<PAGE>   1

                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                    FORM 10-K

                  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
                     OF THE SECURITIES EXCHANGE ACT OF 1934

                   FOR THE FISCAL YEAR ENDED DECEMBER 27, 1997

                         COMMISSION FILE NUMBER 1-12082

                              HANOVER DIRECT, INC.
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)


           DELAWARE                                        13-0853260
(STATE OR OTHER JURISDICTION OF                (IRS EMPLOYER IDENTIFICATION NO.)
 INCORPORATION OR ORGANIZATION)

 1500 HARBOR BOULEVARD WEEHAWKEN, NEW JERSEY                  07087
  (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)                  (ZIP CODE)


                                 (201) 863-7300)
              (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)

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

                                                    NAME OF EACH EXCHANGE
         TITLE OF EACH CLASS                         ON WHICH REGISTERED

  COMMON STOCK, $.66-2/3 PAR VALUE                 AMERICAN STOCK EXCHANGE

         Securities to be 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 20, 1998, the aggregate market value of the voting and
non-voting common equity held by non-affiliates of the registrant was
$193,819,807 (based on the closing price of the Common Stock on the American
Stock Exchange on March 20, 1998).

         As of March 20, 1998, the registrant had 203,800,569 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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                                    P A R T 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. In December 1996, the Company regrouped its catalog titles
so that all significant decisions, including those regarding market positioning
and strategy, merchandising, circulation levels, catalog design, inventory
management and cash management, are made by management of each of 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 brand groups each consisting of one or more catalog titles. All of these
brand groups have continued to 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. The Home
Fashions-Upscale brands includes The Company Store(R), a direct marketer of
upscale home fashions 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, The
Safety Zone(R), a direct marketer of safety, prevention and protection products,
and Colonial Garden Kitchens(R), featuring work saving and lifestyle enhancing
items for the kitchen and home. 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), a
direct marketer of 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 catalogs were
discontinued during the 1996 or 1997 fiscal years.

         During 1997, the Company mailed approximately 244 million catalogs. The
Company maintains a proprietary customer list currently containing approximately
12 million names of customers (down from approximately 14 million names in 1996
and 18 million in 1995) who have made purchases from at least one of the
Company's catalogs within the past 36 months. Over 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 (down from approximately 6 million
names in 1996 and 7 million in 1995).

         In December 1996, the Company announced a plan to reduce its annual
operating costs on continuing catalogs by approximately $50 million starting
January 1, 1997. Actual cost savings under this plan were in excess of $60
million in 1997.

         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
Finance"), a Luxembourg public company, owns approximately 20.3% of the
Company's common stock on a fully diluted basis. Richemont Finance is an
affiliate of Compagnie Financiere Richemont, A.G., a Swiss public company
engaged in luxury goods, tobacco and other business ("Richemont"). NAR Group
Limited, a British Virgin Islands corporation (together with its affiliates,
"NAR"), owns approximately 46.5% of the Company's common stock on a fully
diluted basis. NAR, a private investment holding company, is a joint venture
between the family of Alan G. Quasha, a Director and the Chairman of the Board
of the Company, and Richemont. The Company is a successor in interest to The




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Horn & Hardart Company, a restaurant company founded in 1911, and Hanover House
Industries, Inc., founded in 1934.

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. Through market research and ongoing
testing of new products and concepts, each brand group determines each catalog's
own merchandise strategy, including the appropriate price points, mailing plans
and presentation of its products. The Company is continuing its development of
exclusive or private label products for a number of its catalogs, including
Domestications, Tweeds, Austad's, 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 core 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.

         Home Fashions-Upscale Brands:

         The Company Store is an upscale direct marketer of home fashions
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.

         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 is a direct marketer of safety, protection and
prevention products.

         Colonial Garden Kitchens features work saving and lifestyle enhancing
items for the kitchen and home.

         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 is a European inspired women's fashion catalog featuring
stylish, updated apparel uniquely designed specifically for the Tweeds customer,
emphasizing the varied busy lifestyle.

         Men's Apparel Brands:


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         International Male is 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 is a direct marketer of golf equipment and related apparel and
accessories.

         Gift Brands:

         Gump's By Mail is a leading upscale catalog marketer of 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, on a catalog
by catalog basis, 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. As part of its plan
for the reduction of annual operating costs, the Company reduced catalog
circulation in 1997 in an effort to improve customer retention and target
segmentation.

         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 not only traditional print
space advertisements and promotional inserts in outbound merchandise packages,
but also Internet Web site space advertisements for catalog requests, placed on
both the Company's proprietary sites and third party sites, and visitors to the
Company's proprietary Internet Web sites for all of its catalogs, as well as
third party Internet Web sites on which some catalogs advertise their
merchandise. 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 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.

         The Company is about to enter the evolving field of 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
long-form television programming. In addition, the Company has entered into an
agreement to post some of its catalogs' merchandise offerings on electronic
marketing channels which are not directed to residences but to airport lounges,
hotel room and airplane electronic networks.


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TELEMARKETING

         The Company receives approximately 80% 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 11 million telephone order and customer
service calls in 1997. 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 for home fashions, general
merchandise and apparel, one in Hanover, Pennsylvania for general merchandise
including giftware and other hardgoods, and one in LaCrosse, Wisconsin for home
fashions. The Company's facilities processed approximately 8.6 million packages
in 1997. As part of its plan to reduce annual operating costs, the Company
developed a plan to consolidate its apparel operations in Roanoke, VA and its
Hanover, PA fulfillment operations into its home fashions distribution center in
Roanoke, VA. The apparel operations and two of the six catalogs located in
Hanover, PA were consolidated into the Roanoke home fashions distribution center
in the second half of 1997. The other four catalogs are expected to be
consolidated into the Roanoke home fashions distribution center by the end of
1998.

         The Company mails it 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 14% of the Company's net revenues in 1997.
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 announced a proposed increase in mailing
rates that will take effect in mid-1998. The Company is currently investigating
ways to mitigate the effects of these expected increases. If the Company does
not successfully develop any such plan, it may have a material adverse effect on
its results of operations. The Company also utilizes United Parcel Service,
Federal Express and other delivery services. On August 4, 1997, United Parcel
Service went on strike for 16 days. This strike did not have a material effect
on the Company's ability to conduct its business during this time. 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. The Company expects its actual
United Parcel Service costs to exceed the stated percentage increases and is
investigating alternatives to minimize this impact. The Company does not expect
the increase to have a material adverse effect on its results of operations.


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<PAGE>   6

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. 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. In that connection, the Company agreed to guarantee certain
levels of call volume and the Company anticipates it will meet such targets for
the first performance period. 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 1997, paper costs
approximated 6% of the Company's net revenues. 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.
The Company anticipates that any paper price increase in 1998 will not have a
significant impact on its cost structure.

MANAGEMENT INFORMATION SYSTEMS

         The Company has successfully converted all catalogs to the integrated
mail order and catalog system operating on the mid-range computer systems.
Additionally, there is only one remaining fulfillment center to be 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 27, 1997, the Company had invested approximately $18.1
million of capitalized costs in such systems and anticipates capital
expenditures of approximately $.5 million to complete the conversion.

         Based on its preliminary study, the Company does not expect to have
significant expenditures to modify its computer information systems enabling
proper processing of transactions relating to the year 2000 and beyond. The
Company continues to evaluate appropriate courses of corrective action,
including replacement of certain systems. The Company does not expect the
amounts required to be expensed over the next two years related to the year 2000
modifications to have a material effect on its


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financial position or results of operations. The Company is attempting to
contact 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's systems rely 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 systems.

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 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 27, 1997.

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 1997. 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.

SEARS

         In January 1994, the Company entered into a licensing agreement (the
"Sears Agreement") with the direct marketing subsidiary of Sears Roebuck and Co.
("Sears") to produce specialty catalogs for customers of the discontinued Sears
catalog. The Sears Agreement was terminated by Sears in December 1996 and no
catalogs were mailed by the Company in 1997. The termination of the Sears
Agreement did not have a material impact on the Company's earnings for 1997.
Warrants to purchase Common Stock in 1998 and 1999 conditional upon the business
meeting certain criteria will not be exercisable due to the termination of the
Sears Agreement.


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<PAGE>   8

FINANCING

         Credit Facility. In November 1995, the Company entered into a $75
million secured credit facility (the "Credit Facility") with Congress Financial
Corporation ("Congress") consisting of a three-year revolving line of credit of
up to $65 million and two two-year term loans aggregating $10 million. The
revolving facility carries an interest rate of 1.25% above prime and the term
loan carries an interest rate of 1.5% above prime. The Credit Facility is
secured by all assets of the Company other than certain receivables. At December
27, 1997, the Company had no outstanding borrowings under the revolving credit
facility (excluding approximately $3.0 million of documentary and standby
letters of credit) and approximately $7.9 million outstanding under the term
loans, which were originally due November 1997 and were extended to November
1998. Remaining availability under the Congress facility was $29.0 million at
December 27, 1997. Under the Credit Facility, the Company is required to comply
with certain restrictive debt covenants including maintaining minimum levels of
net worth and working capital. In December 1996, the minimum net worth covenant
was lowered to $70 million. On March 26, 1997, Congress agreed to waive certain
defaults and further reduce the working capital and net worth covenants for
fiscal 1997 as follows:

<TABLE>
<CAPTION>
WORKING CAPITAL (AS DEFINED) IN THE CREDIT
FACILITY                                         AMOUNT
---------------                              --------------
<S>                                          <C>
January through May 1997                     $  (5,000,000)
June through November 1997                   $           0
December 1997 and thereafter                 $ (10,000,000)
</TABLE>

<TABLE>
<CAPTION>
NET WORTH                                        AMOUNT
---------                                    --------------
<S>                                          <C>
January through May 1997                     $  14,000,000
June 1997 and thereafter                     $  21,500,000
</TABLE>


Congress also agreed at that time to amend the covenant relating to material
adverse changes so that measurement thereunder would commence from December 28,
1996. The amount that can be borrowed under the Congress Facility is based on
percentages of acceptable inventory and accounts receivable as reported to
Congress from time to time. Congress began lowering the advance rate for
inventories in November 1996 and continued to reduce it until a new inventory
appraisal was completed in March 1997. The advance rate remained the same
through the balance of 1997. In November 1997, a new inventory appraisal was
completed and negotiations for the refinancing of the Revolving Credit Facility
commenced. Under the terms of the re-negotiated Credit Facility, effective March
1998, the inventory advance rate will be increased at this time and the facility
will be extended to January 31, 2001.

         In September 1996, IMR (an affiliate of NAR) loaned the Company $10
million as evidenced by a subordinated promissory note in the amount of $10
million (the "IMR Promissory Note"). Such loan bore interest at prime plus 1
1/2%, was due on November 14, 1996 and, if it was not repaid before May 15,
1997, was convertible at the option of NAR into shares of Common Stock at the
lower of the fair market value thereof on the date of execution or the then
current fair market value thereof. The IMR Promissory Note was subordinate to
the Credit Facility and excluded from the working capital covenant calculation.
NAR applied this $10 million note to acquire $10 million of the Company's Common
Stock in the 1997 Rights Offering (see "1997 Rights Offering").

         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, currently 12.0%, payable to Richemont quarterly on amounts drawn
under the letters of credit. The Company also agreed to pay a facility fee equal
to 5% of the principal amount of the letters of credit as well as all 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


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<PAGE>   9

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. On December 5, 1996, Richemont advanced the Company $10 million
against the anticipated $28 million line of credit. The Company repaid the $10
million loan after the letter of credit agreement was in place on December 19,
1996. In November 1997, Richemont Finance 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 Finance a fee of 4%
of the principal amount of each letter of credit aggregating $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.

         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 Finance entered into a standby purchase agreement (the
"Richemont Standby Purchase Agreement") to purchase all shares not subscribed to
by shareholders of record at the subscription price. Richemont Finance 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 Finance 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). In connection with the
entering of the Richemont Standby Purchase Agreement, the Company named two
Richemont representatives, Messrs. Jan P. du Plessis and Howard M.S. Tanner, to
its Board of Directors (the "Board") and nominated a third representative to
become a member of the Board, Mr. Shailesh J. Mehta, at the 1997 Annual Meeting
of Shareholders. Messrs. du Plessis and Tanner filled positions vacated by the
resignations of Geraldine Stutz and Jeffery R. Laikind. Mr. Mehta was nominated
and elected to the Board in 1997 to fill a newly created Board position. In
addition, Messrs. du Plessis and Tanner were named to the Audit, Executive and
Stock Option & Executive Compensation Committees of the Board.

         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.


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<PAGE>   10

         In order to facilitate vendor shipments and to permit the commencement
of the Company's plan to consolidate certain of its warehouse facilities,
Richemont Finance 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
are restricted and have not been registered under the Securities Act of 1933, as
amended. The Company also entered into a registration rights agreement with
SMALLCAP that calls for the Company to use its best efforts to effect the
registration of such shares as soon as practicable after April 1, 1998 and has
granted certain piggyback registration rights. The Company may delay such
registration for a period of not more that ninety calendar days if, in the
reasonable judgment of the Board, such filing is not in the best interests of
the Company at such time. Such registration is to be effected by preparation and
filing by the Company with the Securities and Exchange Commission of a
registration statement on Form S-3. The Company is to pay all expenses in
connection with the registration of such shares.

EMPLOYEES

         The Company currently employs approximately 2,700 persons on a full
time basis and approximately 400 persons on a part time basis. In accordance
with a cost savings plan announced in December 1996, the Company eliminated 400
positions in 1997. Approximately 200 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 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 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. Sales from the Internet for


                                       9

<PAGE>   11
Web site merchandisers have grown in 1997. The Company believes strongly in the
future of the Internet and online commerce and has adjusted its marketing focus,
resources, and manpower to that end. However, there can be no assurance that the
Company will be successful in these endeavors.

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. The Company also leased a warehouse facility of
433,000 square feet in Hanover, Pennsylvania which lease expired in May 1997.

         In Roanoke, Virginia, the Company owns a 530,000 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 now closed 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 partnership in which it owns a 50% interest. The Company and the
partnership are currently looking for a sublessee for this now empty 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 previously serviced by such
facility were consolidated with and into the home fashions distribution center
in Roanoke, Virginia in 1997 and the remaining four catalogs are expected to be
consolidated with and into the Roanoke home fashions distribution center by the
end of 1998. During 1998, the Company intends to use the


                                       10

<PAGE>   12
distribution center for third-party fulfillment and processing. The Company
currently intends to vacate this facility in fiscal 1998.

         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 the telemarketing center
extend through 2009.

         The Company's principal retail operations consist of the Gump's retail
store, which occupies approximately 38,600 square feet in a building in
downtown San Francisco, California which is leased pursuant to a 15-year lease
expiring in the year 2010 with two successive five-year renewal options.
A portion of the Gump's facility, consisting of approximately 30,000 square
feet, is subleased and a portion, consisting of approximately 18,800 square
feet, 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.


                                       11

<PAGE>   13

<TABLE>
<CAPTION>
                                                                            APPROXIMATE
LOCATION(a)                                   STATUS                      SQUARE FOOTAGE
--------------------------------------     ------------                   --------------
<S>                                        <C>                            <C>
WAREHOUSE AND FULFILLMENT CENTERS:
Roanoke, VA                                       Owned                       530,000
Hanover, PA                                      Leased                       433,000(b)
Hanover, PA                                Leased/Owned                       265,000
LaCrosse, WI                                     Leased                       185,000

CORPORATE AND ADMINISTRATIVE OFFICES:
Weehawken, NJ                                    Leased                        85,000(c)
San Diego, CA                                    Leased                        30,000(d)
San Francisco, CA                                Leased                        18,800(e)
Beachwood, OH                                    Leased                         7,740

TELEMARKETING AND CUSTOMER SERVICE:
Hanover, PA                                      Leased                       123,000
LaCrosse, WI                                      Owned                        58,000
San Diego, CA                                    Leased                        30,000(d)

RETAIL STORES:
Carlsbad, CA                                     Leased                         3,455
San Francisco, CA                                Leased                        38,600(e)
San Diego, CA                                    Leased                         3,800
West Hollywood, CA                               Leased                         3,600
Tysons Corner, VA                                Leased                         1,700
Mayfield Heights, OH                             Leased                         3,750
Hanover, PA                                      Leased                        24,000
Kenosha, WI                                      Leased                         4,708
LaCrosse, WI                                     Leased                        13,326
Madison, WI                                      Leased                         5,206
Oshkosh, WI                                      Leased                         2,000

MANUFACTURING AND ASSEMBLY:
LaCrosse, WI                                      Owned                       150,000
</TABLE>



(a)      Does not include the leased Roanoke, Virginia facility (closed 1997 in
         conjunction with the consolidation of the Company's warehouse
         facilities) or Edgewater, New Jersey (closed 1995).

(b)      Lease ended in May 1997.

(c)      After sublease of approximately 20,000 square feet to an outside tenant
         effective April, 1998, approximate square footage will be reduced to
         65,000 square feet of office space.

(d)      Telemarketing and corporate/administrative functions are all located
         and performed at the one facility. Square footage stated represents the
         entire facility.

(e)      Retail and office space are all located at the one facility. Square
         footage stated represents allocations to corporate/administrative,
         retail and retail storage space.


                                       12

<PAGE>   14

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.

         On August 14, 1996, People's Bank brought an action in United States
District Court for the District of Connecticut, Civil Action No. 396CV01572,
against the Company alleging breach of contract and requesting $20,000,000 in
damages. The matter was settled in January 1998 by payment of $150,000 without
admission of wrongdoing.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

         None.


                                       13

<PAGE>   15

                                   P A R T 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>
1996
 First Quarter                    $1-13/16                      $1-1/8
 Second Quarter                    2                             1-1/8
 Third Quarter                     1-5/8                           7/8
 Fourth Quarter                    1                               5/8
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
</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 11, 1998, there were approximately 4,440 holders of record
of Common Stock.


                                       14

<PAGE>   16

ITEM 6. SELECTED FINANCIAL DATA

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------------------------------------------
The following table presents selected financial data for each of the years indicated:
(in thousands, except share and per share data)        1993             1994             1995             1996             1997
--------------------------------------------------------------------------------------------------------------------------------
 INCOME STATEMENT DATA:
<S>                                           <C>              <C>              <C>              <C>              <C>
    Revenues                                  $     642,511    $     768,884    $     749,767    $     700,314    $     557,638
    Special charges                                      --               --            1,563           36,724           (2,209)
    Depreciation and amortization                     3,279            6,157            9,020           12,192            8,227
    Operating (loss) income                          19,076           15,975          (22,619)         (94,497)          (1,849)
    Interest expense, net                             2,757            2,813            4,531            8,398            8,028
    Income (loss) before extraordinary items         17,337           14,838          (28,153)        (103,895)         (10,876)
    Extraordinary items                                  --               --           (1,837)          (1,134)              --
--------------------------------------------------------------------------------------------------------------------------------
    Net income (loss)                                17,337           14,838          (29,990)        (105,029)         (10,876)
    Preferred stock dividends                        (4,093)            (135)            (240)            (225)            (190)
--------------------------------------------------------------------------------------------------------------------------------
    Net income (loss) applicable to
    common stockholders                       $      13,244    $      14,703    $     (30,230)   $    (105,254)   $     (11,066)
--------------------------------------------------------------------------------------------------------------------------------

    EBITDA (earnings before interest,
      taxes, depreciation and amortization)   $      22,355    $      22,132    $     (13,599)   $     (82,305)   $       6,378

    EBITDA before special charges             $      22,355    $      22,132    $     (12,036)   $     (45,581)   $       4,169
--------------------------------------------------------------------------------------------------------------------------------
 PER SHARE:
    Income (loss) before extraordinary items  $         .17    $         .16    $        (.30)   $        (.93)   $        (.06)
    Extraordinary items                                  --               --             (.02)            (.01)              --
--------------------------------------------------------------------------------------------------------------------------------
    Net income (loss) - basic and diluted     $         .17    $         .16    $        (.32)   $        (.94)   $        (.06)
--------------------------------------------------------------------------------------------------------------------------------
 Weighted average number of
 shares outstanding
    Basic                                        75,625,330       93,285,190       93,029,816      111,441,247      176,621,080
    Diluted                                      77,064,131       93,285,190       93,029,816      111,441,247      176,621,080
--------------------------------------------------------------------------------------------------------------------------------
 BALANCE SHEET DATA (END OF PERIOD):
    Working capital (deficit)                 $      25,180    $      58,501    $      28,774    $      (1,507)   $      47,570
    Total assets                                    188,838          262,246          279,009          220,827          230,299
    Total debt                                       36,160           37,915           62,802           65,189           38,040
    Shareholders' equity                             45,868          109,725           87,210           31,740           75,551
--------------------------------------------------------------------------------------------------------------------------------
</TABLE>

There were no cash dividends declared on the Common Stock in any of the periods.

See Notes to Consolidated Financial Statements.


                                       15

<PAGE>   17

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                                       1995        1996        1997
--------------------------------------------------------------------------------
<S>                                              <C>         <C>         <C>
Revenues                                         100.0%      100.0%      100.0%
Cost of sales and operating expenses              64.5        68.4        64.2
Write-down of inventory of
 discontinued catalogs                             1.1          .2          --
Special charges                                     .3         5.2         (.4)
Selling expenses                                  27.4        27.9        25.3
General and administrative expenses                8.5        10.1         9.7
Depreciation and amortization                      1.2         1.7         1.5
Loss from operations                              (3.0)      (13.5)        (.3)
Interest expense, net                               .6         1.2         1.4
Net (loss)                                        (4.0)%     (15.0)%      (2.0)%
--------------------------------------------------------------------------------
</TABLE>

RESULTS OF OPERATIONS

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, 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 catalogs 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
continuing 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 has resulted from the Company's previously announced cost
reduction plan. These savings have primarily been 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, have 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. 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.


                                       16
<PAGE>   18

1996 Compared with 1995

Net (Loss). The Company reported a net loss before extraor dinary items of
$103.9 million, or $(.93) per share for the year ended December 28, 1996
compared with a net loss before extraordinary items of $28.2 million, or $(.30)
per share, in 1995. Including the effect of the extraordinary losses of $1.1 and
$1.8 million for the early extinguishment of debt, the Company reported net
losses of $105.0 million and $30.0 million, or $(.94) and $(.32) per share, for
the years ended December 28, 1996 and December 30, 1995, respectively. Per share
amounts are expressed after deducting preferred dividends of $.2 million in both
1996 and 1995. The weighted average number of shares outstanding was 111,441,247
for the year ended December 28, 1996 compared to 93,029,816 in 1995.

During the latter part of the year, the Company completed an assessment of
recoverability of long-lived assets for certain underperforming catalogs and
recorded special charges of $36.7 million. These charges included a provision
for the consolidation of distribution centers and relocation of facilities and
severance expenses approximating $14.7 million. Also included in these charges
was the write-off of certain long-lived assets that the Company's management
determined were impaired of approximately $22.0 million.

The net loss in 1996, after considering special charges, was primarily the
result of (i) increased inventory write-downs due to the Company's inability to
properly sustain its inventory position due to liquidity problems and, in
certain instances, the purchase of inventory quantities in excess of demand,
(ii) lower response rates as a result of increased order cancellations, (iii)
increased fulfillment and telemarketing costs due to inventory handling costs
associated with higher backorder levels and increased merchandise returns, and
(iv) the fixed cost infrastructure which the Company's continuing catalogs could
not fully absorb.

Revenues. Revenues decreased 6.6% in 1996 to $700 million from $750 million in
1995. Revenues of continuing business units increased approximately 2% from $584
million in 1995 to $597 million in 1996, which was offset by a 38% decline to
$103 million in revenues from discontinued catalogs. The Company circulated 332
million catalogs in 1996. Although this represents a 10% reduction from the
prior year, continuing catalog circulation increased 1% from the prior year.

Operating Costs and Expenses. Cost of sales and operating expenses, which
include fulfillment and telemarketing costs, as a percentage of revenues
increased to 68.4% in 1996 from 64.5% in 1995. This increase is primarily
attributable to lower product margins due to lower recovery rates experienced
from accelerated disposition of inventory as a result of poor in-stock positions
resulting from liquidity problems, as well as the Company's decision to continue
to reduce inventory levels. Also, inventory write-downs for continuing catalogs
were $11.2 million in 1996, compared to $4.4 million in 1995, primarily for
Domestications, Tweeds and Austad's. These incremental write-downs were recorded
as part of the Company's plans to reduce its inventory levels and the resulting
expectation of lower recovery rates. In addition, fulfillment costs were higher
in 1996 as a result of increased backorder levels and operating inefficiencies
for most of the year in the Company's Roanoke, Virginia fulfillment center.

The write-down of inventory of discontinued catalogs was $1.1 million in 1996
compared to $8.6 million in 1995. These write-downs consisted of incremental
inventory write-downs in excess of normal seasonal write-downs. During 1995, the
Company discontinued six poorly performing catalogs which had incurred
substantial losses and which the Company believed could not overcome increased
paper and postage prices. The write-down in 1996 was recorded due to
significantly lower recovery rates than previously experienced on the
liquidation of inventory related to these catalogs.

Special charges taken by the Company in 1996 totaled $36.7 million. These
charges consist, in part, of severance ($3.2 million), facility exit/relocation
costs and fixed asset write-offs ($11.5 million). These charges were recorded
due to the Company's decision to move to a more streamlined infrastructure. This
plan included the consolidation of several inefficient fulfillment facilities
into existing underutilized facilities and the relocation of corporate offices.
In addition, the Company's review of the carrying value of certain long-lived
assets of Tweeds, Austad's and The Safety Zone's led to the write-off of
approximately $22 million. The Company recorded special charges of approximately
$1.5 million in 1995 consisting primarily of facility exit costs ($.7 million),
lease termination fees ($.3 million) and severance expenses ($.5 million) in
connection with the closing of some of its facilities.

Selling expenses decreased $10.6 million but increased to 27.9% of revenues in
1996 from 27.4% of revenues in 1995. The total expense decreased mainly due to a
10% reduction in catalog circulation. This decrease was offset by increased
catalog postage expense and lower response rates in the current year for the
discontinued catalogs. This expense as a percentage of revenues increased due to
lower response rates as a result of weak customer demand and increased order
cancellations. Catalog postage and paper expense increased as the Company
increased the number of sale pages in its catalogs which were designed to speed
the sale of slow moving inventory.

General and administrative expenses increased $6.5 million, or 10%, in 1996 to
$70.6 million. The increase is primarily attributable to costs associated with
hiring the Company's new management team and to increased bad debt expense
reflecting higher losses on the Company's private label credit card.

Depreciation and amortization increased $3.2 million to $12.2 million in 1996
from $9.0 million in 1995. The increase was attributable to amortization charges
associated with the Roanoke, Virginia fulfillment facility, the management
information system, the new Gump's retail store and the goodwill and mailing
lists associated with the 1995 acquisitions that did not impact the 1995
operating results for the entire year.

(Loss) from Operations. Loss from operations increased to $94.5 million in 1996
from a loss of $22.6 million in 1995. Losses from operations for discontinued
catalogs decreased to $4.8 million in 1996 from $18.1 million in 1995.

The increased loss from operations was mainly due to an overall erosion of the
Company's product margin. This was caused by increased promotional activity and
higher fulfillment costs. The Company's loss from operations was also negatively
impacted by increased catalog costs due to increased catalog mailing costs,
lower response rates and increased order cancellations.

Interest Income (Expense). Interest expense increased approximately $3.8 million
to $8.9 million in 1996 from $5.1 million in 1995. Included in interest expense
is approximately $1.1 million of debt costs which were paid in prior years. The
increase was due to a higher level of average borrowings outstanding under the
Company's revolving credit facility in 1996 which is attributable to the
Company's deteriorating financial performance in 1996 and increased demands on
its working capital throughout most of the year. Interest income was $.5 million
in 1996 and 1995.


                                       17

<PAGE>   19

Income Taxes. The Company did not record a Federal income tax provision in 1996
or 1995 based on each years' net operating losses. The Company's state tax
provision was $1.0 million in 1996 and 1995.

Shareholders' Equity. The number of shares of Common Stock outstanding increased
by 52,111,797 in 1996 due to shares issued in connection with the Company's 1996
Rights Offering, its equity and incentive plans, the exchange of the 6% Series A
Convertible Preferred Stock and other activities. At December 28, 1996, there
were 144,647,898 shares of Common Stock outstanding compared to 92,536,101
shares of Common Stock outstanding at December 30, 1995.

Extraordinary Items. The extraordinary loss of $1.1 million in 1996 represented
a loss on the early extinguishment of debt which arose in connection with the
payment of the Company's 9.25% Senior Subordinated Notes due in 1998 with
proceeds from the 1996 Rights Offering. The extraordinary loss of $1.8 million
in 1995 represented a loss on the early extinguishment of debt which arose in
connection with the refinancing of the Company's $75 million Revolving Credit
Facility and its $14 million of 9.25% Senior Subordinated Notes due 1998.

LIQUIDITY AND CAPITAL RESOURCES

Liquidity. The Company had $14.8 million and $5.2 million of cash and cash
equivalents at December 27, 1997 and December 28, 1996, respectively. Working
capital and current ratio were $47.6 million and 1.48 to 1 at December 27, 1997
versus a working capital deficit and current ratio of ($1.5) million and .99 to
1 at December 28, 1996. 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 primarily to fund the $20.8 million reduction of accounts payable,
the $13.7 million reduction and complete pay-down of the Company's revolving
debt, $3.5 million of debt payments and $4.2 million of capital expenditures,
primarily for construction at the Roanoke, VA distribution facility.

As a result of the Company's continued operating losses in 1996, 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 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 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 $28 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 3.5% above the prime rate, currently 12%. 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.

At December 27, 1997, the Company had $5.3 million of current debt. On March 25,
1998, Congress agreed to extend the Revolving Credit Facility until January 31,
2001. In addition, the Revolving Term Notes of $7.9 million were extended to
January 31, 2001. The Company will continue to make principal payments of
approximately $.1 million per month. The Company had zero amounts outstanding on
the Congress Credit Facility at December 27, 1997 and $13.7 million at December
28, 1996. The total amount available under the Congress Credit Facility at
December 27, 1997 was $29 million.

Throughout fiscal 1997, the Company implemented several initiatives to
strengthen financial disciplines and account ability across its catalog brands
and corporate organization. These initiatives, in addition to the Company's
operating and cost reduction plan, are designed to better enable the Company to
meet its operating goals through better cash control and "bottom-line"
accountability. Such initiatives have begun to show positive results across the
Company's infrastructure.

In March 1997, the Company received waivers for events of default under the
Credit Facility with Congress which existed at December 28, 1996. In addition,
Congress and the Company agreed to new working capital and net worth covenants
for fiscal 1997. The Company believes that the 1997 Rights Offering, together
with the Credit Facility modifications and the extension of the letter of credit
by Richemont has eased the vendor/credit concerns about the Company's viability.
The Company's ability to continue to improve upon its prior year's performance
and implement its business strategy is critical to maintaining adequate
liquidity.

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 for an aggregate
purchase price of approximately $5.2 million in a private placement.

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.


                                       18
<PAGE>   20

The Company is required to maintain certain financial covenants related to the
Credit Facility with Congress with which the Company is in compliance at
December 27, 1997.

Operating Plan. In December 1996, the Company began an operational realignment
that it believes will better enable it to capitalize on its internal strengths.
The Company is continuing to move to a brand structure whereby individual
catalogs will be better able to manage their resources and capitalize on
business opportunities. This plan provides for each catalog's management team to
be responsible for its brand financial results, working capital requirements and
business investment needs. The Company believes that this structure will result
in better management of vendor relationships, inventories and working capital.

Infrastructure Investments. The Company's plan to restructure its catalogs into
distinct brands and concentrate its mailing efforts on profitable customers is
expected to result in excess capacity throughout its fulfillment centers. The
Company has begun the process to consolidate certain of its fulfillment
operations into its home fashions distribution facility in Roanoke, VA. The
consolidation will be completed in 1998. This will require a capital investment
of approximately $8.0 million during 1997 and 1998, of which approximately $3.6
million was paid for in 1997.

Based on preliminary study, the Company is not expected to have significant
expenditures to modify its computer information systems enabling proper
processing of transactions relating to the year 2000 and beyond. The Company
continues to evaluate appropriate courses of corrective action, including
replacement of certain systems. The Company does not expect the amounts required
to be expensed over the next two years to have a material effect on its
financial position or results of operations. The Company is attempting to
contact vendors and others on whom it relies to assure their systems will be
timely converted. However, there can be no assurance that the systems of other
companies on which the Company's systems rely 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 systems and its business.

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. In 1997 paper prices increased
significantly. 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 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 14% of revenues
in 1997. Paper costs represented approximately 6% of revenues in 1997. The
Company anticipates that any paper price increase in 1998 will not have a
significant impact on its cost structure.

The USPS announced a proposed increase in mailing rates that will take effect in
mid-1998. The Company is currently investigating ways to mitigate the effects of
these expected increases. If the Company does not successfully develop any such
plan, 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. The Company expects its actual United Parcel Services costs to exceed the
stated percentage increases and is investigating alternatives to minimize this
impact. The Company does not expect the increase to have a material adverse
effect on its results of operations.

Cautionary Statements

The following statements constitute forward looking statements which involve
risks and uncertainties:

"The Company is continuing to move to a brand structure whereby individual
catalogs will be better able to manage their resources and capitalize on
business opportunities."

Based on the preliminary study, the Company is not expected to have significant
expenditures to modify its computer information systems enabling proper
processing of transactions relating to the year 2000 and beyond.

The Company does not expect the amount required to be expensed over the next two
years to have a material effect on its financial position or results of
operations.

The Company anticipates that any paper price increase in 1998 will not have a
significant impact on its cost structure.

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:

The Company may develop a plan which fails to offset the effect of anticipated
increases in its postage and UPS costs or which inadequately does so.

The Company is unable to complete, substantially as scheduled, the migration of
fulfillment activities for all of its catalogs to its facility in Roanoke, Va.

A general reduction in the price level of some or all of the merchandise offered
by the Company in its catalogs due to economic conditions in Asia and the highly
competitive nature of the Company's business resulting, for example, in a
decrease in the Company's margins.

A reduction in consumer spending generally or specifically with respect to the
types of merchandise that the Company offers in its catalogs.

A general deterioration in the 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 that the Company
offers in its catalogs.

An increase in the failure rate of consumer indebtedness generally; an increase
in credit sales by the Company accompanied by an increase in its bad debt
experience with respect to consumer debt.


                                       19
<PAGE>   21

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

                  None.


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 27, 1997 and
December 28, 1996, 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 27, 1997. 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 27, 1997 and December 28, 1996 and the results of
their operations and their cash flows for each of the three fiscal years in the
period ended December 27, 1997 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
March 4, 1998 (except with respect to the matter discussed in Note 8, as to
which the date is March 25, 1998).





                                       20

<PAGE>   22
CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------------------------
                                                                                December 28,   December 27,
 As of December 28, 1996 and December 27, 1997 (in thousands)                           1996           1997
-------------------------------------------------------------------------------------------------------------
 ASSETS
<S>                                                                                <C>            <C>
 Current Assets:
     Cash and cash equivalents                                                     $   5,173      $  14,758
     Accounts receivable, net of allowance for doubtful accounts
      of $5,030 in 1996 and $3,358 in 1997                                            29,399         17,684
     Accounts receivable under financing agreement                                        --         21,918
     Inventories                                                                      67,610         64,330
     Prepaid catalog costs                                                            23,401         20,684
     Deferred tax asset, net                                                           3,300          3,300
     Other current assets                                                              3,148          3,083
-------------------------------------------------------------------------------------------------------------
        Total Current Assets                                                         132,031        145,757
-------------------------------------------------------------------------------------------------------------
 Property and Equipment, at cost:
     Land                                                                              4,797          4,909
     Buildings and building improvements                                              16,554         16,486
     Leasehold improvements                                                            9,956          9,040
     Furniture, fixtures and equipment                                                36,511         47,210
     Construction in progress                                                          8,315          4,519
-------------------------------------------------------------------------------------------------------------
                                                                                      76,133         82,164
     Accumulated depreciation and amortization                                       (22,523)       (29,712)
-------------------------------------------------------------------------------------------------------------
     Property and Equipment, net                                                      53,610         52,452
-------------------------------------------------------------------------------------------------------------
     Goodwill, net                                                                    17,901         17,412
     Deferred tax asset, net                                                          11,700         11,700
     Other assets                                                                      5,585          2,978
-------------------------------------------------------------------------------------------------------------
        Total Assets                                                               $ 220,827      $ 230,299
-------------------------------------------------------------------------------------------------------------
 LIABILITIES AND SHAREHOLDERS' EQUITY
 Current Liabilities
     Current portion of long-term debt and capital lease obligations               $  11,452      $   5,305
     Accounts payable                                                                 79,587         58,799
     Accrued liabilities                                                              37,782         30,259
     Customer prepayments and credits                                                  4,717          3,824
-------------------------------------------------------------------------------------------------------------
        Total Current Liabilities                                                    133,538         98,187
-------------------------------------------------------------------------------------------------------------
 Non-current Liabilities:
     Long-term debt                                                                   53,255         32,668
     Obligations under receivable financing                                               --         21,918
     Capital lease obligations                                                           482             67
     Other                                                                             1,812          1,908
-------------------------------------------------------------------------------------------------------------
        Total Non-current Liabilities                                                 55,549         56,561
-------------------------------------------------------------------------------------------------------------
        Total Liabilities                                                            189,087        154,748
-------------------------------------------------------------------------------------------------------------
 Commitments and Contingencies (Note 17)
 Shareholders' Equity
     Series B Convertible Additional Preferred Stock, $.01 par value, authorized,
      issued and outstanding 634,900 shares in 1996 and 1997                           5,748          5,938
     Common Stock, $.66 2/3 par value, authorized 225,000,000 shares; issued
      145,039,915 shares in 1996 and 204,441,538 in 1997                              96,693        136,294
     Capital in excess of par value                                                  270,097        285,165
     Accumulated deficit                                                            (336,586)      (347,652)
-------------------------------------------------------------------------------------------------------------
                                                                                      35,952         79,745
-------------------------------------------------------------------------------------------------------------
     Less:
     Treasury stock, at cost (392,017 shares in 1996 and 686,216 shares in 1997)        (813)          (968)
     Notes receivable from sale of Common Stock                                       (3,399)        (3,226)
-------------------------------------------------------------------------------------------------------------
        Total Shareholders' Equity                                                    31,740         75,551
-------------------------------------------------------------------------------------------------------------
        Total Liabilities and Shareholders' Equity                                 $ 220,827      $ 230,299
-------------------------------------------------------------------------------------------------------------
</TABLE>

See Notes to Consolidated Financial Statements.


                                       21
<PAGE>   23

CONSOLIDATED STATEMENTS OF INCOME (LOSS)

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------------------
 For the years ended December 30, 1995, December 28, 1996 and December 27, 1997
 (In thousands, except per share amounts)                                 1995         1996         1997
--------------------------------------------------------------------------------------------------------
<S>                                                                  <C>          <C>          <C>
 Revenues                                                            $ 749,767    $ 700,314    $ 557,638
--------------------------------------------------------------------------------------------------------
 Operating costs and expenses:
     Cost of sales and operating expenses                              483,493      479,155      358,219
     Write-down of inventory of discontinued catalogs                    8,580        1,100           --
     Special charges (credit)                                            1,563       36,724       (2,209)
     Selling expenses                                                  205,618      195,032      141,411
     General and administrative expenses                                64,112       70,608       53,839
     Depreciation and amortization                                       9,020       12,192        8,227
--------------------------------------------------------------------------------------------------------
                                                                       772,386      794,811      559,487
--------------------------------------------------------------------------------------------------------
 (Loss) from operations                                                (22,619)     (94,497)      (1,849)
     Interest expense                                                   (5,050)      (8,858)      (8,028)
     Interest income                                                       519          460           --
     (Loss) before income taxes                                        (27,150)    (102,895)      (9,877)
     Income tax provision                                                1,003        1,000          999
--------------------------------------------------------------------------------------------------------
     (Loss) before extraordinary item                                  (28,153)    (103,895)     (10,876)
     Extraordinary item (Note 8)                                        (1,837)      (1,134)          --
--------------------------------------------------------------------------------------------------------
 Net (loss)                                                            (29,990)    (105,029)     (10,876)
     Preferred stock dividends                                            (240)        (225)        (190)
--------------------------------------------------------------------------------------------------------
 Net (loss) applicable to Common Shareholders                        $ (30,230)   $(105,254)   $ (11,066)
--------------------------------------------------------------------------------------------------------
 Net (loss) per share:
     Loss before extraordinary item                                  $    (.30)   $    (.93)   $    (.06)
--------------------------------------------------------------------------------------------------------
     Extraordinary item                                                   (.02)        (.01)          --
--------------------------------------------------------------------------------------------------------
     Net (loss) per share - basic and diluted                        $    (.32)   $    (.94)   $    (.06)
--------------------------------------------------------------------------------------------------------
     Weighted average common shares outstanding - basic and diluted     93,030      111,441      176,621
--------------------------------------------------------------------------------------------------------
</TABLE>

See Notes to Consolidated Financial Statements.


                                       22
<PAGE>   24

CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------------------------------
 For the years ended December 30, 1995, December 28, 1996, and December 27, 1997 (in
 thousands)                                                                          1995         1996         1997
-------------------------------------------------------------------------------------------------------------------
<S>                                                                             <C>          <C>          <C>
 Cash flows from operating activities:
      Net (loss)                                                                $ (29,990)   $(105,029)   $ (10,876)
      Adjustments to reconcile net (loss) to net cash (used) by operating
       activities:
        Depreciation and amortization including deferred fees                       9,419       13,277       10,581
        Provision for doubtful accounts                                             4,448        6,805        3,973
        Provision for catalog and facility closings                                10,143       14,720       (2,209)
        Write-off of long-lived assets                                                500       22,000           --
        Extraordinary item - early extinguishment of debt                           1,837        1,134           --
        Provision for losses on notes receivable and marketable securities             --          888           --
        Other, net                                                                     76           53           --
        Compensation expense related to stock options                                  --          540        1,800
        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                                                   (6,161)      (7,863)       7,742
        Inventories                                                                 8,679       11,671        3,280
        Prepaid catalog costs                                                         206       13,717        2,717
        Other assets                                                               (3,131)       1,332         (205)
        Accounts payable                                                           (8,671)     (13,704)     (20,788)
        Accrued liabilities                                                        (1,583)         679       (6,583)
        Customer prepayments and credits                                            3,134       (2,430)        (893)
-------------------------------------------------------------------------------------------------------------------
      Net cash (used) by operating activities                                     (11,094)     (42,210)     (12,735)
-------------------------------------------------------------------------------------------------------------------
 Cash flows from investing activities:
      Acquisitions of property and equipment, net                                 (13,686)      (8,862)      (4,222)
      Purchase of businesses                                                      (13,008)          --           --
      Proceeds from sales of businesses                                                --        1,980           --
      Proceeds from investment                                                         --          794        1,274
      Other, net                                                                   (1,387)          --           --
-------------------------------------------------------------------------------------------------------------------
      Net cash (used) by investing activities                                     (28,081)      (6,088)      (2,948)
-------------------------------------------------------------------------------------------------------------------
 Cash flows from financing activities:
      Net proceeds (payments) under revolving credit facility                          --       11,699      (13,710)
      Proceeds from issuance of debt                                               20,685       10,000           --
      Payments of long-term debt and capital lease obligations                     (1,419)     (17,625)      (3,575)
      Payment of stock issuance costs                                                  --       (1,670)      (3,073)
      Payment of debt issuance costs                                               (2,202)      (1,490)          --
      Proceeds from issuance of Common Stock                                          400       50,653       45,351
      Other, net                                                                      340         (778)         275
-------------------------------------------------------------------------------------------------------------------
      Net cash (used) by financing activities                                      17,804       50,789       25,268
-------------------------------------------------------------------------------------------------------------------
      Net increase (decrease) in cash and cash equivalents                        (21,371)       2,491        9,585
      Cash and cash equivalents, beginning of year                                 24,053        2,682        5,173
-------------------------------------------------------------------------------------------------------------------
      Cash and cash equivalents, end of year                                    $   2,682    $   5,173    $  14,758
-------------------------------------------------------------------------------------------------------------------
      Supplemental cash flow disclosure:
        Interest paid                                                           $   4,586    $   7,773    $   5,674
        Income taxes paid                                                       $   1,318    $   1,096    $     685
-------------------------------------------------------------------------------------------------------------------
</TABLE>

 See Notes to Consolidated Financial Statements.


                                       23
<PAGE>   25

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
For the years ended December 30, 1995, December 28, 1996 and December 27, 1997

                                                             Preferred Stock           Preferred Stock
                                                          Series B, Cumulative          Series A, 6.0%
 (in thousands, except share amounts)                     Shares        Amount        Shares       Amount
-----------------------------------------------------------------------------------------------------------
<S>                                                      <C>        <C>              <C>       <C>
 Balance at January 1, 1995                                    0        $    0       156,600   $ 1,589
 Net income/(loss) applicable to common shareholders
 Issuance of Preferred Stock                             634,900         5,400
 Fair market value of warrant extensions
 Preferred stock dividends and accretion                                   158                      83
 Conversion of the 6% Preferred Stock                                                (78,300)     (877)
 Issuances and forfeitures of Common Stock for
  employee stock plans
-----------------------------------------------------------------------------------------------------------
 Balance at December 30, 1995                            634,900        $5,558        78,300   $   795
-----------------------------------------------------------------------------------------------------------
 Net income/(loss) applicable to common shareholders
 Shares issued in Rights Offering
 Preferred stock dividends and accretion                                   190                      35
 Conversion of the 6% Preferred Stock                                                (78,300)     (830)
 Purchase of treasury stock
 Transfer of treasury stock related to employment
  agreement
 Sale of treasury stock
 Issuances and forfeitures of Common Stock for
  employee stock plans
-----------------------------------------------------------------------------------------------------------
 Balance at December 28, 1996                            634,900        $5,748             0   $     0
-----------------------------------------------------------------------------------------------------------
 Net income (loss) applicable to common shareholders
 Preferred stock dividends and accretion                                   190
 Stock options granted
 Shares issued in 1997 Rights Offering, net of
  issue costs
 Issuance of Common Stock to SMALLCAP World
  Fund, Inc.
 Issuances and forfeitures of Common Stock for
  employee stock plans
-----------------------------------------------------------------------------------------------------------
 Balance at December 27, 1997                            634,900        $5,938             0   $     0
-----------------------------------------------------------------------------------------------------------
</TABLE>


                                       24
<PAGE>   26

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
For the years ended December 30, 1995, December 28, 1996 and December 27, 1997

                                                                Common Stock
                                                             $.66 2/3 par value  Capital in Excess      Accum.
 (in thousands, except share amounts)                        Shares       Amount   of Par Value        (Deficit)
-------------------------------------------------------------------------------------------------------------------
<S>                                                      <C>          <C>          <C>               <C>
 Balance at January 1, 1995                              92,978,234   $   61,985   $  253,210        $ (201,102)
 Net income/(loss) applicable to common shareholders                                                    (30,230)
 Issuance of Preferred Stock
 Fair market value of warrant extensions                                                1,200
 Preferred stock dividends and accretion
 Conversion of the 6% Preferred Stock                       427,785          285          592
 Issuances and forfeitures of Common Stock for
  employee stock plans                                      287,143          191          388
-------------------------------------------------------------------------------------------------------------------
 Balance at December 30, 1995                            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
 Conversion of the 6% Preferred Stock                       819,733          546          284
 Purchase of treasury stock
 Transfer of treasury stock related to employment
  agreement                                                                            (2,750)
 Sale of treasury stock                                                                    28
 Issuances and forfeitures of Common Stock for
  employee stock plans                                    1,778,235        1,187          678
-------------------------------------------------------------------------------------------------------------------
 Balance at December 28, 1996                           145,039,915   $   96,693   $  270,097        $ (336,586)
-------------------------------------------------------------------------------------------------------------------
 Net income (loss) applicable to common shareholders                                                    (11,066)
 Preferred stock dividends and accretion
 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 and forfeitures of Common Stock for
  employee stock plans                                       47,000           31           20
-------------------------------------------------------------------------------------------------------------------
 Balance at December 27, 1997                           204,441,538   $  136,294   $  285,165        $ (347,652)
-------------------------------------------------------------------------------------------------------------------
</TABLE>

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
For the years ended December 30, 1995, December 28, 1996 and December 27, 1997

                                                                                 Notes Receivable
                                                              Treasury Stock       From Sale of      Deferred
 (in thousands, except share amounts)                      Shares        Amount    Common Stock          Comp.         Total
-----------------------------------------------------------------------------------------------------------------------------
<S>                                                   <C>           <C>           <C>              <C>           <C>
 Balance at January 1, 1995                           (1,157,061)   $   (3,345)   $   (1,912)      $     (700)   $  109,725
 Net income/(loss) applicable to common shareholders                                                                (30,230)
 Issuance of Preferred Stock                                                                                          5,400
 Fair market value of warrant extensions                                                                              1,200
 Preferred stock dividends and accretion                                                                                241
 Conversion of the 6% Preferred Stock                                                                                     0
 Issuances and forfeitures of Common Stock for
  employee stock plans                                                                  (111)             406           874
-----------------------------------------------------------------------------------------------------------------------------
 Balance at December 30, 1995                         (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 and forfeitures of Common Stock for
  employee stock plans                                                                (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 dividends and 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 and forfeitures of Common Stock for
  employee stock plans                                  (294,199)         (155)          173                             69
-----------------------------------------------------------------------------------------------------------------------------
 Balance at December 27, 1997                           (686,216)      $  (968)   $   (3,226)      $        0    $   75,551
-----------------------------------------------------------------------------------------------------------------------------
</TABLE>

See Notes to Consolidated Financial Statements.

                                       25
<PAGE>   27

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

YEARS ENDED DECEMBER 30, 1995, DECEMBER 28, 1996 AND DECEMBER 27, 1997

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. HDI also operates several
retail operations in the United States which comprised approximately 5% of HDI's
revenues for the year ended December 27, 1997.

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 27, 1997, December 28, 1996 and December 30,
1995 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 $.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 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 - Costs related to mail order catalogs and promotional
material are capitalized and amortized over their estimated productive lives,
generally not exceeding six months. Total catalog expense was $139.0 million,
$193.5 million and $197.3 million, respectively, in 1997, 1996 and 1995.

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.

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 $3.0 million at December 27, 1997
and December 28, 1996, respectively.

Mailing Lists - The costs of acquired mailing lists are amortized over a five
year period. Mailing lists, included in Other assets, amounted to $.6 million
and $1.2 million at December 27, 1997 and December 28, 1996, respectively, and
are carried net of accumulated amortization of $2.1 million and $1.5 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.

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 of additional accounts receivable and
associated long-term debt. 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 are to be applied
prospectively, from January 1, 1997. Retroactive application is not permitted,
however, the amount of adjustment at December 28, 1996 would have been a
recognition of an additional $24.7 million in both receivables and the
associated receivable financing obligation.

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 1997, 1996
and 1995 was 176,621,080, 111,441,247 and 93,029,816 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 1995, 1996 and 1997.


                                       26
<PAGE>   28
 Recently Issued Accounting Standards - In June 1997, the Financial Accounting
Standards Board issued SFAS No.130, "Reporting Comprehensive Income." This
Statement establishes standards for reporting and display of comprehensive
income and its components (revenues, expenses, gains, and losses) in a full set
of general-purpose financial statements. The statement is effective for fiscal
years beginning after December 15, 1997. Reclassification of financial
statements for earlier periods provided for comparative purposes is required.
The Company is still assessing the impact of the adoption of this statement to
the financial statements.

Additionally, in June 1997, the Financial Accounting Standards Board issued SFAS
No. 131, "Disclosures about Segments of an Enterprise and Related Information."
This statement establishes standards for the way that public business
enterprises report information about operating segments in annual financial
statements and requires that those enterprises report selected information about
operating segments in interim financial reports issued to shareholders. This
statement is effective for financial statements for periods beginning after
December 15, 1997 and need not be applied to interim periods in the initial year
of application. Comparative information for earlier years presented is to be
restated. The Company is still assessing the impact of this statement on its
financial statement disclosure.

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>
--------------------------------------------------------------------------------
 (In thousands)                            1995           1996           1997
--------------------------------------------------------------------------------
<S>                                    <C>            <C>            <C>
 Capital lease obligations             $  1,155       $     --       $    163
 Other equity issuances and
  exchanges                            $  1,456       $  2,855       $ 10,000
 Acquisition of businesses:
  Fair value of assets acquired        $ 45,165       $     --       $     --
  Fair value of liabilities assumed     (26,757)            --             --
  Preferred stock issued                 (5,400)            --             --
 Net cash paid                         $ 13,008       $     --       $     --
--------------------------------------------------------------------------------
</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 10. 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 customer mailing list intangible assets were also
acquired in this transaction. In December 1996, the Com pany 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 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 28, 1996. 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
attempt 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 $1
million decline in fair value of the investment was considered an
other-than-temporary impairment and included in the income statement in 1994.
The convertible debt matures on June 15, 2008. In December 1995, a plan of
reorganization was confirmed by the Bankruptcy Court and the Company expected to
recover the $1.7 million carrying value of its investment; however, only $.8
million of distributions were received through 1996. During 1996, a federal
income tax refund due to Regal was reviewed by the Internal Revenue Service (the
"IRS"), and the results of this review were submitted to the Joint Committee
of the IRS for approval. Due to the uncertainty that recoverability of
substantially all of the remaining


                                       27
<PAGE>   29

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).

Tiger Direct - In February 1995, the Company entered into an agreement to
acquire certain securities of Tiger Direct, Inc. ("Tiger"), a direct marketer of
computer software, peripherals and CD-ROM hardware and software. In February
1995, the Company entered into a loan and security agreement with Tiger pursuant
to which the Company provided a secured working capital line of credit to Tiger,
up to a maximum of $3.0 million, which was loaned under such agreement. In
September 1995, due to the continued deterioration of Tiger's financial
condition, the Company terminated the securities purchase agreement and sold the
loan to a third party and received payment in full for the principal of the loan
and interest to the date of sale.

During the period from February 1995 to September 1995, the Company provided
certain services to Tiger and also incurred certain costs related to entering
into the loan and security agreement aggregating $.5 million. Under the terms of
the agreement, Tiger is required to reimburse the Company for such costs and
services rendered. Tiger refused to reimburse the Company for these costs
causing the Company to institute an action to recover such costs, which were
carried at their estimated realizable value. In February 1997, the Company
recovered $.2 million in settlement of such action.

Boston Publishing Company - In February 1994, the Company acquired a 20% equity
interest in Boston Publishing Company ("BPC") and provided secured and unsecured
loans to BPC. In August 1994, BPC filed for protection under Chapter 11 of the
United States Code.

In 1995, the Company received inventory and the customer mailing list of BPC in
payment of its $1.2 million loan and subsequently realized $.3 million upon
disposition of these assets and wrote-off the remaining assets.

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 previously
announced downsizing of the Company, as discussed in its December 1996 press
release. In addition, the special charges included a write-off for impairment of
long-lived assets of certain under-performing 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 consists 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.

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 $2.7 million of severance during fiscal 1997 and
provided approximately $.5 million for remaining severance to be paid at its
Hanover, PA. distribution center. Reserves for severance costs approximated $1
million and $3.2 million at December 27, 1997 and December 28, 1996,
respectively, and are included in Accrued liabilities in the accompanying
consolidated balance sheet.

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 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.
The remaining four catalogs are expected to be relocated by the end of fiscal
1998. In addition, the Company modified its plan to vacate from its Weehawken,
NJ corporate facility by agreeing to sublet a portion of the facility.
Approximately $4.4 million and $6.3 million of these costs are recorded in
Accrued liabilities in the accompanying consolidated balance sheets at December
27, 1997 and December 28, 1996.

In 1995, the Company incurred costs, aggregating approximately $1.5 million in
connection with the consolidation of its fulfillment facilities. These costs
include moving expenses, lease termination fees and severance expenses,
substantially all of which were paid in 1995.

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 1995, the Company made a decision to discontinue six catalogs. The six
discontinued catalogs generated revenues of $0.6 million, $20 million and $88
million and losses of $0.1 million, $5.1 million and $20 million in 1997, 1996
and 1995, respectively. These losses were attributable to falling revenues due
to poor sales on the discontinued catalogs, increasing operating costs and
expenses and increasing selling expenses predominantly incurred to create
liquidation catalogs. The losses in 1996 and 1995 include provisions of
approximately $1.1 million and $8.6 million, respectively, primarily related to
the write-down of inventory associated with these catalogs to their net
realizable value based on the planned liquidation of such inventory. No such
provision was recorded in 1997. The $8.6 million write-down in 1995 occurred
because the Company anticipated mailing fewer catalogs than originally planned
for 1996, which resulted in significantly more merchandise on-hand that needed
to be moved through non-catalog channels. The inventory write-down of $1.1
million in 1996 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.


                                       28
<PAGE>   30

5. SEARS LICENSING AGREEMENT

In January 1994, the Company entered into a licensing agreement (the "Sears
Agreement") with the direct marketing subsidiary of Sears Roebuck and Co.
("Sears") to produce specialty catalogs for customers of the discontinued Sears
catalog. The Sears Agreement was terminated by Sears in December 1996, and no
catalogs were mailed by the Company in 1997. The 1997 revenues from the Sears
Agreement amounted to $8.5 million which related to catalogs issued in 1996.
Revenues from the Sears Agreement were $82 million and $81 million in 1996 and
1995, respectively. In conjunction with the licensing agreement the Company
issued to Sears a performance warrant to purchase Common Stock in 1998 and 1999.
Due to termination of the Sears agreement, the warrants will not be exercisable.

6. 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 27, 1997 and subsequently has
received waivers for the default.

The proceeds to the Company relating to the sale of receivables for 1997, 1996
and 1995 were $39.0 million, $39.2 million and $46.2 million, respectively. At
December 27, 1997 and December 28, 1996, the uncollected balances under this
program were $29.4 million and $33.5 million, respectively, of which $4.0
million and $4.8 million, respectively, represent deposits under the agreement
which are included in Accounts receivable, net. The total reserve balance
maintained for the repurchase of uncollectible accounts was $2.5 million at
December 27, 1997 and December 28, 1996, of which $1.4 million in both years is
included in Accrued liabilities and the remaining balance is included in the
allowance for doubtful accounts.

Receivables sold under this agreement are considered financial instruments with
off-balance sheet risk as defined in Statement of Financial Accounting Standards
No. 105. 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 $21.9 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 27,
1997.

7. ACCRUED LIABILITIES

Accrued liabilities consist of the following (in thousands):

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
                                                      December 28,  December 27,
                                                              1996          1997
--------------------------------------------------------------------------------
<S>                                                        <C>           <C>
 Restructuring                                             $ 9,504       $ 5,424
 Reserve for future sales returns                            9,036         6,043
 Compensation                                                3,968         7,189
 Taxes                                                       2,696         1,983
 Reserve for repurchase of accounts receivable
  sold with recourse                                         1,389         1,397
 Other                                                      11,189         8,223
   Total                                                   $37,782       $30,259
--------------------------------------------------------------------------------
</TABLE>

8. LONG-TERM DEBT
Long-term debt consists of the following (in thousands):

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
                                                      December 28,  December 27,
                                                              1996          1997
--------------------------------------------------------------------------------
<S>                                                        <C>           <C>
 Congress Facility                                         $22,627       $ 7,917
 Term Financing Facility                                    19,000        18,000
 IMR Promissory Note                                        10,000            --
 6% Mortgage Notes Payable due 1998                          2,969         2,787
 Industrial Revenue Bonds with variable interest
  rates averaging 3.6% in 1996 and 4% in 1997
  due 2003                                                   8,000         8,000
 7.5% Convertible Subordinate Debentures due 2007              751           751
 Other                                                          16            --
                                                            63,363        37,455
 Less: current portion                                      10,108         4,787
   Total                                                   $53,255       $32,668
--------------------------------------------------------------------------------
</TABLE>

Congress Facility - The Congress Facility is comprised of a revolving line of
credit of up to $65 million with a three year term expiring in November 1998
("Congress Revolving Credit Facility") and two year term loans aggregating $10
million expiring in November 1998 ("Revolving Term Notes"). 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. In addition, 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, bears interest at 1.25% above
CoreStates' prime rate and the Revolving Term Notes bears interest at 1.5% above
CoreStates' 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 throughout fiscal
1997. At December 27, 1997 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 27, 1997 were 9.70% and 10%, respectively. As
of December 27, 1997, the Company had no revolving indebtedness and $7.9 mil
lion under the Revolving Term Notes. As of December 28, 1996, the Company had
$13.7 million and $8.9 million under the


                                       29
<PAGE>   31

Congress Revolving Credit Facility and Revolving Term Notes, respectively. The
face amount of unexpired documentary letters of credit at December 27, 1997 and
December 28, 1996 were $3 million and $4.5 million, respectively. At December
27, 1997, availability under the Congress Facility was $29 million.

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 5.13% to 6.04% at December 27,
1997 and 5.47% to 5.73% at December 28, 1996, respectively. The Term Financing
Facility was reduced by annual sinking fund payments of $1.0 million in October
1996 and 1997 and requires annual sinking fund payments of $1.0 million in
October 1998 and 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, 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, the Company paid down $1 million of the underlying debt,
reducing the letters of credit to approximately $26.9 million. The letters of
credit were originally due on February 18, 1998, however, Richemont has extended
the term through March 30, 1999 and modified the letters of credit 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 12%. In 1998, the
Company will pay a facility fee of $1.1 million which is equal to 4% of the
principle 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 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.

IMR Promissory Note - In September 1996, IMR, an affiliate of NAR, loaned the
Company $10 million as evidenced by a subordinated promissory note (the "IMR
Promissory Note"). This loan bore interest at prime plus 1.5%, was due on
November 14, 1996 and, if it was not repaid before May 15, 1997, was convertible
at the option of NAR into shares of Common Stock at the lower of the fair market
value thereof on the date of execution or the then current fair market value
thereof. The IMR Promissory Note was subordinate to the Congress Facility and
was excluded from the working capital covenant calculation. NAR agreed to apply
$10 million of the Company's indebtedness to acquire $10 million of the
Company's Common Stock pursuant to the 1997 Rights Offering (Note 9).

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 mortgage notes
payable are non-recourse notes and are not guaranteed by the Company. The
mortgage notes payable are secured by the manufacturing and office facilities of
The Company Store. The amounts outstanding were $2.8 million and $3.0 million at
December 27, 1997 and December 28, 1996, respectively.

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 an irrevocable letter of credit in the amount of
$8.6 million. The obligations are guaranteed by the Company.

Extraordinary Items - The Company wrote-off approximately $1.8 million and $1.1
million of unamortized debt issuance costs as extraordinary items due to early
extinguishment of debt in 1995 and 1996.

General - At December 27, 1997, the aggregate annual principal and sinking fund
payments required on debt instruments are as follows (in thousands): 1998 -
$4,787; 1999 - $2,000; 2000 - $2,600; 2001 - $6,517; 2002 - $1,600 and
thereafter - $19,951.

9. 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 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, a Luxemborg public company, 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 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").


                                       30

<PAGE>   32

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 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 (Note 8). 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 are restricted and will be
registered under the Securities Act of 1933, as amended, pursuant to a
registration rights agreement with SMALLCAP that calls for the Company to use
its best efforts to effect the registration of such shares as soon as
practicable after April 1, 1998 and has granted certain piggyback registration
rights. The Company may delay such registration for a period of not more than
ninety calendar days. Such registration shall be effected by preparation and
filing by the Company with the Securities and Exchange Commission of a
registration statement on Form S-3. The Company will pay all expenses in
connection with the registration of such shares.

10. 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
will 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 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 1997 and 1996
based on The Safety Zone catalog's operating results in each respective year.

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 1997, 1996 and 1995.

Warrants - The warrants outstanding at December 27, 1997 are as  follows:

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
  Warrants Issued        Exercise Price    Expiration Date
--------------------------------------------------------------------------------
<S>                           <C>             <C>
     1,728,923                $2.16            8/01/98
     3,542,292                 2.59            8/01/98
       375,275                 1.95            8/01/98
     5,646,490
--------------------------------------------------------------------------------
</TABLE>

All of the above issued warrants are held by NAR and its affiliates. The
original terms of these warrant agreements contain certain antidilution
provisions which increased, in the aggregate, the warrants by 612,755 from
5,033,735 to 5,646,490 due to the 1996 Rights Offering (Note 9). The
antidilution provisions resulted in an adjustment to the previous exercise
prices of $2.42, $2.91 and $2.49, respectively.


                                       31
<PAGE>   33

General - At December 27, 1997, there were 203,755,322 shares of Common Stock
and 634,900 shares of Series B Stock outstanding. Additionally, an aggregate of
20,665,576 shares of Common Stock were reserved for issuance pursuant to (i) the
exercise of outstanding options, 13,081,249 (ii) the exercise of outstanding
warrants, 5,646,490 and (iii) the Executive Equity Incentive Plan, 1,937,837.

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.

11. 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 provision of SFAS No 123. The Company has recorded compensation charges of
$1.8 million and $.5 million in 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
discretion of the Compensation Committee. Changes in options outstanding,
expressed in numbers of shares, are as follows:

<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------------
                                                     1995                  1996                  1997
----------------------------------------------------------------------------------------------------------------
                                                        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    496,050    $   3.60     90,000    $   2.42     70,000    $   2.11
 Granted                                      70,000    $   2.11         --          --         --          --
 Exercised                                        --          --         --          --         --          --
 Forfeited                                  (142,000)   $   3.50         --          --    (40,000)   $   2.00
 Expired                                    (334,050)   $   3.65    (20,000)   $   3.50         --          --
----------------------------------------------------------------------------------------------------------------
 Options outstanding, end of period           90,000    $   2.42     70,000    $   2.11     30,000    $   2.25
----------------------------------------------------------------------------------------------------------------
 Options exercisable, end of period           20,000    $   3.50     23,333    $   2.11     20,000    $   2.25
----------------------------------------------------------------------------------------------------------------
</TABLE>

The options outstanding at December 27, 1997 have weighted average exercise
prices of $2.25 with a weighted average contractual life of 2.8 years.

Director's 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.

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. An aggregate of 2,400,000 shares of the Company's Common Stock have
been reserved for issuance under the Incentive Plan. Company financing is
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:

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------------------------------------
                                                          1995                    1996                       1997
--------------------------------------------------------------------------------------------------------------------------
                                                            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       753,830                    877,163                  1,062,496
 Shares purchased                              143,333                    202,000                     47,000
 Shares forfeited                              (20,000)                   (16,667)                        --
--------------------------------------------------------------------------------------------------------------------------
 Shares outstanding, end of period             877,163                  1,062,496                  1,109,496
--------------------------------------------------------------------------------------------------------------------------
 Options outstanding, beginning of period    1,073,836         $2.98    1,021,170         $2.66      640,498         $1.73
--------------------------------------------------------------------------------------------------------------------------
 Granted                                       286,666         $2.53      350,000         $1.00       94,000         $1.00
 Forfeited                                    (339,332)        $3.59     (730,672)        $2.68      (70,498)        $2.60
--------------------------------------------------------------------------------------------------------------------------
 Options outstanding, end of period          1,021,170         $2.66      640,498         $1.73      664,000         $1.53
--------------------------------------------------------------------------------------------------------------------------
 Options exercisable, end of period                 --            --      173,832         $2.56      130,000         $2.58
--------------------------------------------------------------------------------------------------------------------------
</TABLE>


                                       32
<PAGE>   34
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 1997 and 1996: 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 27, 1997:

<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------------
                                                 Options                             Options
                                             Outstanding                         Exercisable
----------------------------------------------------------------------------------------------------------------
                                                Weighted          Weighted                            Weighted
                             Number              Average           Average            Number           Average
 Range of               Outstanding            Remaining          Exercise       Exercisable          Exercise
 Exercise Prices        at 12/27/97     Contractual Life             Price       at 12/27/97             Price
----------------------------------------------------------------------------------------------------------------
<S>                         <C>                      <C>              <C>            <C>                 <C>
 $.69 to $1.00              444,000                  4.8              $.97                --             $  --
 $2.50 to $3.00             220,000                  2.1             $2.62           130,000             $2.58
 $.69 to $3.00              664,000                  3.9             $1.52           130,000             $2.58
----------------------------------------------------------------------------------------------------------------
</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. The amount of amortization relating to differences between the exercise
prices and market value of the Company's common stock on grant dates charged to
expense was approximately $(.3) million and $.1 million for 1996 and 1995,
respectively, net of forfeitures. No amortization was required in 1997 as all
expenses associated with the applicable options were recognized as of the end of
1996 in conjunction with the vesting of the options.

Changes to the notes receivable related to the Incentive Plan are as follows:

<TABLE>
<CAPTION>
-------------------------------------------------------------------------------
                                           1995            1996            1997
-------------------------------------------------------------------------------
<S>                                  <C>             <C>             <C>
 Notes receivable balance,
  beginning of period                $1,522,000      $1,651,000      $1,742,000
 Additions                              229,000         202,000          32,000
 Payments                              (100,000)       (111,000)        (40,000)
 Notes receivable,
  end of period                      $1,651,000      $1,742,000      $1,734,000
-------------------------------------------------------------------------------
</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 this 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>
--------------------------------------------------------------------------------
                                               1995          1996          1997
-------------------------------------------------------------------------------
<S>                                         <C>           <C>           <C>
 Shares outstanding, beginning
  of period                                 380,563       508,134       521,032
 Shares purchased                           216,931        80,550            --
 Shares forfeited                           (89,360)      (67,652)      (38,261)
 Shares outstanding,
  end of period                             508,134       521,032       482,771
--------------------------------------------------------------------------------
</TABLE>

As of December 27, 1997, a total of 69,550 of outstanding shares are scheduled
to vest in February 1998 and August 1998. There are no other outstanding shares
purchased under the 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 aggregating $.8 million. Such amount has been amortized over a
three-year vesting period. The amount of amortization charged to expense was
approximately $.2 million in 1995, net of forfeitures.

The Chief Executive Officer (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 price represents the
average of the low and high fair market value of the Common Stock on August 23,
1996, the date of the closing of the Rights Offering. 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.
Payment for shares purchased upon the exercise of the option shall be in cash or
stock of the Company.


                                       33
<PAGE>   35

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
                                            1996                    1997
--------------------------------------------------------------------------------
                                                Weighted                Weighted
                                                 Average                 Average
                                                Exercise                Exercise
                                      Shares       Price      Shares       Price
--------------------------------------------------------------------------------
<S>                                <C>         <C>         <C>         <C>
 Options outstanding,
  beginning of period                     --   $      --   3,020,000   $    1.16
 Granted                           3,020,000   $    1.16          --   $      --
 Exercised                                --   $      --          --   $      --
 Forfeited                                --   $      --          --   $      --
 Expired                                  --   $      --          --   $      --
 Options outstanding,
  end of period                    3,020,000   $    1.16   3,020,000   $    1.16
 Options exercisable,
  end of period                           --   $      --     755,000   $    1.16
 Weighted average
  fair value of
  options granted                      $ .77                      --
--------------------------------------------------------------------------------
</TABLE>

The options outstanding at December 27, 1997 have an exercise price of $1.16
with a weighted average contractual life of 8.25 years.

The fair value of the options granted in 1996 was estimated on the date of grant
using the Black- Scholes option-pricing model with the following weighted
average assumptions: risk free interest rate of 6.79%, expected lives of 9.85
years, expected volatility of 45.02% and no expected dividends.

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 option price
represents the average of the low and high fair market value of the Common Stock
on August 23, 1996, the date of the closing of the 1996 Rights Offering.

The options expire 10 years from the date of grant and vest over four years. 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. Payment for shares purchased upon the exercise of the
options shall be in cash or stock of the Company.

Options outstanding, granted and the weighted average exercise prices are as
follows:

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
                                            1996                    1997
--------------------------------------------------------------------------------
                                                Weighted                Weighted
                                                 Average                 Average
                                                Exercise                Exercise
                                      Shares       Price      Shares       Price
--------------------------------------------------------------------------------
<S>                                <C>         <C>         <C>         <C>
 Options outstanding,
  beginning of period                     --   $      --   1,000,000   $    1.16
 Granted                           1,000,000   $    1.16          --   $      --
 Exercised                                --   $      --          --   $      --
 Forfeited                                --   $      --          --   $      --
 Expired                                  --   $      --          --   $      --
 Options outstanding,
  end of period                    1,000,000   $    1.16   1,000,000   $    1.16
 Options exercisable,
  end of period                           --   $      --     250,000   $    1.16
 Weighted average
  fair value of
  options granted                 $     0.77                      --
--------------------------------------------------------------------------------
</TABLE>

The options outstanding at December 27, 1997 have an exercise price of $1.16
with a weighted average contractual life of 8 years.

The fair value of the options granted in 1996 was estimated on the date of grant
using the Black-Scholes option-pricing model with the following weighted average
assumptions: risk free interest rate of 6.79%, expected lives of 9.85 years,
expected volatility of 45.02% and no expected dividends.

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 option price represents the average of the low and high fair market value of
the Common Stock on August 23, 1996, the date of the closing of the 1996 Rights
Offering.

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. The performance period has a range of 6 years beginning August 23,
1996, the date of the closing of the 1996 Rights Offering. Payment for shares
purchased upon the exercise of the options shall be in cash or stock of the
Company.

Options outstanding, granted and the weighted average exercise prices are as
follows:

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
                                            1996                    1997
--------------------------------------------------------------------------------
                                                Weighted                Weighted
                                                 Average                 Average
                                                Exercise                Exercise
                                      Shares       Price      Shares       Price
--------------------------------------------------------------------------------
<S>                                <C>         <C>         <C>         <C>
 Options outstanding,
  beginning of period                     --   $      --   2,000,000   $    1.16
 Granted                           2,000,000   $    1.16          --   $      --
 Exercised                                --   $      --          --   $      --
 Forfeited                                --   $      --          --   $      --
 Expired                                  --   $      --          --   $      --
 Options outstanding,
  end of period                    2,000,000   $    1.16   2,000,000   $    1.16
 Options exercisable,
  end of period                           --   $      --          --   $    1.16
 Weighted average
  fair value of
  options granted                 $     0.17                      --
--------------------------------------------------------------------------------
</TABLE>

The options outstanding at December 27, 1997 have an exercise price of $1.16
with a weighted average contractual life of 8.25 years.

The fair value of the options granted in 1996 was estimated on the date of grant
using the Black-Scholes option-price model utilizing a Monte Carlo simulation
with the following weighted average assumptions: risk free interest rate of
6.79%, expected lives of 9.85 years, expected volatility of 45.02% and no
expected dividends.

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 price represents the
average of the low and high fair market value of the Common Stock on August 23,
1996, the date of the closing of the 1996 Rights Offering. The option is subject
to antidilution provisions and due to the Company's 1996 Rights Offering was
adjusted to 377,500 options.


                                       34
<PAGE>   36

The options expire 6 years from the date of grant and vest after one year.
Payment for shares purchased upon the exercise of the options shall be in cash
or stock of the Company.

Options outstanding, granted and the weighted average exercise prices are as
follows:

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
                                             1996                   1997
--------------------------------------------------------------------------------
                                                 Weighted               Weighted
                                                  Average                Average
                                                 Exercise               Exercise
                                      Shares        Price    Shares        Price
--------------------------------------------------------------------------------
<S>                                <C>         <C>         <C>         <C>
 Options outstanding,
  beginning of period                     --      $    --   377,500      $  1.16
 Granted                             377,500      $  1.16        --      $    --
 Exercised                                --      $    --        --      $    --
 Forfeited                                --      $    --        --      $    --
 Expired                                  --      $    --        --      $    --
 Options outstanding,
  end of period                      377,500      $  1.16   377,500      $  1.16
 Options exercisable,
  end of period                           --      $    --   377,500      $  1.16
 Weighted average
  fair value of
  options granted                    $  0.60                     --
--------------------------------------------------------------------------------
</TABLE>

The options outstanding at December 27, 1997 have an exercise price of $1.16
with a weighted average contractual life of 4.25 years.

The fair value of the options granted in 1996 is estimated on the date of grant
using the Black-Scholes option-pricing model with the following weighted average
assumptions: risk free interest rate of 6.42%, expected lives of 5.85 years,
expected volatility of 45.02% and no expected dividends.

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 price
represents the average of the low and high fair market value of the Common Stock
on August 23, 1996, the date of the closing of the 1996 Rights Offering. 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.
Payment for shares purchased upon the exercise of the options shall be in cash
or stock of the Company.

Options outstanding, granted and the weighted average exercise prices are as
follows:

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
                                             1996                   1997
--------------------------------------------------------------------------------
                                                 Weighted               Weighted
                                                  Average                Average
                                                 Exercise               Exercise
                                      Shares        Price     Shares       Price
--------------------------------------------------------------------------------
<S>                                  <C>          <C>        <C>         <C>
 Options outstanding,
  beginning of period                     --      $    --    377,500     $  1.16
 Granted                             377,500      $  1.16         --     $    --
 Exercised                                --      $    --         --     $    --
 Forfeited                                --      $    --         --     $    --
 Expired                                  --      $    --         --     $    --
 Options outstanding,
  end of period                      377,500      $  1.16    377,500     $  1.16
 Options exercisable,
  end of period                           --      $    --         --     $  1.16
 Weighted average
  fair value of
  options granted                 $     0.65                      --
--------------------------------------------------------------------------------
</TABLE>

The options outstanding at December 27, 1997 have an exercise price of $1.16
with a weighted average contractual life of 5.25 years.

The fair value of the options granted in 1996 was estimated on the date of grant
using the Black-Scholes option-pricing model with the following weighted average
assumptions: risk free interest rate of 6.53%, expected lives of 6.85 years,
expected volatility of 45.02% and no expected dividends.

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 price
represents the average of the low and high fair market value of the Common Stock
on August 23, 1996, the date of the closing of the 1996 Rights Offering. 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.
Payment for shares purchased upon the exercise of the options shall be in cash
or stock of the Company.

Options outstanding, granted and the weighted average exercise prices are as
follows:

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
                                             1996                   1997
--------------------------------------------------------------------------------
                                                 Weighted               Weighted
                                                  Average                Average
                                                 Exercise               Exercise
                                      Shares        Price     Shares       Price
--------------------------------------------------------------------------------
<S>                                  <C>          <C>        <C>         <C>
 Options outstanding,
  beginning of period                     --      $    --    377,500     $  1.16
 Granted                             377,500      $  1.16         --     $    --
 Exercised                                --      $    --         --     $    --
 Forfeited                                --      $    --         --     $    --
 Expired                                  --      $    --         --     $    --
 Options outstanding,
  end of period                      377,500      $  1.16    377,500     $  1.16
 Options exercisable,
  end of period                           --      $    --         --     $  1.16
 Weighted average
  fair value of
  options granted                    $  0.69                      --
--------------------------------------------------------------------------------
</TABLE>

The options outstanding at December 27, 1997 have an exercise price of $1.16
with a weighted average contractual life of 6.25 years.


                                       35
<PAGE>   37

The fair value of the options granted in 1996 was estimated on the date of grant
using the Black-Scholes option-pricing model with the following weighted average
assumptions for grants in 1996: risk free interest rate of 6.62%, expected lives
of 7.85 years, expected volatility of 45.02% and no expected dividends.

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 price
represents the average of the low and high fair market value of the Common Stock
on August 23, 1996, the date of the closing of the 1996 Rights Offering. 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.
Payment for shares purchased upon the exercise of the options shall be in cash
or stock of the Company.

Options outstanding, granted and the weighted average exercise prices are as
follows:

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
                                             1996                   1997
--------------------------------------------------------------------------------
                                                  Weighted              Weighted
                                                   Average               Average
                                                  Exercise              Exercise
                                       Shares        Price     Shares      Price
--------------------------------------------------------------------------------
<S>                                   <C>          <C>        <C>        <C>
 Options outstanding,
  beginning of period                      --      $    --    377,500    $  1.16
 Granted                              377,500      $  1.16         --    $    --
 Exercised                                 --      $    --         --    $    --
 Forfeited                                 --      $    --         --    $    --
 Expired                                   --      $    --         --    $    --
 Options outstanding,
  end of period                       377,500      $  1.16    377,500    $  1.16
 Options exercisable,
  end of period                            --      $    --         --    $  1.16
 Weighted average
  fair value of
  options granted                     $  0.74                      --
--------------------------------------------------------------------------------
</TABLE>

The options outstanding at December 27, 1997 have an exercise price of $1.16
with a weighted average contractual life of 7.25 years.

The fair value of the options granted in 1996 was estimated on the date of grant
using the Black-Scholes option-pricing model with the following weighted average
assumptions: risk free interest of 6.73%, expected lives of 8.85 years, expected
volatility of 45.02% and no expected dividends.

1996 Stock Option Plan - Pursuant to the Company's 1996 Stock Option Plan (the
"1996 Plan"), an aggregate of 7,000,000 shares were approved for issuance to
employees of the Company. The option exercise price shall be 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 shall be 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 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.

NON-PERFORMANCE BASED

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
                                       1996                        1997
--------------------------------------------------------------------------------
                                            Weighted                    Weighted
                                             Average                     Average
                                            Exercise                    Exercise
                               Shares          Price        Shares         Price
--------------------------------------------------------------------------------
<S>                         <C>           <C>            <C>          <C>
 Options outstanding,
  beginning of period              --     $       --     1,722,500    $     0.98
 Granted                    1,722,500     $     0.98       882,500    $     1.29
 Exercised                         --     $       --            --    $       --
 Forfeited                         --     $       --      (366,667)   $     1.01
 Expired                           --     $       --            --    $       --
 Options outstanding,
  end of period             1,722,500     $     0.98     2,238,333    $     1.10
 Options exercisable,
  end of period                    --     $       --       460,833    $     0.98
 Weighted average
  fair value of
  options granted          $     0.67                         0.66
--------------------------------------------------------------------------------
</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 1997 and 1996: risk free interest rate of 6.21% and
6.80% respectively, expected lives of 4 and 7 years, respectively, and expected
volatility of 59.40% and 45.35%, respectively, and no expected dividends.

The following table summarizes information about stock options outstanding at
December 27, 1997:

<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------------
                                                 Options                             Options
                                             Outstanding                         Exercisable
----------------------------------------------------------------------------------------------------------------
                                                Weighted          Weighted                            Weighted
                             Number              Average           Average            Number           Average
 Range of               Outstanding            Remaining          Exercise       Exercisable          Exercise
 Exercise Prices        at 12/27/97     Contractual Life             Price       at 12/27/97             Price
----------------------------------------------------------------------------------------------------------------
<S>                       <C>                        <C>             <C>             <C>                 <C>
 $.69 to $1.00            1,605,833                  5.9             $0.96           460,833             $0.98
 $1.43 to $1.75             632,500                  6.5             $1.46                --             $  --
----------------------------------------------------------------------------------------------------------------
 $.69 to $1.75            2,238,333                  6.0             $1.10           460,833             $0.98
----------------------------------------------------------------------------------------------------------------
</TABLE>


                                       36
<PAGE>   38

PERFORMANCE BASED

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
                                       1996                        1997
--------------------------------------------------------------------------------
                                             Weighted                   Weighted
                                              Average                    Average
                                             Exercise                   Exercise
                                  Shares        Price       Shares         Price
--------------------------------------------------------------------------------
<S>                            <C>         <C>           <C>          <C>
 Options outstanding,
  beginning of period                 --   $       --    1,722,500    $     0.98
 Granted                       1,722,500   $     0.98      882,500    $     1.29
 Exercised                            --   $       --           --    $       --
 Forfeited                            --   $       --     (392,084)   $     1.01
 Expired                              --   $       --           --    $       --
 Options outstanding,
  end of period                1,722,500   $     0.98    2,212,916    $     1.10
 Options exercisable,
  end of period                       --   $       --      394,610    $     0.98
 Weighted average
  fair value of
  options granted             $     0.67                      0.66
--------------------------------------------------------------------------------
</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 1997 and 1996: risk free interest rate of 6.21% and
6.80%, respectively, expected lives of 4 and 7 years, respectively, expected
volatility of 59.40% and 45.35%, respectively, and no expected dividends.

The following table summarizes information about stock options outstanding at
December 27, 1997.

<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------------
                                                 Options                             Options
                                             Outstanding                         Exercisable
----------------------------------------------------------------------------------------------------------------
                                                Weighted          Weighted                            Weighted
                             Number              Average           Average            Number           Average
 Range of               Outstanding            Remaining          Exercise       Exercisable          Exercise
 Exercise Prices        at 12/27/97     Contractual Life             Price       at 12/27/97             Price
----------------------------------------------------------------------------------------------------------------
<S>                       <C>                        <C>             <C>             <C>                 <C>
 $.69 to $1.00            1,580,416                  5.9             $0.96           394,610             $0.98
 $1.43 to $1.75             632,500                  6.5             $1.46                --             $  --
----------------------------------------------------------------------------------------------------------------
 $.69 to $1.75            2,212,916                  6.0             $1.10           394,610             $0.98
----------------------------------------------------------------------------------------------------------------
</TABLE>

OTHER STOCK AWARDS

During 1997, the Company granted, and the Compensation Committee approved,
nonqualified 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
5.2 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.

12. EMPLOYEE BENEFIT PLANS

Hanover Direct, Inc. Savings Plan - The 401(k) Savings and Retirement Plan (the
"401(k) Plan") allows eligible employees to contribute a percentage of their
annual compensation to the 401(k) Plan. The Company makes matching contributions
of one-third of the employees' pre-tax contributions up to a maximum of 6%.
Participants may invest contributions in various investment funds or in the
Company's Common Stock.

The Company's contributions charged to expense for 1997, 1996 and 1995 were
approximately $.5 million, $.4 million and $.6 million, respectively.

Supplemental Retirement Plan - The Supplemental Retirement Plan (the "Retirement
Plan") allowed eligible employees to make contributions to a trust where the
contributions were invested by the trust for each participant in a tax free
money market fund. The Company made matching contributions during 1995, 1996 and
1997. Company contributions charged to expense in 1996 and 1995 amounted to
approximately $.1 million and $.2 million, respectively. Expense charged in 1997
was not material. This plan was terminated in 1997.

13. INCOME TAXES

At December 27, 1997, the Company had net operating loss carryforwards ("NOLs")
totalling $246.7 million which expire as follows: In the year 2001 - $17.3
million, 2003 - $14.6 million, 2004 - $14.3 million, 2005 - $20.6 million, 2006
- $46.9 million, 2007 - $27.7 million, 2010 - $23.1 million, 2011 - $63.1
million and 2012 - $19.1 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 $91.4 million of NOLs
subject to a $4 million annual limitation under Section 382 of the Internal
Revenue Code of 1986 and $155.3 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 $63.1 million in
1996 and $19.1 million in 1997, 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 ongoing restructuring and future operating
plans.

For the years ended December 27, 1997 and December 28, 1996, the Company
maintained its deferred tax asset of $15 million (net of a valuation allowance
of $80.1 million in 1997 and $82.6 million in 1996). Management believes that
the $15 million net deferred tax asset still represents a reasonable,
conservative 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.

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.


                                       37
<PAGE>   39

The Company's Federal income tax provision was zero in 1995, 1996 and 1997. The
Company's provision for state income taxes was $1.0 million in 1995, $1.0
million in 1996 and $1.0 million in 1997.

A reconciliation of the Company's net loss for financial statement purposes to
taxable loss for the years ended December 30, 1995, December 28, 1996 and
December 27, 1997 is as follows (in thousands):

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
                                                 1995         1996         1997
-------------------------------------------------------------------------------
<S>                                         <C>          <C>          <C>
 (Loss) before income taxes                 $ (27,150)   $(102,895)   $  (9,877)
 Extraordinary item                            (1,837)      (1,134)          --
 Differences between income before
  taxes for financial statement
  purposes and taxable income:
 State income taxes                            (1,003)      (1,000)        (999)
 Differences attributable to
  subsidiary not included in
  Company's tax return                           (313)          --           --
 Permanent differences                          1,147       14,917          402
 Net change in temporary
  differences                                   6,048       26,983       (8,670)
 Taxable loss                               $ (23,108)   $ (63,129)   $ (19,144)
-------------------------------------------------------------------------------
</TABLE>

The components of the net deferred tax asset at December 27, 1997 are as follows
(in millions):

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
                                                                Non-
                                                    Current   current     Total
-------------------------------------------------------------------------------
<S>                                                    <C>      <C>       <C>
 Federal tax NOL and business
  tax credit carry forwards                                      87.4      87.4
 Allowance for doubtful accounts                        1.2                 1.2
 Inventories                                             .4                  .4
 Prepaid catalog costs                                 (2.2)               (2.2)
 Property and equipment                                          (0.2)     (0.2)
 Excess of net assets of
  acquired business                                              (0.9)     (0.9)
 Mailing Lists                                                    0.8       0.8
 Accrued liabilities                                    4.1                 4.1
 Customer prepayments
  and credits                                           2.1                 2.1
 Deferred Credits                                                 0.4       0.4
 Tax basis in net assets of
  discontinued operations in excess
  of financial statement amount                         0.8                 0.8
 Executive Incentive Plan                                         0.8       0.8
 Other                                                            0.4       0.4
 Deferred Tax Asset                                     6.4      88.7      95.1
 Valuation allowance                                   (3.1)    (77.0)    (80.1)
 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.

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>
--------------------------------------------------------------------------------
                                                 1995         1996         1997
                                              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                            2.4          0.6         6.6
 Net increase in (reversal of)
  temporary differences
   Depreciation and amortization                  3.5          4.0         2.0
   Deferred compensation                          2.5           --        11.3
   Restructuring reserves                          --          5.3       (23.5)
   Inventory                                      4.6         (0.4)      (17.3)
   Prepaid catalog costs                          0.4         (1.1)        9.4
   Allowance for doubtful accounts                1.0          1.1        (7.8)
   Other                                         (4.2)         0.3        (4.9)
 Tax NOLs for which no benefit
  could be recognized                            27.0         21.1        67.9
 Permanent differences                            1.5          5.1         1.4
                                                  3.7)%        1.0%       10.1%
--------------------------------------------------------------------------------
</TABLE>

14. 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>
--------------------------------------------------------------------------------
                                         1995           1996              1997
--------------------------------------------------------------------------------
<S>                                   <C>            <C>               <C>
 Minimum rentals                      $13,070        $12,931           $12,013
--------------------------------------------------------------------------------
</TABLE>

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 27, 1997, are as follows (in thousands):

<TABLE>
<CAPTION>
                                               Operating                Capital
 Year Ending                                      Leases                 Leases
--------------------------------------------------------------------------------
<S>                                             <C>                       <C>
 1998                                            9,384.4                  551.1
 1999                                            7,098.9                   51.2
 2000                                            5,516.1                    4.0
 2001                                            4,755.1                    4.0
 2002                                            4,673.5                    4.0
 Thereafter                                     21,492.4                     --
--------------------------------------------------------------------------------
 Total minimum lease payments                   52,920.4                  614.3
 Less amount representing interest (a)                                     29.3
 Present value of minimum lease payments (b)                              585.0
--------------------------------------------------------------------------------
</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, respectively.


                                       38
<PAGE>   40

The future minimum lease payments under noncancelable leases that remain from
the discontinued restaurant operations as of December 27, 1997 are as follows:
1998 - $.9 million; 1999 - $.9 million; 2000 - $.9 million; 2001 - $.8 million;
2002 - $.5 million; and thereafter $1.1 million. The above amounts exclude
annual sublease income from subleases which have the same expiration as the
underlying leases as follows:1998 - $1.0 million, 1999 - $ .9 million, 2000 -
$.9 million, 2001 - $.7 million, 2002 - $.4 million and thereafter $.8 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.

15. CHANGES IN MANAGEMENT AND
EMPLOYMENT AGREEMENTS

Jack E. Rosenfeld resigned as President and Chief Executive Officer and as a
Director of the Company effective December 30, 1995. In connection with such
resignation, the Company and Mr. Rosenfeld entered into a Termination of
Employment Agreement, dated December 30, 1995 (the "Termination Agreement"),
providing for the termination of (i) the Employment Agreement, dated as of
October 25, 1991, between the Company and Mr. Rosenfeld, and (ii) all benefits,
salary and perquisite provided for therein except for (a) benefits, salary and
perquisite earned and accrued up to December 30, 1995, (b) salary of $500,000
through December 31, 1996, and (c) benefits including (I) continued disability
and term life insurance in amounts not less than the amounts in force on the
date of the Termination Agreement for a three-year period and (II) the right to
continue to participate in the Company's medical plans to the extent he is
eligible for up to three years from the date of the Termination Agreement. The
Termination Agreement calls for Mr. Rosenfeld to serve as a Director Emeritus of
the Company and allowed Mr. Rosenfeld to attend meetings of the Board of
Directors and participate in Board discussions for a one-year period, but Mr.
Rosenfeld had no right to vote on any matters that came before the Board of
Directors. The Termination Agreement precluded Mr. Rosenfeld for a one-year
period from competing with the Company under certain circumstances.

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
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 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.

16. RELATED PARTY TRANSACTIONS

At December 27, 1997, 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.


                                       39
<PAGE>   41

At December 27, 1997, NAR and Richemont owned approximately 46 % and 20 % of the
Company's common stock, respectively.

17. 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.

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 27, 1997 are as follows (in thousands):
1998 - $.4; 1999 - $.4; 2000 - $.4; 2001 - $.4; 2002 - $.3, and thereafter $.9.

18. SELECTED QUARTERLY FINANCIAL INFORMATION
(UNAUDITED)

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
 (in thousands,                    First       Second        Third       Fourth
 except per share amounts)       Quarter      Quarter      Quarter      Quarter
--------------------------------------------------------------------------------
<S>                            <C>          <C>          <C>          <C>
1996
Revenues                       $ 165,527    $ 180,195    $ 156,732    $ 197,860
Gross profit                      55,989       59,912       41,152       63,006
Loss from operations              (7,733)      (9,896)     (25,621)     (51,247)
Net (loss)                        (9,477)     (12,520)     (29,565)     (53,467)
Preferred stock dividends            (59)         (59)         (59)         (48)
Net (loss) applicable to
 Common Shareholders           $  (9,536)   $ (12,579)   $ (29,624)   $ (53,515)
Net (loss) per share -
 basic and diluted             $    (.10)   $    (.13)   $    (.26)   $    (.37)
--------------------------------------------------------------------------------
<CAPTION>
--------------------------------------------------------------------------------
 (in thousands,                     First       Second        Third       Fourth
 except per share amounts)        Quarter      Quarter      Quarter      Quarter
--------------------------------------------------------------------------------
<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
Income (loss) from operations      (4,339)      (3,142)      (1,677)      7,309
Net income (loss)                  (6,621)      (5,648)      (3,421)      4,814
Preferred stock dividends             (48)         (47)         (47)        (48)
Net income (loss) applicable
 to Common Shareholders         $  (6,669)   $  (5,695)   $  (3,468)  $   4,766
Net income (loss) per
 share - basic and diluted      $    (.05)   $    (.04)   $    (.02)  $     .02
--------------------------------------------------------------------------------
</TABLE>


                                       40
<PAGE>   42

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
        FINANCIAL DISCLOSURE

                  None.


                                       41

<PAGE>   43

                                    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>
                                              TITLE AND OTHER                                                 OFFICE HELD
NAME                             AGE          INFORMATION (a)                                                    SINCE
----------------------------    -----         -------------------------------------------------------------   -----------
<S>                              <C>          <C>                                                             <C>
Rakesh K. Kaul                   46           President, Chief Executive Officer and Director since March         1996
                                              7, 1996.  From 1995 until February, 1996, Mr. Kaul was the
                                              Vice Chairman and Chief Operating Officer of Fingerhut
                                              Companies, Inc. From January 1992 until March 1995, Mr.
                                              Kaul was also the Executive Vice President and Chief
                                              Administrative Officer of Fingerhut.  Prior to January
                                              1992, Mr. Kaul was the Senior Vice President, Strategy and
                                              Finance and a director at Shaklee Corporation.

Michael Lutz                     55           Executive Vice President-Chief Operating Officer since              1994
                                              March 1998.  From September 1994 to March 1998, he 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                 49           Senior Vice President and Chief Financial Officer since             1996
                                              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               51           Senior Vice President and Chief Marketing Officer since             1998
                                              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.
</TABLE>


                                       42

<PAGE>   44

<TABLE>
<CAPTION>
                                              TITLE AND OTHER                                                 OFFICE HELD
NAME                             AGE          INFORMATION (a)                                                    SINCE
----------------------------    -----         -------------------------------------------------------------   -----------
<S>                              <C>          <C>                                                             <C>
Michael D. Contino               37           Senior Vice President and Chief Information Officer since           1996
                                              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                      48           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.

Edward J. O'Brien                54           Senior Vice President and Treasurer since March 1991.               1991
                                              Secretary since May 1996.  Mr. O'Brien joined the Company
                                              in 1986 and was elected Vice President in 1988.

William C. Kingsford             51           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.


                                       43

<PAGE>   45

                                     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.
<S>             <C>                                                                   <C>
         1.     Index to Financial Statements

                Report of Independent Public Accountants - Hanover
                Direct, Inc. and Subsidiaries Financial Statements                       20

                Consolidated Balance Sheets as of December 28, 1996
                and December 27, 1997                                                    21

                Consolidated Statements of Income (Loss) for the years
                ended December 30, 1995, December 28, 1996 and December
                27, 1997                                                                 22

                Consolidated Statements of Cash Flows for the years
                ended December 30, 1995, December 28, 1996 and December                  23
                27, 1997

                Consolidated Statements of Shareholders' Equity for the
                years ended December 30, 1995, December 28, 1996 and
                December 27, 1997                                                        24

                Notes to Consolidated Financial Statements for the
                years ended December 30, 1995, December 28, 1996 and
                December 27, 1997                                                        26

         2.     Index to Financial Statement Schedule

                Schedule II -- Valuation and Qualifying Accounts                         46

                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.                    47
</TABLE>

(b)      Reports on Form 8-K: Current Report on Form 8-K dated December
         18, 1997 reporting pursuant to Item 8 the Company's change in
         fiscal year.

(c)      Exhibits required by Item 601 of Regulation S-K.

         See Exhibit Index.

(d)      Financial Statement Schedules

         See (a) 2. above.


                                       44

<PAGE>   46

                                   SIGNATURES

                  Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized.

                                        HANOVER DIRECT, INC.
                                        (registrant)

Date: March 26, 1998                    By:  /s/ Rakesh K. Kaul
                                             ------------------
                                             Rakesh K. Kaul
                                             President and Chief
                                             Executive Officer

                  Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed below by the following persons on behalf of
the registrant and in the capacities indicated and on the date indicated below.

Principal Financial Officer:

         /s/ Larry J. Svoboda
         -------------------------------------
         Larry J. Svoboda
         Senior Vice President and
         Chief Financial Officer

         Board of Directors:

         /s/ Ralph Destino                         /s/ Edmund R. Manwell
         -------------------------------------     ----------------------------
         Ralph Destino, Director                   Edmund R. Manwell, Director


         /s/ J. David Hakman                       /s/ Shailesh J. Mehta
         -------------------------------------     ----------------------------
         J. David Hakman, Director                 Shailesh J. Mehta, Director

         /s/ Rakesh K. Kaul                        /s/ Jan P. du Plessis
         -------------------------------------     ----------------------------
         Rakesh K. Kaul, Director                  Jan P. du Plessis, Director

         /s/ S. Lee Kling
         -------------------------------------     ----------------------------
         S. Lee Kling, Director                    Alan G. Quasha, Director

                                                   /s/ Howard M.S. Tanner
         -------------------------------------     ----------------------------
         Theodore H. Kruttschnitt, Director        Howard M.S. Tanner, Director

         /s/ Elizabeth Valk Long                   /s/ Robert F. Wright
         -------------------------------------     ----------------------------
         Elizabeth Valk Long, Director             Robert F. Wright, Director

Date: March 26, 1998


                                       45

<PAGE>   47
                                                                     Schedule II

                              Hanover Direct, Inc.

                       VALUATION AND QUALIFYING ACCOUNTS
                Years Ended December 27, 1997, December 28, 1996
                             and December 30, 1995

<TABLE>
<CAPTION>

   Column A                                       Column B         Column C                           Column D            Column E
----------------------------------------------------------------------------------------------------------------------------------
                                                                          Additions
                                                Balance at       Charged to        Charged to
                                                 Beginning        Costs and    Other Accounts       Deductions          Balance at
   Description                                   of Period         Expenses          Describe         Describe       End of Period
----------------------------------------------------------------------------------------------------------------------------------
<S>                                         <C>                   <C>              <C>               <C>            <C>
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
----------------------------------------------------------------------------------------------------------------------------------
1995:
   Allowance for Doubtful Accounts
    Receivable, Current                      $   3,912,000        4,796,000            42,000(3)     4,762,000(1)   $    3,988,000
   Reserves for Discontinued Operations          1,668,000                                              29,000(2)        1,639,000
   Reserves for Sales Returns                    6,023,000      103,602,000                        104,090,000(2)        5,535,000
   Deferred Tax Asset Valuation Allowance       38,600,000                          9,900,000(4)                        48,500,000
   Allowance for Net Unrealized Losses
    on Convertible Debt Securities               1,000,000                                                               1,000,000
----------------------------------------------------------------------------------------------------------------------------------
</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.

                                      46

<PAGE>   48

                                  EXHIBIT INDEX

EXHIBIT NUMBER
ITEM 601 OF       DESCRIPTION OF DOCUMENT AND INCORPORATION
REGULATION S-K    BY REFERENCE WHERE APPLICABLE

      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. FILED HEREWITH.

      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.

                                      47

<PAGE>   49

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.

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.




<PAGE>   50

                  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.




<PAGE>   51

                  Incorporated by reference to the Company's Annual Report on
                  Form 10-K for the year ended December 28, 1996.

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.




<PAGE>   52

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.

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. FILED HEREWITH

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. FILED HEREWITH

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




<PAGE>   53

                  Company Store, Tweeds, LWI, Aegis, HDVA, Hanover Realty and
                  Austad. FILED HEREWITH

10.29             Eleventh Amendment to Loan and Security Agreement dated as of
                  March 25, 1998 by and among Congress, HDPA, Brawn, Gump's by
                  Mail, Gump's, The Company Store, Tweeds, LWI, Aegis, HDVA,
                  Hanover Realty and Austad. FILED HEREWITH

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.

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.




<PAGE>   54

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.
                  FILED HEREWITH.


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.
                  FILED HEREWITH.

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.




<PAGE>   55

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.

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.




<PAGE>   56

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. FILED HEREWITH.

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. FILED HEREWITH.

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.

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")
                  FILED HEREWITH.

10.72             Registration Rights Agreement, dated as of November 4, 1997,
                  by and between the Company and SMALLCAP. FILED HEREWITH.




<PAGE>   57

21.1              Subsidiaries of the Registrant. FILED HEREWITH

23.1              Consent of Independent Public Accountants. FILED HEREWITH

27.1              Financial Data Schedule. **/FILED HEREWITH

*        Hanover Direct, Inc., a Delaware corporation, is the successor by
         merger to The Horn & Hardart Company and The Hanover Companies.

**       EDGAR filing only.