,000
Roanoke, VA                                             Vacant             175,000
Hanover, PA                                             Leased/Owned       277,500
LaCrosse, WI                                            Leased             185,000
CORPORATE AND ADMINISTRATIVE OFFICES:
Weehawken, NJ                                           Leased              84,700(a)
Edgewater, NJ                                           Leased              65,000
San Diego, CA                                           Leased              30,000(b)
San Francisco, CA                                       Leased              15,000(c)
Beachwood, OH                                           Leased               7,740(d)
TELEMARKETING AND CUSTOMER SERVICE:
Hanover, PA                                             Leased             123,000
LaCrosse, WI                                            Owned               58,000
San Diego, CA                                           Leased              30,000(b)
RETAIL STORES:
San Francisco, CA                                       Leased              43,000(c)
San Diego, CA                                           Leased               3,800
West Hollywood, CA                                      Leased               3,600
Mayfield Heights, OH                                    Leased               3,750
Hanover, PA                                             Leased              24,000
Kenosha, WI                                             Leased               5,500
LaCrosse, WI                                            Leased              13,326
Madison, WI                                             Leased               5,206
</TABLE>
 
                                       10
<PAGE>   12
 
<TABLE>
<CAPTION>
                                                                         APPROXIMATE
LOCATION                                                   STATUS       SQUARE FOOTAGE
--------                                                   ------       --------------
<S>                                                     <C>             <C>
Oshkosh, WI                                             Leased               2,000
Philadelphia, PA                                        Leased               3,017
Roanoke, VA                                             Leased               7,389
MANUFACTURING AND ASSEMBLY:
LaCrosse, WI                                            Owned              150,000
</TABLE>
 
---------------
(a) After sublease of approximately 20,000 square feet to an outside tenant
    effective April 1998, approximate square footage will be utilized by the
    Company for the 65,000 square feet of office space.
 
(b) Telemarketing and corporate/administrative functions are all located and
    performed at the one facility. Square footage stated represents the entire
    facility.
 
(c) Retail and office space are all located at the one facility. Square footage
    stated represents allocations to administrative, retail and retail storage
    space.
 
(d) Administration and product development for Improvements catalog.
 
ITEM 3.  LEGAL PROCEEDINGS
 
     The Company is involved in various routine lawsuits of a nature which are
deemed customary and incidental to its businesses. In the opinion of management,
the ultimate disposition of such actions will not have a material adverse effect
on the Company's financial position or results of operations.
 
ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
     None.
 
                                       11
<PAGE>   13
 
                                    PART II
 
ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
 
     The Common Stock is traded on the American Stock Exchange (Symbol: HNV).
The following table sets forth, for the periods shown, the high and low sale
prices of the Common Stock reported on the American Stock Exchange Composite
Tape.
 
<TABLE>
<CAPTION>
                                                            HIGH       LOW
                                                            ----       ---
<S>                                                         <C>        <C>
1997
  First Quarter                                             $ 1  1/8   $    5/8
  Second Quarter                                              1  1/8        5/8
  Third Quarter                                               1 11/16    1  1/16
  Fourth Quarter                                              3          1  1/4
1998
  First Quarter                                             $ 3  1/2   $ 2  3/8
  Second Quarter                                              3  5/8     2 11/16
  Third Quarter                                               3  7/16    2  9/16
  Fourth Quarter                                              3  7/16    1 15/16
</TABLE>
 
     The Company is restricted from paying dividends on its Common Stock or from
acquiring its capital stock by certain debt covenants contained in agreements to
which the Company is a party.
 
     As of March 18, 1999, there were approximately 4,010 holders of record of
Common Stock.
 
                                       12
<PAGE>   14
 
ITEM 6.  SELECTED FINANCIAL DATA
 
     The following table presents selected financial data for each of the years
indicated:
 
<TABLE>
<CAPTION>
                                    1994           1995            1996            1997            1998
                                 -----------    -----------    ------------    ------------    ------------
                                              (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<S>                              <C>            <C>            <C>             <C>             <C>
INCOME STATEMENT DATA:
  Revenues                       $   768,884    $   749,767    $    700,314    $    557,638    $    546,114
  Special charges (credits)               --          1,563          36,724          (2,209)           (485)
  Depreciation and amortization        6,157          9,020          12,192           8,227           9,478
  Operating (loss) income             15,975        (22,619)        (94,497)         (1,849)        (16,807)
  Interest expense, net                2,813          4,531           8,398           8,028           7,778
  Income (loss) before
    extraordinary items               14,838        (28,153)       (103,895)        (10,876)        (25,585)
  Extraordinary items                     --         (1,837)         (1,134)             --              --
                                 -----------    -----------    ------------    ------------    ------------
  Net income (loss)                   14,838        (29,990)       (105,029)        (10,876)        (25,585)
  Preferred stock dividends             (135)          (240)           (225)           (190)           (578)
                                 -----------    -----------    ------------    ------------    ------------
  Net income (loss) applicable
    to common stockholders       $    14,703    $   (30,230)   $   (105,254)   $    (11,066)   $    (26,163)
                                 -----------    -----------    ------------    ------------    ------------
  EBITDA (earnings before
    interest, taxes,
    depreciation and
    amortization)                $    22,132    $   (13,599)   $    (82,305)   $      6,378    $     (7,329)
  EBITDA before special
    charges                      $    22,132    $   (12,036)   $    (45,581)   $      4,169    $     (7,814)
                                 -----------    -----------    ------------    ------------    ------------
PER SHARE:
  Income (loss) before
    extraordinary items          $       .16    $      (.30)   $       (.93)   $       (.06)   $       (.13)
  Extraordinary items                     --           (.02)           (.01)             --              --
                                 -----------    -----------    ------------    ------------    ------------
  Net income (loss) -- basic
    and diluted                  $       .16    $      (.32)   $       (.94)   $       (.06)   $       (.13)
                                 -----------    -----------    ------------    ------------    ------------
WEIGHTED AVERAGE NUMBER OF
  SHARES OUTSTANDING:
  Basic                           93,285,190     93,029,816     111,441,247     176,621,080     206,508,110
  Diluted                         93,285,190     93,029,816     111,441,247     176,621,080     206,508,110
                                 -----------    -----------    ------------    ------------    ------------
BALANCE SHEET DATA (END OF
  PERIOD):
  Working capital (deficit)      $    58,501    $    28,774    $     (1,507)   $     47,570    $     43,929
  Total assets                       262,246        279,009         220,827         230,299         218,870
  Total debt(1)                       37,915         62,802          65,189          59,958          58,859
  Shareholders' equity               109,725         87,210          31,740          75,551          66,470
                                 -----------    -----------    ------------    ------------    ------------
</TABLE>
 
---------------
(1) The amounts for 1997 and 1998 include obligations under receivable financing
    of $21,918 and $18,998, respectively, pursuant to SFAS No. 125.
 
     There were no cash dividends declared on the Common Stock in any of the
periods.
 
                See Notes to Consolidated Financial Statements.
                                       13
<PAGE>   15
 
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 revenues of certain items in the Company's
Consolidated Statements of Income (Loss):
 
<TABLE>
<CAPTION>
                                                                    FISCAL YEAR
                                                              -----------------------
                                                              1996     1997     1998
                                                              -----    -----    -----
<S>                                                           <C>      <C>      <C>
Revenues                                                      100.0%   100.0%   100.0%
Cost of sales and operating expenses                           68.4     64.2     62.9
Write-down of inventory of discontinued catalogs                 .2       --       .7
Special charges (credit)                                        5.2      (.4)     (.1)
Selling expenses                                               27.9     25.3     27.2
General and administrative expenses                            10.1      9.7     10.6
Depreciation and amortization                                   1.7      1.5      1.7
Loss from operations                                          (13.5)     (.3)    (3.1)
Interest expense, net                                           1.2      1.4      1.4
Net (loss)                                                    (15.0)%   (2.0)%   (4.8)%
</TABLE>
 
RESULTS OF OPERATIONS
 
  1998 Compared with 1997
 
     Net (Loss).  The Company reported a net loss of $25.6 million or $(.13) per
common share, compared with a net loss of $10.9 million, or ($.06) per common
share, for 1997. Per share amounts are expressed after deducting preferred
dividends of $.6 million and $.2 million in 1998 and 1997, respectively. The
weighted average number of shares outstanding was 206,508,110 for the year ended
December 26, 1998 compared to 176,621,080 in 1997. The increase in weighted
average shares outstanding is primarily due to a rights offering completed in
June 1997.
 
     The higher loss in fiscal 1998 is attributed to:
 
          (i) a $3.7 million charge for the writedown of non core catalog
     inventory as well as a $2.2 million charge for other costs associated with
     plans to discontinue certain under performing company catalog brands
 
          (ii) higher promotional activity primarily in the fourth quarter
 
          (iii) costs related to new business initiatives
 
          (iv) higher selling expenses due to increased promotional activity and
     more competitive mailings in advance of the 1999 postal rate increase
 
          (v) the 1997 special credit exceeded the amount recorded in 1998 by
     $1.7 million
 
          (vi) 1997 income from the partial recovery of previously written-off
     investment securities amounting to $1.3 million
 
     partially offset by,
 
          (i) improved gross margins from reductions in the cost of merchandise
     resulting from the benefits of improved purchasing strategies and
     efficiencies in inventory management for the core catalog brands, as well
     as the positive impact of upsell promotions.
 
          (ii) reduced distribution costs resulting from the completion of the
     consolidation of distribution activities into the Company's Roanoke,
     Virginia facility.
 
     Revenues.  Revenues decreased in 1998 to $546.1 million from $557.6 million
in 1997, primarily as a result of the under performing (non core) catalog
brands, (Tweeds, Austad's and Colonial Garden Kitchens)
 
                                       14
<PAGE>   16
 
partially offset by revenue growth in other brands and the impact of upsell
promotions. The Company's revenues for 1998 for the core catalog brands
increased 3% over 1997.
 
     Catalog circulation decreased to 242 million in 1998 from 244 million in
1997.
 
     Operating Costs and Expenses.  Cost of sales and operating expenses, which
include fulfillment and telemarketing costs, decreased by $14.7 million from
1997. This decrease was the result of a reduction in catalog sales and reduced
merchandise costs as the Company's margins were enhanced by improved product
sourcing and merchandise mix as well as continued improvement in telemarketing
and fulfillment costs. Additionally, the Company attained inventory management
efficiencies resulting in improved order fill rates, lower product delivery
costs and lower backorder levels.
 
     Selling expenses increased $7.4 million in 1998 as a result of the
increased utilization of name list rentals, additional catalog production costs
and new marketing initiatives partially offset by the benefit of reduced, more
targeted circulation strategies. These expenses also include $2.2 million of
charges related to the aforementioned discontinuance of certain under performing
company catalog brands.
 
     General and administrative expenses increased $4.0 million in 1998
primarily due to an increase in spending to support growth initiatives,
including electronic commerce, as well as the impact of an offset to general and
administrative expenses ($1.3 million of income) recorded in 1997 as a result of
asset distributions made to the Company relating to previously written-off
investment securities.
 
     The operating results for 1998 and 1997 include benefits of $0.5 million
and $2.2 million, respectively, relating to the reversal of a portion of the
restructuring charges that were recorded in 1996. The 1998 reversal related to
the Company's decision to remain in its Hanover, Pa. fulfillment center. The
1997 reversal related primarily to the Company's decision to remain in its
Weehawken corporate facility.
 
     Depreciation and amortization increased $1.3 million in 1998 resulting from
fixed asset additions associated with the improvements in the distribution
center in Roanoke, Virginia.
 
     (Loss) from Operations.  The Company's loss from operations increased $15.0
million to $16.8 million in 1998 from a loss of $1.8 million in 1997. As
discussed above, the 1998 operating results include $5.9 million in charges
related to discontinuing certain non core catalog brands as the Company focuses
on building brands with a strong core customer base. The operating results also
include infrastructure costs related to the Company e-commerce initiatives. The
operating results for 1998 and 1997 include a $0.5 and $2.2 million credit,
respectively, relating to the reversal of a portion of the restructuring charges
that were recorded in 1996.
 
     Interest Expense, Net.  Interest expense, net decreased $0.2 million to
$7.8 million in 1998 from $8.0 million in 1997. This improvement was primarily
due to lower interest rates and lower amortization of capitalized debt costs.
 
     Income Taxes.  The Company did not record a Federal income tax provision in
1998 or 1997 based on each years' net operating losses. The Company's state tax
provision was $1.0 million in 1998 and 1997.
 
     Shareholders' Equity.  The number of shares of Common Stock outstanding
increased by 6,672,063 in 1998 due to 5.6 million shares issued in connection
with the exercise of certain common stock purchase warrants, its equity and
incentive plans, and other activities. At December 26, 1998, there were
210,427,385 shares of Common Stock outstanding compared to 203,755,322 shares of
Common Stock outstanding at December 27, 1997.
 
  1997 Compared with 1996
 
     Net (Loss).  The Company reported a net loss of $10.9 million or $(.06) per
common share, compared with a net loss before an extraordinary item of $104
million, or ($.93) per common share, for 1996. The 1996 extraordinary item of
$1.1 million, or ($.01) per common share relates to the early extinguishment of
debt. After giving effect to the extraordinary item, the net loss for 1996 was
$105 million, or ($.94) per common share. Per share amounts are expressed after
deducting preferred dividends of $.2 million in both 1997 and 1996. The weighted
average number of shares outstanding was 176,621,080 for the year ended December
27,
 
                                       15
<PAGE>   17
 
1997 compared to 111,441,247 in 1996. The increase in weighted average shares
outstanding is due to two $50 million rights offerings which were completed in
August 1996 and June 1997, respectively.
 
     The improved operating results in fiscal 1997 are attributed to (i) reduced
circulation to prospective customers and to customers other than core customers,
which resulted in decreased catalog costs, (ii) increased circulation to core
customers, focusing on core products, which resulted in lower selling expenses
relative to sales, (iii) reduced costs of merchandise as the Company began to
realize improvements in its product offerings, (iv) reduced fixed overhead costs
due to the planned relocation and consolidation of facilities, as well as the
Company's cost reduction plan implemented in 1997, (v) improved liquidity,
reduced backorder levels and improved inventory in-stock positions due to the
Company's 1997 Rights Offering, all of which contributed to operating
efficiencies, and (vi) the reversal of a portion of certain non-recurring
charges accrued in the prior year.
 
     Revenues.  Revenues decreased in 1997 to $557.6 million from $700.3 million
in 1996, primarily as a result of a decrease in sales for discontinued catalogs
of $93.8 million. Revenues from continuing catalog brands decreased $48.9
million to $548.6 million from $597.5 million for the prior year. The Company's
revenues for 1997 were planned at reduced levels from 1996 due to the Company's
business formula of reduced circulation, reduced prospecting for most catalogs
and a concentrated focus on core customers with core products. Circulation of
catalogs decreased 7.9% to 243.8 million in 1997.
 
     Operating Costs and Expenses.  Cost of sales and operating expenses, which
include fulfillment and telemarketing costs, decreased by $121 million from
1996. This decrease was primarily the result of reduced merchandise costs of
$91.2 million and other cost reductions of $29.8 million for telemarketing and
fulfillment activities, which are attributable to the planned sales reduction
for 1997, as well as savings created by the consolidation of telemarketing and
fulfillment facilities during the year. In addition, on an overall basis, the
Company's margins were enhanced by improved purchasing strategies and
efficiencies attained through inventory management.
 
     Selling expenses decreased $53.6 million to $141.4 million from $195
million in 1996 as a result of the reduced circulation plan implemented in 1997.
The Company experienced substantial paper price increases in 1997. In spite of
these increased paper prices, the Company was able to reduce its paper costs by
2% as a percentage of net revenues versus 1996 as a result of more targeted
circulation strategies.
 
     General and administrative expenses decreased $16.8 million to $53.8
million in 1997. This decrease resulted from the Company's previously announced
cost reduction plan. These savings were achieved from the reduced overhead
structure resulting from the reorganization of management and operations that
began at the end of 1996. The Company also experienced approximately $2.9
million of decreased costs and bad debt expense associated with its private
label credit program as compared with 1996. In addition, general and
administrative expenses were offset by $1.3 million of income recorded in 1997
as a result of asset distributions made to the Company relating to previously
written-off investment securities.
 
     The operating results for 1997 include a $2.2 million benefit relating to
the reversal of a portion of the restructuring charges that were recorded in
1996. The reversal relates primarily to the Company's decision to remain in its
Weehawken corporate facility.
 
     Depreciation and amortization decreased $4.0 million to $8.2 million in
1997 as a result of the Company's decision to write-off certain intangible
assets and close certain of its facilities at the end of the 1996 fiscal year.
 
     (Loss) from Operations.  The Company's loss from operations decreased to
$1.8 million in 1997 from a loss of $94.5 million in 1996. The Company's focus
on building brands with a core customer base coupled with the cost savings
programs implemented in 1997, as discussed above, has resulted in an improved
operating margin.
 
     Interest Expense, Net.  Interest expense, net decreased $.4 million to $8.0
million in 1997, which includes amortization on debt costs paid in prior years
of $2.3 million. Throughout the 1997 year, the Company maintained lower debt
levels than the prior year due to better management of its working capital.
 
                                       16
<PAGE>   18
 
This improvement was partially offset by increased amortization of debt costs
related to the Company's $26.9 million letter of credit facility.
 
     Income Taxes.  The Company did not record a Federal income tax provision in
1997 or 1996 based on each years' net operating losses. The Company's state tax
provision was $1.0 million in 1997 and 1996.
 
     Shareholders' Equity.  The number of shares of Common Stock outstanding
increased by 59,107,424 in 1997 due to shares issued in connection with the
Company's 1997 Rights Offering, its equity and incentive plans, and other
activities. At December 27, 1997, there were 203,755,322 shares of Common Stock
outstanding compared to 144,647,898 shares of Common Stock outstanding at
December 28, 1996.
 
LIQUIDITY AND CAPITAL RESOURCES
 
     Liquidity.  The Company had $12.2 million and $14.8 million of cash and
cash equivalents at December 26, 1998 and December 27, 1997, respectively.
Working capital and current ratio were $43.9 million and 1.47 to 1 at December
26, 1998 compared to working capital and current ratio of $47.6 million and 1.48
to 1 at December 27, 1997. The primary sources of cash in 1998 were the $13.6
million in proceeds resulting from the exercise of warrants held by Richemont in
addition to $7.3 million in proceeds resulting from additional term loan
borrowings under the Congress Credit Facility. The primary sources of cash in
1997 were the 1997 Rights Offering, which provided $40.1 million of cash and the
$5.2 million issuance of the Company's Common Stock to SMALLCAP WorldFund, Inc.
in a private placement. Cash was used in 1998 primarily to fund a $12.1 million
use of cash in operating activities, capital expenditures of $6.1 million, the
$2.8 million repayment of The Company Store 6% mortgage notes and to reduce the
amounts outstanding under its secured Revolving Credit Facility with Congress.
 
     In 1996, as a result of the Company's continued operating losses, the
Company experienced tightened vendor credit and increased levels of debt. Order
cancellation rates increased and negatively affected initial fulfillment which
resulted in an increase in split shipments and higher customer inquiry calls in
1996 and the first quarter of 1997. As a result of these factors, the Company
decided in late 1996 that it was necessary to obtain relief under its Credit
Facility and to investigate an equity infusion. In December 1996, the Company
closed its agreement with Richemont that provided the Company with approximately
$28 million of letters of credit to replace letters of credit which were issued
under the Credit Facility with Congress. Although this agreement provided the
Company added liquidity, its timing, on December 19, 1996, had minimal effect on
reducing back orders in 1996. Therefore, these back orders carried over to the
first quarter of 1997 and caused an increase in the order cancellation rates in
the period. When the 1996 final financial results became known to the Company,
it concluded such results would have a further negative impact on the Company's
ability to conduct business on normal trade terms. Therefore, the Company
decided it was necessary to obtain an additional equity infusion which would
restore the Company's equity base and provide the Company with additional
liquidity.
 
     On March 26, 1997, the Company announced that it intended to distribute
subscription rights to subscribe for and purchase additional shares of Common
Stock to holders of record of the Company's Common Stock and Series B
Convertible Additional Preferred Stock. The 1997 Rights Offering expired on May
30, 1997 and closed on June 6, 1997. The 1997 Rights Offering generated gross
proceeds of approximately $40 million after giving effect to the $10 million of
indebtedness NAR Group Limited ("NAR") applied to acquire its shares. Richemont
purchased 40,687,970 shares of Common Stock with rights which were not
subscribed for and purchased by shareholders in the 1997 Rights Offering per an
agreement with the Company. On April 23, 1997, Richemont advanced $30 million
against this commitment. This advance was used to repay approximately $13
million of indebtedness under the revolving line of credit, bring past due
vendor accounts current and for other general corporate purposes. The Company
also incurred fees of approximately $3 million in relation to the 1997 Rights
Offering which were paid from such gross proceeds.
 
     The agreement by which Richemont provided the Company with a $27.9 million
letter of credit facility was to expire in February 1998. On October 1, 1997,
the Company paid down $1 million of the underlying debt, reducing the letters of
credit to approximately $26.9 million. The letters of credit carry an interest
rate of
                                       17
<PAGE>   19
 
3.5% above the prime rate, currently 11.25%. At that time, Richemont agreed to
extend its guarantee to March 30, 1999. As consideration for this transaction,
the Company paid to Richemont, in 1998, a fee equal to 4% of the $26.9 million
outstanding letters of credit. On October 1, 1998, the Company paid down an
additional $1 million of the underlying debt, reducing the letters of credit to
approximately $25.8 million. In March 1999, Richemont again definitively agreed
to extend its guarantee under the Reimbursement Agreement to March 31, 2000. As
consideration for this transaction, the Company agreed to pay to Richemont a
facility fee of 9.5% of the principal amount of each letter of credit.
 
     On July 31, 1998, Richemont acquired 5,646,490 additional shares of Common
Stock of the Company pursuant to the exercise of certain common stock purchase
warrants with exercise prices ranging from $1.95 to $2.59 per share and an
aggregate total exercise price of $13.6 million. The Company used the proceeds
of the warrant exercise to reduce amounts outstanding under the Congress Credit
Facility.
 
     In March 1997, the Company received waivers for events of default which
existed at December 28, 1996 under the Credit Facility with Congress. At that
time, Congress and the Company agreed to new working capital and net worth
covenants.
 
     On March 25, 1998, Congress agreed to extend the Revolving Credit Facility
and the Revolving Term Notes to January 31, 2001. The Company is required to
maintain certain financial covenants related to the Credit Facility with
Congress with which the Company was in compliance at December 26, 1998.
 
     At December 26, 1998, the Company had $2.6 million of current debt. Based
upon the December 26, 1998 balance of the Revolving Term Notes, the Company will
continue to make principal payments of $125,000 per month. The Company had zero
amounts outstanding on the Congress Credit Facility at December 26, 1998 and at
December 27, 1997. The total amount available under the Facility at December 26,
1998 was $49 million, including cash on hand.
 
     The Company experiences seasonality in its working capital requirements and
fluctuations in the revolving Credit Facility with peak borrowing requirements
normally occurring during the first and fourth quarters of the year.
 
     Foreign Currency Translation.  The Company minimizes currency risks by
making most foreign purchases in U.S. dollars and does not utilize hedging
instruments.
 
     Effect of Inflation and Cost Increases.  The Company normally experiences
increased costs of sales and operating expenses as a result of the general rate
of inflation and commodity price fluctuations. Operating margins are generally
maintained through internal cost reductions and operating efficiencies and then
through selective price increases where market conditions permit. The Company's
inventory is primarily mail-order merchandise which undergoes sufficiently high
turnover so that the cost of goods sold approximates replacement cost. Because
sales are not dependent on a particular supplier or product brand, the Company
can adjust product mix to mitigate the effects of inflation on its overall
merchandise base.
 
     Paper and Postage.  The Company mails its catalogs and ships most of its
merchandise through the United States Postal Service (USPS), with catalog
mailing and product shipment expenses representing approximately 15% of revenues
in 1998 and 14% of revenues in 1997. Paper costs represented approximately 7% of
revenues in 1998 and 6% of revenues in 1997.
 
     The USPS increased its mailing rates in early 1999. The Company is
implementing plans to mitigate the effect of these increases. If the Company
does not successfully implement any such plans, it may have a material adverse
effect on the results of operations. The United Parcel Service (UPS) raised its
rates for domestic deliveries by 3.6 percent for ground rates and 3.3 percent
for air rates effective February 7, 1998. It has generally been the experience
and the intention of the Company as well as its policy to recover the costs of
shipping, including outbound freight, and handling from its customers.
 
YEAR 2000 ISSUE
 
     The Year 2000 issue relates to the way computer systems and programs
interpret calendar date entries in two-digit date code fields. A system could
fail or make miscalculations due to the inability to distinguish the
                                       18
<PAGE>   20
 
year 2000 from the year 1900. Also, some other systems not normally
characterized as information technology systems may contain embedded hardware or
software that would be susceptible to this problem. As a result, many companies
will need to upgrade or replace computer systems in order to comply with Year
2000 requirements.
 
     During 1996, the Company initiated a strategy to begin the process of
correcting the Year 2000 problems. As part of this strategy, the Company formed
a project team to address internal and external Year 2000 issues related to both
information technology and non-information technology systems. The project was
divided into the following phases: 1) Discovery -- identification of all systems
with potential Year 2000 problems and inventorying those systems which must be
modified or replaced, 2) Assessment -- evaluating, categorizing and prioritizing
of Year 2000 issues, 3) Remediation -- correction of Year 2000 issues by
performing modifications to existing systems or converting to new systems, and
4) Testing/Deployment -- validation testing of Year 2000 readiness to ensure all
problems which were discovered are adequately corrected. At the present time,
the remediation and testing/deployment phases for the Company's information
technology infrastructure are approximately 90% complete and should be completed
by July 1999.
 
     The Company has also performed surveys of its suppliers to determine their
Year 2000 readiness. At October 1998, 34% of all suppliers and 80% of the top
100 suppliers represented their products and services to be Year 2000 compliant.
The Company is requesting remaining suppliers to represent their Year 2000
readiness while it also conducts searches for alternate suppliers.
 
     The Company believes the critical systems which it operates will be Year
2000 compliant by July 1999 and believes it is not likely to encounter any
significant operational problems. However, there is no guarantee that a Year
2000 related failure will not arise. This uncertainty is due, to a large extent,
to the uncertainty surrounding potential third party related Year 2000 problems
as well as the potential failure to discover all its own susceptible internal
systems. The risk to the Company resulting from the failure of third party or
internal systems is similar to other database marketing firms and, for the most
part, to other businesses. A reasonable worst case scenario could involve the
failure of Company or supplier systems which would cause a material disruption
to the Company's operations. For example, this could result in an interruption
of certain normal business activities or operations such as a temporary
inability to process transactions, send invoices or engage in certain business
activities. If the worst case scenario should occur (for any significant
duration), it could have a material adverse impact on the Company's business,
results of operations, liquidity and financial position. However, at this time
the Company is unable to completely determine the financial consequences of such
potential Year 2000 failures.
 
     While the Company expects that its efforts will provide reasonable
assurance that material disruptions will not occur, the potential for
interruption still exists. Accordingly, the Company has contracted with a
consulting firm to develop a contingency plan to provide for the continuation of
processing based upon the outcome of its Year 2000 testing program as well as
the results of surveying its major suppliers. Such a contingency plan may
include securing alternate sources of supply, securing redundant
telecommunication sources, accelerating 1999 year end shipments and any other
measures deemed appropriate. At this time, the Company cannot estimate the
additional cost, if any, that might develop from the implementation of such
contingency plans.
 
     The Company believes it is taking the necessary steps to become Year 2000
compliant. The Company's total cost associated with the necessary modifications
is not expected to be material to its financial position. To date, the Company
has spent an estimated $0.2 million and arranged for the replacement of
equipment in 1999 at a cost of $2.9 million. The entire cost estimated for this
project is $3.6 million. These costs primarily represent planned expenditures to
upgrade or replace computer hardware and software in 1999, as well as the costs
of staff and consultants to perform the project and the costs of software tools
for discovery and testing.
 
                                       19
<PAGE>   21
 
CAUTIONARY STATEMENTS
 
     The following statements constitute forward looking statements which
involve risks and uncertainties:
 
     The Company does not expect the amount required to be expensed over the
next year to have a material effect on its financial position or results of
operations.
 
     The following are important factors, among others, that could cause the
Company's actual results to differ materially from those expressed in any
forward-looking statements made by, or on behalf, of the Company:
 
     A general deterioration of economic conditions in the United States leading
to increased competitive activity including a business failure of a substantial
size company in the retail industry, a reduction in consumer spending generally,
or specifically with reference to the types of merchandise the Company offers in
its catalogs. The failure of the Internet generally to achieve the projections
for it with respect to growth of e-commerce or otherwise.
 
     The ability of the Company's computer system to connect with the systems of
others and to be able to serve the other's fulfillment needs.
 
     The Company has a history of operating losses. Continuation of the
operating losses may prevent the Company from making the investments in
e-commerce which are required to be made to achieve a position of leadership in
serving the e-commerce needs of companies doing business or desiring to do
business on the Internet.
 
     The ability of the Company to attract management with the requisite
experience in e-commerce or in Internet businesses and to develop a culture
which is consistent with the manner in which e-commerce is managed.
 
ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
     None.
 
                                       20
<PAGE>   22
 
ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
 
To the Shareholders of Hanover Direct, Inc.:
 
     We have audited the accompanying consolidated balance sheets of Hanover
Direct, Inc. (a Delaware corporation) and subsidiaries as of December 26, 1998
and December 27, 1997, and the related consolidated statements of income (loss),
shareholders' equity and cash flows for each of the three fiscal years in the
period ended December 26, 1998. These consolidated financial statements and the
schedule referred to below are the responsibility of the Company's management.
Our responsibility is to express an opinion on these consolidated financial
statements and schedule based on our audits.
 
     We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the 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. and
subsidiaries as of December 26, 1998 and December 27, 1997 and the results of
their operations and their cash flows for each of the three fiscal years in the
period ended December 26, 1998 in conformity with generally accepted accounting
principles.
 
     Our audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedule of valuation and qualifying
accounts is presented for purposes of complying with the Securities and Exchange
Commission's rules and is not part of the basic financial statements. The
schedule has been subjected to the auditing procedures applied in the audit of
the basic financial statements and, in our opinion, fairly states in all
material respects the financial data required to be set forth therein in
relation to the basic financial statements taken as a whole.
 
                                          ARTHUR ANDERSEN LLP
 
New York, New York
February 16, 1999 (except with respect to
  the matter discussed in Note 7,
  as to which the date is March 2, 1999)
 
                                       21
<PAGE>   23
 
                          CONSOLIDATED BALANCE SHEETS
 
                 AS OF DECEMBER 27, 1997 AND DECEMBER 26, 1998
                                 (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                                              DECEMBER 27,    DECEMBER 26,
                                                                  1997            1998
                                                              ------------    ------------
<S>                                                           <C>             <C>
                                          ASSETS
CURRENT ASSETS:
  Cash and cash equivalents                                    $  14,758       $  12,207
  Accounts receivable, net of allowance for doubtful
    accounts of $3,358 in 1997 and $2,544 in 1998                 17,684          22,737
  Accounts receivable under financing agreement                   21,918          18,998
  Inventories                                                     64,330          62,322
  Prepaid catalog costs                                           20,684          16,033
  Deferred tax asset, net                                          3,300           3,300
  Other current assets                                             3,083           2,402
                                                               ---------       ---------
         Total Current Assets                                    145,757         137,999
                                                               ---------       ---------
PROPERTY AND EQUIPMENT, AT COST:
  Land                                                             4,909           4,634
  Buildings and building improvements                             16,486          22,724
  Leasehold improvements                                           9,040           9,303
  Furniture, fixtures and equipment                               47,210          51,193
  Construction in progress                                         4,519             113
                                                               ---------       ---------
                                                                  82,164          87,967
  Accumulated depreciation and amortization                      (29,712)        (37,884)
                                                               ---------       ---------
  Property and Equipment, net                                     52,452          50,083
                                                               ---------       ---------
  Goodwill, net                                                   17,412          16,890
  Deferred tax asset, net                                         11,700          11,700
  Other assets                                                     2,978           2,198
                                                               ---------       ---------
         Total Assets                                          $ 230,299       $ 218,870
                                                               =========       =========
                           LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
  Current portion of long-term debt and capital lease
    obligations                                                $   5,305       $   2,573
  Accounts payable                                                58,799          64,594
  Accrued liabilities                                             30,259          22,212
  Customer prepayments and credits                                 3,824           4,691
                                                               ---------       ---------
         Total Current Liabilities                                98,187          94,070
                                                               ---------       ---------
NON-CURRENT LIABILITIES:
  Long-term debt                                                  32,735          37,288
  Obligations under receivable financing                          21,918          18,998
  Other                                                            1,908           2,044
                                                               ---------       ---------
         Total Non-current Liabilities                            56,561          58,330
                                                               ---------       ---------
         Total Liabilities                                       154,748         152,400
                                                               =========       =========
COMMITMENTS AND CONTINGENCIES (Note 16)
SHAREHOLDERS' EQUITY:
  Series B Convertible Additional Preferred Stock, $.01 par
    value, authorized, issued and outstanding 634,900 shares
    in 1997 and 1998                                               5,938           6,128
  Common Stock, $.66 2/3 par value, authorized 225,000,000
    shares; issued 204,441,538 shares in 1997 and
    210,785,688 in 1998                                          136,294         140,524
  Capital in excess of par value                                 285,165         297,751
  Accumulated deficit                                           (347,652)       (373,815)
                                                               ---------       ---------
                                                                  79,745          70,588
                                                               ---------       ---------
  Less:
  Treasury stock, at cost (686,216 shares in 1997 and
    358,303 shares in 1998)                                         (968)           (813)
  Notes receivable from sale of Common Stock                      (3,226)         (3,305)
                                                               ---------       ---------
         Total Shareholders' Equity                               75,551          66,470
                                                               ---------       ---------
         Total Liabilities and Shareholders' Equity            $ 230,299       $ 218,870
                                                               =========       =========
</TABLE>
 
                See Notes to Consolidated Financial Statements.
                                       22
<PAGE>   24
 
                    CONSOLIDATED STATEMENTS OF INCOME (LOSS)
 
 FOR THE YEARS ENDED DECEMBER 28, 1996, DECEMBER 27, 1997 AND DECEMBER 26, 1998
                    (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
 
<TABLE>
<CAPTION>
                                                              1996         1997        1998
                                                            ---------    --------    --------
<S>                                                         <C>          <C>         <C>
REVENUES                                                    $ 700,314    $557,638    $546,114
                                                            ---------    --------    --------
OPERATING COSTS AND EXPENSES:
  Cost of sales and operating expenses                        479,155     358,219     343,554
  Write-down of inventory of discontinued catalogs              1,100          --       3,726
  Special charges (credit)                                     36,724      (2,209)       (485)
  Selling expenses                                            195,032     141,411     148,767
  General and administrative expenses                          70,608      53,839      57,881
  Depreciation and amortization                                12,192       8,227       9,478
                                                            ---------    --------    --------
                                                              794,811     559,487     562,921
                                                            ---------    --------    --------
(LOSS) FROM OPERATIONS                                        (94,497)     (1,849)    (16,807)
  Interest expense, net                                        (8,398)     (8,028)     (7,778)
  (Loss) before income taxes                                 (102,895)     (9,877)    (24,585)
  Income tax provision                                          1,000         999       1,000
                                                            ---------    --------    --------
  (Loss) before extraordinary item                           (103,895)    (10,876)    (25,585)
  Extraordinary item (Note 8)                                  (1,134)         --          --
                                                            ---------    --------    --------
NET (LOSS)                                                   (105,029)    (10,876)    (25,585)
  Preferred stock dividends                                      (225)       (190)       (578)
                                                            ---------    --------    --------
NET (LOSS) APPLICABLE TO COMMON SHAREHOLDERS                $(105,254)   $(11,066)   $(26,163)
                                                            =========    ========    ========
COMPREHENSIVE INCOME                                        $(105,254)   $(11,066)   $(26,163)
                                                            =========    ========    ========
NET (LOSS) PER SHARE:
  Loss before extraordinary item                            $    (.93)   $   (.06)   $   (.13)
  Extraordinary item                                             (.01)         --          --
                                                            ---------    --------    --------
  Net (loss) per share -- basic and diluted                 $    (.94)   $   (.06)   $   (.13)
                                                            =========    ========    ========
  Weighted average common shares outstanding -- basic
     and diluted                                              111,441     176,621     206,508
                                                            =========    ========    ========
</TABLE>
 
                See Notes to Consolidated Financial Statements.
                                       23
<PAGE>   25
 
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
 
FOR THE YEARS ENDED DECEMBER 28, 1996, DECEMBER 27, 1997, AND DECEMBER 26, 1998
                                 (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                                                1996         1997        1998
                                                              ---------    --------    --------
<S>                                                           <C>          <C>         <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
  Net (loss)                                                  $(105,029)   $(10,876)   $(25,585)
  Adjustments to reconcile net (loss) to net cash (used) by
    operating activities:
    Depreciation and amortization including deferred fees        13,277      10,581      11,466
    Provision for doubtful accounts                               6,805       3,973       3,278
    Provision for catalog and facility closings                  14,720      (2,209)       (485)
    Write-down of inventory of discontinued catalogs              1,100          --       3,726
    Write-off of long-lived assets                               22,000          --          --
    Extraordinary item-early extinguishment of debt               1,134          --          --
    Provision for losses on notes receivable and marketable
      securities                                                    888          --          --
    Other, net                                                       53          --          --
    Compensation expense related to stock options                   540       1,800       2,684
    Recovery from investments previously written off                 --      (1,274)         --
  Changes in assets and liabilities, net of effects of
    acquired businesses
    and dispositions of assets:
    Accounts receivable, net                                     (7,863)      7,742      (8,331)
    Inventories                                                  10,571       3,280      (1,718)
    Prepaid catalog costs                                        13,717       2,717       4,651
    Accounts payable                                            (13,704)    (20,788)      5,795
    Accrued liabilities                                             679      (6,583)     (7,562)
    Customer prepayments and credits                             (2,430)       (893)        867
    Other                                                         1,332        (205)       (867)
                                                              ---------    --------    --------
  Net cash (used) by operating activities                       (42,210)    (12,735)    (12,081)
                                                              =========    ========    ========
CASH FLOWS FROM INVESTING ACTIVITIES:
  Acquisitions of property and equipment, net                    (8,862)     (4,222)     (6,111)
  Proceeds from sales of businesses                               1,980          --          --
  Proceeds from investment                                          794       1,274          --
                                                              ---------    --------    --------
  Net cash (used) by investing activities                        (6,088)     (2,948)     (6,111)
                                                              =========    ========    ========
CASH FLOWS FROM FINANCING ACTIVITIES:
  Net proceeds (payments) under revolving credit facility        11,699     (13,710)         --
  Proceeds from term loan facility                                   --          --       7,272
  Proceeds from issuance of debt                                 10,000          --          --
  Payments of long-term debt and capital lease obligations      (17,625)     (3,575)     (5,433)
  Payment of stock issuance costs                                (1,670)     (3,073)         --
  Payment of debt issuance costs                                 (1,490)         --          --
  Proceeds from issuance of Common Stock                         50,653      45,351         561
  Proceeds from issuance of Warrant Exercise                         --          --      13,640
  Other, net                                                       (778)        275        (399)
                                                              ---------    --------    --------
  Net cash provided by financing activities                      50,789      25,268      15,641
                                                              ---------    --------    --------
  Net increase (decrease) in cash and cash equivalents            2,491       9,585      (2,551)
  Cash and cash equivalents, beginning of year                    2,682       5,173      14,758
                                                              ---------    --------    --------
  Cash and cash equivalents, end of year                      $   5,173    $ 14,758    $ 12,207
                                                              =========    ========    ========
SUPPLEMENTAL CASH FLOW DISCLOSURE:
  Interest paid                                               $   7,773    $  5,674    $  5,095
  Income taxes paid                                           $   1,096    $    685    $    447
                                                              =========    ========    ========
</TABLE>
 
                See Notes to Consolidated Financial Statements.
                                       24
<PAGE>   26
 
                CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
 
 FOR THE YEARS ENDED DECEMBER 28, 1996, DECEMBER 27, 1997 AND DECEMBER 26, 1998
                      (IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
                                   PREFERRED STOCK
                                       SERIES B       PREFERRED STOCK         COMMON STOCK         CAPITAL
                                      CUMULATIVE       SERIES A, 6.0%        2/3 PAR6VALUE        IN EXCESS
                                   ----------------   ----------------   ----------------------      OF        ACCUM.
                                   SHARES    AMOUNT   SHARES    AMOUNT     SHARES       AMOUNT    PAR VALUE   (DEFICIT)
                                   -------   ------   -------   ------   -----------   --------   ---------   ---------
<S>                                <C>       <C>      <C>       <C>      <C>           <C>        <C>         <C>
BALANCE AT JANUARY 1, 1996         634,900   $5,558    78,300    $795     93,693,162   $ 62,461   $255,390    $(231,332)
 Net income/(loss) applicable to
   common shareholders                                                                                         (105,254)
 Shares issued in Rights Offering                                         48,748,785     32,499     16,467
 Preferred Stock dividends and
   accretion                                    190                35
 Conversion of the 6% Preferred
   Stock                                              (78,300)   (830)       819,733        546        284
 Purchase of treasury stock
 Transfer of treasury stock
   related to employment
   agreement                                                                                        (2,750)
 Sale of treasury stock                                                                                 28
 Issuances & forfeitures of
   Common Stock for employee
   stock plan                                                              1,778,235      1,187        678
                                   -------   ------   -------    ----    -----------   --------   --------    ---------
BALANCE AT DECEMBER 28, 1996       634,900   $5,748         0    $  0    145,039,915   $ 96,693   $270,097    $(336,586)
 Net income/(loss) applicable to
   common shareholders                                                                                          (11,066)
 Preferred stock accretion                      190
 Stock options granted                                                                               2,340
 Shares issued in 1997 Rights
   Offering, net of issue costs                                           55,654,623     37,103      9,958
 Issuance of Common Stock to
   SMALLCAP World Fund, Inc.                                               3,700,000      2,467      2,750
 Issuances & forfeitures of
   Common Stock for employee
   stock plan                                                                 47,000         31         20
                                   -------   ------   -------    ----    -----------   --------   --------    ---------
BALANCE AT DECEMBER 27, 1997       634,900   $5,938         0    $  0    204,441,538   $136,294   $285,165    $(347,652)
 Net income/(loss) applicable to
   common shareholders                                                                                          (26,163)
 Cash received for tandem
   receivable
 Preferred stock accretion                      190
 Stock options granted                                                                               2,684
 Exercise of Warrants                                                      5,646,490      3,764      9,876
 Issuances & forfeitures of
   Common Stock for employee
   stock plan                                                                697,660        466         26
                                   -------   ------   -------    ----    -----------   --------   --------    ---------
BALANCE AT DECEMBER 26, 1998       634,900   $6,128         0    $  0    210,785,688   $140,524   $297,751    $(373,815)
                                   =======   ======   =======    ====    ===========   ========   ========    =========
 
<CAPTION>
 
                                                             NOTES
                                      TREASURY STOCK       RECEIVABLE    DEFERRED
                                   --------------------   FROM SALE OF   COMPEN-
                                     SHARES     AMOUNT    COMMON STOCK    SATION      TOTAL
                                   ----------   -------   ------------   --------   ---------
<S>                                <C>          <C>       <C>            <C>        <C>
BALANCE AT JANUARY 1, 1996         (1,157,061)  $(3,345)    $(2,023)      $(294)    $  87,210
 Net income/(loss) applicable to
   common shareholders                                                               (105,254)
 Shares issued in Rights Offering                                                      48,966
 Preferred Stock dividends and
   accretion                                                                              225
 Conversion of the 6% Preferred
   Stock                                                                                    0
 Purchase of treasury stock          (301,623)     (396)                                 (396)
 Transfer of treasury stock
   related to employment
   agreement                          916,667     2,750                                     0
 Sale of treasury stock               150,000       178                                   206
 Issuances & forfeitures of
   Common Stock for employee
   stock plan                                                (1,376)        294           783
                                   ----------   -------     -------       -----     ---------
BALANCE AT DECEMBER 28, 1996         (392,017)  $  (813)    $(3,399)      $   0     $  31,740
 Net income/(loss) applicable to
   common shareholders                                                                (11,066)
 Preferred stock accretion                                                                190
 Stock options granted                                                                  2,340
 Shares issued in 1997 Rights
   Offering, net of issue costs                                                        47,061
 Issuance of Common Stock to
   SMALLCAP World Fund, Inc.                                                            5,217
 Issuances & forfeitures of
   Common Stock for employee
   stock plan                        (294,199)     (155)        173                        69
                                   ----------   -------     -------       -----     ---------
BALANCE AT DECEMBER 27, 1997         (686,216)  $  (968)    $(3,226)      $   0     $  75,551
 Net income/(loss) applicable to
   common shareholders                                                                (26,163)
 Cash received for tandem
   receivable                                                    69                        69
 Preferred stock accretion                                                                190
 Stock options granted                                                                  2,684
 Exercise of Warrants                                                                  13,640
 Issuances & forfeitures of
   Common Stock for employee
   stock plan                         327,913       155        (148)                      499
                                   ----------   -------     -------       -----     ---------
BALANCE AT DECEMBER 26, 1998         (358,303)  $  (813)    $(3,305)      $   0     $  66,470
                                   ==========   =======     =======       =====     =========
</TABLE>
 
                See Notes to Consolidated Financial Statements.
 
                                       25
<PAGE>   27
 
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
     YEARS ENDED DECEMBER 28, 1996, DECEMBER 27, 1997 AND DECEMBER 26, 1998
 
1.  BACKGROUND OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
     Nature of Operations -- Hanover Direct, Inc., a Delaware corporation
("HDI"), is a leading specialty direct marketer with a diverse branded portfolio
of home fashions, general merchandise, men's and women's apparel and gift
catalogs, delivered via direct mail and electronic commerce platforms. The
Company currently operates in one line of business direct marketing, through its
branded portfolio of specialty catalogs and related retail operations. The
operations of the Company are directed principally by the Chief Executive
Officer, with oversight by the Executive Committee of the Board of Directors.
 
     The Company utilizes a common support platform for the management of its
operations, consisting of uniform telemarketing, distribution, and inventory
management strategies, as well as a shared financial and accounting organization
and universal information systems that provide customer database management and
support the e-commerce marketing plan. All business is domestic in nature with
no operations or sales outside the United States. Accordingly, there are no
specific operating or geographic segment disclosures, pursuant to SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information", other
than the consolidated financial position and results of operations.
 
     Principles of Consolidation -- The Consolidated Financial Statements
include the accounts of HDI and all subsidiaries (the "Company"). Intercompany
transactions and balances have been eliminated. Certain prior year amounts have
been reclassified to conform to the current year presentation.
 
     Fiscal Year -- The Company operates on a 52 or 53 week fiscal year.
Effective for fiscal 1997, the Company changed its fiscal year to the last
Saturday in December. The years ended December 26, 1998, December 27, 1997 and
December 28, 1996 were 52 week years. Had the Company not changed its year end,
fiscal 1997 would have been a 53 week year and the net loss for 1997 would have
increased by approximately $0.6 million.
 
     Use of Estimates -- The preparation of financial statements in conformity
with 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.
 
     Inventories -- Inventories consist principally of merchandise held for
resale and are stated at the lower of cost or market. Cost is determined using
the first-in, first-out (FIFO) method. 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. Such inventory is directly written down to its net
realizable value. The costs capitalized by the Company are the costs of the
product and freight-in charges.
 
     Prepaid Catalog Costs -- Prepaid catalog costs consist of direct response
advertising costs related to catalog production and mailing. These costs are
deferred and amortized as selling expenses over the estimated period in which
the sales associated with such advertising are generated, in accordance with SOP
93-7, "Reporting on Advertising Costs". Total catalog expense was $193.5
million, $139.0 million and $145.0 million, respectively, in 1996, 1997 and
1998.
 
     Depreciation and Amortization -- Depreciation and amortization of property
and equipment is provided 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 shorter of the
estimated useful lives or the terms of the related leases. Expenditures for
maintenance and repairs are charged to operations as incurred.
 
                                       26
<PAGE>   28
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     YEARS ENDED DECEMBER 28, 1996, DECEMBER 27, 1997 AND DECEMBER 26, 1998
 
     Goodwill, Net -- Excess of cost over the net assets of acquired businesses
is amortized on a straight-line basis over periods of up to forty years.
Accumulated amortization was $3.5 million and $4.0 million at December 27, 1997
and December 26, 1998, respectively.
 
     Mailing Lists -- The costs of acquired mailing lists are amortized over a
five year period. Mailing lists, included in Other assets, amounted to $.7
million and $.3 million at December 27, 1997 and December 26, 1998,
respectively, and are carried net of accumulated amortization of $2.5 million
and $2.9 million, respectively.
 
     Asset Recoverability -- In accordance with Statement of Financial
Accounting Standards (SFAS) No. 121, "Accounting for the Improvement of
Long-lived Assets and Long-Lived Assets to be Disposed Of," the Company reviews
the carrying values of its long-lived and identifiable intangible assets for
possible impairment whenever events or changes in circumstances indicate that
the carrying amount of assets may not be recoverable. Based upon the assessment
of undiscounted cash flows for certain underperforming catalogs, the Company
recorded a charge related to impaired assets of $22.0 million for the fiscal
year ended December 28, 1996 (Note 3). No such adjustment was recorded in 1997
or 1998.
 
     Accounting for Stock Based Compensation -- The Company accounts for its
stock based compensation to employees using the fair value-based method under
SFAS No. 123, "Accounting for Stock-Based Compensation."
 
     Accounting for Income Taxes -- The Company accounts for income taxes in
accordance with SFAS No. 109, "Accounting for Income Taxes." It requires an
asset and liability approach for financial accounting and reporting for income
taxes. The provision for income taxes is based on income after adjustment for
those temporary and permanent items which are not considered in the
determination of taxable income. Deferred taxes result when the Company
recognizes revenue or expenses for income tax purposes in a different year than
for financial reporting purposes.
 
     Accounting for Transfers of Credit Card Receivables -- The Company accounts
for transfers and servicing of financial assets in accordance with SFAS No. 125,
"Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities." This statement provides consistent standards for distinguishing
transfers of financial assets that are sales from transfers that are secured
borrowings. The adoption of this statement in fiscal 1997 resulted in the
recognition of approximately $21.9 million and $19.0 million of additional
accounts receivable and associated long-term debt at December 27, 1997 and
December 26, 1998, respectively. This adjustment was based on the terms of the
Company's agreement with an unrelated third party for the sale and servicing of
accounts receivable. The provisions of this pronouncement were applied
prospectively, from January 1, 1997.
 
     Cash and Cash Equivalents -- Cash and cash equivalents include cash and all
highly liquid investments with original maturities of ninety days or less.
 
     Net (Loss) per Share -- Net (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." The weighted average number of shares used
in the calculation for both basic and diluted net (loss) per share in 1996, 1997
and 1998 was 111,441,247, 176,621,080 and 206,508,110 shares, respectively.
Diluted earnings per share equals basic earnings per share as the dilutive
calculation would have an antidilutive impact as a result of the net loss
incurred in each of the years 1996, 1997 and 1998.
 
     Recently Issued Accounting Standards -- In June 1998, the Financial
Accounting Standards Board ("FASB") issued Statement of Financial Accounting
Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging
Activities." SFAS No. 133 establishes new accounting and reporting standards for
derivative financial instruments, including certain derivative instruments
embedded in other contracts, and hedging activities. This statement is effective
for fiscal years beginning after June 15, 1999. As
 
                                       27
<PAGE>   29
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     YEARS ENDED DECEMBER 28, 1996, DECEMBER 27, 1997 AND DECEMBER 26, 1998
 
the Company currently does not engage in derivative instruments and hedging
activities, this statement is not expected to have a significant impact on the
Company's financial statements.
 
     Revenues -- The Company recognizes revenue at the time merchandise is
shipped to the customer. Amounts billed to customers for postage and handling
charges are recognized as revenue at the time that the revenues on the product
shipment are recognized. The Company provides a reserve for expected future
returns at the time the sale is recorded based upon historical experience.
 
     Fair Value of Financial Instruments -- The fair value of financial
instruments does not materially differ from their carrying values.
 
                 SUPPLEMENTAL DISCLOSURE OF NON-CASH ACTIVITIES
 
<TABLE>
<CAPTION>
                                                      1996      1997      1998
                                                     ------    -------    ----
                                                          (IN THOUSANDS)
<S>                                                  <C>       <C>        <C>
Capital lease obligations                            $   --    $   163    $--
                                                     ------    -------    ---
Other equity issuances and exchanges                 $2,855    $10,000    $--
                                                     ------    -------    ---
</TABLE>
 
2.  ACQUISITIONS AND INVESTMENTS
 
     Acquisitions -- During fiscal 1995, the Company acquired the entities
described below, which were accounted for by the purchase method of accounting.
The operating results of these acquired businesses have been included in the
consolidated statements of income (loss) from the date of acquisition.
 
     Improvements -- In January 1995, the Company acquired substantially all of
the assets of Leichtung, Inc., a direct marketer of wood-working and home
improvement tools and related products sold under the Improvements and Leichtung
Workshops names, for a purchase price of approximately $12.8 million in cash and
the assumption of certain liabilities. The excess purchase price over the fair
values of the net assets acquired (goodwill) was $7.3 million. Approximately
$1.4 million of customer mailing list intangible assets were also purchased in
this transaction.
 
     In the first quarter of 1996, the Company sold the assets of the Leichtung
Workshops catalog for $.9 million in cash and short-term notes and relocated all
Improvements' telemarketing and fulfillment operations to the Company's Hanover,
PA facility. There was no gain or loss recognized on the sale of the assets of
the Leichtung Workshops catalog. The distribution facility in Ohio, which was
being held for sale, was written down to its estimated net realizable value as
of December 28, 1996. During fiscal 1997, the Company sold this facility.
 
     The Safety Zone -- In February 1995, the Company acquired the remaining 80%
of the outstanding common stock it did not already own of Aegis Safety Holdings,
Inc. ("Aegis"), publisher of The Safety Zone catalog, through the issuance of
634,900 shares of a newly-created Series B Convertible Additional Preferred
Stock ("Series B Stock") of the Company with a stated value of $10 per share.
Dividends are payable on the Series B Stock at various rates and times and are
contingent on specific earnings targets. The Series B Stock is also convertible,
subject to antidilution, as discussed in Note 9. The excess purchase price over
the fair values of the net assets acquired (goodwill) was $7.1 million. In
December 1996, the Company wrote-off the goodwill related to this acquisition in
accordance with SFAS No. 121 (Note 3).
 
     Austad's -- In May 1995, the Company acquired 67.5% of the outstanding
shares of Austad's Holdings, Inc. ("Austad's"), which owned The Austad Company
("TAC"), the publisher of the Austad's catalog, featuring golf equipment,
apparel and gifts, for a purchase price of $1.8 million in cash. The excess
purchase price over the fair values of the net assets acquired (goodwill) was
$4.5 million. Approximately $1.2 million of
 
                                       28
<PAGE>   30
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     YEARS ENDED DECEMBER 28, 1996, DECEMBER 27, 1997 AND DECEMBER 26, 1998
 
customer mailing list intangible assets were also acquired in this transaction.
In December 1996, the Company wrote-off the goodwill and mailing lists in
accordance with SFAS No. 121 (Note 3).
 
     Other Investments -- Other investments, which are recorded in Other assets
in the accompanying consolidated balance sheets, include the following:
 
     Blue Ridge Associates -- In January 1994, the Company purchased for $1.1
million a 50% interest in Blue Ridge Associates ("Blue Ridge"), a partnership
which owns the apparel distribution center in Roanoke, VA. The remaining 50%
interest is held by an unrelated third party. This investment is accounted for
by the equity method of accounting. The Company's investment in Blue Ridge was
approximately $.9 million at December 27, 1997 and December 26, 1998. In
December 1996, the Company decided to consolidate fulfillment and telemarketing
activities handled at this facility into its home fashions distribution facility
in Roanoke, VA and attempted to sublease the vacated space. The partnership is
currently looking for a sub-lessee for the apparel distribution center.
 
     Regal Communications, Inc. -- During 1994, the Company invested
approximately $2.7 million in convertible debt securities of Regal
Communications, Inc. ("Regal"). In September 1994, Regal filed for protection
under Chapter 11 of the United States Code. As a result, during 1994, the
Company wrote down the convertible debentures to the estimated fair value of
$1.7 million. The convertible debt matures on June 15, 2008, only $.8 million of
distributions were received through 1996. Due to the uncertainty that
recoverability of substantially all of the remaining investment balance was
subject to a favorable outcome, in December 1996 the Company wrote-off the
remaining $.9 million balance as the decline in fair value was considered an
other-than-temporary impairment. In the third and fourth quarters of 1997, the
Company received approximately $1.3 million related to distributions made by
Regal. This amount was recorded as income and is reflected as a reduction in
general and administrative expenses in the accompanying consolidated statements
of income (loss).
 
3.  SPECIAL CHARGES
 
     In December 1996, the Company recorded special charges aggregating
approximately $36.7 million. These charges consisted of severance and facility
exit/relocation costs and fixed asset write-offs related to the downsizing of
the Company. In addition, the special charges included a write-off for
impairment of long-lived assets of certain underperforming catalogs. In December
1997, the Company adjusted its previous estimates for severance, facility
exit/relocation and fixed asset write-offs based upon exit plan modifications
related to its Weehawken, NJ corporate facility and delays in relocating from
its Hanover, PA distribution center. Such adjustments resulted in a reduction of
special charges of approximately $2.2 million which consisted of $.4 million in
restructuring reserve reductions and $1.8 million related to the reversal of the
reserve for fixed assets expected to be abandoned. In 1998, the Company further
adjusted its estimate for fixed asset write-offs by $0.5 million based upon its
decision not to exit its distribution facility in Hanover, PA.
 
     Severance -- The cost of employee severance includes termination benefits
for line and supervisory personnel in fulfillment, telemarketing, MIS,
merchandising, and various levels of corporate and catalog management. The
Company paid approximately $0.6 million and $2.7 million of severance during
fiscal 1998 and 1997, respectively. No remaining reserve was required at
December 26, 1998 for severance costs.
 
     Facility Exit/Relocation Costs and Fixed Asset Write-Offs -- These costs
are primarily composed of the Company's decision to sublet its Weehawken, NJ
corporate facility, and consolidate its Roanoke, VA apparel distribution center
and Hanover, PA distribution center into its Roanoke, VA home fashion
distribution center. As of December 27, 1997, the Company consolidated the
Roanoke, VA apparel distribution center and relocated two of six catalogs from
its Hanover, PA distribution center into its Roanoke, VA home fashion
distribution center. Two of the remaining four catalogs were relocated by the
end of fiscal 1998, while the other two catalogs will remain in the Hanover, PA
distribution center. In addition, the Company modified its
 
                                       29
<PAGE>   31
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     YEARS ENDED DECEMBER 28, 1996, DECEMBER 27, 1997 AND DECEMBER 26, 1998
 
plan to vacate from its Weehawken, NJ corporate facility by agreeing to sublet a
portion of the facility. Approximately $3.3 million and $4.4 million of these
costs are recorded in Accrued liabilities in the accompanying consolidated
balance sheets at December 26, 1998 and December 27, 1997, respectively.
 
     Impairment of Long-Lived Assets -- The Company considers a history of
catalog operating losses to be its primary indicator of potential impairment.
Assets are grouped and evaluated for impairment at the lowest level for which
there are identifiable cash flows that are independent of the cash flows of
other groups of assets. The assets are deemed to be impaired if a forecast of
undiscounted future operating cash flows is less than the carrying amounts.
Considerable management judgment is necessary to estimate discounted future cash
flows and, accordingly, actual results could vary significantly from such
estimates. The Company recognized an impairment loss of approximately $22.0
million in fiscal 1996 which was primarily composed of the write-off of goodwill
and mailing lists associated with Tweeds, Austad's and The Safety Zone.
 
4.  WRITE-DOWN OF INVENTORY OF DISCONTINUED CATALOGS
 
     In 1998, the Company made a decision to discontinue the traditional catalog
operations of the Tweeds, Austad's and Colonial Garden Kitchens catalog brands.
These brands are to be repositioned primarily as e-commerce brands. The three
non core catalogs generated revenues of $96.2 million, $65.6 million and $46.3
million and variable contribution losses of $6.6 million, $1.9 million and $8.9
million in 1996, 1997 and 1998, respectively. The variable contribution losses
in 1998 include provisions of approximately $3.7 million related to the
write-down of inventory associated with these catalogs to their net realizable
value based on the planned liquidation of such inventory and $2.2 million of
additional fourth quarter charges relating to prepaid catalog costs associated
with the discontinuance of the catalog operations.
 
     In 1995, the Company made a decision to discontinue six catalog brands. The
six discontinued catalog brands generated revenues of $20 million and $0.6
million and losses of $5.1 million and $0.1 million in 1996 and 1997,
respectively. The loss in 1996 includes a provision of approximately $1.1
million primarily related to the write-down of inventory associated with these
catalog brands to their net realizable value based on the planned liquidation of
such inventory. This write-down was required due to lower than anticipated
recovery rates on liquidation of such inventory.
 
     The Company utilizes various methods to dispose of the inventory related to
discontinued catalogs, including special sale catalogs, sales sections in other
catalogs and liquidations of remaining inventory through off-price merchants.
These losses represent an incremental provision in excess of the original
provision included in cost of sales expense.
 
5.  ACCOUNTS RECEIVABLE, NET
 
     The Company currently maintains an agreement with an unrelated third party
which provides for the sale and servicing of accounts receivable originating
from the Company's revolving credit cards. The agreement expires in December
2000. The Company remains obligated to repurchase uncollectible accounts
pursuant to the recourse provisions of the agreement and is required to maintain
a specified percentage of all outstanding receivables sold under the program as
a deposit with the third party to secure its obligations under the agreement.
The Company is required to maintain certain annual financial covenants related
to this agreement and was not in compliance at December 26, 1998 and
subsequently has received waivers for the default.
 
     On March 9, 1999, the Company executed an agreement with a third party
whereby the third party will replace the current service provider of the
Company's private label credit card program. The agreement provides for the sale
of the existing portfolio to the third party, at similar terms, and also
provides for the Company to share credit risk with the third party above an
agreed upon benchmark for the first eighteen months of the agreement. After the
expiration of this period, the transaction is non-recourse to the Company. No
gain or loss will be recognized upon execution of the new agreement. The
agreement expires in
 
                                       30
<PAGE>   32
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     YEARS ENDED DECEMBER 28, 1996, DECEMBER 27, 1997 AND DECEMBER 26, 1998
 
March 2002 and can be renewed for additional one year terms. There are no
financial covenants associated with this agreement. The Company expects
conversion to the new program to occur by mid 1999.
 
     The proceeds to the Company relating to the sale of receivables for 1996,
1997 and 1998 were $39.2 million, $39.0 million, and $33.3 million respectively.
At December 27, 1997 and December 26, 1998, the uncollected balances under this
program were $29.4 million and $24.7 million, respectively, of which $4.0
million and $3.5 million respectively represent deposits under the agreement
which are included in Accounts receivable, net. The total reserve balances
maintained for the repurchase of uncollectible accounts were $2.5 million and
$2.0 million at December 27, 1997 and December 26, 1998, of which $1.4 million
at December 27, 1997 and $1.5 million at December 26, 1998 are included in
Accrued liabilities and the remaining balance is included in the allowance for
doubtful accounts.
 
     Because the Company's sales are primarily made to individual customers
located throughout the United States, the Company believes there are no
concentrations of credit risks.
 
     In addition, in accordance with SFAS No. 125 (Note 1), the Company has
reflected approximately $19.0 million of balances transferred pursuant to the
agreement with the unrelated third party as Accounts receivable under financing
agreement and as a long-term obligation on the consolidated balance sheet at
December 26, 1998.
 
6.  ACCRUED LIABILITIES
 
     Accrued liabilities consist of the following (in thousands):
 
<TABLE>
<CAPTION>
                                                     DECEMBER 27,    DECEMBER 26,
                                                         1997            1998
                                                     ------------    ------------
<S>                                                  <C>             <C>
Restructuring                                          $ 5,424         $ 3,286
Reserve for future sales returns                         6,043           4,778
Compensation                                             7,189           3,999
Taxes                                                    1,983           1,211
Reserve for repurchase of accounts receivable sold
  with recourse                                          1,397           1,491
Other                                                    8,223           7,447
                                                       -------         -------
Total                                                  $30,259         $22,212
                                                       =======         =======
</TABLE>
 
7.  LONG-TERM DEBT
 
     Long-term debt consists of the following (in thousands):
 
<TABLE>
<CAPTION>
                                                     DECEMBER 27,    DECEMBER 26,
                                                         1997            1998
                                                     ------------    ------------
<S>                                                  <C>             <C>
Congress Facility                                      $ 7,917         $14,033
Term Financing Facility                                 18,000          17,000
6% Mortgage Notes Payable due 1998                       2,787              --
Industrial Revenue Bonds due 2003                        8,000           8,000
7.5% Convertible Subordinate Debentures due 2007           751             751
Obligations under Capital Leases                           585              77
                                                       -------         -------
                                                        38,040          39,861
Less: current portion                                    5,305           2,573
                                                       -------         -------
Total                                                  $32,735         $37,288
                                                       =======         =======
</TABLE>
 
                                       31
<PAGE>   33
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     YEARS ENDED DECEMBER 28, 1996, DECEMBER 27, 1997 AND DECEMBER 26, 1998
 
     Congress Facility -- The Congress Facility is comprised of a revolving line
of credit of up to $65 million and term loans aggregating $14.0 million at
December 26, 1998. The amount that can be borrowed under the Congress Facility
is based on percentages of eligible inventory and accounts receivable. The
Congress Facility is secured by all assets of the Company. On March 25, 1998,
the Company amended its agreement with Congress to extend the facility until
January 31, 2001. The Congress Facility places limitations on the incurrence of
additional indebtedness. Beginning in November 1996, Congress lowered the
advance rate by which the available inventory is calculated. Pursuant to the
amendment discussed above, advance rates were increased along with other
modifications that increased the Company's availability under the Facility. The
Congress Revolving Credit Facility, prior to the amendment, bore interest at
1.25% above the prime rate and the Revolving Term Notes bore interest at 1.5%
above prime rate. As amended, the Revolving Credit Facility bears interest at
prime plus .5% or Eurodollar plus 2.5% and the Revolving Term Note bears
interest at prime plus .75% or Eurodollar plus 2.75%. The Company is required to
maintain minimum net worth and working capital throughout the terms of the
agreement. The Company was in compliance with such covenants at December 26,
1998. At December 26, 1998 and for the remainder of the agreement, net worth and
working capital are required to be $21.5 and $(10) million, respectively. The
rates of interest related to the Congress Revolving Credit Facility and
Revolving Term Notes at December 26, 1998 were 8.25% and 8.5%, respectively. As
of December 26, 1998, the Company had no revolving indebtedness and $14.0
million outstanding in Revolving Term Notes, respectively. As of December 27,
1997, the Company also had no revolving indebtedness and $7.9 million
outstanding in Revolving Term Notes, respectively. The face amount of unexpired
documentary letters of credit at December 27, 1997 and December 26, 1998 were
$3.0 million and $2.8 million respectively. At December 26, 1998, availability
under the Congress Facility was approximately $49 million, including cash on
hand.
 
     Term Financing Facility -- The Company borrowed $10 million in each of 1994
and 1995 under a Term Financing Facility. The interest rate on the Term
Financing Facility is based on the equivalent rate of A-1 commercial paper
existing at the time of each borrowing. The face rate ranged from 5.24% to 5.91%
at December 26, 1998 and 5.13% to 6.04% at December 27, 1997. The Term Financing
Facility was reduced by annual principal payments of $1.0 million in October
1997 and 1998 and requires annual principal payments of $1.0 million in October
1999 with this amount increasing to $1.6 million for each of the nine years
thereafter. The Term Financing Facility continues to be outstanding and in
effect under its original terms.
 
     In December 1996, the Company finalized its agreement (the "Reimbursement
Agreement") with Richemont Finance S.A. ("Richemont"), who along with the family
of Alan G. Quasha, Chairman of the Board of the Company, jointly own NAR Group
Limited ("NAR"), that provided the Company with approximately $27.9 million of
letters of credit through Swiss Bank, New York Branch issued under the Congress
Facility. These letters of credit were issued for $8.6 million related to the
Industrial Revenue Bonds due 2003 and $19.3 million related to the Term
Financing Facility. On October 1, 1997 and October 1, 1998, the Company paid
down $1 million of the underlying debt, reducing the letters of credit to
approximately $25.8 million. The letters of credit were originally due on
February 18, 1998, however, the term was extended through March 30, 1999 and the
letters of credit were modified to reflect assignment of obligations to Swiss
Bank, Stamford Branch. The letters of credit carry an interest rate of 3.5%
above the prime rate, currently 11.25%. In 1998, the Company paid a facility fee
of $1.1 million which is equal to 4% of the principal amount of the letters of
credit. On March 2, 1999, Richemont agreed to extend its guarantee under the
Reimbursement Agreement to March 31, 2000. As consideration for this guarantee,
the Company agreed to pay to Richemont a facility fee of 9.5% of the principal
amount of the letters of credit.
 
     In the event that the Company has not paid in full, by the expiration date,
any outstanding balances under the letters of credit, Richemont shall have the
option, exercisable at any time prior to payment in full of all amounts
outstanding under the letters of credit to convert such amount into common stock
of the Company at the mean of the bid and ask prices of the Company's Common
Stock on November 8, 1996, or the mean of
 
                                       32
<PAGE>   34
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     YEARS ENDED DECEMBER 28, 1996, DECEMBER 27, 1997 AND DECEMBER 26, 1998
 
the bid and ask prices of the Company's Common Stock on each of the thirty days
immediately prior to the date of exercise of the conversion privilege. The
Reimbursement Agreement is subordinate to the Congress Facility.
 
     6% Mortgage Notes Payable Due 1998 -- In connection with The Company Store
acquisition, subsidiaries of the Company executed and delivered two secured
notes in the aggregate amount of $3.5 million with interest at 6% per annum with
principal and interest payments payable monthly on a fifteen-year amortization
schedule with the remaining balance due in August 1998. The notes were repaid in
full in August 1998.
 
     Industrial Revenue Bonds Due 2003 -- The Industrial Revenue Bonds are due
on December 1, 2003 and are secured by the related assets purchased from the
proceeds of the bonds and by the Reimbursement Agreement. The obligations are
guaranteed by the Company.
 
     General -- At December 26, 1998, the aggregate annual principal payments
required on debt instruments are as follows (in thousands): 1999 -- $2,573;
2000 -- $3,104; 2001 -- $12,633; 2002 -- $1,600; 2003 -- $9,600 and
thereafter -- $10,351.
 
8.  RIGHTS OFFERINGS AND ADDITIONAL INVESTMENTS
 
1997 RIGHTS OFFERING
 
     The Company commenced a $50 million rights offering (the "1997 Rights
Offering") on April 29, 1997. Holders of record of the Company's Common Stock
and Series B Convertible Additional Preferred Stock as of April 28, 1997, the
record date, were eligible to participate in the 1997 Rights Offering. The
Rights were exercisable at $.90 per share. The 1997 Rights Offering expired on
May 30, 1997, with 55,654,623 rights to purchase shares exercised, and it closed
on June 6, 1997.
 
     Richemont entered into a standby purchase agreement to purchase all shares
not subscribed for by shareholders of record at the subscription price.
Richemont purchased 40,687,970 shares in the 1997 Rights Offering and, as a
result, then owned approximately 20.3% of the Company. The Company paid in cash,
from the proceeds of the 1997 Rights Offering, to Richemont on the closing date
approximately $1.8 million, which represented an amount equal to 1% of the
aggregate offering price of the aggregate number of shares issuable upon closing
of the 1997 Rights Offering other than with respect to the shares of Common
Stock held by NAR or its affiliates plus an amount equal to one-half of one
percent of the aggregate number of shares acquired by NAR upon exercise of their
rights (Standby Fee) plus an amount equal to 4% of the aggregate offering price
in respect to all unsubscribed shares (Take-Up Fee).
 
     On April 26, 1997, NAR irrevocably agreed with the Company, subject to and
upon the consummation of the 1997 Rights Offering, to exercise certain of the
rights distributed to it for the purchase of 11,111,111 shares of Common Stock
that had an aggregate purchase price of approximately $10 million. NAR agreed to
pay for, and the Company agreed to accept as payment, for the exercise of such
rights the surrender by NAR of the principal amount due under the
Intercontinental Mining & Resources Limited ("IMR") Promissory Note dated
September 1996 in the principal amount of $10 million and cancellation thereof.
 
     In order to facilitate vendor shipments and to permit the commencement of
the Company's plan to consolidate certain of its warehousing facilities,
Richemont advanced $30 million as of April 23, 1997 against its commitment to
purchase all of the unsubscribed shares pursuant to the standby purchase
agreement. The Company executed a subordinated promissory note in the amount of
$30 million to evidence this indebtedness (the "Richemont Promissory Note").
 
     The gross cash proceeds from the 1997 Rights Offering of $40 million (after
giving effect to the acquisition and exercise by NAR of rights having an
aggregate purchase price of $10 million which were paid for by surrender and
cancellation of the $10 million IMR Promissory Note) were used to repay the $30
million principal amount outstanding under the Richemont Promissory Note and the
balance of the proceeds
                                       33
<PAGE>   35
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     YEARS ENDED DECEMBER 28, 1996, DECEMBER 27, 1997 AND DECEMBER 26, 1998
 
were used for working capital and general corporate purposes, including
repayment of amounts outstanding under the Company's Revolving Credit Facility.
 
1996 RIGHTS OFFERING
 
     The Company commenced its $50 million Rights Offering (the "1996 Rights
Offering") on July 19, 1996. Holders of record of the Company's Common Stock, 6%
Series A Convertible Additional Preferred Stock and Series B Convertible
Additional Preferred Stock as of July 18, 1996 were eligible to participate in
the 1996 Rights Offering. The rights were exercisable at a price of $1.03 per
share.
 
     Shareholders received 0.51 rights for each share of Common Stock held, 3.72
rights for each share of Series A Convertible Additional Preferred Stock held
and 0.77 rights for each share of Series B Convertible Additional Preferred
Stock held as of the record date. The 1996 Rights Offering closed on August 23,
1996.
 
     Due to the Company's continued operating losses, the Company requested that
NAR advance up to $25 million against all the rights distributed to it and/or
its commitment to purchase all of the unsubscribed shares. In May 1996, NAR
advanced the Company $25 million under a promissory note. Under the provisions
of the promissory note, the Company repaid NAR the $25 million advance plus
accrued interest upon the closing of the 1996 Rights Offering.
 
     The Company issued 48,748,785 shares pursuant to the 1996 Rights Offering
which generated proceeds of approximately $48 million, net of expenses. NAR
received rights entitling it to purchase 24,015,964 shares in the 1996 Rights
Offering and exercised such rights. In addition, the Company and NAR entered
into a Standby Purchase Agreement, pursuant to which NAR purchased 6,898,866
shares not subscribed for by shareholders and received approximately $.5 million
as a fee. The proceeds of the 1996 Rights Offering were used by the Company: (i)
to repay the $14 million principal amount of 9.25% Notes held by an affiliate of
NAR plus accrued interest, (ii) to repay the $25 million principal amount
advanced under the promissory note plus accrued interest and (iii) to repay
approximately $9 million under the Congress Facility. The Company recorded an
extraordinary expense related to the early extinguishment of the 9.25% Notes,
representing a write-off of the unamortized debt issuance costs of approximately
$1.1 million.
 
ADDITIONAL INVESTMENTS
 
     In November 1997, the Company announced that SMALLCAP World Fund, Inc.
("SMALLCAP"), a mutual fund and substantial investor in the Company, agreed to
purchase 3.7 million shares of the Company's Common Stock at $1.41 per share,
which represented fair market value, for an aggregate purchase price of
approximately $5.2 million in a private placement. This transaction was
consummated on November 6, 1997. These shares were restricted and were
subsequently registered under the Securities Act of 1933, as amended, pursuant
to a registration rights agreement with SMALLCAP that called for the Company to
use its best efforts to effect the registration of such shares as soon as
practicable after April 1, 1998.
 
     On July 31, 1998, Richemont acquired 5,646,490 additional shares of Common
Stock of the Company pursuant to the exercise of certain common stock purchase
warrants with exercise prices from $1.95 to $2.59 per share and an aggregate
total exercise price of $13.6 million. The Company used the proceeds of the
warrant exercise to reduce the amounts outstanding under the Congress Credit
Facility.
 
9.  CAPITAL STOCK
 
     Series B Convertible Additional Preferred Stock -- In February 1995, the
Company issued 634,900 shares of its Class B Convertible Additional Preferred
Stock ("Series B Stock") to acquire the remaining 80% of the outstanding common
stock of Aegis Safety Holdings, Inc. ("Aegis"), publisher of The Safety Zone
catalog. The Series B Stock has a stated value of $10 per share. Non-cumulative
dividends were to accrue and be paid at 5% per annum during each of the first
three years after the February 1995 closing if Aegis attains at least $1
 
                                       34
<PAGE>   36
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     YEARS ENDED DECEMBER 28, 1996, DECEMBER 27, 1997 AND DECEMBER 26, 1998
 
million in earnings before interest and taxes each year. In years four and five,
dividends are cumulative and will accrue and be paid at 7% per annum and are not
contingent on the achievement of any earnings target. Dividends were not paid in
1996 and 1997 based on The Safety Zone catalog's operating results for the year.
In 1998 no dividend was paid, however, an accrual was made for $388,000 to cover
the dividend requirement for a portion of the fourth year at a rate of 7%.
 
     The Series B Stock is convertible at any time, at $6.66 per share, subject
to antidilution, at the option of the holder and is convertible at the Company's
option if the market value of the Company's Common Stock is greater than $6.66
per share, subject to antidilution, for 20 trading days in any consecutive 30
day trading period. If, after five years, the Series B Stock is not converted,
it is mandatorily redeemable, at the Company's option, in cash or for 952,352
shares of the Company's Common Stock provided the market value of the stock is
at least $6.33 per share, subject to antidilution. If the market value of the
Company's Common Stock does not meet this minimum, the redemption rate is
subject to adjustment which would increase the number of shares for which the
Series B Stock is redeemed. In December 1996, the Company filed a registration
statement on Form S-3 with the Securities and Exchange Commission registering
952,352 shares of the Company's Common Stock related to the future conversion of
the Series B Stock.
 
     The fair value of the Series B Stock, which is based on an independent
appraisal, was $.9 million less than the stated value at February 1995. This
discount is being amortized over a five year period and resulted in a charge of
$.2 million to preferred stock dividends in the consolidated statements of
income (loss) in 1996, 1997 and 1998.
 
     General -- At December 26, 1998, there were 210,427,385 shares of Common
Stock and 634,900 shares of Series B Stock outstanding. Additionally, an
aggregate of 14,362,830 shares of Common Stock were reserved for issuance
pursuant to the exercise of outstanding options.
 
     Dividend Restrictions -- The Company is restricted from paying dividends on
its Common Stock or from acquiring its capital stock by certain debt covenants
contained in agreements to which the Company is a party.
 
10.  STOCK BASED COMPENSATION PLANS
 
     The Company has established several stock based compensation programs for
the benefit of its employees. As discussed in Note 1, the Company adopted the
fair value provisions of SFAS No 123. The Company has recorded compensation
charges of $2.7 million, $1.8 million and $.5 million in 1998, 1997 and 1996,
respectively. The effects of applying SFAS No. 123 for recognizing compensation
costs are not indicative of future amounts. SFAS No. 123 does not apply to
awards prior to 1996 and additional awards in the future are anticipated. The
information below details each of the respective plans, including the changes
during the years presented.
 
     1978 Stock Option Plan -- Pursuant to the Company's Stock Option Plan (the
"1978 Plan"), an aggregate of 2,830,519 shares were approved for issuance to
employees and consultants of the Company. The option price and the periods over
which an option is exercisable are specified by the Compensation Committee of
the Board of Directors.
 
     Options expire five years from the date of grant and generally vest over
three to four years. Payment for shares purchased upon the exercise of an option
shall be in cash or stock of the Company. If paid in cash, a partial payment may
be made with the remainder in installments evidenced by promissory notes at the
 
                                       35
<PAGE>   37
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     YEARS ENDED DECEMBER 28, 1996, DECEMBER 27, 1997 AND DECEMBER 26, 1998
 
discretion of the Compensation Committee. Changes in options outstanding,
expressed in numbers of shares, are as follows:
 
                             1978 STOCK OPTION PLAN
 
<TABLE>
<CAPTION>
                                           1996                 1997                1998
                                    ------------------   ------------------   -----------------
                                              WEIGHTED             WEIGHTED            WEIGHTED
                                              AVERAGE              AVERAGE             AVERAGE
                                              EXERCISE             EXERCISE            EXERCISE
                                    SHARES     PRICE     SHARES     PRICE     SHARES    PRICE
                                    -------   --------   -------   --------   ------   --------
<S>                                 <C>       <C>        <C>       <C>        <C>      <C>
Options outstanding, beginning of
  period                             90,000    $2.42      70,000    $2.11     30,000    $2.25
Granted                                  --       --          --       --         --       --
Exercised                                --       --          --       --         --       --
Forfeited                                --       --     (40,000)   $2.00         --       --
Expired                             (20,000)   $3.50          --       --         --       --
                                    -------    -----     -------    -----     ------    -----
Options outstanding, end of period   70,000    $2.11      30,000    $2.25     30,000    $2.25
                                    =======    =====     =======    =====     ======    =====
Options exercisable, end of period   23,333    $2.11      20,000    $2.25     30,000    $2.25
                                    =======    =====     =======    =====     ======    =====
</TABLE>
 
     The options outstanding at December 26, 1998 have a weighted average
exercise price of $2.25 with a weighted average contractual life of 1.8 years.
 
     Director Options -- In June 1994, one director was granted non-qualified
options to purchase shares at an exercise price of $6.125 per share, of which
50,000 shares will expire in March 2000. In February 1996, four directors were
granted options to purchase 5,000 shares each, at the current market price,
which at the time was $1.44. These options expire in February 2001. In 1998,
5,000 options were canceled for a director no longer on the board.
 
     Executive Equity Incentive Plan -- In December 1992, the Board of Directors
adopted the 1993 Executive Equity Incentive Plan (the "Incentive Plan"). The
Incentive Plan was approved by shareholders at the 1993 Annual Meeting. Pursuant
to the Incentive Plan, options to purchase shares of the Company's Common Stock
will be granted from time to time by the Compensation Committee of the Board of
Directors to selected executives of the Company or its affiliates. For each such
option granted up to a maximum of 250,000, the selected executive will receive
the right to purchase on a specified date (the "Tandem Investment Date") a
number of shares of the Company's Common Stock ("Tandem Shares") equal to
one-half the maximum number of shares of the Company's Common Stock covered by
such option. Company financing is
 
                                       36
<PAGE>   38
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     YEARS ENDED DECEMBER 28, 1996, DECEMBER 27, 1997 AND DECEMBER 26, 1998
 
available under the Incentive Plan to pay for the purchase price of the Tandem
Shares. Changes in shares and options outstanding, expressed in numbers of
shares, for the Incentive Plan are as follows:
 
                        EXECUTIVE EQUITY INCENTIVE PLAN
 
<TABLE>
<CAPTION>
                                      1996                   1997                   1998
                              --------------------   --------------------   --------------------
                                          WEIGHTED               WEIGHTED               WEIGHTED
                                          AVERAGE                AVERAGE                AVERAGE
                                          EXERCISE               EXERCISE               EXERCISE
                               SHARES      PRICE      SHARES      PRICE      SHARES      PRICE
                              ---------   --------   ---------   --------   ---------   --------
<S>                           <C>         <C>        <C>         <C>        <C>         <C>
Shares outstanding,
  beginning of period           877,163              1,062,496              1,109,496
Shares purchased                202,000                 47,000                     --
Shares forfeited                (16,667)                    --                 (2,000)
                              ---------              ---------              ---------
Shares outstanding, end of
  period                      1,062,496              1,109,496              1,107,496
                              =========              =========              =========
Options outstanding,
  beginning of period         1,021,170    $2.66       640,498    $1.73       664,000    $1.53
Granted                         350,000    $1.00        94,000    $1.00            --       --
Forfeited                      (730,672)   $2.68       (70,498)   $2.60       (50,000)   $2.50
                              ---------    -----     ---------    -----     ---------    -----
Options outstanding, end of
  period                        640,498    $1.73       664,000    $1.53       614,000    $1.44
                              =========    =====     =========    =====     =========    =====
Options exercisable, end of
  period                        173,832    $2.56       130,000    $2.58        80,000    $2.63
                              =========    =====     =========    =====     =========    =====
</TABLE>
 
     The fair value of each option granted is estimated on the date of grant
using the Black-Scholes option-pricing model with the following weighted average
assumptions for grants in 1996 and 1997: risk free interest rate of
6.06% -- 6.37%, expected lives of 6 years, expected volatility of
39.07% -- 40.81%, and no expected dividends.
 
     The following table summarizes information about stock options outstanding
at December 26, 1998:
 
<TABLE>
<CAPTION>
                         OPTIONS OUTSTANDING             OPTIONS EXERCISABLE
                 ------------------------------------   ----------------------
                                WEIGHTED
                                 AVERAGE     WEIGHTED                 WEIGHTED
                   NUMBER       REMAINING    AVERAGE      NUMBER      AVERAGE
RANGE OF         OUTSTANDING   CONTRACTUAL   EXERCISE   EXERCISABLE   EXERCISE
EXERCISE PRICES  AT 12/26/98      LIFE        PRICE     AT 12/26/98    PRICE
---------------  -----------   -----------   --------   -----------   --------
<S>              <C>           <C>           <C>        <C>           <C>
$ .69 to $1.00     444,000         3.8        $ .97           --          --
$2.50 to $3.00     170,000         1.4        $2.65       80,000       $2.63
                   -------                                ------
Total              614,000         3.1        $1.44       80,000       $2.63
</TABLE>
 
     Options granted under the Incentive Plan become exercisable three years
after the dates of grant and expire six years from the dates of grant. The
purchase price is payable in full at the time of purchase in cash or shares of
the Company's Common Stock valued at their fair market value or in a combination
thereof.
 
                                       37
<PAGE>   39
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     YEARS ENDED DECEMBER 28, 1996, DECEMBER 27, 1997 AND DECEMBER 26, 1998
 
     Changes to the notes receivable related to the Incentive Plan are as
follows:
 
<TABLE>
<CAPTION>
                                            1996          1997          1998
                                         ----------    ----------    ----------
<S>                                      <C>           <C>           <C>
Notes receivable balance, beginning of
  period                                 $1,651,000    $1,742,000    $1,734,000
Additions                                   202,000        32,000            --
Payments                                   (111,000)      (40,000)      (31,000)
                                         ----------    ----------    ----------
Notes receivable, end of period          $1,742,000    $1,734,000    $1,703,000
                                         ==========    ==========    ==========
</TABLE>
 
     Under the terms of the Incentive Plan, the purchase price for shares is
based upon the market price at the date of purchase, and payment is made in the
form of a 20% cash down payment and a six year note that bears interest at the
mid-term applicable federal rate, as determined by the Internal Revenue Service,
as of the month of grant of such shares. The Incentive Plan participants
purchased shares at prices ranging from $1.00 to $4.94, with the Company
accepting notes bearing interest at rates ranging from 5.00% to 7.75%.
 
     All Employee Equity Investment Plan -- In December 1992, the Board of
Directors adopted the 1993 All Employee Equity Investment Plan (the "Investment
Plan"). Such plan was approved by the shareholders at the 1993 Annual Meeting.
Each full-time or permanent part-time employee of the Company or its affiliates
who has attained the age of 18, has met certain standards of continuous service
with the Company or an affiliate of the Company and is not covered by a
collective bargaining agreement may participate in the Investment Plan. The plan
was terminated on July 31, 1996 and closed to any future purchases.
 
     Under the Investment Plan, employees were given the opportunity to purchase
shares of the Company's Common Stock at a 40% discount from the average market
value of a share of stock over a 20-day period prior to subscription. Shares
became vested over a three-year period and upon such date when a participant
ceased employment, any unvested shares were forfeited.
 
     Changes in shares outstanding expressed in numbers of shares for the
Investment Plan were as follows:
 
<TABLE>
<CAPTION>
                                                 1996       1997       1998
                                                -------    -------    -------
<S>                                             <C>        <C>        <C>
Shares outstanding, beginning of period         508,134    521,032    482,771
Shares purchased                                 80,550         --         --
Shares forfeited                                (67,652)   (38,261)   (10,432)
                                                -------    -------    -------
Shares outstanding, end of period               521,032    482,771    472,339
                                                =======    =======    =======
</TABLE>
 
     As of December 26, 1998, a total of 11,027 of outstanding shares are
scheduled to vest in February 1999. There are no other outstanding shares
purchased under the Investment Plan which have not yet been vested.
 
     Restricted Stock Award Plan -- In December 1992, the Board of Directors
adopted the 1993 Restricted Stock Award Plan (the "Restricted Stock Plan"). An
aggregate of 500,000 shares of the Company's Common Stock have been reserved for
issuance under the Restricted Stock Plan. During 1993, 224,300 shares were
awarded to participants.
 
     1996 Stock Option Plan -- Pursuant to the Company's 1996 Stock Option Plan
(the "1996 Plan"), an aggregate of 7,000,000 shares of the Company's Common
Stock were approved for issuance to employees of the Company. The option
exercise price is the fair market value as of the date of grant. The exercise
price of incentive stock options granted to an employee who owns more than 10%
of the total combined voting power of all classes of stock of the Company is
equal to 110% of the fair market value of the Company's Common Stock on the date
of grant. Options granted may be performance based and all options granted must
be specifically identified as incentive stock options or nonqualified options,
as defined in the Internal Revenue Code. No employee may be granted stock
options in excess of 500,000 shares of the Company's Common
 
                                       38
<PAGE>   40
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     YEARS ENDED DECEMBER 28, 1996, DECEMBER 27, 1997 AND DECEMBER 26, 1998
 
Stock and 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 such limitation
is exceeded, the option shall be treated as nonqualified. Stock options may be
granted for terms not to exceed 10 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 stock possessing more than 10% of the total combined voting
power of all classes of stock, the options must become exercisable within 5
years. Payment for shares purchased upon exercise of options shall be in cash or
stock of the Company.
 
     Changes in options outstanding, granted and the weighted average exercise
prices are as follows:
 
                             1996 STOCK OPTION PLAN
 
<TABLE>
<CAPTION>
                                            1996                    1997                    1998
                                    ---------------------   ---------------------   ---------------------
                                                 WEIGHTED                WEIGHTED                WEIGHTED
                                                 AVERAGE                 AVERAGE                 AVERAGE
                                                 EXERCISE                EXERCISE                EXERCISE
                                      SHARES      PRICE       SHARES      PRICE       SHARES      PRICE
                                    ----------   --------   ----------   --------   ----------   --------
<S>                                 <C>          <C>        <C>          <C>        <C>          <C>
Options outstanding, beginning of
  period                                    --       --      3,445,000    $0.98      4,451,249    $0.98
Granted                              3,445,000    $0.98      1,765,000    $1.29      1,550,000    $3.07
Exercised                                   --       --             --       --       (363,949)   $1.01
Forfeited                                   --       --       (758,751)   $1.01       (335,900)   $1.52
Expired                                     --       --             --       --             --       --
                                    ----------    -----     ----------    -----     ----------    -----
Options outstanding, end of period   3,445,000    $0.98      4,451,249    $1.10      5,301,400    $1.66
                                    ==========    =====     ==========    =====     ==========    =====
Options exercisable, end of period          --    $  --        855,443    $0.98      1,749,232    $1.07
                                    ==========    =====     ==========    =====     ==========    =====
Weighted average fair value of
  options granted                   $     0.67              $     0.66              $     1.50
                                    ==========              ==========              ==========
</TABLE>
 
     The fair value of each option granted is estimated on the date of grant
using the Black-Scholes option-pricing model with the following weighted average
assumptions for grants in 1996, 1997 and 1998: risk free interest rate of 6.80%,
6.21% and 5.64% respectively, expected lives of 7, 4 and 4 years, respectively,
and expected volatility of 45.35%, 59.40% and 55.82%, respectively, and no
expected dividends. The following table summarizes information about stock
options outstanding at December 26, 1998:
 
<TABLE>
<CAPTION>
                         OPTIONS OUTSTANDING             OPTIONS EXERCISABLE
                 ------------------------------------   ----------------------
                                WEIGHTED
                                 AVERAGE     WEIGHTED                 WEIGHTED
                   NUMBER       REMAINING    AVERAGE      NUMBER      AVERAGE
RANGE OF         OUTSTANDING   CONTRACTUAL   EXERCISE   EXERCISABLE   EXERCISE
EXERCISE PRICES  AT 12/26/98      LIFE        PRICE     AT 12/26/98    PRICE
---------------  -----------   -----------   --------   -----------   --------
<S>              <C>           <C>           <C>        <C>           <C>
$.69 to $1.00     2,688,570        4.9        $0.96      1,405,958     $0.97
$1.43 to $1.75    1,122,830        5.6        $1.46        343,274     $1.46
$2.44 to $2.88      415,000        6.8        $2.60             --        --
$3.19 to $3.50    1,075,000        6.1        $3.24             --        --
                  ---------                              ---------
Total             5,301,400        5.4        $1.66      1,749,232     $1.07
</TABLE>
 
     The Chief Executive Officer (The "CEO") Stock Option Plans -- the
information below details each of the stock based plans granted in 1996 for the
benefit of the CEO. In each of the plans: (1) the option price represents the
average of the low and high fair market values of the Common Stock on August 23,
1996, the date of the closing of the 1996 Rights Offering, (2) the options
outstanding at December 26, 1998 have an
 
                                       39
<PAGE>   41
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     YEARS ENDED DECEMBER 28, 1996, DECEMBER 27, 1997 AND DECEMBER 26, 1998
 
exercise price of $1.16, and (3) payment for shares purchased upon the exercise
of the option shall be in cash or stock of the Company.
 
     The details of the plans are as follows:
 
          The CEO Tandem Plan -- Pursuant to the Company's Tandem Plan (the
     "Tandem Plan"), the right to purchase an aggregate of 1,000,000 shares of
     Common Stock and an option to purchase 2,000,000 shares of Common Stock was
     approved for issuance to the CEO. The option is subject to antidilution
     provisions and due to the Company's 1996 Rights Offering was adjusted to
     1,510,000 shares of Common Stock and 3,020,000 options. The options expire
     10 years from the date of grant and vest over four years. The options
     outstanding at December 26, 1998 have a weighted average contractual life
     of 7.25 years.
 
          The CEO Performance Year Plan --Pursuant to the Company's Performance
     Year Plan (the "Performance Plan"), an option to purchase an aggregate of
     1,000,000 shares of Common Stock was approved for issuance to the CEO in
     1996. The options are based upon performance as defined by the Compensation
     Committee of the Board of Directors. Should a performance target not be
     attained, the option is carried over to the succeeding year in conjunction
     with that year's option until the expiration date. The options expire 10
     years from the date of grant and vest over four years. Payment for shares
     purchased upon the exercise of the options shall be in cash or stock of the
     Company. The options outstanding at December 26, 1998 have a weighted
     average contractual life of 7 years.
 
          The CEO Closing Price Option Plan -- Pursuant to the Company's Closing
     Price Option Plan (the "Closing Price Plan"), an option to purchase an
     aggregate of 2,000,000 shares of Common Stock was approved for issuance to
     the CEO in 1996. The options expire 10 years from the date of grant and
     will become vested upon the Company's stock price reaching a specific
     target over a consecutive 91 calendar day period as defined by the
     Compensation Committee of the Board of Directors. In May 1998, the
     Compensation Committee of the Board of Directors reduced the target per
     share market price at which the Company's Common Stock had to trade in
     consideration of the dilutive effect of the increase in outstanding shares
     from the date of the grant. The performance period has a range of 6 years
     beginning August 23, 1996, the date of the closing of the 1996 Rights
     Offering. The options outstanding at December 26, 1998 have a weighted
     average contractual life of 7.25 years.
 
          The CEO Six Year Stock Option Plan -- Pursuant to NAR's Six Year Stock
     Option Plan (the "Six Year Plan"), an option to purchase an aggregate of
     250,000 shares of Common Stock was granted to the CEO by NAR. The option is
     subject to antidilution provisions and due to the Company's 1996 Rights
     Offering was adjusted to 377,500 options. The options expire 6 years from
     the date of grant and vest after one year. The options outstanding at
     December 26, 1998 have a weighted average contractual life of 3.25 years.
 
          The CEO Seven Year Stock Option Plan -- Pursuant to NAR's Seven Year
     Stock Option Plan (the "Seven Year Plan"), an option to purchase an
     aggregate of 250,000 shares of Common Stock was granted to the CEO by NAR.
     The option is subject to antidilution provisions and due to the Company's
     1996 Rights Offering was adjusted to 377,500 options. The options expire 7
     years from the date of grant and vest after two years. The options
     outstanding at December 26, 1998 have a weighted average contractual life
     of 4.25 years.
 
          The CEO Eight Year Stock Option Plan -- Pursuant to NAR's Eight Year
     Stock Option Plan (the "Eight Year Plan"), an option to purchase an
     aggregate of 250,000 shares of Common Stock was granted to the CEO by NAR.
     The option is subject to antidilution provisions and due to the Company's
     1996 Rights Offering was adjusted to 377,500 options. The options expire 8
     years from the date of grant and vest after three years. The options
     outstanding at December 26, 1998 have a weighted average contractual life
     of 5.25 years.
 
                                       40
<PAGE>   42
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     YEARS ENDED DECEMBER 28, 1996, DECEMBER 27, 1997 AND DECEMBER 26, 1998
 
          The CEO Nine Year Stock Option Plan -- Pursuant to NAR's Nine Year
     Stock Option Plan (the "Nine Year Plan"), an option to purchase an
     aggregate of 250,000 shares of common stock was granted to the CEO by NAR.
     The option was subject to antidilution provisions and due to the Company's
     1996 Rights Offering was adjusted to 377,500 options. The options expire 9
     years from the date of grant and vest after four years. The options
     outstanding at December 26, 1998 have a weighted average contractual life
     of 6.25 years.
 
     For the combined CEO plans, options outstanding, granted and the weighted
average exercise prices are as follows:
 
                             CEO STOCK OPTION PLANS
 
<TABLE>
<CAPTION>
                                              1996                    1997                   1998
                                     ----------------------   --------------------   --------------------
                                                   WEIGHTED               WEIGHTED               WEIGHTED
                                                   AVERAGE                AVERAGE                AVERAGE
                                                   EXERCISE               EXERCISE               EXERCISE
                                       SHARES       PRICE      SHARES      PRICE      SHARES      PRICE
                                     -----------   --------   ---------   --------   ---------   --------
<S>                                  <C>           <C>        <C>         <C>        <C>         <C>
Options outstanding, beginning of
  period                                      --       --     7,530,000    $1.16     7,530,000    $1.16
Granted                                7,530,000    $1.16            --       --            --       --
Exercised                                     --       --            --       --            --       --
Forfeited                                     --       --            --       --            --       --
Expired                                       --       --            --       --            --       --
                                     -----------              ---------              ---------
Options outstanding, end of period     7,530,000    $1.16     7,530,000    $1.16     7,530,000    $1.16
                                     ===========    =====     =========    =====     =========    =====
Options exercisable, end of period            --    $  --     1,382,500    $1.16     2,765,000    $1.16
                                     ===========    =====     =========    =====     =========    =====
Weighted average fair value of
  options granted                    $0.17- 0.77                     --                     --
                                     ===========              =========              =========
</TABLE>
 
     The fair value of the options granted in 1996 for each of the CEO Stock
Option Plans was estimated on the date of grant using the Black-Scholes
option-price model with the following weighted average assumptions:
 
<TABLE>
<CAPTION>
                                                                          EXPECTED
                                                INTEREST     EXPECTED     DIVIDEND     LIFE
                  RISK-FREE                       RATE      VOLATILITY     YIELD      (YEARS)
                  ---------                     --------    ----------    --------    -------
<S>                                             <C>         <C>           <C>         <C>
CEO Tandem Plan                                   6.79%       45.02%        0.00%      9.85
CEO Performance Plan                              6.79%       45.02%        0.00%      9.85
CEO Closing Price Plan(1)                         6.79%       45.02%        0.00%      9.85
CEO Six Year Plan                                 6.42%       45.02%        0.00%      5.85
CEO Seven Year Plan                               6.53%       45.02%        0.00%      6.85
CEO Eight Year Plan                               6.62%       45.02%        0.00%      7.85
CEO Nine Year Plan                                6.73%       45.02%        0.00%      8.85
</TABLE>
 
---------------
(1) The CEO Closing Price Option Plan used the Black-Scholes option-pricing
    model in conjunction with a Monte Carlo simulation.
 
                                       41
<PAGE>   43
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     YEARS ENDED DECEMBER 28, 1996, DECEMBER 27, 1997 AND DECEMBER 26, 1998
 
     The following table summarizes information about stock options outstanding
at December 26, 1998:
 
<TABLE>
<CAPTION>
                                       OPTIONS OUTSTANDING                  OPTIONS EXERCISABLE
                           -------------------------------------------    -----------------------
                                              WEIGHTED        WEIGHTED                   WEIGHTED
                             NUMBER           AVERAGE         AVERAGE       NUMBER       AVERAGE
        RANGE OF           OUTSTANDING       REMAINING        EXERCISE    EXERCISABLE    EXERCISE
     EXERCISE PRICES       AT 12/26/98    CONTRACTUAL LIFE     PRICE      AT 12/26/98     PRICE
     ---------------       -----------    ----------------    --------    -----------    --------
<S>                        <C>            <C>                 <C>         <C>            <C>
$1.16                       7,530,000           6.7            $1.16       2,765,000      $1.16
</TABLE>
 
OTHER STOCK AWARDS
 
     During 1997, the Company granted, and the Compensation Committee approved,
non-qualified options to certain employees for the purchase of an aggregate of
1,000,000 shares of the Company's Common Stock. The options become vested over
three years and expire in 2003.
 
     The options have an exercise price of $1.00 and a remaining contractual
life of 4.2 years. The fair value of the options at the date of grant was
estimated to be $.52 based on the following weighted average assumptions: risk
free interest rate of 6.48%, expected life of 4 years, expected volatility of
59.40% and no expected dividends. During 1998, 191,000 options were exercised
leaving 809,000 options outstanding (with 142,332 exercisable) at December 26,
1998.
 
11.  EMPLOYEE BENEFIT PLANS
 
     The Company maintains four defined contribution plans, one of which
terminated in 1997. The current plans collectively benefit all employees of the
Company and provide employees with the option of investing in the Company's
stock. The employer's matching contributions range from 2% to 4 1/2% of annual
compensation. Combined matching contributions for all plans were $.8 million,
$.7 million and $.6 million for 1996, 1997 and 1998, respectively.
 
12.  INCOME TAXES
 
     At December 26, 1998, the Company had net operating loss carryforwards
("NOLs") totalling $283.2 million which expire as follows: In the year
2001 -- $18.1 million, 2003 -- $14.6 million, 2004 -- $14.3 million,
2005 -- $20.6 million, 2006 -- $46.9 million, 2007 -- $27.7 million,
2010 -- $24.6 million, 2011 -- $64.9 million, 2012 -- $30.0 million and
2018 -- $21.5 million. The Company also has $1 million of general business tax
credit carry-forwards that expire in 2000 through 2009. The Company's available
NOLs for tax purposes consist of $92.2 million of NOLs subject to a $4 million
annual limitation under Section 382 of the Internal Revenue Code of 1986 and
$191.0 million of NOLs not subject to a limitation. The unused portion of the $4
million annual limitation for any year may be carried forward to succeeding
years to increase the annual limitation for those succeeding years.
 
     SFAS No. 109 requires that the future tax benefit of such NOLs be recorded
as an asset to the extent that management assesses the utilization of such NOLs
to be "more likely than not." Despite incurring additional NOLs of $30.0 million
in 1997 and $21.5 million in 1998, management believes that the Company will be
able to utilize up to $43 million of NOLs based upon the Company's assessment of
numerous factors, including its future operating plans.
 
     For the years ended December 27, 1997 and December 26, 1998, the Company
maintained its deferred tax asset of $15 million (net of a valuation allowance
of $80.1 million in 1997 and $94.7 million in 1998). Management believes that
the $15 million net deferred tax asset still represents a reasonable estimate of
the future utilization of the NOLs and the reversal of timing items and will
continue to routinely evaluate the likelihood of future profits and the
necessity of future adjustments to the deferred tax asset valuation allowance.
 
                                       42
<PAGE>   44
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     YEARS ENDED DECEMBER 28, 1996, DECEMBER 27, 1997 AND DECEMBER 26, 1998
 
     Realization of the future tax benefits is dependent on the Company's
ability to generate taxable income within the carryforward 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 NOLs
and reversals of temporary differences.
 
     The Company's Federal income tax provision was zero in 1996, 1997 and 1998.
The Company's provision for state income taxes was $1.0 million per year in
1996, 1997, and 1998.
 
     A reconciliation of the Company's net loss for financial statement purposes
to taxable loss for the years ended December 28, 1996, December 27, 1997 and
December 26, 1998 is as follows (in thousands):
 
<TABLE>
<CAPTION>
                                                      1996         1997        1998
                                                    ---------    --------    --------
<S>                                                 <C>          <C>         <C>
(Loss) before income taxes                          $(102,895)   $ (9,877)   $(24,585)
Extraordinary item                                     (1,134)         --          --
Differences between income before taxes for
  financial statement purposes and taxable income:
State income taxes                                     (1,000)       (999)     (1,000)
Permanent differences                                  14,917         413         420
Net change in temporary differences                    26,983     (19,543)      3,677
                                                    ---------    --------    --------
Taxable loss                                        $ (63,129)   $(30,006)   $(21,488)
                                                    =========    ========    ========
</TABLE>
 
     The components of the net deferred tax asset at December 26, 1998 are as
follows (in millions):
 
<TABLE>
<CAPTION>
                                                                         NON-
                                                             CURRENT    CURRENT    TOTAL
                                                             -------    -------    -----
<S>                                                          <C>        <C>        <C>
Federal tax NOL and business tax credit carry forwards        $ --       $99.1     $99.1
Allowance for doubtful accounts                                0.9          --       0.9
Inventories                                                    1.7          --       1.7
Prepaid catalog costs                                         (1.5)         --      (1.5)
Property and equipment                                          --         1.8       1.8
Excess of net assets of acquired business                       --        (1.0)     (1.0)
Mailing Lists                                                   --         1.2       1.2
Accrued liabilities                                            4.4          --       4.4
Customer prepayments and credits                               1.7          --       1.7
Deferred Credits                                                --         0.4       0.4
Tax basis in net assets of discontinued operations in
  excess of financial statement amount                         0.7          --       0.7
Executive Incentive Plan                                        --         0.1       0.1
Other                                                           --         0.2       0.2
                                                              ----       -----     -----
Deferred Tax Asset                                             7.9       101.8     109.7
Valuation allowance                                           (4.6)      (90.1)    (94.7)
                                                              ----       -----     -----
Deferred Tax Asset, net                                       $3.3       $11.7     $15.0
                                                              ====       =====     =====
</TABLE>
 
     The Company has established a valuation allowance for a portion of the
deferred tax asset, due to the limitation on the utilization of the NOLs and its
estimate of the future utilization of the NOLs.
 
                                       43
<PAGE>   45
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     YEARS ENDED DECEMBER 28, 1996, DECEMBER 27, 1997 AND DECEMBER 26, 1998
 
     The Company's tax returns for years subsequent to 1984 have not been
examined by the Internal Revenue Service ("IRS"). Availability of the NOLs might
be challenged by the IRS upon examination of such returns which could affect the
availability of NOLs. The Company believes, however, that IRS challenges that
would limit the utilization of NOLs will not have a material adverse effect on
the Company's financial position.
 
     Total tax expense for each of the three fiscal years presented differ from
the amount computed by applying the Federal statutory tax rate due to the
following:
 
<TABLE>
<CAPTION>
                                                         1996          1997          1998
                                                       PERCENT       PERCENT       PERCENT
                                                      OF PRE-TAX    OF PRE-TAX    OF PRE-TAX
                                                        INCOME         LOSS          LOSS
                                                      ----------    ----------    ----------
<S>                                                   <C>           <C>           <C>
Tax (benefit) at Federal statutory rate                 (35.0)%       (35.0)%       (35.0)%
State and local taxes                                     0.6           6.6           2.6
Net increase in (reversal of) temporary differences
  Depreciation and amortization                           4.0         (10.3)          3.1
  Deferred compensation                                    --           7.3           0.9
  Restructuring reserves                                  5.3         (44.8)         (7.8)
  Customer allowance & return reserves                    0.9          (9.4)         (0.5)
  Inventory                                              (0.4)        (11.5)          4.8
  Prepaid catalog costs                                  (1.1)          7.6           2.0
  Allowance for doubtful accounts                         1.1          (9.4)         (1.2)
  Other                                                  (0.6)          1.2           3.9
Tax NOLs for which no benefit could be recognized        21.1         106.4          30.6
Permanent differences                                     5.1           1.5           0.6
                                                        -----         -----         -----
                                                          1.0%         10.2%          4.0%
                                                        =====         =====         =====
</TABLE>
 
13.  LEASES
 
     Certain leases to which the Company is a party provide for payment of real
estate taxes and other expenses. Most leases are operating leases and include
various renewal options with specified minimum rentals. Rental expense for
operating leases related to continuing operations were as follows (in
thousands):
 
<TABLE>
<CAPTION>
                                          1996       1997       1998
                                         -------    -------    ------
<S>                                      <C>        <C>        <C>
Minimum rentals                          $12,931    $12,013    $9,297
                                         -------    -------    ------
</TABLE>
 
                                       44
<PAGE>   46
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     YEARS ENDED DECEMBER 28, 1996, DECEMBER 27, 1997 AND DECEMBER 26, 1998
 
     Future minimum lease payments under noncancelable operating and capital
leases relating to continuing operations that have initial or remaining terms in
excess of one year, together with the present value of the net minimum lease
payments as of December 26, 1998, are as follows (in thousands):
 
<TABLE>
<CAPTION>
                                                           OPERATING    CAPITAL
YEAR ENDING                                                 LEASES      LEASES
-----------                                                ---------    -------
<S>                                                        <C>          <C>
1999                                                       $ 7,957.9      73.7
2000                                                         6,073.2       4.0
2001                                                         5,104.5        --
2002                                                         4,875.5        --
2003                                                         4,454.9        --
Thereafter                                                  25,442.7        --
                                                           ---------     -----
Total minimum lease payments                               $53,908.7      77.7
                                                           =========
Less amount representing interest(a)                                        .8
                                                                         -----
Present value of minimum lease payments(b)                               $76.9
                                                                         =====
</TABLE>
 
---------------
(a) Amount necessary to reduce net minimum lease payments to present value
    calculated at the Company's incremental borrowing rate at the inception of
    the leases.
 
(b) Reflected in the balance sheet as current and noncurrent capital lease
    obligations of $1,344,000 and $482,000 at December 28, 1996 and $518,000 and
    $67,000 at December 27, 1997, and $73,000 and $4,000 at December 26, 1998.
 
     The future minimum lease payments under noncancelable leases that remain
from the discontinued restaurant operations as of December 26, 1998 are as
follows: 1999 -- $.7 million; 2000 -- $.7 million; 2001 -- $.7 million;
2002 -- $.5 million; 2003 -- $.4 million and thereafter $.7 million. The above
amounts exclude annual sublease income from subleases which have the same
expiration as the underlying leases as follows: 1999 -- $.6 million, 2000 -- $.6
million, 2001 -- $.6 million, 2002 -- $.4 million, 2003 -- $.3 million and
thereafter $.5 million.
 
     In connection with the Company's investment in Blue Ridge Associates, a
subsidiary of the Company is contingently liable with respect to the lease
obligation related to the apparel distribution center in Roanoke, VA. The
Company does not guarantee the indebtedness associated with the Roanoke apparel
center held by Blue Ridge Associates.
 
14.  CHANGES IN MANAGEMENT AND EMPLOYMENT AGREEMENTS
 
     On March 7, 1996, Rakesh K. Kaul was named President and Chief Executive
Officer and elected to the Board of Directors of the Company. Effective that
date, Mr. Kaul entered into an Executive Employment Agreement (the "Employment
Agreement") which provides for an "at will" term commencing on March 7, 1996 at
a base salary of $525,000 per year. The Employment Agreement also provides for
Mr. Kaul's participation in the Short-Term Incentive Plan for Rakesh K. Kaul.
That plan, which was approved by the shareholders at the June 20, 1996
shareholders meeting, provides for an annual bonus of between 0% and 125% of Mr.
Kaul's base salary, depending on the attainment of various performance
objectives as determined in accordance with objective formulae or standards to
be adopted by the Compensation Committee as part of the performance goals for
each such year. The Employment Agreement also provides for Mr. Kaul's
participation in the Long-Term Incentive Plan for Rakesh K. Kaul. That plan,
which was approved by the shareholders at the June 20, 1996 shareholders
meeting, provides for the purchase by Mr. Kaul of 1,000,000 shares of Common
Stock at their fair market value; an option expiring March 7, 2006 for the
purchase of 2,000,000 shares of (the "Tandem Plan") Common Stock; an option
expiring March 7, 2006 to purchase
 
                                       45
<PAGE>   47
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     YEARS ENDED DECEMBER 28, 1996, DECEMBER 27, 1997 AND DECEMBER 26, 1998
 
2,000,000 shares of Common Stock (the "Closing Price Plan") exercisable only
upon satisfaction of the condition that the closing price of the Common Stock
has attained an average of $7.00 per share, subsequently amended to $4.50 per
share (as discussed in Note 10, "Stock Based Compensation Plans"), during a
91-day period ending on or before March 7, 2002; an option expiring March 7,
2006 to purchase 1,000,000 shares of Common Stock at their fair market value,
subject to the attainment of certain objective performance goals to be set by
the Compensation Committee; and four options expiring March 7, 2002, and the
first three anniversaries thereof, respectively, for the purchase of 250,000
shares of Common Stock each, granted by NAR, the Company's majority shareholder
(the "NAR Options"). As a result of the 1996 Rights Offering, Mr. Kaul was
granted an additional .51 shares for each share of Common Stock he was granted
under the Tandem Stock Purchase Right, the Tandem Option, and the NAR Options
(collectively, the "Award Shares") which resulted in his being granted 1,510,000
shares, 3,020,000 options and 1,510,000 options, respectively. The Employment
Agreement also provides for the grant of registration rights under the
Securities Act of 1993, as amended (the "Securities Act"), for shares of Common
Stock owned by Mr. Kaul. Pursuant to the Employment Agreement, the Company will
make Mr. Kaul whole, on an after-tax basis, for various relocation and temporary
living expenses related to his employment with the Company. In the event that
Mr. Kaul's employment is actually or constructively terminated by the Company,
other than for cause, he will be entitled for a 12-month period commencing on
the date of his termination to (i) a continuation of his base salary, (ii)
continued participation in the Company's medical, dental, life insurance and
retirement plans offered to senior executives of the Company, and (iii) a bonus,
payable in 12 equal installments, equal to 100% of his base salary (at the rate
in effect immediately prior to such termination). In addition, Mr. Kaul will be
entitled to receive (i) to the extent not previously paid, the short-term bonus
payable to Mr. Kaul for the year preceding the year of termination and (ii) for
the year in which Mr. Kaul's employment is terminated, an additional bonus equal
to his annual base salary for such year, pro-rated to reflect the portion of
such year during which Mr. Kaul is employed. Mr. Kaul's employment will be
deemed to be constructively terminated by the Company in the event of a change
in control (as defined in the Employment Agreement), the Company's bankruptcy, a
material diminution of his responsibilities, or a relocation of the Company's
headquarters outside the New York metropolitan area without his prior written
consent. In the event that Mr. Kaul's employment terminates other than as a
result of a termination by the Company, Mr. Kaul will not be entitled to any
payment or bonus, other than any short-term bonus he is entitled to receive from
the year prior to termination.
 
15.  RELATED PARTY TRANSACTIONS
 
     At December 26, 1998, current and former officers and executives of the
Company owed the Company approximately $3.0 million of which approximately $1.7
million relates to receivables, excluding accrued interest, under the Executive
Equity Incentive Plan. These amounts due to the Company bear interest at rates
ranging from 5.00% to 7.75% and are due from 1999 to 2002. An additional $1.0
million relates to a receivable, excluding accrued interest, under the Long-Term
Incentive Plan for Rakesh K. Kaul.
 
     At December 26, 1998, Richemont Finance S.A., a Luxemburg company, owned
approximately 49% of the Company's common stock through direct ownership. On
June 1, 1998, Richemont entered into an agreement with a third party, whereby
Richemont was granted an irrevocable proxy to vote approximately 9.3 million
shares currently held by the third party. Accordingly, Richemont has voting
control of 53% of the Company.
 
16.  COMMITMENTS AND CONTINGENCIES
 
     The Company is involved in various routine lawsuits of a nature which are
deemed customary and incidental to its business. In the opinion of management,
the ultimate disposition of such actions will not have a material adverse effect
on the Company's financial position or results of operations.
 
                                       46
<PAGE>   48
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     YEARS ENDED DECEMBER 28, 1996, DECEMBER 27, 1997 AND DECEMBER 26, 1998
 
     In connection with certain discontinued restaurant transactions, the
Company remains contingently liable with respect to lease obligations for 6
restaurant properties, should the buyers fail to perform under the agreements.
The future minimum lease payments as of December 26, 1998 are as follows (in
thousands): 1998 -- $.4; 1999 -- $.4; 2000 -- $.4; 2001 -- $.4; 2002 -- $.3, and
thereafter $.9.
 
17.  SELECTED QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
 
<TABLE>
<CAPTION>
                                                         FIRST      SECOND     THIRD      FOURTH
                                                        QUARTER    QUARTER    QUARTER    QUARTER
                                                        --------   --------   --------   --------
                                                        (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S>                                                     <C>        <C>        <C>        <C>
1997
Revenues                                                $129,725   $133,750   $122,597   $171,566
Gross profit                                              43,663     47,210     42,228     66,318
Loss from operations                                      (4,339)    (3,142)    (1,677)     7,309
Net (loss)                                                (6,621)    (5,648)    (3,421)     4,814
Preferred stock dividends                                    (48)       (47)       (47)       (48)
Net (loss) applicable to Common Shareholders            $ (6,669)  $ (5,695)  $ (3,468)  $  4,766
                                                        --------   --------   --------   --------
Net (loss) per share basic and diluted                  $   (.05)  $   (.04)  $   (.02)  $    .02
                                                        ========   ========   ========   ========
1998
Revenues                                                $124,535   $134,562   $123,417   $163,600
Gross profit                                              45,834     50,903     46,554     59,269
Income (loss) from operations                             (2,964)    (2,367)      (763)   (10,713)
Net income (loss)                                         (4,649)    (4,859)    (2,836)   (13,241)
Preferred stock dividends                                   (122)      (158)      (158)      (140)
Net income (loss) applicable to Common Shareholders     $ (4,771)  $ (5,017)  $ (2,994)  $(13,381)
                                                        --------   --------   --------   --------
Net income (loss) per share-basic and diluted           $   (.02)  $   (.02)  $   (.01)  $   (.06)
                                                        ========   ========   ========   ========
</TABLE>
 
                                       47
<PAGE>   49
 
ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
 
     None.
 
                                       48
<PAGE>   50
 
                                    PART III
 
ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
 
(a) Identification of Directors:
 
     The information required by this item is incorporated by reference from the
Company's definitive proxy statement to be filed by the Company pursuant to
Regulation 14A.
 
(b) Identification of Executive Officers:
 
<TABLE>
<CAPTION>
                                                                                      OFFICE HELD
NAME                    AGE              TITLE AND OTHER INFORMATION(A)                  SINCE
----                    ---              ------------------------------               -----------
<S>                     <C>    <C>                                                    <C>
Rakesh K. Kaul          47     President, Chief Executive Officer and Director           1996
                               since March 7, 1996. From 1995 until February 1996,
                               Mr. Kaul served as the Vice Chairman and Chief
                               Operating Officer of Fingerhut Companies, Inc. From
                               January 1992 until March 1995, Mr. Kaul was the
                               Executive Vice President and Chief Administrative
                               Office of Fingerhut. Prior to January 1992, Mr.
                               Kaul served as the Senior Vice President, Strategy
                               and Finance and a director at Shaklee Corporation.
 
Michael Lutz            56     Executive Vice President -- Chief Operating Officer       1994
                               since March 1998. From September 1994 to March
                               1998, Mr. Lutz was Executive Vice
                               President -- Operations of the Company. Prior to
                               September 1994, Mr. Lutz held various positions
                               with New Hampton, Inc./Avon Direct Response.
 
Larry J. Svoboda        50     Senior Vice President and Chief Financial Officer         1996
                               since September 25, 1996. From 1987 to September
                               1996, Mr. Svoboda was the Chief Financial Officer
                               of the Florsheim Shoe Company. Prior to 1987, Mr.
                               Svoboda was with the Sara Lee Corporation.
 
Richard B. Hoffman      52     Senior Vice President and Chief Marketing Officer         1998
                               since March 1998. Prior to March 1998, Mr. Hoffman
                               was engaged in private marketing consulting from
                               March 1997. Mr. Hoffman was President and Chief
                               Operating Officer of Jayhawk Acceptance Corporation
                               from February 1996 to March 1997. Prior to February
                               1996, Mr. Hoffman was a Senior Vice President at
                               Fingerhut Companies, Inc.
 
Michael D. Contino      38     Senior Vice President and Chief Information Officer       1996
                               since December 1996. Mr. Contino joined the Company
                               in 1995 as Director of Computer Operations and
                               Telecommunications. Prior to 1995, Mr. Contino was
                               the Senior Manager of I.S. Operations at New
                               Hampton, Inc., a subsidiary of Spiegel, Inc.
 
Ralph Bulle             49     Senior Vice President -- Human Resources since June       1996
                               1996. Mr. Bulle joined the Company in 1993 as Vice
                               President -- Human Resources. Prior to 1993, Mr.
                               Bulle was Senior Vice President -- Operations &
                               Human Resources for Seaman Furniture Company.
 
Robert J. Vill          42     Vice President -- Finance and Treasurer since             1998
                               November 1998. From April 1995 to November 1998,
                               Mr. Vill was Vice President and Treasurer for Saks
                               Fifth Avenue; prior thereto, he served as its
                               Assistant Treasurer.
</TABLE>
 
                                       49
<PAGE>   51
 
<TABLE>
<CAPTION>
                                                                                      OFFICE HELD
NAME                    AGE              TITLE AND OTHER INFORMATION(A)                  SINCE
----                    ---              ------------------------------               -----------
<S>                     <C>    <C>                                                    <C>
William C. Kingsford    52     Vice President and Corporate Controller since May         1997
                               1997. Prior to May 1997, Mr. Kingsford was Vice
                               President and Chief Internal Auditor at Melville
                               Corporation.
</TABLE>
 
---------------
(a) All references to dates and positions held by such executive officers prior
    to September 1993 refer to the Company's predecessor, The Horn & Hardart
    Company ("H&H"). H&H merged with and into the Company in September 1993,
    with the Company surviving.
 
     Pursuant to the Company's By-Laws, its officers are chosen annually by the
Board of Directors and hold office until their respective successors are chosen
and qualified.
 
ITEM 11.  EXECUTIVE COMPENSATION
 
     The information required by this item is incorporated by reference from the
Company's definitive proxy statement to be filed by the Company pursuant to
Regulation 14A.
 
ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
 
     The information required by this item is incorporated by reference from the
Company's definitive proxy statement to be filed by the Company pursuant to
Regulation 14A.
 
ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
 
     The information required by this item is incorporated by reference from the
Company's definitive proxy statement to be filed by the Company pursuant to
Regulation 14A.
 
                                       50
<PAGE>   52
 
                                    PART IV
 
ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
 
     (a) The following documents are filed as part of this report.
 
<TABLE>
<CAPTION>
                                                                           PAGE
                                                                           NO.
                                                                           ----
        <C>  <S>                                                           <C>
         1.  Index to Financial Statements
             Report of Independent Public Accountants -- Hanover Direct,
             Inc. and Subsidiaries Financial Statements..................    21
             Consolidated Balance Sheets as of December 27, 1997 and
             December 26, 1998...........................................    22
             Consolidated Statements of Income (Loss) for the years ended
             December 28, 1996, December 27, 1997 and December 26,
             1998........................................................    23
             Consolidated Statements of Cash Flows for the years ended
             December 28, 1996, December 27, 1997 and December 26,
             1998........................................................    24
             Consolidated Statements of Shareholders' Equity for the
             years ended December 28, 1996, December 27, 1997 and
             December 26, 1998...........................................    25
             Notes to Consolidated Financial Statements for the years
             ended December 28, 1996, December 27, 1997 and December 26,
             1998........................................................    26
             Supplementary Data:
             Selected quarterly financial information (unaudited) for the
             two fiscal years ended December 26, 1998....................    47
         2.  Index to Financial Statement Schedule
             Schedule II -- Valuation and Qualifying Accounts............    52
             Schedules other than that listed above are omitted because
             they are not applicable or the required information is shown
             in the financial statements or notes thereto................
         3.  Exhibits
             The exhibits required by Item 601 of Regulation S-K filed as
             part of, or incorporated by reference in, this report are
             listed in the accompanying Exhibit Index....................    54
</TABLE>
 
     Reports on Form 8-K:  None.
 
     (c) Exhibits required by Item 601 of Regulation S-K.
 
         See Exhibit Index.
 
     (d) Financial Statement Schedules
 
         See (a) 2. above.
 
                                       51
<PAGE>   53
 
                                                                     SCHEDULE II
 
                              HANOVER DIRECT, INC.
 
                       VALUATION AND QUALIFYING ACCOUNTS
                YEARS ENDED DECEMBER 26, 1998, DECEMBER 27, 1997
                             AND DECEMBER 28, 1996
 
<TABLE>
<CAPTION>
            COLUMN A                COLUMN B               COLUMN C              COLUMN D      COLUMN E
            --------                --------               --------             -----------   -----------
                                                          ADDITIONS
                                                 ----------------------------
                                   BALANCE AT    CHARGED TO      CHARGED TO                   BALANCE AT
                                    BEGINNING     COSTS AND    OTHER ACCOUNTS   DEDUCTIONS      END OF
DESCRIPTION                         OF PERIOD     EXPENSES        DESCRIBE       DESCRIBE       PERIOD
-----------                        -----------   -----------   --------------   -----------   -----------
<S>                                <C>           <C>           <C>              <C>           <C>
1998:
  Allowance for Doubtful Accounts
    Receivable, Current..........  $ 4,755,000     3,278,000                      3,998,000(1)   4,035,000
  Reserves for Discontinued
    Operations...................    1,354,000                                      372,000(2)     982,000
  Restructuring Reserve..........    5,424,000                                    2,138,000(2)   3,286,000
  Reserves for Sales Returns.....    6,043,000    14,755,000                     16,020,000(2)   4,778,000
  Deferred Tax Asset Valuation
    Allowance....................   80,100,000                   14,600,000(4)                 94,700,000
  Allowance for Net Unrealized
    Losses on Convertible Debt
    Securities...................
1997:
  Allowance for Doubtful Accounts
    Receivable, Current..........  $ 6,419,000     3,973,000                      5,637,000(1)   4,755,000
  Reserves for Discontinued
    Operations...................    1,722,000                                      368,000(2)   1,354,000
  Restructuring Reserve..........    9,504,000      (400,000)                     3,680,000(2)   5,424,000
  Reserves for Sales Returns.....    9,036,000    76,507,000                     79,500,000(2)   6,043,000
  Deferred Tax Asset Valuation
    Allowance....................   82,600,000                 (2,500,000)(4)                  80,100,000
  Allowance for Net Unrealized
    Losses on Convertible Debt
    Securities...................    1,888,000                                    1,888,000(1)
1996:
  Allowance for Doubtful Accounts
    Receivable, Current..........  $ 3,988,000     6,805,000                      4,374,000(1)   6,419,000
  Reserves for Discontinued
    Operations...................    1,639,000                       83,000(2)                  1,722,000
  Restructuring Reserve..........                  9,504,000                                    9,504,000
  Reserves for Sales Returns.....    5,535,000   106,836,000                    103,335,000(2)   9,036,000
  Deferred Tax Asset Valuation
    Allowance....................   48,500,000                   34,100,000(4)                 82,600,000
  Allowance for Net Unrealized
    Losses on Convertible Debt
    Securities...................    1,000,000       888,000                                    1,888,000
</TABLE>
 
---------------
(1) Accounts written-off.
 
(2) Utilization of reserves.
 
(3) Represents acquired allowance for doubtful accounts receivable.
 
(4) Represents the change in the valuation allowance offset by the change in the
    gross tax asset.
 
                                       52
<PAGE>   54
 
                                   SIGNATURES
 
     Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this Amendment to report to
be signed on its behalf by the undersigned, thereunto duly authorized.
 
                                          HANOVER DIRECT, INC.
                                          (registrant)
 
                                          By: /s/ RAKESH K. KAUL
                                            ------------------------------------
                                            Rakesh K. Kaul
                                            President and Chief
                                            Executive Officer
 
Date: March 31, 1999
 
                                       53
<PAGE>   55
 
                                 EXHIBIT INDEX
 
<TABLE>
<CAPTION>
EXHIBIT NUMBER
 ITEM 601 OF                                                                               PAGE
REGULATION S-K  DESCRIPTION OF DOCUMENT AND INCORPORATION BY REFERENCE WHERE APPLICABLE    NO.
--------------  -----------------------------------------------------------------------    ----
<C>             <S>                                                                        <C>
     2.1        Asset Purchase Agreement dated as of December 1, 1994 among the
                Company, LWI Holdings, Inc., Bankers Trust Company, Leichtung, Inc. and
                DRI Industries, Inc. Incorporated by reference to the Company's Annual
                Report on Form 10-K for the year ended December 31, 1994.
     2.2        Stock Purchase Agreement dated as of February 16, 1995 among the
                Company, Hanover Holdings, Inc., Aegis Safety Holdings, Inc., F.L.
                Holdings, Inc., Roland A.E. Franklin, Martin E. Franklin, Jonathan
                Franklin, Floyd Hall, Frederick Field, Homer G. Williams, Frank
                Martucci, Norm Thompson Outfitters, Inc. and Capital Consultants, Inc.
                (as agent) (collectively, the "Aegis Sellers"). Incorporated by
                reference to the Company's Annual Report on Form 10-K for the year
                ended December 31, 1994.
      2.3       Stock Purchase Agreement dated as of May 19, 1995 by and among the
                Company, Austad Holdings, Inc. ("AHI"), The Austad Company ("TAC"),
                David B. Austad ("DBA"), Denise Austad ("DA"), David Austad, as
                custodian ("DBAC"), Oscar Austad, Dorothy Austad, Randall Austad,
                Kristi Austad, Lori Miller, Robin Miller, Kerri Derenge, Sharon Stahl,
                Lori Miller, as custodian, Dorothy Austad, as attorney-in-fact, and
                Kara Miller (collectively, the "Austad Individuals"). Incorporated by
                reference to the Company's Annual Report on Form 10-K for the year
                ended December 30, 1995.
      2.4       Agreement and Plan of Corporate Separation and Reorganization dated as
                of February 16, 1996 by and among the Company, AHI, TAC, DBA, DBAC, and
                DA. Incorporated by reference to the Company's Annual Report on Form
                10-K for the year ended December 30, 1995.
      3.1       Restated Certificate of Incorporation. Incorporated by reference to the
                Company's Annual Report on Form 10-K for the year ended December 28,
                1996.
      3.2       Certificate of Correction filed to correct a certain error in the
                Restated Certificate of Incorporation. Incorporated by reference to the
                Company's Annual Report on Form 10-K for the year ended December 26,
                1998.
     3.3        By-laws. Incorporated by reference to the Company's Quarterly Report on
                Form 10-Q for the quarterly period ended September 27, 1997.
      4.1       Warrant Agreement dated as of October 25, 1991 ("NAR Warrant") between
                the Company* and NAR Group Limited ("NAR") for 279,110 shares of Common
                Stock. Incorporated by reference to the Company's* Current Report on
                Form 8-K dated October 25, 1991.
      4.2       Registration Rights Agreement dated as of July 8, 1991 among the
                Company*, NAR and Intercontinental Mining & Resources Limited ("IMR").
                Incorporated by reference to the Company's* Current Report on Form 8-K
                Dated July 10, 1991.
      4.3       Warrant Agreement dated as of January 1, 1994 between the Company and
                Sears Shop At Home Services, Inc. ("Sears"). Incorporated by reference
                to the Company's Annual Report on Form 10-K for the year ended December
                31, 1994.
      4.4       Registration Rights Agreement dated as of February 16, 1995 among the
                Company and the Aegis Sellers. Incorporated by reference to the
                Company's Annual Report on Form 10-K for the year ended December 31,
                1994.
      4.5       Warrant Agreement dated as of July 8, 1991 between the Company and IMR
                for 1,750,000 shares of Common Stock. Incorporated by reference to the
                Company's Current Report on Form 8-K dated July 10, 1991.
      4.6       Warrant Agreement dated as of October 25, 1991 between the Company and
                NAR for 931,791 shares of Common Stock. Incorporated by reference to
                the Company's Current Report on Form 8-K dated October 25, 1991.
</TABLE>
 
                                       54
<PAGE>   56
 
<TABLE>
<CAPTION>
EXHIBIT NUMBER
 ITEM 601 OF                                                                               PAGE
REGULATION S-K  DESCRIPTION OF DOCUMENT AND INCORPORATION BY REFERENCE WHERE APPLICABLE    NO.
--------------  -----------------------------------------------------------------------    ----
<C>             <S>                                                                        <C>
      4.7       Second Amendment to Warrant Agreement and Warrant Certificate for
                931,791 shares of Common Stock, between the Company and NAR dated as of
                November 13, 1995. Incorporated by reference to the Company's Annual
                Report on Form 10-K for the year ended December 30, 1995.
      4.8       First Amendment to Warrant Agreement and Warrant Certificate for
                1,750,000 shares of Common Stock, between the Company and IMR dated as
                of November 13, 1995. Incorporated by reference to the Company's Annual
                Report on Form 10-K for the year ended December 30, 1995.
      4.9       First Amendment to Warrant Agreement and Warrant Certificate for
                279,110 shares of Common Stock, between the Company and NAR dated as of
                November 13, 1995. Incorporated by reference to the Company's Annual
                Report on Form 10-K for the year ended December 30, 1995.
     4.10       Second Amendment to Warrant Agreement between the Company and IMR dated
                as of August 23, 1996. Incorporated by reference to the Company's
                Annual Report on Form 10-K for the year ended December 28, 1996.
     4.11       Second Amendment to Warrant Agreement between the Company and NAR dated
                as of August 23, 1996. Incorporated by reference to the Company's
                Annual Report on Form 10-K for the year ended December 28, 1996.
     4.12       Third Amendment to Warrant Agreement between the Company and NAR dated
                as of August 23, 1996. Incorporated by reference to the Company's
                Annual Report on Form 10-K for the year ended December 28, 1996.
     10.1       Stock Option Plan, as amended. Incorporated by reference to the
                Company's* Annual Report on Form 10-K for the fiscal year ended
                December 28, 1991.
     10.2       Account Purchase Agreement dated as of December 21, 1992 among the
                Company*, Hanover Direct Pennsylvania, Inc. ("HDPI"), Brawn of
                California, Inc. ("Brawn") and General Electric Capital Corporation
                ("GECC"). Incorporated by reference to the Company's* Annual Report on
                Form 10-K for the fiscal year ended December 26, 1992.
     10.3       Amendment No. 1 to the Account Purchase Agreement dated as of July 12,
                1993 among the Company*, HDPI, Brawn, Gump's By Mail, Gump's, Gump's
                Holdings and GECC. Incorporated by reference to the Company's* Current
                Report on Form 8-K dated July 12, 1993.
     10.4       Amendment No. 2 to the Account Purchase Agreement dated as of June 1,
                1995 among the Company, HDPI, Brawn, Gump's, Gump's By Mail, Gump's
                Holdings and GECC. Incorporated by reference to the Company's Annual
                Report on Form 10-K for the year ended December 30, 1995.
     10.5       Waiver and Amendment No. 3 to the Account Purchase Agreement dated as
                of December 14, 1995 among the Company, HDPI, Brawn and GECC.
                Incorporated by reference to the Company's Annual Report on Form 10-K
                for the year ended December 30, 1995.
     10.6       Amendment No. 4 to the Amended and Restated Account Purchase Agreement
                dated as of June 28, 1996 among the Company, HDPI, Brawn, Gump's,
                Gump's by Mail, Gump's Holdings and GECC. Incorporated by reference to
                the Company's Annual Report on Form 10-K for the year ended December
                28, 1996.
     10.7       Form of Stock Option Agreement between the Company* and certain
                Directors of the Company, as amended. Incorporated by reference to the
                Company's* Annual Report on Form 10-K for the fiscal year ended
                December 28, 1991.
     10.8       Termination of Employment Agreement and Employment and Consulting
                Agreement dated as of December 31, 1995 between the Company and Jack E.
                Rosenfeld. Incorporated by reference to the Company's Annual Report on
                Form 10-K for the year ended December 28, 1996.
     10.9       Registration Rights Agreement between the Company and Rakesh K. Kaul,
                dated as of August 23, 1996. Incorporated by reference to the Company's
                Annual Report on Form 10-K for the year ended December 28, 1996.
</TABLE>
 
                                       55
<PAGE>   57
 
<TABLE>
<CAPTION>
EXHIBIT NUMBER
 ITEM 601 OF                                                                               PAGE
REGULATION S-K  DESCRIPTION OF DOCUMENT AND INCORPORATION BY REFERENCE WHERE APPLICABLE    NO.
--------------  -----------------------------------------------------------------------    ----
<C>             <S>                                                                        <C>
    10.10       Form of Indemnification Agreement among the Company* and each of the
                Company's directors and executive officers. Incorporated by reference
                to the Company's* Current Report on Form 8-K dated October 25, 1991.
    10.11       Letter Agreement dated May 5, 1989 among the Company*, Theodore H.
                Kruttschnitt, J. David Hakman and Edmund R. Manwell. Incorporated by
                reference to the Company's* Current Report on Form 8-K dated May 10,
                1989.
    10.12       Hanover Direct, Inc. Savings Plan as amended. Incorporated by reference
                to the Company's Annual Report on Form 10-K for the year ended January
                1, 1994.
    10.13       Restricted Stock Award Plan. Incorporated by reference to the
                Company's* Registration Statement on Form S-8 filed on February 24,
                1993, Registration No. 33-58760.
    10.14       All Employee Equity Investment Plan. Incorporated by reference to the
                Company's* Registration Statement on Form S-8 filed on February 24,
                1993, Registration No. 33-58756.
    10.15       Executive Equity Incentive Plan, as amended. Incorporated by reference
                to the Company's Annual Report on Form 10-K for the year ended December
                28, 1996.
    10.16       Form of Supplemental Retirement Plan. Incorporated by reference to the
                Company's Annual Report on Form 10-K for the year ended January 1,
                1994.
    10.17       1996 Stock Option Plan, as amended. Incorporated by reference to the
                Company's 1997 Proxy Statement.
    10.18       Loan and Security Agreement dated as of November 14, 1995 by and among
                Congress Financial Corporation ("Congress"), Hanover Direct
                Pennsylvania, Inc. ("HDPA"), Brawn of California, Inc. ("Brawn"),
                Gump's by Mail, Inc. ("Gump's by Mail"), Gump's Corp.("Gump's"), The
                Company Store, Inc. ("The Company Store") , Tweeds, Inc. ("Tweeds"),
                LWI Holdings, Inc.("LWI"), Aegis Catalog Corporation ("Aegis"), Hanover
                Direct Virginia, Inc. ("HDVA") and Hanover Realty Inc. ("Hanover
                Realty"). Incorporated by reference to the Company's Annual Report on
                Form 10-K for the year ended December 30, 1995.
    10.19       First Amendment to Loan and Security Agreement dated as of February 22,
                1996 by and among Congress, HDPA, Brawn, Gump's by Mail, Gump's, The
                Company Store, Tweeds, LWI, Aegis, HDVA, Hanover Realty and TAC.
                Incorporated by reference to the Company's Annual Report on Form 10-K
                for the year ended December 28, 1996.
    10.20       Second Amendment to Loan and Security Agreement dated as of April 16,
                1996 by and among Congress, HDPA, Brawn, Gump's by Mail, Gump's, The
                Company Store, Tweeds, LWI, Aegis, HDVA, Hanover Realty and Austad.
                Incorporated by reference to the Company's Annual Report on Form 10-K
                for the year ended December 28, 1996.
    10.21       Third Amendment to Loan and Security Agreement dated as of May 24, 1996
                by and among Congress, HDPA, Brawn, Gump's by Mail, Gump's, The Company
                Store, Tweeds, LWI, Aegis, HDVA, Hanover Realty and Austad.
                Incorporated by reference to the Company's Annual Report on Form 10-K
                for the year ended December 28, 1996.
    10.22       Fourth Amendment to Loan and Security Agreement dated as of May 31,
                1996 by and among Congress, HDPA, Brawn, Gump's by Mail, Gump's, The
                Company Store, Tweeds, LWI, Aegis, HDVA, Hanover Realty and Austad.
                Incorporated by reference to the Company's Annual Report on Form 10-K
                for the year ended December 28, 1996.
    10.23       Fifth Amendment to Loan and Security Agreement dated as of September
                11, 1996 by and among Congress, HDPA, Brawn, Gump's by Mail, Gump's,
                The Company Store, Tweeds, LWI, Aegis, HDVA, Hanover Realty and Austad.
                Incorporated by reference to the Company's Annual Report on Form 10-K
                for the year ended December 28, 1996.
</TABLE>
 
                                       56
<PAGE>   58
 
<TABLE>
<CAPTION>
EXHIBIT NUMBER
 ITEM 601 OF                                                                               PAGE
REGULATION S-K  DESCRIPTION OF DOCUMENT AND INCORPORATION BY REFERENCE WHERE APPLICABLE    NO.
--------------  -----------------------------------------------------------------------    ----
<C>             <S>                                                                        <C>
    10.24       Sixth Amendment to Loan and Security Agreement dated as of December 5,
                1996 by and among Congress, HDPA, Brawn, Gump's by Mail, Gump's, The
                Company Store, Tweeds, LWI, Aegis, HDVA, Hanover Realty and Austad.
                Incorporated by reference to the Company's Annual Report on Form 10-K
                for the year ended December 28, 1996.
    10.25       Seventh Amendment to Loan and Security Agreement dated as of December
                18, 1996 by and among Congress, HDPA, Brawn, Gump's by Mail, Gump's,
                The Company Store, Tweeds, LWI, Aegis, HDVA, Hanover Realty and Austad.
                Incorporated by reference to the Company's Annual Report on Form 10-K
                for the year ended December 28, 1996.
    10.26       Eighth Amendment to Loan and Security Agreement dated as of March 26,
                1997 by and among Congress, HDPA, Brawn, Gump's by Mail, Gump's, The
                Company Store, Tweeds, LWI, Aegis, HDVA, Hanover Realty and Austad.
                Incorporated by reference to the Company's Annual Report on Form 10-K
                for the year ended December 26, 1998.
    10.27       Ninth Amendment to Loan and Security Agreement dated as of April 18,
                1997 by and among Congress, HDPA, Brawn, Gump's by Mail, Gump's, The
                Company Store, Tweeds, LWI, Aegis, HDVA, Hanover Realty and Austad.
                Incorporated by reference to the Company's Annual Report on Form 10-K
                for the year ended December 26, 1998.
    10.28       Tenth Amendment to Loan and Security Agreement dated as of October 31,
                1997 by and among Congress, HDPA, Brawn, Gump's by Mail, Gump's, The
                Company Store, Tweeds, LWI, Aegis, HDVA, Hanover Realty and Austad.
                Incorporated by reference to the Company's Annual Report on Form 10-K
                for the year ended December 26, 1998.
    10.29       Eleventh Amendment to Loan and Security Agreement dated as of
                          , 1998 by and among Congress, HDPA, Brawn, Gump's by Mail,
                Gump's, The Company Store, Tweeds, LWI, Aegis, HDVA, Hanover Realty and
                Austad. Incorporated by reference to the Company's Annual Report on
                Form 10-K for the year ended December 26, 1998.
    10.30       Subordination Agreement, dated as of November 14, 1995, among Congress,
                IMR, and the Trustee. Incorporated by reference to the Company's Annual
                Report on Form 10-K for the year ended December 30, 1995.
    10.31       Long-Term Incentive Plan for Rakesh K. Kaul. Incorporated by reference
                to the Company's Annual Report on Form 10-K for the year ended December
                28, 1996.
    10.32       Short-Term Incentive Plan for Rakesh K. Kaul. Incorporated by reference
                to the Company's Annual Report on Form 10-K for the year ended December
                28, 1996.
    10.33       Employment Agreement dated as of March 7, 1996 between the Company and
                Rakesh K. Kaul. Incorporated by reference to the Company's Annual
                Report on Form 10-K for the year ended December 28, 1996.
    10.34       Tandem Option Plan dated as of August 23, 1996 between the Company and
                Rakesh K. Kaul. Incorporated by reference to the Company's Annual
                Report on Form 10-K for the year ended December 28, 1996.
    10.35       Closing Price Option dated as of August 23, 1996 between the Company
                and Rakesh K. Kaul. Incorporated by reference to the Company's Annual
                Report on Form 10-K for the year ended December 28, 1996.
    10.36       Performance Price Option dated as of August 23, 1996 between the
                Company and Rakesh K. Kaul. Incorporated by reference to the Company's
                Annual Report on Form 10-K for the year ended December 28, 1996.
    10.37       Six-Year Stock Option dated as of August 23, 1996 between NAR and
                Rakesh K. Kaul. Incorporated by reference to the Company's Annual
                Report on Form 10-K for the year ended December 28, 1996.
</TABLE>
 
                                       57
<PAGE>   59
 
<TABLE>
<CAPTION>
EXHIBIT NUMBER
 ITEM 601 OF                                                                               PAGE
REGULATION S-K  DESCRIPTION OF DOCUMENT AND INCORPORATION BY REFERENCE WHERE APPLICABLE    NO.
--------------  -----------------------------------------------------------------------    ----
<C>             <S>                                                                        <C>
    10.38       Seven-Year Stock Option dated as of August 23, 1996 between NAR and
                Rakesh K. Kaul. Incorporated by reference to the Company's Annual
                Report on Form 10-K for the year ended December 28, 1996.
    10.39       Eight-Year Stock Option dated as of August 23, 1996 between NAR and
                Rakesh K. Kaul. Incorporated by reference to the Company's Annual
                Report on Form 10-K for the year ended December 28, 1996.
    10.40       Nine-Year Stock Option dated as of August 23, 1996 between NAR and
                Rakesh K. Kaul. Incorporated by reference to the Company's Annual
                Report on Form 10-K for the year ended December 28, 1996.
    10.41       Letter of Credit, dated December 18, 1996, from Swiss Bank Corporation,
                New York Branch in favor of Fleet National Bank, as trustee.
                Incorporated by reference to the Company's Annual Report on Form 10-K
                for the year ended December 28, 1996.
    10.42       Substitute Letter of Credit, dated February 18, 1998, from Swiss Bank
                Corporation, Stamford Branch ("Swiss Bank") in favor of State Street
                Bank and Trust Company, as trustee. Incorporated by reference to the
                Company's Annual Report on Form 10-K for the year ended December 26,
                1998.
    10.43       Reimbursement Agreement, dated as of December 18, 1996, by and between
                Swiss Bank and the Company. Incorporated by reference to the Company's
                Annual Report on Form 10-K for the year ended December 28, 1996.
    10.44       First Amendment to Reimbursement Agreement, dated as of February 18,
                1998, by and between Swiss Bank and the Company. Incorporated by
                reference to the Company's Annual Report on Form 10-K for the year
                ended December 26, 1998.
    10.45       Hanover Indemnity Agreement, dated as of December 18, 1996, between
                Richemont Finance S.A. ("Richemont") and the Company, HDPI, Brawn,
                Gump's, Gump's by Mail, The Company Store, Tweeds, LWI, Aegis, HDVA and
                Hanover Realty. Incorporated by reference to the Company's Annual
                Report on Form 10-K for the year ended December 28, 1996.
    10.46       Subordination Agreement, dated as of December 18, 1996, between
                Congress and Swiss Bank. Incorporated by reference to the Company's
                Annual Report on Form 10-K for the year ended December 28, 1996.
    10.47       Subordination Agreement, dated as of December 18, 1996 between Congress
                and Richemont. Incorporated by reference to the Company's Annual Report
                on Form 10-K for the year ended December 28, 1996.
    10.48       Series A Note Agreement, dated as of November 9, 1994, between the
                Company and Norwest Bank Minnesota, N.A. ("Norwest"), as trustee.
                Incorporated by reference to the Company's Annual Report on Form 10-K
                for the year ended December 28, 1996.
    10.49       Placement Agreement, dated as of November 9, 1994, by and between the
                Company and NationsBank of North Carolina, N.A. Incorporated by
                reference to the Company's Annual Report on Form 10-K for the year
                ended December 28, 1996.
    10.50       Remarketing and Interest Services Agreement, dated as of November 9,
                1994, by and between the Company and NationsBank of North Carolina,
                N.A. Incorporated by reference to the Company's Annual Report on Form
                10-K for the year ended December 28, 1996.
    10.51       First Supplemental Series A Note Agreement, dated as of December 29,
                1995, between the Company and Norwest. Incorporated by reference to the
                Company's Annual Report on Form 10-K for the year ended December 28,
                1996.
    10.52       First Amendment to Placement Agreement, dated as of December 29, 1995
                by and between the Company and NationsBank of North Carolina, N.A.
                Incorporated by reference to the Company's Annual Report on Form 10-K
                for the year ended December 28, 1996.
</TABLE>
 
                                       58
<PAGE>   60
 
<TABLE>
<CAPTION>
EXHIBIT NUMBER
 ITEM 601 OF                                                                               PAGE
REGULATION S-K  DESCRIPTION OF DOCUMENT AND INCORPORATION BY REFERENCE WHERE APPLICABLE    NO.
--------------  -----------------------------------------------------------------------    ----
<C>             <S>                                                                        <C>
    10.53       First Amendment to Remarketing and Interest Services Agreement, dated
                as of December 29, 1995 by and between the Company and NationsBank of
                North Carolina, N.A. Incorporated by reference to the Company's Annual
                Report on Form 10-K for the year ended December 28, 1996.
    10.54       Second Supplemental Series A Note Agreement, dated as of December 18,
                1996, between the Company and Norwest. Incorporated by reference to the
                Company's Annual Report on Form 10-K for the year ended December 28,
                1996.
    10.55       Second Amendment to Series A Note, dated December 18, 1996 made by the
                Company. Incorporated by reference to the Company's Annual Report on
                Form 10-K for the year ended December 28, 1996.
    10.56       Second Amendment to Placement Agreement, dated as of December 18, 1996
                by and between the Company and NationsBank of North Carolina, N.A.
                Incorporated by reference to the Company's Annual Report on Form 10-K
                for the year ended December 28, 1996.
    10.57       Second Amendment to Remarketing and Interest Services Agreement, dated
                as of December 18, 1996 by and between the Company and NationsBank of
                North Carolina, N.A. Incorporated by reference to the Company's Annual
                Report on Form 10-K for the year ended December 28, 1996.
    10.58       Series B Note Agreement dated as of April 25, 1995, between the Company
                and Norwest. Incorporated by reference to the Company's Annual Report
                on Form 10-K for the year ended December 28, 1996.
    10.59       First Amendment to Series B Note Agreement, dated as of December 29,
                1995, between the Company and Norwest. Incorporated by reference to the
                Company's Annual Report on Form 10-K for the year ended December 28,
                1996.
    10.60       Second Amendment to Series B Note Agreement, dated as of December 18,
                1996, between the Company and Norwest. Incorporated by reference to the
                Company's Annual Report on Form 10-K for the year ended December 28,
                1996.
    10.61       Second Amendment to Series B Note, dated December 18, 1996 made by the
                Company. Incorporated by reference to the Company's Annual Report on
                Form 10-K for the year ended December 28, 1996.
    10.62       Series B Letter of Credit, dated as of December 18, 1996, issued by
                Swiss Bank. Incorporated by reference to the Company's Annual Report on
                Form 10-K for the year ended December 28, 1996.
    10.63       Amendment to Series B Letter of Credit, dated as of February 18, 1998,
                between Swiss Bank and Norwest. Incorporated by reference to the
                Company's Annual Report on Form 10-K for the year ended December 26,
                1998.
    10.64       NAR Promissory Note dated as of September 11, 1996. Incorporated by
                reference to the Company's Annual Report on Form 10-K for the year
                ended December 28, 1996.
    10.65       Series A Letter of Credit, dated as of December 18, 1996, issued by
                Swiss Bank. Incorporated by reference to the Company's Annual Report on
                Form 10-K for the year ended December 28, 1996.
    10.66       Amendment to Series A Letter of Credit, dated as of February 18, 1998,
                between Swiss Bank and Norwest. Incorporated by reference to the
                Company's Annual Report on Form 10-K for the year ended December 26,
                1998.
    10.67       First Amendment to Series A Note, dated as of December 29, 1995 made by
                Hanover Direct, Inc. Incorporated by reference to the Company's Annual
                Report on Form 10-K for the year ended December 28, 1996.
    10.68       $10,000,000 Series B Note, dated as of April 27, 1995 and made by
                Hanover Direct, Inc. Incorporated by reference to the Company's Annual
                Report on Form 10-K for the year ended December 28, 1996.
</TABLE>
 
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<PAGE>   61
 
<TABLE>
<CAPTION>
EXHIBIT NUMBER
 ITEM 601 OF                                                                               PAGE
REGULATION S-K  DESCRIPTION OF DOCUMENT AND INCORPORATION BY REFERENCE WHERE APPLICABLE    NO.
--------------  -----------------------------------------------------------------------    ----
<C>             <S>                                                                        <C>
    10.69       First Supplemental Series B Note Agreement, dated as of December 29,
                1995. Incorporated by reference to the Company's Annual Report on Form
                10-K for the year ended December 28, 1996.
    10.70       $10,000,000 Series A Note, dated as of November 9, 1994 and made by
                Hanover Direct, Inc. Incorporated by reference to the Company's Annual
                Report on Form 10-K for the year ended December 28, 1996.
    10.71       Stock Purchase Agreement, dated as of November 4, 1997, by and between
                the Company and SMALLCAP World Fund, Inc. ("SMALLCAP") Incorporated by
                reference to the Company's Annual Report on Form 10-K for the year
                ended December 27, 1997.
    10.72       Registration Rights Agreement, dated as of November 4, 1997, by and
                between the Company and SMALLCAP. Incorporated by reference to the
                Company's Annual Report on Form 10-K for the year ended December 27,
                1997.
   **10.73      Twelfth Amendment to Loan and Security Agreement, dated as of September
                30, 1998 by and among Congress, HDPI, Brawn, GBM, Gump's, Hanover
                Holding Corp. ("HH Corp."), LWI, Aegis, HDV, Hanover Realty, Austad,
                Tweeds, LLC ("Tweeds LLC"), Silhouettes, LLC ("Silhouettes LLC"),
                Hanover Company Store, LLC ("HCS LLC"), Domestications, LLC
                ("Domestications LLC") and Colonial Garden Kitchens, Inc. ("Colonial
                Garden"). **FILED HEREWITH
   **10.74      Thirteenth Amendment to Loan and Security Agreement, dated as of
                September 30, 1998, by and among Congress, HDPI, Brawn, GBM, Gump's, HH
                Corp., LWI, Aegis, HDV, Hanover Realty, Austad, Tweeds LLC, Silhouettes
                LLC, HCS LLC, Domestications LLC and Colonial Garden. **FILED HEREWITH
    **21.1      Subsidiaries of the Registrant. **FILED HEREWITH
    **23.1      Consent of Independent Public Accountants. **FILED HEREWITH
     27.1       Financial Data Schedule. **FILED HEREWITH
</TABLE>
 
---------------
 * Hanover Direct, Inc., a Delaware corporation, is the successor by merger to
   The Horn & Hardart Company and The Hanover Companies.
 
** EDGAR filing only.
 
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