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                       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 30, 2000

                         COMMISSION FILE NUMBER 1-12082
                            ------------------------

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

                                    DELAWARE
                 (STATE OR OTHER JURISDICTION OF INCORPORATION
                                OR ORGANIZATION)

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

                                   13-0853260
                       (IRS EMPLOYER IDENTIFICATION NO.)

                                     07087
                                   (ZIP CODE)

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

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

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                                                           NAME OF EACH EXCHANGE
             TITLE OF EACH CLASS                            ON WHICH REGISTERED
             -------------------                           ---------------------
<S>                                            <C>
       COMMON STOCK, $.66 2/3 PAR VALUE                   AMERICAN STOCK EXCHANGE
</TABLE>

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: None

     Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No []

     Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]

     As of March 16, 2001, the aggregate market value of the voting and
non-voting common equity held by non-affiliates of the registrant was
$24,511,160 (based on the closing price of the Common Stock on the American
Stock Exchange on March 16, 2001 of $0.29 per share; shares of Common Stock
owned by directors and officers of the Company are excluded from this
calculation; such exclusion does not represent a conclusion by the Company that
all of such directors and officers are affiliates of the Company).

     As of March 16, 2001, the registrant had 213,696,331 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 11, 12 and 13 of Part III
of this Form 10-K.

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                              HANOVER DIRECT, INC.
                                   FORM 10-K
                  FOR THE FISCAL YEAR ENDED DECEMBER 30, 2000

                                     INDEX

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<S>          <C>                                                           <C>
                                    PART I
ITEM 1.      Business....................................................    2
               General...................................................    2
               Strategic Realignment.....................................    2
               Hanover Brands............................................    3
               erizon....................................................    6
               Incubator Investments.....................................    8
               Credit Management.........................................    8
               Financing.................................................    8
               Additional Investments....................................   10
               Employees.................................................   11
               Seasonality...............................................   11
               Competition...............................................   11
               Trademarks................................................   12
               Government Regulation.....................................   12
ITEM 2.      Properties..................................................   12
ITEM 3.      Legal Proceedings...........................................   13
ITEM 4.      Submission of Matters to a Vote of Security Holders.........   13

                                    PART II
ITEM 5.      Market for Registrant's Common Equity and Related
             Stockholder's Matters.......................................   14
ITEM 6.      Selected Financial Data.....................................   15
ITEM 7.      Management's Discussion and Analysis of Consolidated
             Financial Condition and Results of Operations...............   16
               Results of Operations.....................................   16
               Liquidity and Capital Resources...........................   20
               Forward Looking Statements................................   22
               Cautionary Statements.....................................   22
ITEM 7A.     Quantitative and Qualitative Disclosures about Market
             Risk........................................................   24
ITEM 8.      Financial Statements and Supplementary Data.................   25
ITEM 9.      Changes in and Disagreements with Accountants on Accounting
             and Financial Disclosure....................................   55

                                   PART III
ITEM 10.     Directors and Executive Officers of the Registrant..........   57
ITEM 11.     Executive Compensation......................................   61
ITEM 12.     Security Ownership of Certain Beneficial Owners and
             Management..................................................   61
ITEM 13.     Certain Relationships and Related Transactions..............   61
                                    PART IV
ITEM 14.     Exhibits, Financial Statement Schedules and Reports on Form
             8-K.........................................................   62
             Signatures..................................................   64
</TABLE>
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                                     PART I

ITEM 1.  BUSINESS

GENERAL

     Hanover Direct, Inc. (the "Company") provides quality, branded merchandise
through a portfolio of catalogs and e-commerce platforms to consumers, as well
as a comprehensive range of Internet, e-commerce and fulfillment services to
businesses.

     Hanover Brands, Inc. ("Hanover Brands"), the Company's business-to-consumer
subsidiary, is comprised of its catalog and Web site portfolio of home fashions,
apparel, general merchandise and gift brands including during 2000
Domestications, The Company Store, Scandia Down, Turiya, Domestications Kitchen
& Garden, Kitchen & Home, Encore, Improvements, Silhouettes, International Male,
Undergear and Gump's By Mail. Each brand can be accessed on the Internet
individually by name. In addition, the Company was the exclusive distributor of
the Compagnie de la Chine brand in North America and owns Gump's, a retail store
based in San Francisco, California. In January 2001, the Company announced that
it plans to discontinue certain businesses, including the Turiya, Kitchen & Home
and Domestications Kitchen & Garden catalogs, and to end its marketing agreement
with Compagnie de la Chine.

     During 2000, erizon, Inc. ("erizon"), the Company's business-to-business
subsidiary, was comprised of the Company's direct commerce IT platform, Keystone
Internet Services, Inc., the Company's third party, end-to-end, fulfillment,
logistics and e-care provider, and Desius LLC, offering Web shop services and e-
commerce systems development. erizon also serviced the logistical, IT and
fulfillment needs of Hanover Brands through an intercompany services agreement
which was terminated effective December 30, 2000. In January 2001, the Company
announced that it planned to cease Desius LLC's business operations. Thereafter,
erizon will consist principally of the third party fulfillment business of
Keystone Internet Services, Inc.

     On December 5, 2000, the Company's Board of Directors elected Thomas C.
Shull as President, Chief Executive Officer and a member of the Board replacing
Rakesh K. Kaul who resigned on December 5, 2000 as President and Chief Executive
Officer and a member of the Board.

     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. The Company is a successor in interest to The Horn &
Hardart Company, a restaurant company founded in 1911, and Hanover House
Industries, Inc., founded in 1934. Richemont Finance S.A. ("Richemont"), a
Luxembourg company, owns approximately 47.9% of the Company's outstanding common
stock and holds an irrevocable proxy from a third party to vote an additional
approximately 2.0% of the Company's common stock currently held by such third
party. Richemont is an affiliate of Compagnie Financiere Richemont, A.G., a
Swiss based publicly traded luxury goods company.

STRATEGIC REALIGNMENT

     On January 5, 2001, the Company announced a strategic business realignment
program which included (1) the elimination of approximately 285 FTE positions
across all its business units, (2) the closure of the Company's Always In Style
business, (3) the discontinuance by Hanover Brands of the underperforming
Turiya, Kitchen & Home and Domestications Kitchen & Garden catalogs while
incorporating some of the product offerings within continuing catalogs, (4) the
termination by Hanover Brands of its marketing agreement with Compagnie de la
Chine, (5) the closure by Hanover Brands of certain retail outlets and a
satellite facility in New Jersey, (6) the expected closure by erizon of its
leased fulfillment and telemarketing facility in Maumelle, Arkansas later in the
year, and (7) the immediate cessation by erizon of the operations of Desius LLC.

     Such actions were taken in an effort to direct the Company's resources
primarily towards growth in core brands, such as The Company Store,
Domestications, Improvements and Silhouettes brands, while reducing costs in all
areas of the business and eliminating investment activities that had not yet
generated sufficient revenue to produce profitable returns. erizon intends to
consolidate the Maumelle operations within its remaining facilities and intends
to provide the bulk of its fulfillment services for third party clients of its
Keystone Internet Services, Inc. subsidiary within its existing operations. The
consolidation of Keystone

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activities in other facilities is intended to provide a better opportunity to
the Company to focus resources, particularly customer service support, on
clients to service their needs.

     In March 2001, the Company took additional steps in its strategic business
realignment program which included (1) the elimination of approximately 24 FTE
positions principally in Hanover Brands and the Company's IT operations, (2) the
expected closure by the Company of a portion of its leased principal executive
offices in Weehawken, New Jersey and a leased storage facility later in the
year, (3) the execution of an agreement for a new discount buyers club to
consumers with MemberWorks Incorporated, and (4) initiatives directed at
achieving costs savings in package shipping costs and telemarketing and customer
service.

     The Company has retained Newmark Retail Financial Advisors LLC to seek
qualified purchasers for its Gump's By Mail and Gump's San Francisco business,
its Brawn of California business, including the International Male and Undergear
brands, and its 277,500 square foot warehouse and fulfillment facility located
in Hanover, Pennsylvania.

     As a result of all the foregoing strategic business realignment actions,
the Company's business to business revenues in fiscal 2001 and beyond will be
materially reduced and for the foreseeable future limited to approximately 15
third party clients serviced by Keystone Internet Services, Inc. Taken in
conjunction with the Company's announced intention to direct resources primarily
towards growth in core brands, these actions will cause the Company, pursuant to
SFAS No. 131, to report results for the consolidated operations of the Company
as one segment commencing in fiscal 2001.

     The Company intends to continue to investigate both internal and external
opportunities to further reduce costs, improve cashflow and maximize shareholder
value.

HANOVER BRANDS

     General.  The Company, through Hanover Brands, is a leading specialty
direct marketer with a diverse portfolio of branded home fashions, general
merchandise, men's and women's apparel and gift products marketed via direct
mail-order catalogs and connected Internet Web sites. The Company's catalog
titles are organized into six brand groups -- Home Fashions -- Mid-Market
brands, Home Fashions -- Upscale brands, General Merchandise brands, Women's
Apparel brands, Men's Apparel brands and Gift brands groups -- each consisting
of one or more catalog/online titles. All of these brand groups utilize central
purchasing and inventory management functions and erizon's common systems
platform, telemarketing, fulfillment, distribution and administrative functions.
During 2000, the Company mailed approximately 265 million catalogs, answered
more than 11.2 million customer service/order calls and processed and shipped
11.5 million packages to customers.

     The Company reviews its portfolio of catalogs as well as new opportunities
to acquire or develop catalogs from time to time.

     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 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, The Company Store and Improvements, to further enhance the brand
identity of the catalogs.

     The Company's specialty catalogs typically range in size from approximately
54 to 112 pages with nine to twenty-six 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 that is responsible for the designs, layout, copy, feel and theme
of the book. Generally, the initial sourcing of new merchandise for a catalog
begins four to seven months before the catalog is mailed.

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     The following is a description of the Company's catalogs in each of the
Company's six brand groups:

Home Fashions -- Mid-Market Brands:

     Domestications is a leading home fashions catalog offering affordable
luxury for every room in the home for today's value-oriented and style-conscious
consumer.

     Domestications Kitchen & Garden offers decorating products geared toward
answering and solving kitchen and garden needs. In January 2001, the Company
announced that it plans to discontinue Domestications Kitchen & Garden but
intends to incorporate some of the catalog's product offerings within its
continuing catalogs.

Home Fashions -- Upscale Brands:

     The Company Store is an upscale home fashions catalog focused on high
quality down products and other private label and branded home furnishings.

     Kitchen & Home features distinctive and highly functional entertaining and
decorating products. In January 2001, the Company announced that it plans to
discontinue Kitchen & Home but intends to incorporate some of the catalog's
product offerings within its continuing catalogs.

     Scandia Down is a nationally known retailer specializing in luxury down
products and home fashions.

     Launched in 1999, Turiya is a luxury home furnishings catalog featuring
exclusive designers with the finest products, textiles, tailoring and concierge
level customer care. In January 2001, the Company announced that it plans to
discontinue Turiya but intends to incorporate some of the catalog's product
offerings within its continuing catalogs.

General Merchandise Brands:

     Improvements is a leading do-it-yourself home improvement catalog offering
quick and clever problem solvers to make life easier around the home, yard and
car. Improvements also presents The Safety Zone, which offers innovative
products for health, comfort and safety.

     Launched in 1999, Encore offers the best from America's finest catalogs in
one easy-to-shop-from format.

Women's Apparel Brands:

     Silhouettes is a leading fashion catalog offering large size women upscale
apparel and accessories.

Men's Apparel Brands:

     International Male offers contemporary men's fashions and accessories at
reasonable prices.

     Undergear is a leader in fashionable and functional men's underwear,
workout wear and active wear.

Gift Brands:

     Gump's By Mail(R) and Gump's(R) San Francisco are luxury sources for
discerning customers of jewelry, gifts and home furnishings, as well as market
leaders in offering Asian inspired products.

     Compagnie de la Chine offers collections of tableware, glassware, textiles
and home decor based on Chinese ancestral designs, natural materials and
traditional techniques. In 1999, the Company became the exclusive distributor of
the Compagnie de la Chine brand in North America. In January 2001, the Company
announced that it had terminated its marketing agreement with Compagnie de la
Chine.

     In March 1999, the Company, through a newly formed subsidiary, started up
and promoted a discount buyers club to consumers known as "The Shopper's Edge."
In exchange for an up-front membership fee, the Shopper's Edge program enables
members to purchase a wide assortment of merchandise at discounts which are not
available through traditional retail channels. Initially, prospective members
participate in a 30-day trial period that, unless canceled, is automatically
converted into a full membership term, which is one year in duration.
Memberships are automatically renewed at the end of each term unless canceled by
the member.

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     Effective December 1999, the Company sold its interest in The Shopper's
Edge subsidiary to an unrelated third party for a nominal fair value based upon
an independent appraisal. The Company entered into a solicitation services
agreement with the purchaser whereby the Company will provide solicitation
services for the program, and will receive commissions for member acceptances
based on a fixed fee per member basis, adjusted for cancellation rates on a
prospective basis. This agreement to provide solicitation services continued
throughout the year 2000.

     Marketing and Database Management.  The Company maintains a proprietary
customer list currently containing approximately 8 million names of customers
who have purchased from one of the Company's catalogs within the past 36 months.
Approximately 3.5 million of the names on the list represent customers who have
made purchases from at least one of the Company's catalogs within the last 12
months. The list contains name, gender, residence and historical transaction
data. This database is selectively enhanced with demographic, socioeconomic,
lifestyle and purchase behavior overlays from other sources.

     The Company utilizes modeling and segmentation analysis to devise catalog
marketing and circulation strategies that are intended to maximize customer
contribution by catalog. This analysis is the basis for the Company's
determination of which of the Company's catalogs will be mailed and how
frequently to a particular customer, as well as the promotional incentive
content of the catalog(s) such customer receives.

     The Company utilizes name lists rented from other mailers and compilers as
a primary source of new customers for the Company's catalogs. 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's Encore catalog, by
offering the best selling merchandise from both the Company's and third party
catalogs, is tailor-made to appeal to and attract new customers derived from
these name lists. Other sources of new customers include traditional print space
advertisements and promotional inserts in outbound merchandise packages.

     The Internet as a source of new customers continues to grow in importance.
The Company maintains an active presence on the Internet by having a
commerce-enabled Web site for each 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 Web sites for each brand are
promoted within each catalog, in traditional print media advertising, in TV
commercials, and on third party Web sites. The Company utilizes marketing
opportunities available to it by posting its catalog merchandise and accepting
orders on third party Web sites, for which it is charged a commission. Third
party Web site-advertising arrangements entered into by the Company includes
partnerships with Excite, ArtSelect, Yahoo, and AOL.

     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 phone service costs (both inbound and
outbound calls) are typically contracted for a two to three-year period. In the
fourth quarter of 1999, the Company entered into a two-year call center service
agreement with MCI Worldcom under which it obtained a reduction in the rate it
had been paying pursuant to its then current telecommunications contract. In
connection therewith, the Company agreed to guarantee certain levels of call
volume and the Company has met and anticipates that it will continue to meet
such targets.

     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 2000, paper costs
approximated 6.4% of the Company's net revenues. Although the Company
experienced a reduction in paper prices during 1999, paper prices increased by
approximately 10% during the year 2000. The Company normally experiences
increased costs of sales and operating expenses as a result of the general rate
of inflation and commodity price fluctuations. Operating margins are generally
maintained through internal cost

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reductions and operating efficiencies, and then through selective price
increases where market conditions permit.

     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
through special sale catalogs, sales/liquidation postings in brand Web sites,
e-auctions, its outlet stores and to jobbers.

     The Company acquires products for resale in its catalogs from numerous
domestic and foreign vendors. No single third party source supplied more than
10% of the Company's products in 2000. 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.

     The Company receives approximately 76.5% of its orders through its
toll-free telephone service, which offers customer access seven days per week,
24 hours per day.

     Telemarketing and Distribution.  Hanover Brands' telemarketing and
distribution needs are provided by erizon. The management information systems
used by Hanover Brands are discussed below. The Company mails its catalogs
through the United States Postal Service ("USPS") utilizing pre-sort, bulk mail
and other discounts. Most of the Company's packages are shipped through the
USPS. Overall, catalog mailing and package shipping costs approximated 17.1% of
the Company's net revenues in 2000. The USPS has implemented postage rate
increases ranging from 15% for Priority Mail to 1.3% for 4th class mail
effective January 2001. The Company does not expect the increase to have a
material adverse effect on its results of operations. The Company mitigates the
impact of postage rate increases by obtaining 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 Company also utilizes
United Parcel Service and other delivery services. In February 2000, United
Parcel Service increased its ground and air rates by 3.1% and 3.5%,
respectively. The Company examines alternative shipping services with
competitive rate structures from time to time.

ERIZON

     General.  The Company, through erizon, is an end-to-end technology
solutions provider for e-commerce customers. During 2000, erizon was comprised
of the Company's telemarketing, fulfillment and distribution functions as well
as its proprietary, fully integrated systems platform internally known as
Pegasus. That system is described under "Management Information Systems" below.
Other assets include four warehouse fulfillment centers totaling approximately
2.0 million square feet, and five telemarketing/e-care centers with over 750
agent positions.

     In addition, erizon is home to Keystone Internet Services, Inc.
("Keystone"), providing back-end e-commerce services to a roster of Internet
players. Keystone's services range from fulfillment and e-care to platform
logistics products. During 2000, erizon was also home to Desius LLC, the
Company's e-commerce software systems and programming Web shop joint venture for
e-commerce applications. erizon also services the logistical, IT and fulfillment
needs of Hanover Brands. In January 2001, the Company announced that it plans to
cease Desius LLC's business operations. Thereafter, erizon will consist
principally of the third party fulfillment business of Keystone Internet
Services, Inc.

     Telemarketing.  The Company has created a telephone network to link its
five primary telemarketing facilities in Hanover, Pennsylvania, York,
Pennsylvania, LaCrosse, Wisconsin, San Diego, California and Maumelle, Arkansas.
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. In the fourth
quarter of 1999, the Company entered into a two-year call center services
agreement with MCI Worldcom. In April 2000 the Company entered into a three-year
agreement with GE Capital International Services to provide telemarketing
services in India. See "Hanover Brands -- Purchasing."

     The Company trains its telemarketing service representatives to be
courteous, efficient and knowledgeable about the Company's products and those of
its third party customers. Telemarketing service representa-

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tives 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 four distribution centers in
four principal locations: one in Maumelle, Arkansas, one in Roanoke, Virginia,
one in Hanover, Pennsylvania, and one in LaCrosse, Wisconsin. The Company uses
these facilities to handle merchandise distribution for Hanover Brands as well
as its third-party e-tail clients. See "Properties." In January 2001, the
Company announced that it plans to close its distribution center in Maumelle,
Arkansas.

     Management Information Systems.  All the Company's catalogs are part of its
integrated mail order and catalog system operating on its mid-range computer
systems. Additionally, its fulfillment centers are part of the Company's
warehouse management system. The Company's systems have been designed to meet
its requirements as a high volume publisher of multiple catalogs. The Company is
continuing to devote resources to improving its systems.

     The Company's software system is an on-line, real-time system which is used
in managing all phases of the Company's operations and 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 management information
systems are designed to permit the Company to achieve efficiencies in the way
its financial, merchandising, inventory, telemarketing, fulfillment and
accounting functions are performed.

     Keystone Internet Services.  Launched in 1998, Keystone initially serviced
the needs of other direct marketers without back-end fulfillment resources.
Keystone currently offers e-commerce solutions and services to a customer base
of brand name manufacturers and retailers who lack the end-to-end systems needed
to enter e-commerce quickly, easily and affordably.

     Keystone offers its client base of 15 third party clients as of December
30, 2000 the resources needed on the "front-end" ranging from Web site creation
and management to Internet marketing to multi-channel marketing promotions to
structured financing. "Front-end" logistical services provided by Keystone
include telemarketing and e-care. Keystone can take orders off the Web and
answer e-mails as well as handle order processing, credit card transaction
processing, customer database management and systems programming and interface
support. On the "back-end," Keystone offers services including fulfillment,
order management, inventory management and facility management. All this can be
done using the Company's proprietary Pegasus multi-channel, multi-title platform
described above.

     Desius.  In 1999, the Company entered into a joint venture with RS Software
(India), Ltd. to provide Web shop services and e-commerce software, systems and
programming, augmenting the Company's programming services. The Desius teams
have been based in Calcutta, India and the United States in an effort to provide
24/7 service. The Calcutta based Desius team also has provided additional
resources including creative marketing, Web site creation, maintenance and
management. Desius also has served as the outsourcing arm for Keystone clients
which lack resources in these areas. In January 2001, the Company announced that
it plans to cease Desius LLC's business operations.

     Intercompany Services Agreement.  erizon and Hanover Brands, two wholly
owned subsidiaries of the Company, entered into an exclusive intercompany
services agreement. The intercompany services agreement was terminated as of
December 30, 2000. Under the intercompany services agreement, erizon was
obligated to provide services to Hanover Brands for (i) fulfillment services,
such as order processing, customer service, warehousing, inventory maintenance,
shipping and billing; (ii) information technology and Internet services, such as
Web site design, development, hosting, systems administration and maintenance;
and (iii) general and administrative services. The provision of services was
coordinated by designated management teams from erizon and Hanover Brands and
was performed in accordance with agreed upon service levels.

     For provision of the services under the intercompany service agreement,
Hanover Brands periodically paid erizon fees, and reimbursed erizon for certain
out-of-pocket expenses and any taxes, duties or tariffs. If the volume of
transactions exceeded projections, erizon earned certain incremental fees,
charges and/or other payments.

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     Any Web sites created in connection with the agreement belong to Hanover
Brands. Any proprietary rights in information, data or knowledge provided by
erizon for Hanover Brands under the intercompany services agreement is the
property of erizon, subject to a non-exclusive, non-transferable license to
Hanover Brands. Generally, each party retained the right to use general
knowledge, experience and know-how obtained in connection with the intercompany
service agreement. erizon maintained ownership of all hardware and software used
in the performance of the services.

     Under the agreement, each party was obligated to indemnify the other (and
its related entities) from third party claims arising out of infringement of
intellectual property rights; arising out of that party's property, as well as
personal and property damage to employees, agents, subcontractors and business
associates caused by the party or its related entities; and arising out of
certain additional indemnities regarding certain obligations under the
agreement. With certain exceptions, both parties have limited their liability to
the other to direct damages with an aggregate limit.

INCUBATOR INVESTMENTS

     In 1999, the Company began to focus on expansion of its business portfolio
through new Internet-related initiatives and sought to take equity stakes in
promising on-line businesses and an active role in their development and
technology.

     In 1999, the Company acquired a majority equity interest in Always in
Style, LLC, an interactive service that provides consumers with personalized
style and taste advice and tailored e-commerce merchandise offers. Retailers
participating in the Always in Style retail network are provided with a
ready-made solution and a virtually instantaneous way of adding this
functionality to their Web sites. Always in Style was formally launched in
November 1999. In January 2001, the Company announced that it plans to
discontinue the Always in Style business and in March 2001 sold its interest in
Always in Style, LLC to its partner in such venture.

     In 2000, the Company acquired minority equity interests of an immaterial
value in two on-line businesses with which the Company does business.

CREDIT MANAGEMENT

     Several of the Company's catalogs, including Domestications, International
Male and Gump's By Mail, offer their own private label credit cards. In 1999,
the Company entered into a new three-year account purchase and credit card
marketing and services agreement with Capital One Services, Inc. and Capital One
Bank under which Capital One provides for the sale and servicing of accounts
receivable origination from the Company's private label credit card program.

FINANCING

     Congress Credit Facility.  On March 24, 2000, the Company amended its
credit facility with Congress Financial Corporation ("Congress") to provide the
Company with a maximum credit line, subject to certain limitations, of up to
$82.5 million (the "Congress Credit Facility"). The Congress Credit Facility, as
amended, expires on January 31, 2004 and is comprised of a revolving loan
facility, a $17.5 million Tranche A Term Loan and a $7.5 million Tranche B Term
Loan. Total cumulative borrowings, however, are subject to limitations based
upon specified percentages of eligible receivables and eligible inventory, and
the Company is required to maintain $3.0 million of excess credit availability
at all times. The Congress Credit Facility, as amended, is secured by all the
assets of the Company and places restrictions on the incurrence of additional
indebtedness and on the payment of common stock dividends. As of December 30,
2000, the Company had $38.1 million of borrowings outstanding under the amended
Congress Credit Facility comprised of $15.7 million under the revolving loan
facility, and $14.9 million and $7.5 million of Tranche A Term Loans and Tranche
B Term Loans, respectively. The Company may draw upon the amended Congress
Credit Facility to fund working capital requirements as needed.

     The amended Congress Credit Facility replaced a $65.0 million revolving
line of credit facility with Congress as well as the Company's $16.0 million
Term Financing Facility and $8.0 million of Industrial Revenue Bonds. Both the
Term Financing Facility and the Industrial Revenue Bonds were supported by
letters of credit issued by UBS, AG and guaranteed by Richemont Finance S.A. The
Company utilized

                                        8
<PAGE>   10

$24.0 million of proceeds under the amended Congress Credit Facility to
reimburse UBS, AG for drawings on the letters of credit made by the trustees of
the Term Financing Facility and the Industrial Revenue Bonds.

     Term Financing Arrangement/Letters of Credit.  During 1994 and 1995, the
Company entered into a term loan agreement with a syndicate of financial
institutions, which provided for borrowings of $20 million (the "Term Financing
Facility"). The Term Financing Facility bore interest based on A-1 commercial
paper rates existing at the time of each borrowing. As of December 25, 1999, the
Company had $16 million of outstanding borrowings under the Term Financing
Facility bearing applicable rates of interest ranging from 5.3% to 6.0%. The
Company was required to make annual principal payments of approximately $1.6
million for each of the next ten years.

     As of December 25, 1999, three letters of credit issued by UBS AG, Stamford
Branch ("UBS"), and guaranteed by Richemont Finance S.A. ("Richemont"),
supported the Term Financing Facility and the Company's Industrial Revenue
Bonds. These letters of credit originated in December 1996, when the Company
finalized its agreement (the "Reimbursement Agreement") with Richemont that
provided the Company with up to approximately $28 million of letters of credit
through Swiss Bank Corporation, New York Branch ("Swiss Bank"). The three
letters of credit were initially to expire on February 18, 1998. In the event
that the Company had not paid in full, by the expiration date of the letters of
credit, any outstanding balances under the letters of credit, Richemont had 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 was
subordinate to the Congress Credit Facility.

     In November 1997, Richemont definitively agreed to extend its guarantee
under the Reimbursement Agreement to March 30, 1999. 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.

     In the first quarter of 1999, Richemont extended its guarantee under the
Reimbursement Agreement to March 31, 2000. As consideration for this
transaction, the Company paid to Richemont a fee of 9.5% of the principal amount
of each letter of credit including a facility fee of $500,000. The extension
required the approval of Congress and UBS (the successor to Swiss Bank
Corporation, Stamford Branch), which approvals were obtained in March 1999, and
was subject to certain other conditions. During March 1999, the extension of the
Richemont guarantee and the closing of this transaction were consummated.
Accordingly, the expiration dates of the three letters of credit were extended
through March 31, 2000.

     The Company did not extend or renew the UBS letters of credit supporting
the Term Financing Facility and the Industrial Revenue Bonds, and, accordingly,
the $16 million of outstanding borrowings under the Term Financing Facility and
the $8 million of outstanding borrowings under the Industrial Revenue Bonds were
required to be redeemed. On March 24, 2000, the Trustees under the Term
Financing Facility and the Industrial Revenue Bonds made drawings under the UBS
letters of credit, and used the proceeds of the drawings to redeem the Term
Financing Facility and the Industrial Revenue Bonds. The Company borrowed
approximately $24 million under the Congress Credit Facility on March 24, 2000
to reimburse UBS for the drawings on these letters of credit. As a result, both
the Term Financing Facility and the Industrial Revenue Bonds have been paid in
full, and the Company has also paid all amounts payable to UBS and Richemont
relating to the letters of credit.

     Richemont $10.0 Million Line of Credit Facility.  From March 24, 2000
through August 24, 2000, the Company was a party to a $10.0 million unsecured
line of credit facility (the "Richemont $10.0 million Line of Credit") with
Richemont Finance S.A. The Richemont $10.0 million Line of Credit facility
provided the Company with financing from Richemont should the excess
availability under the Congress Credit Facility fall below $3.0 million.
Additionally, the Company could have borrowed up to $5.0 million under the
Richemont $10.0 million Line of Credit to pay trade creditors in the ordinary
course of business. On August 24, 2000, the Richemont $10.0 million Line of
Credit was terminated and all borrowings outstanding as of August 24, 2000

                                        9
<PAGE>   11

of approximately $5.0 million, plus accrued and unpaid interest and fees, were
repaid and retired from a portion of the net proceeds obtained from the issuance
of the Company's Series A Cumulative participating Preferred Stock to Richemont.

     Richemont $25.0 Million Line of Credit Facility.  From March 1, 2000
through August 24, 2000, the Company was a party to a $25.0 million unsecured
line of credit facility (the "Richemont $25.0 million Line of Credit") with
Richemont which provided the Company with funding from Richemont to continue the
development and expansion of the Company's B-to-B e-commerce transaction
services operation. On August 24, 2000, the Richemont $25.0 million Line of
Credit was terminated and all borrowings outstanding as of August 24, 2000 of
approximately $25.0 million, plus accrued and unpaid interest and fees, were
repaid and retired from a portion of the net proceeds obtained from the issuance
of the Company's Series A Cumulative Participating Preferred Stock to Richemont.

     Series A Cumulative Participating Preferred Stock.  On August 24, 2000, the
Company issued 1.4 million shares of preferred stock designated as Series A
Cumulative Participating Preferred Stock (the "Series A Preferred Stock") to
Richemont, the holder of approximately 47.9% of the Company's Common Stock, for
$70.0 million. The Series A Preferred Stock is described below under "Additional
Investments."

     General.  At December 30, 2000, the Company had $1.7 million in cash and
cash equivalents compared with $2.8 million at December 25, 1999. Working
capital and current ratios at December 30, 2000 were $16.8 million and 1.15 to 1
versus $18.0 million and 1.19 to 1 at December 25, 1999. Total cumulative
borrowings, including financing under capital lease obligations, as of December
30, 2000 aggregated $39.0 million, $35.3 million of which is classified as
long-term. Remaining availability under the Congress Revolving Credit Facility
as of December 30, 2000 was $44.4 million ($46.1 million including cash on
hand). Capital commitments at December 30, 2000 totaled approximately $570,000,
principally for the Lawson human resources/payroll system, fixtures and
equipment for the Company's warehouse and fulfillment facility in Maumelle,
Arkansas, IT hardware and software and an upgrade of the Kronos payroll
reporting system.

ADDITIONAL INVESTMENTS

     On August 24, 2000, the Company issued and sold 1.4 million shares of
preferred stock designated as Series A Cumulative Participating Preferred Stock
in a private placement (not involving the use of underwriters or other placement
agents) to Richemont, a Luxembourg company which owns approximately 47.9% of the
Company's outstanding Common Stock, for an aggregate purchase price of $70.0
million in cash. There were no underwriting discounts or commissions related to
such sale. The rights of the holders of the Company's Common Stock have been
limited or qualified by such issuance and sale.

     The Series A Preferred Stock has a par value of $0.01 per share, and a
liquidation preference of $50.00 per share, and was recorded net of issuance
costs of $2.3 million. The issuance costs will be accreted as a dividend over a
five-year period ending on the mandatory redemption date. Dividends are
cumulative and accrue at an annual rate of 15%, or $7.50 per share, and are
payable quarterly either in cash or in-kind through the issuance of additional
Series A Preferred Stock. Cash dividend payments are required for dividend
payment dates occurring after February 1, 2004. As of December 30, 2000, the
Company accreted dividends of $3.8 million, and reserved 75,498 additional
shares of Series A Preferred Stock for the payment of such dividend. In-kind
dividends and issuance cost accretion are charged against additional paid-in
capital, with a corresponding increase in the carrying amount of the Series A
Preferred Stock. Cash dividends will also be reflected as a charge to additional
paid-in capital, however, no adjustment to the carrying amount of the Series A
Preferred Stock will be made. The Series A Preferred Stock is generally
non-voting, except if dividends have been in arrears and unpaid for four
quarterly periods, whether or not consecutive. The holder of the Series A
Preferred Stock shall then have the exclusive right to elect two directors of
the Company until such time as all such cumulative dividends accumulated on the
Series A Preferred Stock have been paid in full. Furthermore, the holder of the
Series A Preferred Stock is entitled to receive additional participating
dividends in the event any dividends are declared or paid on, or any other
distribution is made with respect to, the Common Stock of the Company. The
additional dividends would be equal to 6150% of the amount of the dividends or
distributions payable in respect of one share of Common Stock. In the event of a
liquidation or dissolution of the Company, the holder of the Series A Preferred
Stock shall be paid an amount equal to $50.00 per share of Series A Preferred
Stock plus the amount of any accrued and unpaid dividends, before any payments
to other stockholders.

                                        10
<PAGE>   12

     The Company may redeem the Series A Preferred Stock in whole at any time
and the holder of the Series A Preferred Stock may elect to cause the Company to
redeem all or any of such holder's Series A Preferred Stock under certain
circumstances involving a change of control, asset disposition or equity sale.
Mandatory redemption of the Series A Preferred Stock by the Company is required
on August 23, 2005 (the "Final Redemption Date") at a redemption price of $50.00
per share of Series A Preferred Stock plus the amount of any accrued and unpaid
dividends. If, at the Final Redemption Date, the Company does not have
sufficient capital and surplus legally available to redeem all the outstanding
shares of the Series A Preferred Stock, the Company will be required to take all
measures permitted under the Delaware General Corporation Law to increase the
amount of its capital and surplus legally available and to redeem as many shares
of the Series A Preferred Stock as it may legally redeem. Thereafter, as funds
become available, the Company will be required to redeem as many additional
shares of the Series A Preferred Stock as it legally can, until it has redeemed
all remaining outstanding shares of the Series A Preferred Stock.

     The sale of the shares of Series A Preferred Stock to Richemont was exempt
from the registration requirements of the Securities Act of 1933, as amended, by
reason of Section 506 of Regulation D promulgated thereunder. The facts relied
upon to make such exemption available are that the Series A Preferred Stock was
offered and sold to a single investor, Richemont, which is an accredited
investor, and the Company complied with the requirements of Rules 501 and 502 of
Regulation D promulgated under the Act.

EMPLOYEES

     As of December 30, 2000 the Company employed approximately 3,231 people on
a full-time basis and approximately 596 people on a part-time basis. The number
of part-time employees at December 30, 2000 reflects a temporary increase in
headcount necessary to fill the seasonal increase in orders during the holiday
season.

     On January 5, 2001, the Company announced the elimination of approximately
285 FTE positions across all its business units and in March 2001, the Company
eliminated certain additional positions principally in Hanover Brands and its IT
operations. The Company intends to make prospective payments to separated
employees either weekly or bi-weekly based upon each person's previous payment
schedule.

SEASONALITY

     The revenues and business for both the Hanover Brands and erizon
subsidiaries are seasonal. The Company processes and ships more catalog orders
during the fourth quarter holiday season than in any other quarter of the year.
Many of the Company's clients for B-to-B e-commerce transaction services
experience similar seasonal trends resulting in increased order processing
during the holiday season. Accordingly, the Company recognizes a
disproportionate share of annual revenue during the last three months of the
year.

COMPETITION

     The Company believes that the principal bases upon which it competes in the
Hanover Brands business are quality, value, service, proprietary product
offerings, catalog design, web site design, convenience, speed 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. A number of such competitors have substantially greater
financial, distribution and marketing resources than the Company. Sales from the
Internet for web site merchandisers grew in 2000. The Company believes in the
future of the Internet and online commerce, including the marketing
opportunities arising from this medium, and has directed part of its marketing
focus, resources and manpower to that end.

     The Company believes that the principal bases upon which it competes in the
erizon business are value, service, flexibility, scalability, convenience and
efficiency. The Company's third party fulfillment business

                                        11
<PAGE>   13

competes with NewRoads, Inc., Client Logic, Inc., PFS Web, Inc., ASD Systems,
Inc. and SubmitOrder.com, amongst others. A number of the Company's competitors
have substantially greater financial, distribution and marketing resources than
the Company.

TRADEMARKS

     Each of the Company's catalogs has its own federally registered trademarks
that are owned by Hanover Brands and its subsidiaries. Hanover Brands and its
subsidiaries also own numerous trademarks, copyrights and service marks on
logos, products and catalog offerings. erizon has federally registered
trademarks that are used by its subsidiaries. The Company and its subsidiaries
also have protected various trademarks internationally. The Company and its
subsidiaries vigorously protect such marks and believe 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
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

  Hanover Brands:

     The Company's Hanover Brands subsidiary owns and operates a 150,000 square
foot home fashion manufacturing facility located in LaCrosse, Wisconsin. The
facility produces down-filled comforters for sale under "The Company Store" and
"Turiya" brand names. In addition, the Company leases the following properties:

     - A 84,700 square foot corporate headquarters and administrative offices
       located in Weehawken, New Jersey under a 15 year lease expiring in April
       2005, and

     - 12 retail outlet stores located in California, Ohio, Pennsylvania and
       Wisconsin. In January 2001, the Company announced that it intended to
       close certain of these retail outlet stores.

  erizon:

     The Company's erizon subsidiary owns and operates the following properties:

     - A 775,000 square foot warehouse and fulfillment facility located in
       Roanoke, Virginia,

     - A 277,500 square foot warehouse and fulfillment facility located in
       Hanover, Pennsylvania, and

     - A 58,000 square foot telemarketing facility located in LaCrosse,
       Wisconsin.

     Each of these properties is subject to a mortgage in favor of the Company's
lender, Congress Financial Corporation.

     In addition, the Company leases the following properties:

     - A 750,000 square foot warehouse and telemarketing facility located in
       Maumelle, Arkansas,

     - A 185,000 square foot warehouse and fulfillment facility located in
       LaCrosse, Wisconsin under a 13 year lease expiring in December 2001, and

     - A 123,000 square foot telemarketing and customer service facility located
       in Hanover, Pennsylvania, under a recently renewed 3-year lease expiring
       in January 2003.

                                        12
<PAGE>   14

     Additionally, the Company utilizes temporary storage facilities ranging in
size between 50,000 and 150,000 square feet to house merchandise during the
holiday selling period and leases two additional satellite telemarketing
facilities in York, Pennsylvania and San Diego, California.

     In January 2001, the Company announced that it expected to close its leased
warehouse and telemarketing facility located in Maumelle, Arkansas during 2001.
The Company also announced that it would consolidate the Maumelle operations
within its remaining facilities and provide the bulk of its fulfillment services
for third party clients of its Keystone Internet Services, Inc. subsidiary
within its existing operations.

ITEM 3.  LEGAL PROCEEDINGS

     A class action lawsuit was commenced on March 3, 2000 entitled Edwin L.
Martin v. Hanover Direct, Inc. and John Does 1 through 10, bearing case no.
CJ2000-177 in the State Court of Oklahoma (District Court in and for Sequoyah
County). Plaintiff commenced the action on behalf of himself and a class of
persons who have at any time purchased a product from the Company and paid for
an "insurance charge." The complaint sets forth claims for breach of contract,
unjust enrichment, recovery of money paid absent consideration, fraud and a
claim under the New Jersey Consumer Fraud Act. The complaint alleges that the
Company charges its customers for delivery insurance even though, among other
things, the Company's common carriers already provide insurance and the
insurance charge provides no benefit to the Company's customers. Plaintiff also
seeks a declaratory judgment as to the validity of the delivery insurance. The
damages sought are (i) an order directing the Company to return to plaintiff and
class members the "unlawful revenue" derived from the insurance charges, (ii)
declaring the rights of the parties, (iii) permanently enjoining the Company
from imposing the insurance charge, (iv) awarding threefold damages of less than
$75,000 per plaintiff and per class member, and (v) attorneys' fees and costs.
The Company's motion to dismiss is pending and the discovery commenced; the
Company believes it has defenses against the claims, however, it is too early to
determine the outcome or range of potential settlement, which could have a
material impact on the Company's results of operations when settled in a future
period.

     At the end of January 2000, the Company received a letter from the Federal
Trade Commission ("FTC") conducting an inquiry into the marketing of The
Shopper's Edge club to determine whether, in connection with such marketing, any
entities have engaged in (1) unfair or deceptive acts or practices in violation
of Section 5 of the FTC Act and/or (2) deceptive or abusive telemarketing acts
or practices in violation of the FTC's Telemarketing Sales Rule. The inquiry was
undertaken pursuant to the provisions of Sections 6, 9 and 10 of the FTC Act.
Following such an investigation, the FTC may initiate an enforcement action if
it finds "reason to believe" that the law is being violated. When there is
"reason to believe" that a law violation has occurred, the FTC may issue a
complaint setting forth its charges. If the respondent elects to settle the
charges, it may sign a consent agreement (without admitting liability) by which
it consents to entry of a final order and waives all right to judicial review.
If the FTC accepts such a proposed consent, it places the order on the record
for sixty days of public comment before determining whether to make the order
final. The Company believes that it complied with all enumerated aspects of the
investigation. It has not received notice of an enforcement action or a
complaint against it.

     See also Note 17 to the Company's Consolidated Financial Statements for the
years ended December 30, 2000, December 25, 1999 and December 26, 1998 elsewhere
herein.

     In addition, the Company is involved in various routine lawsuits of a
nature, which are deemed customary and incidental to its businesses. In the
opinion of management, the ultimate disposition of these actions will not have a
material adverse effect on the Company's financial position or results of
operations.

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

     None.

                                        13
<PAGE>   15

                                    PART II

ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

     The Company's Common Stock trades on the American Stock Exchange under the
symbol "HNV". The following table sets forth, for the periods shown, the high
and low sale prices of the Company's Common Stock as reported on the American
Stock Exchange Composite Tape. As of March 16, 2001, there were 213,696,331
shares of Common Stock outstanding and approximately 3,742 holders of record of
Common Stock.

<TABLE>
<CAPTION>
                                                               HIGH      LOW
                                                              ------    ------
<S>                                                           <C>       <C>
FISCAL 2000
  First Quarter (Dec. 26, 1999 to March 25, 2000)...........  $3.688    $2.313
  Second Quarter (March 26, 2000 to June 24, 2000)..........   2.560     0.938
  Third Quarter (June 25, 2000 to Sept. 23, 2000)...........   1.688     0.500
  Fourth Quarter (Sept. 24, 2000 to Dec. 30, 2000)..........   0.625     0.188
FISCAL 1999
  First Quarter (Dec. 27, 1998 to March 27, 1999)...........  $3.813    $2.125
  Second Quarter (March 28, 1999 to June 26, 1999)..........   3.188     2.250
  Third Quarter (June 27, 1999 to Sept. 25, 1999)...........   3.000     1.563
  Fourth Quarter (Sept. 26, 1999 to Dec. 25, 1999)..........   3.875     1.875
</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.

                                        14
<PAGE>   16

ITEM 6.  SELECTED FINANCIAL DATA

     The following table presents selected financial data for each of the fiscal
years indicated:

<TABLE>
<CAPTION>
                                       2000         1999         1998         1997          1996
                                     ---------    ---------    ---------    ---------    ----------
                                       (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AND PER SHARE DATA)
<S>                                  <C>          <C>          <C>          <C>          <C>
INCOME STATEMENT DATA:
  Net Revenues.....................  $603,014     $549,852     $546,114     $557,638     $ 700,314

  Special charges (credit).........    19,126          144         (485)      (2,209)       36,724

  (Loss) from operations...........   (70,552)     (13,756)     (16,807)      (1,849)      (94,497)
  (Gain) on sale of The Shopper's
     Edge..........................        --       (4,343)          --           --            --
  (Gain) on sale of Austad's.......        --         (967)          --           --            --
  (Loss) before interest and
     taxes.........................   (70,552)      (8,446)     (16,807)      (1,849)      (94,497)
  Interest expense, net............    10,083        7,338        7,778        8,028         8,398
  (Loss) before extraordinary
     items.........................   (80,800)     (16,314)     (25,585)     (10,876)     (103,895)
  Extraordinary items..............        --           --           --           --        (1,134)
                                     --------     --------     --------     --------     ---------
  Net (loss).......................   (80,800)     (16,314)     (25,585)     (10,876)     (105,029)
  Preferred stock dividends........     4,015          634          578          190           225
                                     --------     --------     --------     --------     ---------
  (Loss) applicable to common
     stockholders..................  $(84,815)    $(16,948)    $(26,163)    $(11,066)    $(105,254)
                                     --------     --------     --------     --------     ---------
PER SHARE:
  (Loss) before extraordinary
     items.........................  $   (.40)    $   (.08)    $   (.13)    $   (.06)    $    (.93)
  Extraordinary items..............        --           --           --           --          (.01)
                                     --------     --------     --------     --------     ---------
  (Loss) -- basic and diluted......  $   (.40)    $   (.08)    $   (.13)    $   (.06)    $    (.94)
                                     --------     --------     --------     --------     ---------
WEIGHTED AVERAGE NUMBER OF SHARES
       OUTSTANDING (THOUSANDS):
  Basic............................   213,252      210,719      206,508      176,621       111,441
  Diluted..........................   213,252      210,719      206,508      176,621       111,441
BALANCE SHEET DATA (END OF PERIOD):
  Working capital (deficit) (1)....  $ 16,835     $ 17,990     $ 43,929     $ 47,570     $  (1,507)
  Total assets.....................   203,019      191,419      218,870      230,299       220,827
  Total debt (1)...................    39,036       42,835       58,859       59,958        65,189
  Redeemable preferred stock.......    71,628           --           --           --            --
  Shareholders' equity (deficit)...   (24,452)      53,865       66,470       75,551        31,740
</TABLE>

---------------
(1) The amounts for 1998 and 1997 include both a receivable and an obligation
    under receivables financing of $18,998 and $21,918, respectively, pursuant
    to SFAS No. 125.

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

                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 net revenues of certain items in the Company's
Consolidated Statements of Income (Loss):

<TABLE>
<CAPTION>
                                                                    FISCAL YEAR
                                                              -----------------------
                                                              2000     1999     1998
                                                              -----    -----    -----
<S>                                                           <C>      <C>      <C>
Net revenues................................................  100.0%   100.0%   100.0%
Cost of sales and operating expenses........................   67.2     63.7     62.9
Write-down (recovery) of inventory of discontinued
  catalogs..................................................    0.3     (0.4)     0.7
Special charges (credit)....................................    3.2       --     (0.1)
Selling expenses............................................   25.4     24.8     27.2
General and administrative expenses.........................   14.1     12.5     10.6
Depreciation and amortization...............................    1.5      1.7      1.7
(Gain) on sale of The Shopper's Edge........................     --     (0.8)      --
(Gain) on sale of Austad's..................................     --     (0.2)      --
Loss before interest and taxes..............................  (11.7)    (1.5)    (3.1)
Interest expense, net.......................................    1.7      1.3      1.4
Net (loss)..................................................  (13.4)%   (3.0)%   (4.7)%
</TABLE>

RESULTS OF OPERATIONS

  2000 COMPARED WITH 1999

     Net (Loss).  The Company reported a net loss of $80.8 million or $(.40) per
common share for fiscal year 2000 compared with a net loss of $16.3 million or
($.08) per common share for fiscal year 1999. Per share amounts are expressed
after deducting preferred dividends of $4.0 million in 2000 and $0.6 million in
1999. The weighted average number of shares outstanding was 213,251,945 for
fiscal year 2000 compared to 210,718,546 for fiscal year 1999. The increase in
weighted average shares outstanding was primarily due to the February 2000
redemption of the Company's Series B Convertible Additional Preferred Stock via
the issuance of 2,193,317 shares of the Company's Common Stock as well as shares
issued in connection with the Company's stock option plans.

     Compared to the comparable period in 1999, the $64.5 million increase in
net loss was primarily due to:

           i. higher distribution and systems development costs primarily
              related to the expansion of the Company's business to business
              ("B-to-B") e-commerce transaction services operation;

           ii. the recording of special charges in the fourth quarter of 2000 in
               connection with the Company's strategic business realignment
               program;

          iii. the impact of the write-down of inventory associated with the
               decision made in the fourth quarter of 2000 to discontinue three
               catalog brands;

           iv. higher general and administrative expenses; and

           v. higher interest expense.

     Net Revenues.  Net revenues increased $53.2 million or 9.7 % to $603.0
million for fiscal year 2000 from $549.9 million for fiscal year 1999.
Approximately $52.5 million of this increase is attributable to revenues
generated from the Company's core brands, which amounted to $547.0 million, an
increase of 10.6% over the comparable period in 1999. This increase is
attributable to higher demand across most merchandise categories aided by an
increase in circulation of catalogs offering these core brands which increased
from 214 million catalogs in 1999 to 251 million in 2000. Net revenues from
discontinued brands in fiscal year 2000 amounted to $18.4 million which
represents a $15.0 million decrease from 1999 which also included two additional
brands which had been discontinued or repositioned earlier in that year. This
decrease in net revenues, however, was offset by an increase of approximately
the same amount in net revenues generated by the Company's B-to-B e-commerce
transaction services operation which increased by 101.3% to $30 million for
fiscal year 2000.

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<PAGE>   18

     Cost of Sales and Operating Expenses.  Cost of sales and operating expenses
increased by $54.5 million or 15.5% over the amount reported for 1999. A
significant portion of this increase can be attributed to the increase in net
revenues for the fiscal 2000 year; however, cost of sales and operating
expenses, as a percent of net revenue, increased to 67.2% in fiscal 2000
compared with 63.7% in 1999 primarily due to higher distribution and systems
development costs associated with the expansion of the Company's B-to-B e-
commerce transaction services operation. This expansion included the investment
for a new fulfillment and distribution facility in Maumelle, Arkansas in
addition to increased headcount and higher facility/equipment rental expenses.

     Special Charges.  In December 2000, the Company developed a plan to
strategically realign the business and direct the Company's resources primarily
towards growth in Hanover Brands while at the same time reducing costs in all
areas of the business and eliminating investment activities that had not
generated sufficient revenue to produce profitable returns. Key elements of this
strategic business realignment plan include:

     - Concentrate on core brands;

     - Reduce several hundred full-time equivalent positions across all business
       units;

     - Close the Always in Style business;

     - Eliminate underperforming catalogs: Turiya, Kitchen & Home,
       Domestications Kitchen & Garden;

     - Terminate the Compagnie de la Chine marketing agreement;

     - Close the fulfillment and telemarketing facility in Maumelle, Arkansas
       and consolidate Keystone fulfillment operations; and

     - Cease Desius LLC's business operations.

     As a result of actions needed to execute this plan, the Company recorded a
special charge of $19.1 million in fiscal year 2000 to cover costs related to
severance, facility exit costs and fixed-asset write-offs.

     Write-down of Inventory of Discontinued Catalog Brands.  As part of the
Company's strategic business realignment plan, the Company decided to eliminate
three underperforming catalogs: Turiya, Kitchen & Home and Domestications
Kitchen & Garden. The inventory on-hand at December 30, 2000 was written-down to
its net realizable value based upon plans developed for the liquidation of the
merchandise. This write-down resulted in a charge of $2.0 million, which
compares to a recovery recorded in 1999 of $1.9 million, representing favorable
results in liquidating merchandise provided for in 1998 that was associated with
the discontinued Austad's, Tweeds and Colonial Garden Kitchens catalog brands.

     Selling Expenses.  Selling expenses increased by $16.9 million or 12.4%
over fiscal year 1999. As a percent of net revenues, they were 25.4% versus
24.8% in 1999. The increase as a percent of net revenues can be attributable to
the increase in circulation in year 2000 as well as an additional charge of $0.7
million incurred in the fourth quarter related to the write-down of prepaid
catalog costs associated with the discontinuance of three catalogs at the end of
fiscal 2000 year.

     General and Administrative Expenses.  General and administrative expenses
increased by $16.0 million or 23.1% over fiscal year 1999. This increase was
primarily a result of additional professional fees and consulting costs
associated with splitting the Company into two separate business segments and
the addition of personnel and related costs to support the expansion of the
Company's B-to-B e-commerce transaction services operations. A portion of the
increase in general and administrative expenses is attributable to the increase
in compensation expense related to stock options which resulted from the new
Executive Employment Agreement entered into with the Company's former Chief
Executive Officer. In addition, a portion of the increase is attributable to
charges incurred in the fourth quarter of 2000 related to the transition of
senior management.

     Depreciation and Amortization.  Depreciation and amortization decreased by
$0.3 million (3.1%) from fiscal year 1999.

     Loss before Interest and Taxes.  The Company's loss before interest and
taxes increased by $62.1 million to $70.5 million in fiscal 2000 from a loss of
$8.4 million in fiscal 1999. Beginning in 2000, the Company's results were
comprised of the following segments:

     - Direct Commerce:  Income before interest and taxes on a pro-forma basis
       decreased by $7.5 million primarily due to higher catalog costs
       reflecting higher paper costs as well as an increase in circulation,
       higher merchandise postage expense and higher personnel-related expenses,
       all of which were partially
                                        17
<PAGE>   19

       offset by the 1999 reversal of a portion of the 1998 charge for the
       write-down of discontinued catalog inventory.

     - B-to-B Services:  Loss before interest and taxes on a pro-forma basis
       increased by $38.6 million primarily due to higher distribution and
       systems development costs, which included higher costs related to an
       increase in headcount as well as higher consulting and facility/equipment
       rental expenses, primarily as a result of the 2000 expansion of the
       Company's B-to-B e-commerce transaction services operation. This
       expansion included the addition of a new fulfillment and distribution
       facility in Maumelle, Arkansas. Additionally, the Company incurred a
       higher provision for doubtful accounts.

     - Corporate/Other:  Loss before interest and taxes on a pro-forma basis
       increased by $16.0 million primarily attributable to costs associated
       with splitting the Company into two business segments and the costs
       recorded for the transition of senior management in the fourth quarter of
       2000.

     Interest Expense, Net.  Interest expense, net increased by $2.7 million to
$10.1 million in 2000 primarily due to higher average borrowings and interest
rates during the 2000 period.

     Income Taxes.  The Company did not record a Federal income tax provision in
2000 or 1999 due to net operating losses incurred during both years. The
Company's state tax provision was $0.2 million and $0.5 million for fiscal 2000
and fiscal 1999, respectively.

  1999 COMPARED WITH 1998

     Net (Loss).  The Company reported a net loss of $16.3 million or $(.08) per
common share for fiscal year 1999 compared with a net loss of $25.6 million or
($.13) per common share for fiscal year 1998. Per share amounts are expressed
after deducting preferred dividends of $0.6 million in both 1999 and 1998,
respectively. The weighted average number of shares outstanding was 210,718,546
for fiscal year 1999 compared to 206,508,110 for fiscal year 1998. The increase
in weighted average shares outstanding is due to the exercise of common stock
purchase warrants by Richemont Finance S.A. in July 1998.

     Compared to the comparable period in 1998, the $9.3 million decrease in net
loss was primarily due to:

           i. higher demand for the Company's core catalog offerings;

           ii. the 1999 gain on sale of The Shopper's Edge of $4.3 million;

          iii. 1998 losses from non-core catalogs, which were discontinued or
               repositioned during 1999;

          iv. 1998 charges of approximately $5.9 million relating to the
              discontinuance or repositioning of the Company's non-core
              catalogs; $3.7 million related to write-down of inventory ($1.9
              million of which was reversed in 1999) and $2.2 million related to
              write-off of prepaid catalog costs; and

           v. gain on sale of the non-core Austad's catalog of $1.0 million

     partially offset by,

           i. 1999 losses resulting from the Company's e-commerce related
              strategic initiatives; and

           ii. higher personnel related expenses.

     Revenues.  Revenues increased $3.8 million (0.7%) to $549.9 million for
fiscal year 1999 from $546.1 million for fiscal year 1998. This increase was
primarily due to higher demand for the Company's core catalogs offerings and
revenues from the expansion of the Company's third party B-to-B e-commerce
transaction services operation partly offset by lower demand from the Company's
non-core catalogs. Revenues from core catalogs increased by $18.6 million (3.8%)
while revenues from non-core catalogs decreased by $29.7 million (60.9%). The
Company circulated 235 million catalogs during fiscal year 1999 versus 242
million catalogs during fiscal year 1998 reflecting the discontinuance or
repositioning of the Company's non-core catalogs. Circulation of the Company's
core catalogs increased approximately 6.0% during fiscal year 1999. The number
of customers having made a purchase from the Company's catalogs during fiscal
year 1999 remained at approximately 4 million, consistent with fiscal year 1998.

     Fiscal year 1999 revenues of $14.9 million resulted from the expansion of
the Company's e-commerce transaction services operation, which provided Internet
order processing, customer care, and shipping and distribution services to third
party clients primarily during the 4th quarter. Third party B-to-B e-commerce
transaction service revenues for fiscal 1998 were approximately $2.1 million.

                                        18
<PAGE>   20

     Cost of Sales and Operating Expenses.  Cost of sales and operating expenses
increased by $6.9 million (2.0%) from fiscal year 1998. This increase includes
higher order processing, distribution and systems development costs related to
the expansion of the Company's e-commerce transaction services operation.
Furthermore, additional personnel related costs, which include temporary
increases in headcount, were incurred in order to fill the seasonal increase in
Internet orders during the holiday period. These cost increases along with
demand related increases in cost of merchandise sold from the Company's core
catalogs were partly offset by cost decreases resulting from the discontinuance
or repositioning of the Company's under-performing non-core catalogs.

     Selling Expenses.  Selling expenses decreased by $12.2 million (8.2%) from
fiscal year 1998. This reflects a $13.6 million decrease in expenses (including
a $2.2 million charge in 1998 for the write-down of certain non-core catalog
prepaid assets) resulting from the discontinuance or repositioning of the
Company's non-core catalogs. Selling expenses related to the Company's core
catalogs increased by $1.4 million (1.0%) due to an increase in circulation
during 1999 partly offset by lower name list rental and catalog production
costs.

     General and Administrative Expenses.  General and administrative expenses
increased by $11.0 million (19.1%) from fiscal year 1998. This increase is
primarily due to higher professional fees and Internet advertising costs related
to the Company's e-commerce strategic initiatives and higher personnel related
expenses.

     Depreciation and Amortization.  Depreciation and amortization decreased by
$0.1 million (1.0%) from fiscal year 1998.

     Loss before Interest and Taxes.  The Company's loss before interest and
taxes decreased by $8.4 million to $8.4 million in fiscal 1999 from a loss of
$16.8 million in fiscal 1998. Beginning in 1999, the Company's results are
comprised of the following segments:

     - Direct Commerce:  Income before interest and taxes increased by $23.1
       million primarily due to higher demand for the Company's core catalog
       offerings, the gain on sale of The Shopper's Edge ($4.3 million), 1998
       losses from the Company's non-core catalogs, 1998 charges related to the
       discontinuance of non-core catalogs ($5.9 million, of which $1.9 million
       was reversed during 1999), and the gain on sale of Austads ($1.0
       million). This was partially offset by the cost of the Company's catalog
       related e-commerce strategic initiatives (primarily Internet advertising
       costs) and higher personnel related administrative expenses.

     - B-to-B Services:  Loss before interest and taxes increased by $15.2
       million primarily due to 1999 losses related to the expansion of the
       Company's third party B-to-B e-commerce transaction services operation,
       higher professional fees resulting from the separation of the Company's
       direct commerce/B-to-B services operations, and higher personnel related
       administrative expenses. These results reflect overhead costs incurred by
       the Company throughout fiscal 1999 to systematize the infrastructure in
       order to service the expected increase in third party Internet customers,
       which were brought online primarily during the second half of the year.

     Interest Expense, Net.  Interest expense, net decreased by $0.4 million to
$7.3 million in 1999 due to lower average borrowings outstanding during 1999.

     Income Taxes.  The Company did not record a Federal income tax provision in
1999 or 1998 due to net operating losses incurred during both years. The
Company's state tax provision was $0.5 million and $1.0 million for fiscal 1999
and 1998, respectively.

     Shareholders' Equity.  The number of shares of Common Stock outstanding
increased by 439,574 during 1999 primarily due to shares issued in connection
with the Company's stock option plans. At December 25, 1999, there were
210,866,959 shares of Common Stock outstanding compared to 210,427,385 shares of
Common Stock outstanding at December 26, 1998.

                                        19
<PAGE>   21

     Shopper's Edge Up-sell Program.  In March 1999, the Company, through a
newly formed subsidiary, started up and promoted a discount buyers club to
consumers known as "The Shopper's Edge." In exchange for an up-front membership
fee, the Shopper's Edge program enables members to purchase a wide assortment of
merchandise at discounts which were not available through traditional retail
channels. Initially, prospective members participated in a 45-day trial period
that, unless canceled, was automatically converted into a full membership term,
which was one year in duration. Memberships were automatically renewed at the
end of each term unless canceled by the member.

     During 1999, primarily as a result of timing of revenue and expense
recognition, the Shopper's Edge subsidiary incurred losses of $4.3 million
reflecting both cash payments and outstanding liabilities to the Company of $3.3
million and $1.0 million, respectively. The Company's operating results
reflected $0.1 million of net losses after the elimination of these intercompany
transactions. The Company recorded membership fee revenue as well as an
allowance for estimated cancellations, on a straight-line basis over the
one-year membership term, which commenced immediately following the expiration
of the initial 45-day trial period. Costs tied to acceptances such as
commissions paid to service providers as well as membership servicing and
transaction-processing expenses were deferred and expensed as membership fee
revenue was recognized. All other costs, including membership kits and postage,
were expensed as incurred. Under the terms of the program, the Company was
entitled to periodic withdrawals of funds provided by up-front membership fees.
These withdrawals, however, were subject to contractual limitations as the
Shopper's Edge subsidiary was required to maintain adequate cash balances to
fund estimated membership reimbursements resulting from cancellations.
Accordingly, funds retained within the Shopper's Edge subsidiary were reported
as "restricted cash" in the Company's balance sheet during 1999. If membership
reimbursements due to cancellations exceeded the amount of funds retained by the
Shopper's Edge subsidiary, the Company was liable to cover the shortfall.

     Effective December 1999, the Company sold its interest in the Shopper's
Edge subsidiary to an unrelated third party for a nominal fair value based upon
an independent appraisal. At the time of the sale, the liabilities of the
subsidiary exceeded the assets by $4.3 million resulting in a gain on sale to
the Company of $4.3 million. The gain represented the portion of deferred income
of the Shopper's Edge that the Company received in the form of withdrawals
discussed above which, in accordance with the Company's revenue recognition
policy for memberships, would not have been earned until the completion of the
membership term. The deferred income was recognized immediately upon the sale
and has been reflected as a gain on sale in the accompanying consolidated
statement of income (loss) for the year ended December 25, 1999. There are no
conditions to the obligations of the Company to refund any portion of the cash
withdrawals received prior to the sale. The Company entered into a solicitation
services agreement with the purchaser whereby the Company will provide
solicitation services for the program and will receive commissions for member
acceptances based on a fixed fee per member basis, adjusted for cancellation
rates on a prospective basis. Membership revenue earned during the fiscal year
ended December 25, 1999 was $3.9 million which was included in revenues in the
accompanying consolidated statement of income (loss). Had the new solicitation
services agreement been in place for fiscal 1999, net revenues on a pro-forma
basis would have increased by $1.4 million reflecting the inclusion of $5.3
million of fee revenue for solicitation services provided versus $3.9 million of
recorded membership fee revenue under the old agreement. Furthermore, on a
pro-forma basis, the Company's loss from operations would have decreased by $5.4
million to $8.4 million.

LIQUIDITY AND CAPITAL RESOURCES

     Net cash used by operating activities.  During 2000, net cash used by
operating activities was $51.8 million. This was primarily due to net losses
which, when adjusted for depreciation, amortization and other non-cash items,
comprised $38.2 million of operating cash used in the period. Additionally, cash
outflows resulted from increases in inventory, accounts receivable and prepaid
catalog costs, slightly offset by increases in accounts payable, customer
prepayments and credits and accrued liabilities.

     Net cash used by investing activities.  During 2000, net cash used by
investing activities of $13.6 million was primarily due to capital expenditures
of $14.6 million partly offset by proceeds of $1.0 million from the sale of the
Company's investment in Blue Ridge Associates. The capital expenditures were
primarily for new equipment purchases for the Company's new fulfillment and
distribution facility in Maumelle, Arkansas, as well as computer hardware and
software purchases to upgrade the Company's information technology platform.

                                        20
<PAGE>   22

     Net cash provided by financing activities.  During 2000, net cash provided
by financing activities of $64.2 million was primarily due to the net proceeds
of $67.7 million attributable to the issuance of 1.4 million shares of Series A
Cumulative Participating Preferred Stock to Richemont Finance S.A., partly
offset by a net decrease in borrowings of $3.7 million and the payment of debt
issuance costs of $2.8 million primarily related to the March 2000 refinancing
of the Company's credit facilities. During March 2000, the Company refinanced
$24.0 million of borrowings under the Term Financing Facility and Industrial
Revenue Bonds with additional borrowings under the Congress Credit Facility as
discussed below.

     Congress Credit Facility.  On March 24, 2000, the Company amended its
credit facility with Congress Financial Corporation ("Congress") to provide the
Company with a maximum credit line, subject to certain limitations, of up to
$82.5 million (the "Congress Credit Facility"). The Congress Credit Facility, as
amended, expires on January 31, 2004 and is comprised of a revolving loan
facility, a $17.5 million Tranche A Term Loan and a $7.5 million Tranche B Term
Loan. Total cumulative borrowings, however, are subject to limitations based
upon specified percentages of eligible receivables and eligible inventory, and
the Company is required to maintain $3.0 million of excess credit availability
at all times. The Congress Credit Facility, as amended, is secured by all the
assets of the Company and places restrictions on the incurrence of additional
indebtedness and on the payment of Common Stock dividends. As of December 30,
2000, the Company had $38.1 million of borrowings outstanding under the amended
Congress Credit Facility comprised of $15.7 million under the revolving loan
facility, and $14.9 million and $7.5 million of Tranche A Term Loans and Tranche
B Term Loans, respectively. The Company may draw upon the amended Congress
Credit Facility to fund working capital requirements as needed.

     The amended Congress Credit Facility replaced the original $65.0 million
revolving line of credit facility with Congress, as well as the Company's $16.0
million Term Financing Facility and $8.0 million of Industrial Revenue Bonds.
Both the Term Financing Facility and the Industrial Revenue Bonds were supported
by letters of credit issued by UBS, AG and guaranteed by Richemont Finance S.A.,
which letters of credit were scheduled to expire on March 31, 2000. The Company
utilized $24.0 million of proceeds under the amended Congress Credit Facility to
reimburse UBS, AG for drawings on the letters of credit made by the trustees of
the Term Financing Facility and the Industrial Revenue Bonds, both of which were
required to be redeemed upon the expiration of the letters of credit.

     Richemont $10.0 Million Line of Credit Facility.  From March 24, 2000
through August 24, 2000, the Company was a party to a $10.0 million unsecured
line of credit facility (the "Richemont $10.0 million Line of Credit") with
Richemont Finance S.A. ("Richemont"). The Richemont $10.0 million Line of Credit
facility provided the Company with financing from Richemont should the excess
availability under the Congress Credit Facility fall below $3.0 million.
Additionally, the Company could have borrowed up to $5.0 million under the
Richemont $10.0 million Line of Credit to pay trade creditors in the ordinary
course of business. On August 24, 2000, the Richemont $10.0 million Line of
Credit was terminated and all borrowings outstanding as of August 24, 2000 of
approximately $5.0 million, plus accrued and unpaid interest and fees, were
repaid and retired from a portion of the net proceeds obtained from the issuance
of the Company's Series A Cumulative Participating Preferred Stock to Richemont.

     Richemont $25.0 Million Line of Credit Facility.  From March 1, 2000
through August 24, 2000, the Company was a party to a $25.0 million unsecured
line of credit facility (the "Richemont $25.0 million Line of Credit") with
Richemont which provided the Company with funding from Richemont to continue the
development and expansion of the Company's B-to-B e-commerce transaction
services operation. On August 24, 2000, the Richemont $25.0 million Line of
Credit was terminated and all borrowings outstanding as of August 24, 2000 of
approximately $25.0 million, plus accrued and unpaid interest and fees, were
repaid and retired from a portion of the net proceeds obtained from the issuance
of the Company's Series A Cumulative Participating Preferred Stock to Richemont.

     Cumulative Participating Preferred Stock.  On August 24, 2000, the Company
issued 1.4 million shares of Series A Cumulative Participating Preferred Stock
at a share price equal to its liquidation value of $50.00 per share (the "Series
A Preferred Stock") to Richemont, obtaining proceeds of approximately $67.7
million, net of issuance costs. Approximately $30.9 million of net proceeds were
used to repay and retire all borrowings outstanding under the Richemont $25.0
million Line of Credit and the Richemont $10.0 million Line of Credit, plus
accrued and unpaid interest and fees, and, as a result, both the Richemont $25.0
million Line of Credit and the Richemont $10.0 million Line of Credit were
terminated. The remaining net

                                        21
<PAGE>   23

proceeds of approximately $36.8 million were used to reduce debt levels under
the Congress Credit Facility to lower the Company's debt service costs. This
resulted in an increase in credit availability under the Congress Credit
Facility that the Company may draw upon when necessary to fund its working
capital requirements.

     Dividends on the Series A Preferred Stock are cumulative and accrue at an
annual rate of 15%, or $7.50 per share, and are payable quarterly either in cash
or in kind through the issuance of additional Series A Preferred Stock. As of
December 30, 2000, the Company had accrued dividends of $3.8 million, and has
reserved 75,498 additional shares of Series A Preferred Stock for the payment of
such dividends. Cash dividend payments are required for dividend payment dates
occurring after February 1, 2004. Mandatory redemption of the Series A Preferred
Stock by the Company is required on August 23, 2005 (the "Final Redemption
Date") at a redemption price of $50.00 per share of Series A Preferred Stock
plus the amount of any accrued and unpaid dividends. If, at the Final Redemption
Date, the Company does not have sufficient capital and surplus legally available
to redeem all the outstanding shares of the Series A Preferred Stock, the
Company will be required to take all measures permitted under the Delaware
General Corporation Law to increase the amount of its capital and surplus
legally available and to redeem as many shares of the Series A Preferred Stock
as it may legally redeem. Thereafter, as funds become available, the Company
will be required to redeem as many additional shares of the Series A Preferred
Stock as it legally can, until it has redeemed all remaining outstanding shares
of the Series A Preferred Stock.

     General.  At December 30, 2000, the Company had $1.7 million in cash and
cash equivalents compared with $2.8 million at December 25, 1999. Working
capital and current ratios at December 30, 2000 were $16.8 million and 1.15 to 1
versus $18.0 million and 1.19 to 1 at December 25, 1999. Total cumulative
borrowings, including financing under capital lease obligations, as of December
30, 2000, aggregated $39.0 million, $35.3 million of which is classified as
long-term. Remaining availability under the Congress Revolving Credit Facility
as of December 30, 2000 was $44.4 million ($46.1 million including cash on
hand). Capital commitments at December 30, 2000 totaled approximately $0.6
million principally for the Lawson human resources/payroll system, fixtures and
equipment for the Company's warehouse and fulfillment facility in Maumelle,
Arkansas, IT hardware and software and an upgrade of the Kronos payroll
reporting system. Management believes that the Company has sufficient liquidity
and availability under its credit agreements to fund its planned operations
through at least December 29, 2001. Achievement of the cost saving and other
objectives of the Company's strategic business realignment plan is critical to
the maintenance of adequate liquidity.

FORWARD LOOKING STATEMENTS

     The following statement constitutes a forward-looking statement within the
meaning of the Private Securities Litigation Reform Act of 1995:

     "Management believes that the Company has sufficient liquidity and
availability under its credit agreements to fund its planned operations through
at least December 29, 2001."

CAUTIONARY STATEMENTS

     The following material identifies important factors that could cause actual
results to differ materially from those expressed in the forward looking
statement identified above and in any other forward looking statements contained
elsewhere herein:

          The current general deterioration in economic conditions in the United
     States leading to reduced consumer confidence, reduced disposable income
     and increased competitive activity and the business failure of companies in
     the retail, catalog and direct marketing industries. Such economic
     conditions leading to a reduction in consumer spending generally and in
     home fashions specifically, and leading to a reduction in consumer spending
     specifically with reference to other types of merchandise the Company
     offers in its catalogs or over the Internet, or which are offered by the
     Company's third party fulfillment clients.

          Customer response to the Company's merchandise offerings and
     circulation changes; effects of shifting patterns of e-commerce versus
     catalog purchases; costs associated with printing and mailing catalogs and
     fulfilling orders; dependence on customers' seasonal buying patterns; and
     fluctuations in foreign currency exchange rates.

                                        22
<PAGE>   24

          The ability of the Company to achieve projected levels of sales and
     reducing costs commensurately. Increases in postage, printing and paper
     prices and/or the inability of the Company to reduce expenses generally as
     required and/or increase prices of the Company's merchandise.

          The failure of the Internet generally to achieve the projections for
     it with respect to growth of e-commerce or otherwise, and the failure of
     the Company to increase Internet sales. The imposition of regulatory, tax
     or other requirements with respect to Internet sales. Actual or perceived
     technological difficulties or security issues with respect to conducting
     e-commerce over the Internet generally or through the Company's web sites
     or those of its third-party fulfillment clients specifically.

          The ability of the Company to attract and retain management and
     employees generally and specifically with the requisite experience in
     e-commerce, Internet and direct marketing businesses. The ability of
     employees of the Company who have been promoted as a result of the
     Company's recently announced restructuring plan to perform the
     responsibilities of their new positions.

          The current general deterioration in economic conditions in the United
     States leading to key vendors and suppliers reducing or withdrawing trade
     credit to companies in the retail, and catalog and direct marketing
     industries. The risk that key vendors or suppliers may reduce or withdraw
     trade credit to the Company, convert the Company to a cash basis or
     otherwise change credit terms, or require the Company to provide letters of
     credit or cash deposits to support its purchase of inventory, increasing
     the Company's cost of capital and impacting the Company's ability to obtain
     merchandise in a timely manner. Vendors may begin to withhold shipments of
     merchandise to the Company. The ability of the Company to find alternative
     vendors and suppliers on competitive terms if existing vendors or suppliers
     ceases doing business with the Company.

          The inability of the Company to timely obtain and distribute
     merchandise, leading to an increase in backorders and cancellations.

          Defaults under the Congress Credit Facility, or inadequacy of
     available borrowings thereunder, may reduce or impair the Company's ability
     to obtain letters of credit or other credit to support its purchase of
     inventory and support normal operations, impacting the Company's ability to
     obtain, market and sell merchandise in a timely manner.

          The ability of the Company to continue to make borrowings under the
     Congress Credit Facility is subject to the Company's continued compliance
     with certain financial and other covenants contained therein, including net
     worth, net working capital, capital expenditure and EBITDA covenants.
     Borrowings under the Congress Credit Facility are also subject to
     limitations based upon specified percentages of eligible receivables and
     eligible inventory, and the requirement that the Company maintain $3.0
     million of excess credit availability at all times. The enforcement by
     Congress of such covenants and limitations.

          The Company has a history of operating losses. Continuation of the
     operating losses, and the incidence of costs associated with the Company's
     recently announced restructuring plan, may result in the Company failing to
     comply with certain financial and other covenants contained in the Congress
     Credit Facility, including net worth, net working capital, capital
     expenditure and EBITDA covenants.

          The ability of the Company to complete the Company's recently
     announced restructuring program, within the time periods anticipated by the
     Company. The ability of the Company to realize the aggregate cost savings
     anticipated in connection with the restructuring plan, or within the time
     periods anticipated therefor. The aggregate costs of effecting the
     restructuring plan may be greater than the amounts anticipated by the
     Company.

          The ability of the Company to transfer third party fulfillment
     operations conducted at the fulfillment centers located in Maumelle,
     Arkansas and Kindig Lane, Hanover, Pennsylvania to other facilities in a
     timely manner while satisfying its contractual obligations to provide
     fulfillment services for third party clients and itself.

          The ability of the Company to dispose of assets related to its third
     party fulfillment business, to the extent not transferred to other
     facilities.

                                        23
<PAGE>   25

          The initiation by the Company of additional cost cutting and
     restructuring initiatives, the costs associated therewith, and the ability
     of the Company to timely realize any savings anticipated in connection
     therewith.

          The ability of the Company to maintain insurance coverage required in
     order to operate its businesses and as required by the Congress Credit
     Facility.

          The inability of the Company to access the capital markets due to
     market conditions generally, including a lowering of the market valuation
     of companies in the direct marketing and retail businesses, and the
     Company's business situation specifically.

          The Company's dependence up to August 24, 2000 on Richemont and its
     affiliates for financial support and the fact that they are not under any
     obligation ever to provide any additional support in the future.

          The ability of the Company to achieve the cost saving and other
     objectives of its strategic business realignment plan.

ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     INTEREST RATES:  The Company's exposure to market risk relates to interest
rate fluctuations for borrowings under the Congress Revolving Credit Facility,
which bears interest at variable rates. At December 30, 2000, outstanding
principal balances under the Congress Revolving Credit Facility subject to
variable rates of interest were approximately $38.1 million. If interest rates
were to increase by one quarter of one percent from current levels, the
resulting increase in interest expense of approximately $0.1 million would not
have a material impact on the Company's results of operations taken as a whole.

                                        24
<PAGE>   26

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 30, 2000
and December 25, 1999, and the related consolidated statements of income (loss),
shareholders' equity(deficit) and cash flows for each of the three fiscal years
in the period ended December 30, 2000. 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 auditing standards generally
accepted in the United States. 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 30, 2000 and December 25, 1999 and the results of
their operations and their cash flows for each of the three fiscal years in the
period ended December 30, 2000 in conformity with accounting principles
generally accepted in the United States.

     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 20, 2001

                                        25
<PAGE>   27

                          CONSOLIDATED BALANCE SHEETS

                 AS OF DECEMBER 30, 2000 AND DECEMBER 25, 1999

                (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AMOUNTS)

<TABLE>
<CAPTION>
                                                              DECEMBER 30,    DECEMBER 25,
                                                                  2000            1999
                                                              ------------    ------------
<S>                                                           <C>             <C>
                                          ASSETS
CURRENT ASSETS:
  Cash and cash equivalents.................................    $  1,691        $  2,849
  Accounts receivable, net of allowance for doubtful
     accounts of $5,668 in 2000 and $3,300 in 1999..........      27,703          29,287
  Inventories...............................................      69,612          54,816
  Prepaid catalog costs.....................................      23,084          20,305
  Deferred tax asset, net...................................       3,300           3,300
  Other current assets......................................       3,056           2,935
                                                                --------        --------
          Total Current Assets..............................     128,446         113,492
                                                                --------        --------
PROPERTY AND EQUIPMENT, AT COST:
  Land......................................................       4,724           4,634
  Buildings and building improvements.......................      23,442          23,269
  Leasehold improvements....................................      12,624           9,491
  Furniture, fixtures and equipment.........................      59,773          53,863
  Construction in progress..................................         647           1,990
                                                                --------        --------
                                                                 101,210          93,247
  Accumulated depreciation and amortization.................     (55,570)        (46,360)
                                                                --------        --------
  Property and equipment, net...............................      45,640          46,887
                                                                --------        --------
  Goodwill, net.............................................      15,816          16,336
  Deferred tax asset, net...................................      11,700          11,700
  Other assets..............................................       1,417           3,004
                                                                --------        --------
          Total Assets......................................    $203,019        $191,419
                                                                ========        ========
                      LIABILITIES AND SHAREHOLDERS' EQUITY(DEFICIT)
CURRENT LIABILITIES:
  Current portion of long-term debt and capital lease
     obligations............................................    $  3,718        $  3,257
  Accounts payable..........................................      67,858          63,549
  Accrued liabilities.......................................      34,443          24,284
  Customer prepayments and credits..........................       5,592           4,412
                                                                --------        --------
          Total Current Liabilities.........................     111,611          95,502
                                                                --------        --------
NON-CURRENT LIABILITIES:
  Long-term debt............................................      35,318          39,578
  Other.....................................................       8,914           2,474
                                                                --------        --------
          Total Non-current Liabilities.....................      44,232          42,052
                                                                --------        --------
          Total Liabilities.................................     155,843         137,554
                                                                --------        --------
SERIES A CUMULATIVE PARTICIPATING PREFERRED STOCK
  mandatorily redeemable at $50 per share ($70,000),
  2,345,000 shares authorized, 1,475,498 shares issued at
  December 30, 2000 and none at December 25, 1999...........      71,628              --
SHAREHOLDERS' EQUITY(DEFICIT):
Series B Convertible Additional Preferred Stock, $10 stated
  value, authorized, issued and outstanding: none at
  December 30, 2000 and 634,900 shares at December 25,
  1999......................................................          --           6,318
Common Stock, $.66 2/3 par value, authorized 300,000,000
  shares in 2000 and 1999; issued 214,425,498 shares in 2000
  and 211,519,511 shares in 1999............................     142,951         141,013
Capital in excess of par value..............................     307,595         301,088
Accumulated deficit.........................................    (471,651)       (390,763)
                                                                --------        --------
                                                                 (21,105)         57,656
                                                                --------        --------
Less:
Treasury stock, at cost (729,167 shares in 2000 and 652,552
  shares in 1999)...........................................      (2,223)         (1,829)
Notes receivable from sale of Common Stock..................      (1,124)         (1,962)
                                                                --------        --------
          Total Shareholders' Equity(Deficit)...............     (24,452)         53,865
                                                                --------        --------
          Total Liabilities and Shareholders'
            Equity(Deficit).................................    $203,019        $191,419
                                                                ========        ========
</TABLE>

                See notes to consolidated financial statements.

                                        26
<PAGE>   28

                    CONSOLIDATED STATEMENTS OF INCOME (LOSS)

 FOR THE YEARS ENDED DECEMBER 30, 2000, DECEMBER 25, 1999 AND DECEMBER 26, 1998

              (IN THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS)

<TABLE>
<CAPTION>
                                                               2000        1999        1998
                                                             --------    --------    --------
<S>                                                          <C>         <C>         <C>
NET REVENUES...............................................  $603,014    $549,852    $546,114
                                                             --------    --------    --------
OPERATING COSTS AND EXPENSES:
  Cost of sales and operating expenses.....................   404,959     350,502     343,554
  Write-down of inventory of discontinued catalogs.........     2,048      (1,932)      3,726
  Special charges (credit).................................    19,126         144        (485)
  Selling expenses.........................................   153,462     136,584     148,767
  General and administrative expenses......................    84,881      68,928      57,881
  Depreciation and amortization............................     9,090       9,382       9,478
                                                             --------    --------    --------
                                                              673,566     563,608     562,921
                                                             --------    --------    --------
(LOSS) FROM OPERATIONS.....................................   (70,552)    (13,756)    (16,807)
  (Gain) on sale of The Shopper's Edge.....................        --      (4,343)         --
  (Gain) on sale of Austad's...............................        --        (967)         --
                                                             --------    --------    --------
(LOSS) BEFORE INTEREST AND TAXES...........................   (70,552)     (8,446)    (16,807)
  Interest expense, net....................................    10,083       7,338       7,778
                                                             --------    --------    --------
  (Loss) before income taxes...............................   (80,635)    (15,784)    (24,585)
  Income tax provision.....................................       165         530       1,000
                                                             --------    --------    --------
NET (LOSS) AND COMPREHENSIVE (LOSS)........................   (80,800)    (16,314)    (25,585)
  Preferred stock dividends................................     4,015         634         578
                                                             --------    --------    --------
NET (LOSS) APPLICABLE TO COMMON SHAREHOLDERS...............  $(84,815)   $(16,948)   $(26,163)
                                                             ========    ========    ========
NET (LOSS) PER COMMON SHARE:
  Net (loss) per common share -- basic and diluted.........  $   (.40)   $   (.08)   $   (.13)
                                                             ========    ========    ========
  Weighted average common shares outstanding -- basic and
     diluted (thousands)...................................   213,252     210,719     206,508
                                                             ========    ========    ========
</TABLE>

                See notes to consolidated financial statements.

                                        27
<PAGE>   29

                     CONSOLIDATED STATEMENTS OF CASH FLOWS

 FOR THE YEARS ENDED DECEMBER 30, 2000, DECEMBER 25, 1999 AND DECEMBER 26, 1998
                           (IN THOUSANDS OF DOLLARS)

<TABLE>
<CAPTION>
                                                               2000        1999        1998
                                                             --------    --------    --------
<S>                                                          <C>         <C>         <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
  Net (loss)...............................................  $(80,800)   $(16,314)   $(25,585)
  Adjustments to reconcile net (loss) to net cash (used) by
     operating activities:
     Depreciation and amortization, including deferred
       fees................................................    11,271      11,951      11,466
     Provision for doubtful accounts.......................     4,947       2,817       3,278
     Special charges (credit)..............................    19,126         144        (485)
     Write-down of inventory of discontinued catalogs
       (recovery)..........................................     2,048      (1,932)      3,726
     Gain on the sale of Austad's..........................        --        (967)         --
     Compensation expense related to stock options.........     5,175       2,890       2,684
  Changes in assets and liabilities
     Accounts receivable...................................    (3,363)     (8,639)     (8,331)
     Inventories...........................................   (16,844)      8,853      (1,718)
     Prepaid catalog costs.................................    (2,779)     (4,288)      4,651
     Accounts payable......................................     4,309      (1,045)      5,795
     Accrued liabilities...................................     2,119         710      (7,562)
     Customer prepayments and credits......................     1,180        (279)        867
     Other, net............................................     1,803        (572)       (867)
                                                             --------    --------    --------
  Net cash (used) by operating activities..................   (51,808)     (6,671)    (12,081)
                                                             --------    --------    --------
CASH FLOWS FROM INVESTING ACTIVITIES:
     Acquisitions of property and equipment................   (14,581)     (4,830)     (6,111)
     Proceeds from sale of Austad's........................        --       1,568          --
     Proceeds from investment..............................       988          --          --
                                                             --------    --------    --------
  Net cash (used) by investing activities..................   (13,593)     (3,262)     (6,111)
                                                             --------    --------    --------
CASH FLOWS FROM FINANCING ACTIVITIES:
     Net borrowings under revolving credit facility........    12,810       5,202          --
     Borrowings from term loan facility....................     9,820          --       7,272
     Payments of long-term debt and capital lease
       obligations.........................................   (24,130)     (2,745)     (5,433)
     Net proceeds from issuance of preferred stock.........    67,700          --          --
     Payment of debt issuance costs........................    (2,770)     (2,701)         --
     Payment of preferred stock dividends..................      (920)         --          --
     Proceeds from issuance of stock options...............       847         936         492
     Proceeds from exercise of stock warrants..............        --          --      13,640
     Other, net............................................       886        (117)       (330)
                                                             --------    --------    --------
  Net cash provided by financing activities................    64,243         575      15,641
                                                             --------    --------    --------
  Net (decrease) in cash and cash equivalents..............    (1,158)     (9,358)     (2,551)
  Cash and cash equivalents at the beginning of the year...     2,849      12,207      14,758
                                                             --------    --------    --------
  Cash and cash equivalents at the end of the year.........  $  1,691    $  2,849    $ 12,207
                                                             ========    ========    ========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
     Cash paid during the year for:
       Interest............................................  $  7,723    $  4,765    $  5,095
       Income taxes........................................  $    414    $    713    $    447
     Non-cash investing and financing activities:
       Redemption of Series B Convertible Additional
          Preferred Stock..................................  $  6,350    $     --    $     --
       Stock dividend and accretion Series A Cumulative
          Participating Preferred Stock....................  $  3,927    $     --    $     --
       Non-cash gain on sale of The Shopper's Edge.........  $     --    $  4,343    $     --
       Tandem share expirations............................  $    394    $  1,016    $     --
       Capital lease obligations...........................  $     --    $    517    $     --
</TABLE>

                See notes to consolidated financial statements.

                                        28
<PAGE>   30

            CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY(DEFICIT)

 FOR THE YEARS ENDED DECEMBER 26, 1998, DECEMBER 25, 1999 AND DECEMBER 30, 2000
                      (IN THOUSANDS OF DOLLARS AND SHARES)
<TABLE>
<CAPTION>
                                           PREFERRED
                                             STOCK
                                           SERIES B            COMMON STOCK         CAPITAL
                                          CONVERTIBLE       $.66 2/3 PAR VALUE     IN EXCESS                  TREASURY STOCK
                                       -----------------    -------------------     OF PAR       ACCUM.      -----------------
                                       SHARES    AMOUNT     SHARES      AMOUNT       VALUE      (DEFICIT)    SHARES    AMOUNT
                                       ------    ------     ------      ------     ---------    ---------    ------    ------
<S>                                    <C>       <C>        <C>        <C>         <C>          <C>          <C>       <C>
BALANCE AT DECEMBER 27, 1997.........    635     $ 5,938    204,442    $136,294    $285,165     $(347,652)    (686)    $  (968)
Net (loss) applicable to common
  shareholders.......................                                                             (26,163)
Cash received for Tandem
  receivable.........................
Preferred stock accretion............                190
Stock options granted................                                                 2,684
Exercise of Warrants.................                         5,646       3,764       9,876
Issuance & forfeitures of Common
  Stock for employee stock plan......                           698         466          26                    328         155
                                        ----     -------    -------    --------    --------     ---------     ----     -------
BALANCE AT DECEMBER 26, 1998.........    635     $ 6,128    210,786    $140,524    $297,751     $(373,815)    (358)    $  (813)
                                        ====     =======    =======    ========    ========     =========     ====     =======
Net (loss) applicable to common
  shareholders.......................                                                             (16,948)
Preferred stock accretion............                190
Stock options granted................                                                 2,890
Cash received for Tandem
  receivable.........................
Issuance & forfeitures of Common
  Stock for employee stock plan......                           734         489         447
Tandem share expirations.............                                                                         (294)     (1,016)
                                        ----     -------    -------    --------    --------     ---------     ----     -------
BALANCE AT DECEMBER 25, 1999.........    635     $ 6,318    211,520    $141,013    $301,088     $(390,763)    (652)    $(1,829)
                                        ====     =======    =======    ========    ========     =========     ====     =======
Net (loss) applicable to common
  shareholders.......................                                                             (84,815)
Preferred stock accretion............                 32                               (152)          152
Preferred stock dividend.............                                                (3,775)        3,775
Stock options granted................                                                 5,175
Cash received for Tandem
  receivable.........................
Tandem note write-down...............
Issuance & forfeitures of Common
  Stock for employee stock plan......                           713         476         371                                 --
Tandem share expirations.............                                                                          (77)       (394)
Conversion to Common Stock...........   (635)     (6,350)     2,192       1,462       4,888
                                        ----     -------    -------    --------    --------     ---------     ----     -------
BALANCE AT DECEMBER 30, 2000.........     --     $    --    214,425    $142,951    $307,595     $(471,651)    (729)    $(2,223)
                                        ====     =======    =======    ========    ========     =========     ====     =======

<CAPTION>

                                         NOTES
                                       RECEIVABLE
                                       FROM SALE
                                       OF COMMON
                                         STOCK        TOTAL
                                       ----------     -----
<S>                                    <C>           <C>
BALANCE AT DECEMBER 27, 1997.........   $(3,226)     $ 75,551
Net (loss) applicable to common
  shareholders.......................                 (26,163)
Cash received for Tandem
  receivable.........................        69            69
Preferred stock accretion............                     190
Stock options granted................                   2,684
Exercise of Warrants.................                  13,640
Issuance & forfeitures of Common
  Stock for employee stock plan......      (148)          499
                                        -------      --------
BALANCE AT DECEMBER 26, 1998.........   $(3,305)     $ 66,470
                                        =======      ========
Net (loss) applicable to common
  shareholders.......................                 (16,948)
Preferred stock accretion............                     190
Stock options granted................                   2,890
Cash received for Tandem
  receivable.........................       327           327
Issuance & forfeitures of Common
  Stock for employee stock plan......                     936
Tandem share expirations.............     1,016            --
                                        -------      --------
BALANCE AT DECEMBER 25, 1999.........   $(1,962)     $ 53,865
                                        =======      ========
Net (loss) applicable to common
  shareholders.......................                 (84,815)
Preferred stock accretion............                      32
Preferred stock dividend.............                      --
Stock options granted................                   5,175
Cash received for Tandem
  receivable.........................        10            10
Tandem note write-down...............       434           434
Issuance & forfeitures of Common
  Stock for employee stock plan......                     847
Tandem share expirations.............       394            --
Conversion to Common Stock...........                      --
                                        -------      --------
BALANCE AT DECEMBER 30, 2000.........   $(1,124)     $(24,452)
                                        =======      ========
</TABLE>

                See notes to consolidated financial statements.

                                        29
<PAGE>   31

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

     YEARS ENDED DECEMBER 30, 2000, DECEMBER 25, 1999 AND DECEMBER 26, 1998

1.  BACKGROUND OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

     Nature of Operations -- Hanover Direct, Inc., a Delaware corporation (the
"Company"), operates as both a specialty direct marketer and as a provider of
business to business ("B-to-B") e-commerce transaction services. As a specialty
direct marketer, the Company markets a diverse portfolio of branded home
fashions, home improvements, men's and women's apparel, and gift products,
through mail-order catalogs and connected Internet Web sites directly to the
consumer ("direct commerce"). As a provider of B-to-B e-commerce transaction
services, the Company offers a full range of order processing, customer care,
customer information, and shipping and distribution services to third party
clients in the United States.

     The Company utilizes a fully integrated system and operations support
platform initially developed to manage the Company's wide variety of
catalog/Internet product offerings. This infrastructure has been leveraged and
expanded to provide the aforementioned B-to-B e-commerce transaction services on
behalf of third party clients. Beginning in 1999, the Company adopted SFAS No.
131, "Disclosures about Segments of an Enterprise and Related Information" to
report its direct commerce and B-to-B e-commerce transaction services as
separate operating and reporting segments. However, the Company intends to
report operating results as one segment commencing with the 2001 fiscal year as
a result of actions taken with respect to the strategic business realignment
program (Notes 3 and 10).

     Basis of Presentation -- The consolidated financial statements include all
subsidiaries of the Company, and all intercompany transactions and balances have
been eliminated. The preparation of financial statements, in conformity with
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. Certain
prior year amounts have been reclassified to conform to the current year's
presentation.

     Fiscal Year -- The Company operates on a 52 or 53 week fiscal year, ending
on the last Saturday in December. The year ended December 30, 2000 was a 53-week
year. The years ended December 25, 1999 and December 26, 1998 were 52-week
years. Had fiscal 2000 been a 52-week year, the total revenue would have
decreased by $5.2 million.

     Cash and Cash Equivalents -- Cash includes cash equivalents consisting of
highly liquid investments with original maturity of ninety days or less.

     Inventories -- Inventories consist principally of merchandise held for
resale and are stated at the lower of cost or market. Cost, which is determined
using the first-in, first-out (FIFO) method, includes the cost of the product as
well as freight-in charges. 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.

     Prepaid Catalog Costs -- Prepaid catalog costs consist of direct response
advertising costs related to catalog production and mailing. In accordance with
SOP 93-7, "Reporting on Advertising Costs," these costs are deferred and
amortized as selling expenses over the estimated period in which the sales
related to such advertising are generated. Total catalog expense was $150.4
million, $133.0 million and $145.0 million for fiscal years 2000, 1999 and 1998,
respectively.

     Depreciation and Amortization -- Depreciation and amortization of property
and equipment is computed on the straight-line method over the following lives:
buildings and building improvements, 30-40 years; furniture, fixtures and
equipment, 3-10 years; and leasehold improvements, over the estimated useful
lives or the terms of the related leases, whichever is shorter. Repairs and
maintenance are expensed as incurred.

     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 $5.0 million and $4.5 million at December 30, 2000
and December 25, 1999, respectively.

                                        30
<PAGE>   32
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     YEARS ENDED DECEMBER 30, 2000, DECEMBER 25, 1999 AND DECEMBER 26, 1998

     Impairment of Long-lived Assets -- In accordance with Statement of
Financial Accounting Standards ("SFAS") No. 121,"Accounting for the Impairment
of Long-lived Assets and Long-lived Assets to be Disposed Of," the Company
reviews long-lived assets for impairment whenever events indicate that the
carrying amount of such assets may not be fully recoverable. The Company
performs non-discounted cash flow analyses to determine if impairment exists. If
impairment is determined to exist, any related impairment loss is calculated
based on fair value. Impairment losses on assets to be disposed, if any, are
based on the estimated proceeds to be received, less costs of disposal.

     Stock Based Compensation -- The Company accounts for its stock based
compensation to employees using the fair value-based methodology under SFAS No.
123, "Accounting for Stock-Based Compensation."

     Income Taxes -- The Company accounts for income taxes in accordance with
SFAS No. 109, "Accounting for Income Taxes." 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 tax results when the Company recognizes revenues or expenses
for income tax purposes in a different year than for financial reporting
purposes.

     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 for fiscal
2000, 1999 and 1998 was 213,251,945, 210,718,546 and 206,508,110 shares,
respectively. Diluted earnings per share equals basic earnings per share as the
dilutive calculation for preferred stock and stock options would have an
anti-dilutive impact as a result of the net losses incurred during fiscal years
2000, 1999 and 1998. The number of potentially dilutive securities excluded from
the calculation of diluted earnings per share were 2,678,492, 9,233,837, and
10,000,131 common share equivalents for fiscal 2000, 1999 and 1998,
respectively. These amounts consist of the following: 2,678,492 options to
purchase common stock for fiscal 2000, 6,846,995 options to purchase common
stock and 2,386,842 common stock equivalents for the potential conversion of the
Series B Convertible Additional Preferred Stock for fiscal 1999, and 7,787,936
options to purchase common stock and 2,212,195 common stock equivalents for the
potential conversion of the Series B Preferred Stock for fiscal 1998.

     Revenue Recognition --

     -- Direct Commerce:  The Company recognizes revenue, net of estimated
returns, upon shipment of merchandise to customers. Postage and handling charges
billed to customers are also recognized as revenue upon shipment of related
merchandise. The Company accrues for expected future returns at the time of sale
based upon historical and current trends. The Company defers revenue recognition
for membership fees received in its Buyer's Club programs until the cancellation
period ends. Thereafter, revenue is recognized on a monthly basis over the
remaining membership period.

     -- B-to-B Services:  Revenues from the Company's e-commerce transaction
services are recognized as the related services are provided. Customers are
charged on an activity unit basis, which applies a contractually specified rate
according to the type of transaction service performed.

     Fair Value of Financial Instruments -- The carrying amounts for cash and
cash equivalents, accounts receivable, accounts payable and the current portion
of long-term debt approximate fair value due to the short maturities of these
instruments. Additionally, the current value of long-term debt also approximates
fair value, as this debt bears interest at prevailing market rates.

     Derivative Investments and Hedging Activities -- The Company is required to
adopt the provisions of SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities," and its related amendment in SFAS No. 138, "Accounting for
Certain Derivative Instruments and Certain Hedging Activities," as of December
31, 2000. These pronouncements require companies to reflect the fair value of
all derivative instruments, including those embedded in other contracts, as
assets or liabilities in a company's financial statements.

                                        31
<PAGE>   33
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     YEARS ENDED DECEMBER 30, 2000, DECEMBER 25, 1999 AND DECEMBER 26, 1998

Changes in fair value of derivative instruments is generally reflected in
earnings, with the exception of certain hedging transactions, for which the
change in fair value may be accounted for as a component of other comprehensive
income, provided certain criteria are met as specified in these pronouncements.
The Company currently does not utilize derivative instruments or engage in
hedging transactions, nor is there any embedded derivative instrument as of
December 30, 2000 that must be recognized pursuant to these statements.
Accordingly, the Company does not expect the impact of the adoption of these
pronouncements on December 31, 2000 to have a material impact on the Company's
financial position or results of operations.

2.  DIVESTITURES

     During 1999 and 2000, the Company sold the following businesses:

     Austad's:  In October 1999, the Company sold the remaining assets of its
non-core Austad's catalog, which featured golf equipment, apparel and gifts, for
$1.6 million. The assets disposed of primarily included inventory and intangible
assets, which were written off in 1996, such as customer lists and trademarks.
The combined book value of assets sold was approximately $0.6 million resulting
in a net pre-tax gain of $1.0 million.

     The Shopper's Edge:  In March 1999, the Company, through a newly formed
subsidiary, started up and promoted a discount buyers club to consumers known as
"The Shopper's Edge." In exchange for an up-front membership fee, the Shopper's
Edge program enables members to purchase a wide assortment of merchandise at
discounts which are not available through traditional retail channels.
Initially, prospective members participated in a 45-day trial period that,
unless canceled, was automatically converted into a full membership term, which
was one year in duration. Memberships were automatically renewed at the end of
each term unless canceled by the member.

     During 1999, primarily as a result of timing of revenue and expense
recognition, the Shopper's Edge subsidiary incurred losses of $4.3 million
reflecting both cash payments and outstanding liabilities to the Company of $3.3
million and $1.0 million, respectively. The Company's operating results reflect
$0.1 million of net losses after the elimination of these intercompany
transactions. The Company recorded membership fee revenue, as well as an
allowance for estimated cancellations, on a straight-line basis over the
one-year membership term, which commenced immediately following the expiration
of the initial 45-day trial period. Costs tied to acceptances such as
commissions paid to service providers as well as membership servicing and
transaction-processing expenses were deferred and expensed as membership fee
revenue was recognized. All other costs, including membership kits and postage,
were expensed as incurred. Under the terms of the program, the Company was
entitled to periodic withdrawals of funds provided by up-front membership fees.
These withdrawals, however, were subject to contractual limitations as the
Shopper's Edge subsidiary was required to maintain adequate cash balances to
fund estimated membership reimbursements resulting from cancellations.
Accordingly, funds retained within the Shopper's Edge subsidiary were reported
as "restricted cash" in the Company's balance sheet during 1999. If membership
reimbursements due to cancellations exceeded the amount of funds retained by the
Shopper's Edge subsidiary, the Company was liable to cover the shortfall.

     Effective December 1999, the Company sold its interest in the Shopper's
Edge subsidiary to an unrelated third party for a nominal fair value based upon
an independent appraisal. At the time of the sale, the liabilities of the
subsidiary exceeded the assets by $4.3 million resulting in a gain on sale to
the Company of $4.3 million. The gain represented the portion of deferred income
of the Shopper's Edge that the Company received in the form of withdrawals
discussed above which, in accordance with the Company's revenue recognition
policy for memberships, would not have been earned until the completion of the
membership term. The deferred income was recognized immediately upon the sale
and has been reflected as a gain on sale in the accompanying consolidated
statement of income (loss) for the year ended December 25, 1999. There are no
conditions to the obligations of the Company to refund any portion of the cash
withdrawals received prior to the sale. The Company entered into a solicitation
services agreement with the purchaser whereby the Company will provide
solicitation services for the program and will receive commissions for member
acceptances based on a fixed fee per member basis, adjusted for cancellation
rates on a prospective basis. Membership revenue earned during
                                        32
<PAGE>   34
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     YEARS ENDED DECEMBER 30, 2000, DECEMBER 25, 1999 AND DECEMBER 26, 1998

the fiscal year ended December 25, 1999 was $3.9 million, which is included in
revenues in the accompanying consolidated statement of income (loss). Had the
new solicitation services agreement been in place for fiscal 1999, net revenues
on a pro-forma basis would have increased by $1.4 million reflecting the
inclusion of $5.3 million of fee revenue for solicitation services provided
versus $3.9 million of recorded membership fee revenue under the old agreement.
Furthermore, on a pro-forma basis, the Company's loss from operations would have
decreased by $5.4 million to $8.4 million. In the fiscal year 2000, the Company
received approximately $5.0 million of fee revenue for solicitation services
provided.

     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 an apparel distribution center in Roanoke, VA. The remaining 50%
interest is held by an unrelated third party. This investment was accounted for
under the equity method of accounting. The Company's investment in Blue Ridge
was approximately $0.8 million at December 25, 1999. In December 1996, the
Company consolidated the fulfillment and telemarketing activities handled at
this facility into its home fashion distribution facility in Roanoke, VA, and
attempted to sublease the vacated space. In April 1999, the Company sublet the
vacated premises to an unrelated third party for a five-year period expiring in
April 2004. In February 2000, the Company sold its partnership interest in Blue
Ridge to the holder of the other 50% for $0.8 million, which approximated the
Company's carrying value of the investment.

3.  SPECIAL CHARGES

     In December 2000, the Company recorded special charges aggregating
approximately $19.1 million. These charges consist of severance ($5.0 million),
facility exit costs ($5.9 million) and fixed asset write-offs ($8.2 million, of
which $7.2 million is non-cash) related to the Company's previously announced
strategic business realignment program which included (1) the elimination of
approximately 285 FTE positions across all its business units, (2) the closure
of the Company's Always in Style business, (3) the discontinuance by Hanover
Brands of the under performing Turiya, Kitchen & Home and Domestications Kitchen
& Garden catalogs while incorporating some of the product offerings within
continuing catalogs, (4) the termination by Hanover Brands of its marketing
agreement with Compagnie de la Chine, (5) the closure by Hanover Brands of
certain retail outlets and a satellite facility in New Jersey, (6) the expected
closure by erizon of its leased fulfillment and telemarketing facility in
Maumelle, Arkansas later in the year, and (7) the immediate cessation by erizon
of the operations of Desius LLC.

     Such actions were taken in an effort to direct the Company's resources
primarily towards continued profitable growth in Hanover Brands, such as The
Company Store, Domestications, Improvements and Silhouettes brands, while
reducing costs in all areas of the business and eliminating investment
activities that had not yet generated sufficient revenue to produce profitable
returns. erizon intends to consolidate the Maumelle operations within its
remaining facilities and intends to provide the bulk of its fulfillment services
for third party clients of its Keystone Internet Services, Inc. ("Keystone")
subsidiary within its existing operations. The consolidation of Keystone
activities in other facilities is intended to provide a better opportunity to
focus resources, particularly customer service support, on clients to service
their needs.

     Severance -- The cost of employee severance includes termination benefits
for line and supervisory personnel in fulfillment, telemarketing, MIS,
merchandising, and various level of corporate and catalog management.
Approximately $4.3 million of these costs are recorded in accrued liabilities in
the accompanying consolidated balance sheet at December 30, 2000.

     Facility Exit Costs and Fixed Asset Write-offs -- These costs are primarily
related to the Company's decision to close its fulfillment center in Maumelle,
Arkansas, exit office space located in Edgewater, New Jersey and close several
of its retail outlets. Furthermore, costs associated with closing the Always in
Style business and terminating its marketing agreement with Compagnie de la
Chine are included in the amount written off. Approximately $4.2 million of
these costs are included in accrued liabilities at December 30, 2000 and an
additional $2.5 million are included in other non-current liabilities as they
will not be paid until 2002 or later.

                                        33
<PAGE>   35
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     YEARS ENDED DECEMBER 30, 2000, DECEMBER 25, 1999 AND DECEMBER 26, 1998

     The Company has retained Newmark Retail Financial Advisors LLC to seek
qualified purchasers for its Gump's By Mail and Gump's San Francisco business,
its Brawn of California business, including the International Male and Undergear
brands, and its 277,500 square foot warehouse and fulfillment facility located
in Hanover, Pennsylvania.

     In March 2001, the Company sold the Always in Style business to its
business partner, which resulted in a nominal gain.

     In December 1996, the Company recorded special charges of approximately
$36.7 million, which consisted of severance, facility exit/relocation costs and
fixed asset write-offs related to the downsizing of the Company, and a write-off
for impairment of long-lived assets of certain under-performing catalogs. In
1998, the Company adjusted further its reserve for fixed asset write-offs by
$0.5 million reflecting the Company's decision to remain in its Hanover, PA
distribution center.

     During 1999, the Company revised its estimates for losses on sublease
arrangements for its Roanoke, VA apparel distribution center and its San
Francisco, CA office facilities. The Company reduced its estimate for sublease
losses for the Roanoke, VA apparel distribution center by $0.5 million due to
the Company's release from any lease-related obligations resulting from the sale
of its partnership interest in Blue Ridge Associates, a partnership which owned
the facility. This was more than offset by a higher estimate for sublease losses
related to the San Francisco, CA office facilities of $0.6 million due to higher
than anticipated rent escalations. Approximately $0.7 million of estimated
losses on sublease arrangements are recorded in accrued liabilities in the
Company's consolidated balance sheet at December 30, 2000 and an additional $1.3
million are included in other non-current liabilities as they will not be paid
until 2002 or later.

4.  WRITE-DOWN OF INVENTORY OF DISCONTINUED CATALOGS

     In the fourth quarter of 2000 the Company made a decision to discontinue
three catalogs brands, Domestications Kitchen & Garden, Turiya and Kitchen &
Home. These three catalog brands generated revenues of $18.4 million, $19.6
million and $31.6 million in 2000, 1999 and 1998, respectively. In 2000, the
Company recorded provisions of approximately $2.0 million related to the
write-down of inventory associated with these catalogs to their net realizable
value based upon the planned liquidation of such inventory, and $0.7 million of
additional fourth quarter charges related to the acceleration of the
amortization of prepaid catalog costs associated with the discontinuance of
these catalogs' operations based upon their estimated realizability relative to
the wind-down plan in 2001.

     In 1998, the Company decided to discontinue the traditional catalog
operations of the Tweeds, Austad's and Colonial Garden Kitchens catalog brands.
These "non-core" catalog brands were to be repositioned as primarily e-commerce
brands and, if unsuccessful, discontinued. Revenues from the aforementioned
non-core catalogs were $19.0 million and $48.7 million for fiscal 1999 and 1998,
respectively. In 1998, the Company recorded provisions of approximately $3.7
million related to the write-down of inventory associated with these catalogs to
net realizable value based on the planned liquidation of such inventory and $2.2
million of additional charges related to prepaid catalog costs associated with
the discontinuance of these catalogs' operations.

     The Company utilizes various liquidation vehicles to dispose of aged
catalog inventory including special sales catalogs, sales sections in other
catalogs, and liquidations through off-price merchants. During 1999, the Company
was able to utilize special sales catalogs, which provide higher cost
recoveries, to dispose of its non-core catalog inventory to a larger extent than
anticipated at the end of 1998. Accordingly, $1.9 million of the 1998 charges
were reversed and included in the Company's 1999 results.

     During 1999, the Company sold the remaining assets of its non-core Austad's
catalog for $1.6 million; fully discontinued its Tweeds catalog operation; and
repositioned and relaunched its Colonial Garden Kitchens catalog as
Domestications Kitchen & Garden, which was subsequently discontinued.

5.  TRANSFER OF CREDIT CARD ACCOUNTS RECEIVABLE

     Through July 1999, the Company was a party to an agreement involving the
sale and servicing of accounts receivable originating from the Company's private
label credit card program. This agreement included full recourse provisions
obligating the Company to repurchase non-collectible receivables as well as a

                                        34
<PAGE>   36
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     YEARS ENDED DECEMBER 30, 2000, DECEMBER 25, 1999 AND DECEMBER 26, 1998

requirement for the Company to maintain a deposit, based on a specified
percentage of outstanding receivables, to secure the Company's obligations under
the contract. Approximately $3.5 million was held as security by the unrelated
third party as of December 26, 1998. Due to the conditions imposed under the
agreement, the Company, in accordance with SFAS No. 125 ("Accounting for
Transfers and Servicing of Financial Assets and Extinguishment of Liabilities"),
accounted for the transfer of its private label credit card receivables as a
secured borrowing. Accordingly, the Company recorded both a financing receivable
as well as a corresponding long-term obligation of $19.0 million in its December
26, 1998 consolidated balance sheet.

     During July 1999, the Company finalized a new three-year credit card
marketing and servicing agreement with a new provider and terminated the
previously mentioned agreement. The new terms include provisions requiring the
Company to equally share credit losses over an agreed upon benchmark for the
first 18 months of the agreement, however, the Company is not obligated to
repurchase any non-collectible receivables. Upon the expiration of this period,
all credit card receivables transfers are non-recourse to the Company.
Furthermore, the Company is no longer required to maintain a deposit as security
for its performance under the terms of the new agreement. Reflecting the change
in terms included in the new agreement, the Company, in accordance with SFAS No.
125, now accounts for the transfer of its private label credit card receivables
as a sale. Accordingly, the Company's December 30, 2000 consolidated balance
sheet no longer reflects a financing receivable and a related long-term
obligation. No gain or loss was recognized upon the transition to the new
program.

     As of December 25, 1999, the Company maintained a shared credit risk
reserve of $0.6 million that is recorded in accrued liabilities. Since the 18
month period that the Company is obligated to share credit losses expired in
December 2000, there is no shared credit risk reserve maintained at December 30,
2000.

6.  ACCRUED LIABILITIES

     Accrued liabilities consist of the following (in thousands):

<TABLE>
<CAPTION>
                                                           DEC. 30,    DEC. 25,
                                                             2000        1999
                                                           --------    --------
<S>                                                        <C>         <C>
Restructuring............................................  $ 9,160     $ 2,299
Reserve for future sales returns.........................    3,371       4,680
Compensation.............................................   13,466       8,290
Taxes....................................................    1,134         881
Reserve for accounts receivable -- shared credit risk....       --         612
Reserve for discontinued operations......................       86         849
Other....................................................    7,226       6,673
                                                           -------     -------
          Total..........................................  $34,443     $24,284
                                                           =======     =======
</TABLE>

                                        35
<PAGE>   37
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     YEARS ENDED DECEMBER 30, 2000, DECEMBER 25, 1999 AND DECEMBER 26, 1998

7.  LONG-TERM DEBT

     Long-term debt consists of the following (in thousands):

<TABLE>
<CAPTION>
                                                           DEC. 30,    DEC. 25,
                                                             2000        1999
                                                           --------    --------
<S>                                                        <C>         <C>
Congress Facility........................................  $38,065     $17,735
Term Financing Facility..................................       --      16,000
Industrial Revenue Bonds due 2003........................       --       8,000
7.5% Convertible Subordinated Debentures due 2007........      751         751
Obligations under capital leases.........................      192         349
Other....................................................       28          --
                                                           -------     -------
                                                            39,036      42,835
Less: current portion....................................    3,718       3,257
                                                           -------     -------
          Total..........................................  $35,318     $39,578
                                                           =======     =======
</TABLE>

     Revolving Credit Facility -- On December 25, 1999, the Company's credit
facility (the "Congress Credit Facility") with Congress Financial Corporation
("Congress") was a $65.0 million revolving line of credit, of which $12.5
million was a term loan. Total borrowings under the Congress Credit Facility,
however, were subject to limitations based upon specified percentages of
eligible inventory and eligible accounts receivable. The revolving line of
credit facility bore interest at prime plus .25% or LIBOR plus 2.75%, and the
term loan bore interest at prime plus .50% or LIBOR plus 2.75%. The use of a
prime or LIBOR based rate was determinable at the Company's discretion.
Additionally, the Congress Credit Facility, which was secured by all assets of
the Company, contained restrictive covenants including restrictions on
indebtedness and common stock dividends, and required the maintenance of a $21.5
million net worth and a $(10.0) million working capital (deficit) position, as
defined. As of December 25, 1999, the Company had an outstanding term loan of
$12.5 million, bearing a weighted average interest rate of 9.0%, and $5.2
million of outstanding borrowings under the revolving line of credit, bearing an
interest rate of 8. 75%.

     On March 24, 2000, the Congress Credit Facility was further amended to
provide for a maximum credit line, subject to certain limitations, of up to
$82.5 million. The Congress Credit Facility, as amended, expires on January 31,
2004 and is comprised of a revolving loan facility, a $17.5 million Tranche A
Term Loan having an eighty-four month term, and a $7.5 million Tranche B Term
Loan having a thirty-six month term. Total cumulative borrowings are subject to
limitations based upon specified percentages of eligible receivables and
eligible inventory, and the Company is required to maintain $3.0 million of
excess credit availability at all times. The Congress Credit Facility, as
amended, is secured by all the assets of the Company and places restrictions on
the incurrence of additional indebtedness and on the payment of common stock
dividends. The Company paid a $1.4 million closing fee to Congress to secure the
amendment of the Congress Credit Facility. As of December 30, 2000, the Company
had $38.1 million of borrowings outstanding under the amended Congress Credit
Facility comprised of $15.7 million under the revolving loan facility, bearing
an interest rate of 10.0%, and $14.9 million, bearing an interest rate of
10.25%, and $7.5 million, bearing an interest rate of 13.75%, of Tranche A Term
Loans and Tranche B Term Loans, respectively.

     The revolving loan facility bears interest at prime plus .5% or Eurodollar
plus 2.5%, the Tranche A Term Loans bear interest at prime plus .75% or
Eurodollar plus 3.5%, and the Tranche B Term Loans bear interest at prime plus
4.25%, but in no event less than 13.0%. Under the amended Congress Credit
Facility, the Company is required to maintain minimum net worth, working capital
and EBITDA as defined throughout the term of the agreement. At December 30,
2000, the Company was in compliance with these covenants.

     Term Financing Facility -- During 1994 and 1995, the Company entered into a
term loan agreement with a syndicate of financial institutions, which provided
for borrowings of $20 million ("Term Financing Facility"). The Term Financing
Facility bore interest based on "A-1" commercial paper rates existing at the
time of each borrowing. As of December 25, 1999, the Company had $16.0 million
of outstanding borrowings

                                        36
<PAGE>   38
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     YEARS ENDED DECEMBER 30, 2000, DECEMBER 25, 1999 AND DECEMBER 26, 1998

under the Term Financing Facility bearing applicable rates of interest ranging
from 5.3% to 6.0%. The Term Financing Facility was paid in full on March 24,
2000 (see below).

     Industrial Revenue Bonds due 2003 -- The Industrial Revenue Bonds ("IRBs")
of $8.0 million were due on December 1, 2003. The IRBs were secured by all
assets purchased with the proceeds thereof and, as of December 25, 1999, were
supported by an $8.0 million letter of credit issued by UBS AG, Stamford Branch
("UBS") and guaranteed by Richemont Finance, S.A. ("Richemont"). The Industrial
Revenue Bonds were redeemed on March 24, 2000 (see below).

     As of December 25, 1999, letters of credit, issued by the UBS and
guaranteed by Richemont, supported both the Term Financing Facility and the
Industrial Revenue Bonds (see below). Originating in December 1996 and renewed
in 1998 and 1999, the terms of the UBS letters of credit, which were scheduled
to expire on March 31, 2000, required the Company to pay to Richemont an annual
facility fee equal to 9.5% of the $25.8 million principal amount, or $2.4
million. The principal amount of the UBS letters of credit approximated the
combined outstanding borrowings under the Term Financing Facility and the
Industrial Revenue Bonds at the time of renewal.

     The Company elected not to extend or renew the UBS letters of credit
supporting the Term Financing Facility and the Industrial Revenue Bonds, and to
redeem the $16.0 million of outstanding borrowings under the Term Financing
Facility and the $8.0 million of outstanding borrowings under the Industrial
Revenue Bonds. On March 24, 2000, the trustees under the Term Financing Facility
and the Industrial Revenue Bonds made drawings under the UBS letters of credit,
and used the proceeds of the drawings to redeem the Term Financing Facility and
the Industrial Revenue Bonds. The Company utilized funds borrowed under the
Congress Credit Facility on March 24, 2000 to reimburse UBS for the drawings on
these letters of credit. As a result, both the Term Financing Facility and the
Industrial Revenue Bonds have been paid in full, and the Company has paid all
amounts payable to UBS or Richemont relating to the letters of credit.

     Richemont Lines of Credit -- On March 24, 2000, the Company negotiated a
new $10.0 million unsecured line of credit (the "Richemont $10.0 million Line of
Credit") with Richemont Finance S.A. ("Richemont"). Borrowings under the
Richemont $10.0 million Line of Credit bore interest at a rate of 0.125% per
month (an annualized rate of 1.5%) on the average monthly balance outstanding.
In addition, the Company paid Richemont a monthly facility fee of approximately
$0.1 million each month during the term of the Richemont $10.0 million Line of
Credit. The maximum amount available to be drawn under the Richemont $10.0
million Line of Credit (the "Maximum Amount") was initially $10.0 million and
would be reduced on a dollar-for-dollar basis for each dollar of equity
contributed to the Company or any of its subsidiaries by Richemont or any
subsidiary or affiliate of Richemont. If the excess availability under the
Congress Revolving Credit Facility was less than $3.0 million, the Company would
be required to borrow under the Richemont $10.0 million Line of Credit, and pay
to Congress the amount such that the excess availability under the Congress
Revolving Credit Facility after such payment would be at least $3.0 million. The
Company could also borrow up to $5.0 million under the Richemont $10.0 million
Line of Credit to pay trade creditors in the ordinary course of business. On
August 24, 2000, the Richemont $10 million Line of Credit was terminated and all
borrowings outstanding of approximately $5.0 million, plus accrued and unpaid
interest, were repaid and retired from a portion of the net proceeds obtained
from the issuance of the Company's Series A Cumulative Participating Preferred
Stock to Richemont (see Note 8).

     On March 1, 2000, the Company negotiated a new $25.0 million unsecured Line
of Credit (the "Richemont $25.0 million Line of Credit") with Richemont.
Borrowings under the Richemont $25.0 million Line of Credit bore interest at a
rate of 0.583% per month (an annualized rate of 7.0%) on the average monthly
balance outstanding. In addition, the Company paid Richemont a monthly fee of
approximately $0.1 million each month from March 1, 2000 up to the Maturity
Date. The Richemont $25.0 million Line of Credit was to mature on the earlier of
December 30, 2000 or the date on which Richemont made an equity infusion in the
Company or any of the Company's subsidiaries (such earlier date, the "Maturity
Date"). On August 24, 2000, the Richemont $25.0 million Line of Credit was
terminated and all borrowings outstanding of approximately $25.0 million, plus
accrued and unpaid interest, were repaid and retired from a portion of the

                                        37
<PAGE>   39
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     YEARS ENDED DECEMBER 30, 2000, DECEMBER 25, 1999 AND DECEMBER 26, 1998

net proceeds obtained from the issuance of the Company's Series A Cumulative
Participating Preferred Stock to Richemont (see Note 8).

     General -- At December 30, 2000, the aggregate annual principal payments
required on debt instruments are as follows (in thousands): 2001 -- $3,718;
2002 -- $3,630; 2003 -- $7,872; 2004 -- $18,212; 2005 -- $4,853; and
thereafter -- $751.

8.  SERIES A CUMULATIVE PARTICIPATING PREFERRED STOCK

     On August 24, 2000, the Company issued 1.4 million shares of preferred
stock designated as Series A Cumulative Participating Preferred Stock (the
"Series A Preferred Stock") to Richemont, the holder of approximately 47.9% of
the Company's Common Stock, for $70 million. The Series A Preferred Stock has a
par value of $0.01 per share and a liquidation preference of $50.00 per share
and was recorded net of issuance costs of $2.3 million. The issuance costs will
be accreted as a dividend over a five-year period ending on the mandatory
redemption date. Dividends are cumulative and accrue at an annual rate of 15%,
or $7.50 per share, and are payable quarterly either in cash or in-kind through
the issuance of additional Series A Preferred Stock. Cash dividend payments are
required for dividend payment dates occurring after February 1, 2004. As of
December 30, 2000, the Company accreted dividends of $3.8 million, and reserved
75,498 additional shares of Series A Preferred Stock for the payment of such
dividends. In-kind dividends and issuance cost accretion are charged against
additional paid-in capital, with a corresponding increase in the carrying amount
of the Series A Preferred Stock. Cash dividends will also be reflected as a
charge to additional paid-in capital, however, no adjustment to the carrying
amount of the Series A Preferred Stock will be made. The Series A Preferred
Stock is generally non-voting, except if dividends have been in arrears and
unpaid for four quarterly periods, whether or not consecutive. The holder of the
Series A Preferred Stock is entitled to receive additional participating
dividends in the event any dividends are declared or paid, or any other
distribution is made, with respect to the Common Stock of the Company. The
additional dividends would be equal to the applicable percentage of the amount
of the dividends or distributions payable in respect of one share of Common
Stock. In the event of a liquidation or dissolution of the Company, the holder
of the Series A Preferred Stock shall be paid an amount equal to $50.00 per
share of Series A Preferred Stock plus the amount of any accrued and unpaid
dividends, before any payments to other shareholders.

     The Company may redeem the Series A Preferred Stock in whole at any time
and the holder of the Series A Preferred Stock may elect to cause the Company to
redeem all or any of such holder's Series A Preferred Stock under certain
circumstances involving a change of control, asset disposition or equity sale.
Mandatory redemption of the Series A Preferred Stock by the Company is required
on August 23, 2005 (the "Final Redemption Date") at a redemption price of $50.00
per share of Series A Preferred Stock plus the amount of any accrued and unpaid
dividends. If, at the Final Redemption Date, the Company does not have
sufficient capital and surplus legally available to redeem all the outstanding
shares of the Series A Preferred Stock, the Company will be required to take all
measures permitted under the Delaware General Corporation Law to increase the
amount of its capital and surplus legally available and to redeem as many shares
of the Series A Preferred Stock as it may legally redeem. Thereafter, as funds
become available, the Company will be required to redeem as many additional
shares of the Series A Preferred Stock as it legally can, until it has redeemed
all remaining outstanding shares of the Series A Preferred Stock.

9.  CAPITAL STOCK

     Series B Convertible Additional Preferred Stock -- In February 1995, the
Company issued 634,900 shares of its Class B Convertible Additional Preferred
Stock ("Series B Stock") to acquire the remaining 80% of the outstanding common
stock of Aegis Safety Holdings, Inc. ("Aegis"), publisher of The Safety Zone
catalog. The Series B Stock had a stated value of $10 per share. Non-cumulative
dividends were to accrue and be paid at 5% per annum during each of the first
three years after the February 1995 closing if Aegis attained at least $1.0
million in earnings before interest and taxes each year. In years four and five,
dividends, which became cumulative and were to accrue and be paid at 7% per
annum, were no longer contingent upon the achievement of any earnings target.
Dividends were not accrued or paid during the first three years after closing
based on

                                        38
<PAGE>   40
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     YEARS ENDED DECEMBER 30, 2000, DECEMBER 25, 1999 AND DECEMBER 26, 1998

The Safety Zone catalog's operating results for each respective year. During the
Company's 1999 and 1998 fiscal years, no dividends were paid; however, the
Company accrued $0.4 million during each year in order to recognize its
cumulative dividend payment obligations.

     The Series B Stock was convertible at any time, at $6.66 per share, subject
to anti-dilution, at the option of the holder and was convertible at the
Company's option if the market value of the Company's Common Stock was greater
than $6.66 per share, subject to anti-dilution, for 20 trading days in any
consecutive 30 day trading period. If, after five years, the Series B Stock was
not converted, it was 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 was at least $6.33 per share, subject to anti-dilution. If the market
value of the Company's Common Stock did not meet this minimum, the redemption
rate was subject to adjustment, which would increase the number of shares for
which the Series B Stock was redeemed.

     The fair value of the Series B Stock, which was based on an independent
appraisal, was $0.9 million less than the stated value at February 1995. This
discount was amortized over a five year period and resulted in a charge of
approximately $0.2 million to preferred stock dividends in the consolidated
statements of income (loss) for fiscal years 1995 through 1999, respectively.

     In February 2000, the Series B Stock was redeemed via the issuance of
2,193,317 shares of the Company's Common Stock. The increase in common shares
issued upon redemption reflected a market value for the Company's shares on the
date of redemption of $2.75 per share versus the $6.66 per share amount
specified on the closing date. The Company also made a $0.9 million payment for
all unpaid cumulative preferred dividends on the Series B Stock.

     Weighted average common shares outstanding as of December 25, 1999 would
have been 212,911,863 versus a reported 210,718,546, assuming conversion of the
Series B Stock at the beginning of 1999. Reported quarterly and total year net
(loss) per common share amounts would not have been affected by the pro-forma
increase in weighted average common shares outstanding.

     General -- At December 30, 2000, there were 214,425,498 and 213,696,331
shares of Common Stock issued and outstanding, respectively. Additionally, an
aggregate of 18,043,947 shares of Common Stock was reserved for issuance
pursuant to the exercise of outstanding options.

     Treasury stock consisted of 729,167 and 652,552 shares of Common Stock at
December 30, 2000 and December 25, 1999, respectively. In December 2000 and
December 1999, the Company retained 80,000 and 294,249 shares, respectively, of
outstanding Common Stock held in escrow on behalf of certain participants in the
Company's Executive Equity Incentive Plan whose rights, under the terms of the
plan, expired during 2000 and 1999.

     Dividend Restrictions -- The Company is restricted from paying dividends on
its Common Stock or from acquiring its capital stock by certain debt covenants
contained in agreements to which the Company is a party.

10.  SEGMENT REPORTING

     Effective June 26, 1999, the Company adopted SFAS No. 131, "Disclosures
about Segments of an Enterprise and Related Information." The adoption of SFAS
No. 131 coincided with the Company's decision to realign its business structure
into two separate operating and reporting segments: direct commerce and business
to business ("B-to-B") e-commerce transaction services. This reflected the
Company's strategic initiative to reposition itself as both a specialty direct
marketer and as a provider of B-to-B e-commerce transaction services.

     The direct commerce segment is comprised of the Company's portfolio of
branded specialty mail-order catalogs and connected Internet Web sites, as well
as its retail operations, all of which market products directly to the consumer.
Revenues are derived primarily from the sale of merchandise through the
Company's catalogs and related Internet product offerings and its retail
outlets. Other sources of revenue are derived from various up-sell initiatives
and other catalog related revenue. The B-to-B e-commerce transaction services
segment represents the Company's e-commerce support and fulfillment operations.
Revenues are derived
                                        39
<PAGE>   41
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     YEARS ENDED DECEMBER 30, 2000, DECEMBER 25, 1999 AND DECEMBER 26, 1998

primarily from e-commerce transaction services, which include order processing,
customer care, and shipping and distribution services.

     The Company's management reviews income (loss) from operations to evaluate
performance and allocate resources. As income taxes are centrally managed at the
corporate level, deferred tax assets are not allocated by segment. The
accounting policies of the segments are the same as those described in the
Summary of Significant Accounting Policies.

     Reportable segment data were as follows (in thousands of dollars):

<TABLE>
<CAPTION>
                                DIRECT      B-TO-B     ELIMINATION/
                               COMMERCE    SERVICES       OTHER        CONSOLIDATED
                               --------    --------    ------------    ------------
<S>                            <C>         <C>         <C>             <C>
RESULTS FOR THE FISCAL YEAR
  ENDED
DECEMBER 30, 2000:
Revenue from external
  customers..................  $572,995    $ 30,008     $      11        $603,014
Inter-segment revenues.......        --     103,282      (103,282)             --
Income/(loss) before interest
  & taxes....................     8,103     (57,908)      (20,747)        (70,552)
Interest income/(expense)....    (4,744)     (4,524)         (815)        (10,083)
                               --------    --------     ---------        --------
Income/(loss) before income
  taxes......................  $  3,359    $(62,432)    $ (21,562)       $(80,635)
                               ========    ========     =========        ========
RESULTS FOR THE FISCAL YEAR
  ENDED DECEMBER 25, 1999:
Revenue from external
  customers..................  $534,978    $ 14,874     $      --        $549,852
Inter-segment revenues.......        --     102,923      (102,923)             --
Income/(loss) before interest
  & taxes....................    10,445     (18,881)          (10)         (8,446)
Interest income/(expense)....    (1,971)     (5,313)          (54)         (7,338)
                               --------    --------     ---------        --------
Income/(loss) before income
  taxes......................  $  8,474    $(24,194)    $     (64)       $(15,784)
                               ========    ========     =========        ========
RESULTS FOR THE FISCAL YEAR
  ENDED
DECEMBER 26, 1998:
Revenue from external
  customers..................  $543,994    $  2,120     $      --        $546,114
Inter-segment revenues.......        --     105,344      (105,344)             --
Income/(loss) before interest
  & taxes....................   (12,685)     (3,721)         (401)        (16,807)
Interest income/(expense)....    (2,576)     (4,647)         (555)         (7,778)
                               --------    --------     ---------        --------
Income/(loss) before income
  taxes......................  $(15,261)   $ (8,368)    $    (956)       $(24,585)
                               ========    ========     =========        ========
</TABLE>

     Income/(loss) before interest and taxes for the direct commerce segment
included (income)/loss from the write-down of inventory of discontinued catalogs
of $2.0 million, $(1.9) million and $3.7 million for the years ended December
30, 2000, December 25, 1999 and December 26, 1998, respectively. The results for
the direct commerce segment for the fiscal year ended December 25, 1999 also
include $4.3 million and $1.0 million related to the gain on sale of The
Shopper's Edge and the gain on sale of the Company's non-core Austad's catalog,
respectively.

     During the first quarter of 2000, the Company, as part of its initiative to
reposition itself as both a specialty direct marketer and as a provider of
B-to-B e-commerce transaction services, modified its business segmentation,
resulting in the reclassification of certain general and administrative expenses
from its direct commerce and B-to-B e-commerce transaction services segments to
the corporate level. Accordingly, the Company's "Elimination/All Other" category
now includes these corporate operating expenses as well as

                                        40
<PAGE>   42
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     YEARS ENDED DECEMBER 30, 2000, DECEMBER 25, 1999 AND DECEMBER 26, 1998

inter-segment elimination, and non-reportable operating segments (primarily the
Company's Always in Style joint venture). Segmented income/(loss) before
interest and taxes for the years ended December 25, 1999 and December 26, 1998,
on a pro-forma basis to reflect this modification, would have been $15.6 million
and $(2.6) million for the direct commerce segment, $(19.3) million and $(12.3)
million for the B-to-B e-commerce transaction services segment and $(4.8)
million and $(1.9) million for all other, respectively.

<TABLE>
<CAPTION>
                                DIRECT      B-TO-B     ELIMINATION/
                               COMMERCE    SERVICES       OTHER        CONSOLIDATED
                               --------    --------    ------------    ------------
                                            (IN THOUSANDS OF DOLLARS)
<S>                            <C>         <C>         <C>             <C>
FOR THE FISCAL YEAR ENDED
DECEMBER 30, 2000:
Depreciation and
  amortization...............  $  2,043    $  6,801      $    246        $  9,090
Provision for doubtful
  accounts...................       328       4,344           275           4,947
Stock compensation expense...     3,714       1,461            --           5,175
Total assets.................  $141,125    $144,120       (82,226)       $203,019
Capital expenditures.........       586      13,259           736          14,581
FOR THE FISCAL YEAR ENDED
DECEMBER 25, 1999:
Depreciation and
  amortization...............  $  2,525    $  6,791      $     66        $  9,382
Provision for doubtful
  accounts...................     1,958         801            58           2,817
Stock compensation expense...     2,115         775            --           2,890
Total assets.................  $126,686    $ 47,451      $ 17,282        $191,419
Capital expenditures.........       792       3,751           287           4,830
FOR THE FISCAL YEAR ENDED
DECEMBER 26, 1998:
Depreciation and
  amortization...............  $  3,034    $  6,444      $     --        $  9,478
Provision for doubtful
  accounts...................     3,228          50            --           3,278
Stock compensation expense...     2,009         675            --           2,684
Total assets.................  $161,143    $ 42,118      $ 15,609        $218,870
Capital expenditures.........     1,352       4,759            --           6,111
</TABLE>

     In conjunction with the Company's strategic realignment plan, the Company
has (1) terminated an intercompany services agreement between erizon and Hanover
Brands effective December 30, 2000, (2) ceased the Desius LLC business
operations of erizon and (3) announced the closure of erizon's leased
fulfillment and telemarketing facility in Maumelle, Arkansas. As a result of
these actions, the Company's business to business revenues in fiscal 2001 and
beyond will be materially reduced and for the foreseeable future limited to 15
third party clients serviced by Keystone Internet Services. Taken in conjunction
with the Company's announced intention to direct resources primarily towards
growth in core brands, such as The Company Store, Domestications, Improvements
and Silhouettes brands, these actions will cause the Company, pursuant to SFAS
131, to report results for the consolidated operations of Hanover Direct, Inc.
as one segment commencing in fiscal year 2001.

11.  STOCK BASED COMPENSATION PLANS

     The Company has established several stock based compensation plans for the
benefit of its officers and employees. As discussed in the Summary of
Significant Accounting Policies (Note 1), the Company applies the fair-value
based methodology of SFAS No. 123 and, accordingly, has recorded stock
compensation expense of $5.2 million, $3.0 million and $2.7 million for fiscal
2000, 1999 and 1998, 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 Company's stock
compensation plans, including any changes during the years presented.

                                        41
<PAGE>   43
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     YEARS ENDED DECEMBER 30, 2000, DECEMBER 25, 1999 AND DECEMBER 26, 1998

     1978 Stock Option Plan -- Pursuant to the Company's 1978 Stock Option Plan,
an aggregate of 2,830,519 shares were approved for issuance to employees and
consultants of the Company. The Compensation Committee of the Board of Directors
determined the option price and the period over which an option was exercisable.

     Options expired five years from the date of grant and generally vested over
three to four years. Payment for shares purchased upon the exercise of an option
was to be in cash or stock of the Company. If paid in cash, a partial payment
was to 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>
                                                        1978 STOCK OPTION PLAN
                                    ---------------------------------------------------------------
                                           2000                  1999                   1998
                                    ------------------    -------------------    ------------------
                                              WEIGHTED               WEIGHTED              WEIGHTED
                                              AVERAGE                AVERAGE               AVERAGE
                                              EXERCISE               EXERCISE              EXERCISE
                                    SHARES     PRICE      SHARES      PRICE      SHARES     PRICE
                                    ------    --------    -------    --------    ------    --------
<S>                                 <C>       <C>         <C>        <C>         <C>       <C>
Options outstanding, beginning of
  period..........................   --         --         30,000     $2.25      30,000     $2.25
Granted...........................   --         --             --        --          --        --
Exercised.........................   --         --             --        --          --        --
Forfeited.........................   --         --        (30,000)    $2.25          --        --
Expired...........................   --         --             --        --          --        --
                                      --                  -------                ------
Options outstanding, end of
  period..........................   --         --             --        --      30,000     $2.25
                                      ==         ==       =======     =====      ======     =====
Options exercisable, end of
  period..........................   --         --             --        --      30,000     $2.25
                                      ==         ==       =======     =====      ======     =====
</TABLE>

     As of December 30, 2000, there were no stock options outstanding or
exercisable under the 1978 Stock Option Plan and the Company does not anticipate
any further issuance under this plan.

     1999 Stock Option Plan for Directors -- During August 1999, the Board of
Directors adopted the 1999 Stock Option Plan for Directors providing stock
options to purchase shares of Common Stock of the Company to certain eligible
directors who were neither employees of the Company nor non-resident aliens (the
"Director's Plan"). The Director's Plan was ratified by the Company's
shareholders at the 2000 Annual Meeting. The Company may issue stock options to
purchase up to 700,000 shares of Common Stock to eligible directors at an
exercise price equal to the fair market value as of the date of grant. An
eligible director shall receive a stock option grant to purchase 50,000 shares
of Common Stock as of the effective date of his/her initial appointment or
election to the Board of Directors. Furthermore, on each Award Date, defined as
August 4, 2000 or August 3, 2001, eligible directors shall be granted stock
options to purchase an additional 10,000 shares of Common Stock. Stock options
granted have terms of 10 years and shall vest and become exercisable over three
(3) years from the date of grant; however, in the event of a change in control,
options shall vest and become exercisable immediately. Payment for shares
purchased upon exercise of options shall be in cash or stock of the Company.

                                        42
<PAGE>   44
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     YEARS ENDED DECEMBER 30, 2000, DECEMBER 25, 1999 AND DECEMBER 26, 1998

     Options outstanding, granted and the weighted average exercise prices under
the 1999 Stock Option Plan for Directors are as follows:

                      1999 STOCK OPTION PLAN FOR DIRECTORS

<TABLE>
<CAPTION>
                                                                      2000
                                                              --------------------
                                                                          WEIGHTED
                                                                          AVERAGE
                                                                          EXERCISE
                                                               SHARES      PRICE
                                                              --------    --------
<S>                                                           <C>         <C>
Options outstanding, beginning of period....................        --        --
Granted.....................................................   540,000     $2.15
Exercised...................................................        --        --
Forfeited...................................................  (120,000)     2.25
Expired.....................................................        --        --
                                                              --------
Options outstanding, end of period..........................   420,000     $2.13
                                                              ========     =====
Options exercisable, end of period..........................   116,667     $2.35
                                                              ========     =====
Weighted average fair value of options granted..............  $   1.07
                                                              ========
</TABLE>

     The fair value of each option granted is estimated on the date of grant
using the Black-Scholes option-pricing model. The weighted average assumptions
for grants in fiscal 2000 under the 1999 Stock Option Plan for Directors were as
follows: risk free interest rate of 5.87%, expected volatility of 54.35%,
expected life of 6 years, and no expected dividends. The following table
summarizes information about stock options outstanding at December 30, 2000
under the 1999 Stock Option Plan for Directors:

<TABLE>
<CAPTION>
                                       OPTIONS OUTSTANDING                OPTIONS EXERCISABLE
                              --------------------------------------    -----------------------
                                              WEIGHTED
                                NUMBER         AVERAGE      WEIGHTED      NUMBER       WEIGHTED
                              OUTSTANDING     REMAINING     AVERAGE     EXERCISABLE    AVERAGE
EXERCISE                          AT         CONTRACTUAL    EXERCISE        AT         EXERCISE
PRICES                         12/30/00         LIFE         PRICE       12/30/00       PRICE
--------                      -----------    -----------    --------    -----------    --------
<S>                           <C>            <C>            <C>         <C>            <C>
$1.00.......................     70,000          9.6         $1.00             --          --
$2.35.......................    350,000          8.8         $2.35        116,667       $2.35
                                -------          ---         -----        -------       -----
                                420,000          8.9         $2.13        116,667       $2.35
                                =======          ===         =====        =======       =====
</TABLE>

     Other Director Options -- In February 1996, four directors were granted
options to purchase 5,000 shares each at an exercise price of $1.44. Of the
20,000 total options granted, 10,000 options were exercised and 5,000 were
canceled leaving 5,000 options outstanding and exercisable at December 30, 2000.
The remaining options expired in February 2001.

     1993 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 the Company's shareholders at the
1993 Annual Meeting. The Incentive Plan encouraged executives to acquire and
retain a significant ownership stake in the Company. Under the Incentive Plan,
executives were given an opportunity to purchase shares of Common Stock with up
to 80% of the purchase price financed with a six year full recourse Company
loan, which bore interest at the mid-term applicable federal rate as determined
by the Internal Revenue Service. The Incentive Plan participants purchased
shares of Common Stock at prices ranging from $0.69 to $4.94, with the Company
accepting notes bearing interest at rates ranging from 5.00% to 7.75%. For each
share of stock an employee purchased, he/she received stock options to acquire
two additional shares of Common Stock, up to a maximum of 250,000 shares in the
aggregate. The stock options, which were granted by the Compensation Committee
of the Board of Directors, vested after three years and expired after six years.
On December 31, 1996, the Incentive Plan was terminated in accordance with its

                                        43
<PAGE>   45
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     YEARS ENDED DECEMBER 30, 2000, DECEMBER 25, 1999 AND DECEMBER 26, 1998

terms, and no additional Common Stock was purchased or stock options granted.
Changes in shares and options outstanding, expressed in numbers of shares, for
the Incentive Plan are as follows:

<TABLE>
<CAPTION>
                                                EXECUTIVE EQUITY INCENTIVE PLAN
                             ----------------------------------------------------------------------
                                     2000                    1999                     1998
                             --------------------    ---------------------    ---------------------
                                         WEIGHTED                 WEIGHTED                 WEIGHTED
                                         AVERAGE                  AVERAGE                  AVERAGE
                                         EXERCISE                 EXERCISE                 EXERCISE
                              SHARES      PRICE       SHARES       PRICE       SHARES       PRICE
                             --------    --------    ---------    --------    ---------    --------
<S>                          <C>         <C>         <C>          <C>         <C>          <C>
Shares outstanding,
  beginning of period......   808,247                1,102,496                1,104,496
Shares purchased...........        --                       --                       --
Shares forfeited...........   (80,000)                (294,249)                  (2,000)
                             --------                ---------                ---------
Shares outstanding, end of
  period...................   728,247                  808,247                1,102,496
                             ========                =========                =========
Options outstanding,
  beginning of period......   454,000     $1.13        614,000     $1.44        664,000     $1.53
Granted....................        --        --             --        --             --        --
Exercised..................  (274,000)     1.00        (60,000)     2.67             --        --
Forfeited..................  (100,000)     1.00       (100,000)     2.11        (50,000)     2.50
                             --------                ---------                ---------
Options outstanding, end of
  period...................    80,000     $1.72        454,000     $1.13        614,000     $1.44
                             ========     =====      =========     =====      =========     =====
Options exercisable, end of
  period...................    80,000     $1.72        454,000     $1.13        170,000     $2.65
                             ========     =====      =========     =====      =========     =====
</TABLE>

     The following table summarizes information about stock options outstanding
under the Incentive Plan at December 30, 2000:

<TABLE>
<CAPTION>
                                              OPTIONS OUTSTANDING/EXERCISABLE
                                         ------------------------------------------
                                                           WEIGHTED
                                           NUMBER           AVERAGE        WEIGHTED
                                         OUTSTANDING       REMAINING       AVERAGE
               EXERCISE                      AT           CONTRACTUAL      EXERCISE
                 PRICE                   12/30/2000          LIFE           PRICE
               --------                  -----------      -----------      --------
<S>                                      <C>              <C>              <C>
$0.69..................................    40,000             2.0           $0.69
$2.75..................................    40,000             0.6            2.75
                                           ------
          Total........................    80,000             1.3           $1.72
                                           ======             ===           =====
</TABLE>

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

<TABLE>
<CAPTION>
                                                   2000          1999          1998
                                                 ---------    ----------    ----------
<S>                                              <C>          <C>           <C>
Notes Receivable balance, beginning of
  period.......................................  $ 655,500    $1,690,500    $1,721,500
Additions......................................         --            --            --
Payments.......................................     (9,600)     (262,000)      (31,000)
Forfeitures....................................   (321,500)     (773,000)           --
                                                 ---------    ----------    ----------
Notes Receivable balance, end of period........  $ 324,400    $  655,500    $1,690,500
                                                 =========    ==========    ==========
</TABLE>

     In December 1999, the rights of certain participants in the Incentive Plan
expired. These participants had cumulative promissory notes of approximately
$1.0 million payable to the Company, comprised of $0.8 million of principal and
$0.2 million of interest, on the expiration date. Accordingly, collateral
encompassing 80,000 shares and 294,249 shares of the Company's Common Stock in
fiscal years 2000 and 1999, respectively, held in escrow on behalf of each
participant, was transferred to and retained by the Company in satisfaction of
the aforementioned promissory notes, which were no longer required to be
settled. The Company recorded these

                                        44
<PAGE>   46
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     YEARS ENDED DECEMBER 30, 2000, DECEMBER 25, 1999 AND DECEMBER 26, 1998

shares as treasury stock. Furthermore, these participants forfeited their
initial 20% cash down payment, which was required for entry into the Incentive
Plan. The Incentive Plan has been terminated.

     Management Stock Option Plans -- The Company approved for issuance to
employees 20,000,000 shares of the Company's Common Stock pursuant to the
Company's 2000 Management Stock Option Plan and 7,000,000 shares of the
Company's Common Stock pursuant the Company's 1996 Stock Option Plan. Under both
plans, the option exercise price is equal to the fair market value as of the
date of grant. However, for stock options granted to an employee owning more
than 10% of the total combined voting power of all classes of Company stock, the
exercise price is equal to 110% of the fair market value of the Company's Common
Stock as of the grant date. Stock options granted to an individual employee
under the 2000 Management Stock Option Plan may not exceed 1,000,000 shares of
the Company's Common Stock. Stock options granted to an individual employee
under the 1996 Stock Option Plan may not exceed 500,000 shares of the Company's
Common Stock and may be performance-based. All options granted must be
specifically identified as incentive stock options or non-qualified stock
options, as defined in the Internal Revenue Code. Furthermore, the aggregate
fair market value of Common Stock for which an employee is granted incentive
stock options that first became exercisable during any given calendar year shall
be limited to $100,000. To the extent such limitation is exceeded, the option
shall be treated as a non-qualified stock option. 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.

     For the combined Management Stock Option Plans, options outstanding,
granted and the weighted average exercise prices are as follows:

<TABLE>
<CAPTION>
                                 2000                       1999                      1998
                        -----------------------    ----------------------    ----------------------
                                       WEIGHTED                  WEIGHTED                  WEIGHTED
                                       AVERAGE                   AVERAGE                   AVERAGE
                                       EXERCISE                  EXERCISE                  EXERCISE
                          SHARES        PRICE        SHARES       PRICE        SHARES       PRICE
                        -----------    --------    ----------    --------    ----------    --------
<S>                     <C>            <C>         <C>           <C>         <C>           <C>
Options outstanding,
  beginning of
  period..............    5,927,984     $1.99       5,301,400     $1.66       4,451,249     $1.10
Granted...............    5,459,000      2.71       2,010,000      2.53       1,550,000      3.07
Exercised.............     (414,537)     1.10        (693,821)     1.01        (363,949)     1.01
Forfeited.............   (1,731,500)     2.26        (689,595)     1.95        (335,900)     1.52
Expired...............           --        --              --        --              --        --
                        -----------                ----------                ----------
Options outstanding,
  end of period.......    9,240,947     $2.41       5,927,984     $1.99       5,301,400     $1.66
                        ===========     =====      ==========     =====      ==========     =====
Options exercisable,
  end of period.......    3,235,167     $1.82       2,620,344     $1.41       1,749,232     $1.07
                        ===========     =====      ==========     =====      ==========     =====
Weighted average fair
  value of options
  granted.............  $      1.60                $     1.21                $     1.50
                        ===========                ==========                ==========
</TABLE>

     The fair value of each option granted is estimated on the date of grant
using the Black-Scholes option pricing model. The weighted average assumptions
for grants in fiscal 2000, 1999 and 1998 are as follows: risk free interest rate
of 5.60%, 5.83% and 5.64%, respectively, expected volatility of 56.85%, 53.81%
and 55.82%, respectively, expected lives of 6 years for fiscal 2000 and 4 years
for fiscal 1999 and 1998, and no expected

                                        45
<PAGE>   47
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     YEARS ENDED DECEMBER 30, 2000, DECEMBER 25, 1999 AND DECEMBER 26, 1998

dividends. The following table summarizes information about stock options
outstanding at December 30, 2000 under the Combined Management Stock Option
Plans:

<TABLE>
<CAPTION>
                                       OPTIONS OUTSTANDING                OPTIONS EXERCISABLE
                              --------------------------------------    -----------------------
                                              WEIGHTED
                                NUMBER         AVERAGE      WEIGHTED      NUMBER       WEIGHTED
RANGE OF                      OUTSTANDING     REMAINING     AVERAGE     EXERCISABLE    AVERAGE
EXERCISE                          AT         CONTRACTUAL    EXERCISE        AT         EXERCISE
PRICES                         12/30/00         LIFE         PRICE       12/30/00       PRICE
--------                      -----------    -----------    --------    -----------    --------
<S>                           <C>            <C>            <C>         <C>            <C>
$0.25 to $1.01..............   1,854,939         4.7         $0.97       1,301,692      $0.96
$1.43 to $1.75..............   1,109,998         5.8         $1.56         650,497      $1.45
$2.37 to $2.94..............   1,707,010         5.7         $2.47         593,342      $2.49
$3.00 to $3.50..............   4,569,000         7.8         $3.18         689,636      $3.20
                               ---------                                 ---------
                               9,240,947         6.6         $2.41       3,235,167      $1.82
                               =========         ===         =====       =========      =====
</TABLE>

     The Chief Executive Officer (the "CEO") Stock Option Plans -- The
information below details each of the stock-based plans granted in 1996 for the
benefit of Rakesh K. Kaul, the former Chief Executive Officer of the Company
(the "CEO"). In each of the plans: (1) the option price represents the average
of the low and high fair market values of the Common Stock on August 23, 1996,
the date of the closing of the 1996 Rights Offering, (2) the options outstanding
at December 30, 2000 have an exercise price of $1.16, and (3) payment for shares
purchased upon the exercise of the option shall be in cash or stock of the
Company.

     The details of the plans are as follows:

     The CEO Tandem Plan -- Pursuant to the Company's Tandem Plan (the "Tandem
Plan"), the right to purchase an aggregate of 1,000,000 shares of Common Stock
and an option to purchase 2,000,000 shares of Common Stock was approved for
issuance to the CEO. The option is subject to anti-dilution provisions and due
to the Company's 1996 Rights Offering was adjusted to 1,510,000 shares of Common
Stock and 3,020,000 options. The options expire 10 years from the date of grant
and vest over four years. The options outstanding at December 30, 2000 have a
weighted average contractual life of 5.25 years.

     The CEO Performance Year Plan -- Pursuant to the Company's Performance Year
Plan (the "Performance Plan"), an option to purchase an aggregate of 1,000,000
shares of Common Stock was approved for issuance to the CEO in 1996. The options
are based upon performance as defined by the Compensation Committee of the Board
of Directors. Should a performance target not be attained, the option is carried
over to the succeeding year in conjunction with that year's option until the
expiration date. The options expire 10 years from the date of grant and vest
over four years. Payment for shares purchased upon the exercise of the options
shall be in cash or stock of the Company. The options outstanding at December
30, 2000 have a weighted average contractual life of 5 years.

     The CEO Closing Price Option Plan -- Pursuant to the Company's Closing
Price Option Plan (the "Closing Price Plan"), an option to purchase an aggregate
of 2,000,000 shares of Common Stock was approved for issuance to the CEO in
1996. The options originally expired 10 years from the date of grant and would
vest upon the Company's stock price reaching a specific target over a
consecutive 91-calendar day period as defined by the Compensation Committee of
the Board of Directors. In May 1998, the Compensation Committee of the Board of
Directors reduced the target per share market price at which the Company's
Common Stock had to trade in consideration of the dilutive effect of the
increase in outstanding shares from the date of the grant. The performance
period has a range of 6 years beginning August 23, 1996, the date of the closing
of the 1996 Rights Offering. The options outstanding at December 30, 2000 have a
weighted average contractual life of 5.25 years.

     As part of a new Executive Employment Agreement entered into by the Company
and the former CEO on March 6, 2000, the Closing Price Plan was amended to
provide for a three year vesting schedule provided the CEO remained employed by
the Company. The impact of this change on earnings for fiscal year 2000 was to
increase the Company's annual charge for compensation related to stock options
by $0.9 million.

                                        46
<PAGE>   48
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     YEARS ENDED DECEMBER 30, 2000, DECEMBER 25, 1999 AND DECEMBER 26, 1998

     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 Group Limited ("NAR"), a
related party at the time of grant, in 1996. The option is subject to anti-
dilution provisions and due to the Company's 1996 Rights Offering was adjusted
to 377,500 option shares. The options expire 6 years from the date of grant and
vest after one year. The options outstanding at December 30, 2000 have a
weighted average contractual life of 1.25 years.

     The CEO Seven Year Stock Option Plan -- Pursuant to NAR's Seven Year Stock
Option Plan (the "Seven Year Plan"), an option to purchase an aggregate of
250,000 shares of Common Stock was granted to the CEO by NAR in 1996. The option
is subject to anti-dilution provisions and due to the Company's 1996 Rights
Offering was adjusted to 377,500 option shares. The options expire 7 years from
the date of grant and vest after two years. The options outstanding at December
30, 2000 have a weighted average contractual life of 2.25 years.

     The CEO Eight Year Stock Option Plan -- Pursuant to NAR's Eight Year Stock
Option Plan (the "Eight Year Plan"), an option to purchase an aggregate of
250,000 shares of Common Stock was granted to the CEO by NAR in 1996. The option
is subject to anti-dilution provisions and due to the Company's 1996 Rights
Offering was adjusted to 377,500 option shares. The options expire 8 years from
the date of grant and vest after three years. The options outstanding at
December 30, 2000 have a weighted average contractual life of 3.25 years.

     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 in 1996. The option
is subject to anti-dilution provisions and due to the Company's 1996 Rights
Offering was adjusted to 377,500 option shares. The options expire 9 years from
the date of grant and vest after four years. The options outstanding at December
30, 2000 have a weighted average contractual life of 4.25 years.

     For the combined CEO Stock Option Plans, options outstanding, granted and
the weighted average exercise prices are as follows:

<TABLE>
<CAPTION>
                                               CEO STOCK OPTION PLANS
                       -----------------------------------------------------------------------
                               2000                     1999                     1998
                       ---------------------    ---------------------    ---------------------
                                    WEIGHTED                 WEIGHTED                 WEIGHTED
                                    AVERAGE                  AVERAGE                  AVERAGE
                                    EXERCISE                 EXERCISE                 EXERCISE
                        SHARES       PRICE       SHARES       PRICE       SHARES       PRICE
                       ---------    --------    ---------    --------    ---------    --------
<S>                    <C>          <C>         <C>          <C>         <C>          <C>
Options outstanding,
  beginning of
  period.............  7,530,000     $1.16      7,530,000     $1.16      7,530,000     $1.16
Granted..............         --        --             --        --             --        --
Exercised............         --        --             --        --             --        --
Forfeited............         --        --             --        --             --        --
Expired..............         --        --             --        --             --        --
                       ---------                ---------                ---------
Options outstanding,
  end of period......  7,530,000     $1.16      7,530,000     $1.16      7,530,000     $1.16
                       =========     =====      =========     =====      =========     =====
Options exercisable,
  end of period......  7,040,000     $1.16      4,147,500     $1.16      2,765,000     $1.16
                       =========     =====      =========     =====      =========     =====
</TABLE>

                                        47
<PAGE>   49
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     YEARS ENDED DECEMBER 30, 2000, DECEMBER 25, 1999 AND DECEMBER 26, 1998

     The fair value of the options granted in 1996 for each of the CEO Stock
Option Plans was estimated on the date of grant using the Black-Scholes option
pricing model with the following weighted average assumptions:

<TABLE>
<CAPTION>
                                               RISK-FREE                              EXPECTED
                                               INTEREST      EXPECTED     DIVIDEND      LIFE
                                                 RATE       VOLATILITY     YIELD      (YEARS)
                                               ---------    ----------    --------    --------
<S>                                            <C>          <C>           <C>         <C>
CEO Tandem Plan..............................    6.79%        45.02%        0.00%       9.85
CEO Performance Plan.........................    6.79%        45.02%        0.00%       9.85
CEO Closing Price Plan (1)...................    6.79%        45.02%        0.00%       9.85
CEO Six Year Plan............................    6.42%        45.02%        0.00%       5.85
CEO Seven Year Plan..........................    6.53%        45.02%        0.00%       6.85
CEO Eight Year Plan..........................    6.62%        45.02%        0.00%       7.85
CEO Nine Year Plan...........................    6.73%        45.02%        0.00%       8.85
</TABLE>

---------------
(1) The CEO Closing Price Plan used the Black-Scholes option pricing model in
conjunction with a Monte Carlo simulation.

     The following table summarizes information about stock options outstanding
at December 30, 2000 under the combined CEO Stock Option Plans:

<TABLE>
<CAPTION>
                            OPTIONS OUTSTANDING             OPTIONS EXERCISABLE
                    ------------------------------------   ----------------------
                                   WEIGHTED
                      NUMBER        AVERAGE     WEIGHTED     NUMBER      WEIGHTED
RANGE OF            OUTSTANDING    REMAINING    AVERAGE    EXERCISABLE   AVERAGE
EXERCISE                AT        CONTRACTUAL   EXERCISE       AT        EXERCISE
PRICES               12/30/00        LIFE        PRICE      12/30/00      PRICE
--------            -----------   -----------   --------   -----------   --------
<S>                 <C>           <C>           <C>        <C>           <C>
$1.16                7,530,000        4.7        $1.16      7,040,000     $1.16
</TABLE>

     The new Executive Employment Agreement entered into by the Company on March
6, 2000 provided Rakesh K. Kaul with the option to purchase 6% of the common
stock of erizon, Inc. at the estimated fair market value on the date of grant
which option was to vest in equal parts over a four year period and to expire
ten years from the date of grant. The Company recorded compensation expense of
$0.8 million during the year ended December 30, 2000 related to this option
grant. The fair value of options at the date of grant was estimated to be
$62,000 per share based on the following assumptions: risk-free interest rate of
6.0%, expected life of 4 years, expected volatility of 54.8% and no expected
dividends.

     As described more fully in Note 17, the Company is currently involved in
negotiations with Rakesh K. Kaul, the Company's former President and Chief
Executive Officer, regarding the amount of cash and benefits to which Mr. Kaul
is entitled as a result of his resignation on December 5, 2000. Since the
negotiations are still pending, it is unknown at this time what the impact of
his resignation will have on all of the option plans described above.

OTHER STOCK AWARDS

     During 1997, the Company granted, and the Compensation Committee of the
Board of Directors approved, non-qualified options to certain employees for the
purchase of an aggregate of 1,000,000 shares of the Company's Common Stock. The
options vested over three years and are due to expire in 2003. The options have
an exercise price of $0.75 and a remaining contractual life of 2.2 years. The
fair value of the options at the date of grant was estimated to be $0.52 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. As of December 30, 2000, there were 809,000 options outstanding and
exercisable.

     During January 2001, the Company granted, and the Company's Board of
Directors approved, options for the purchase of an aggregate of 4,000,000 shares
of Common Stock with an exercise price of $0.25 per share. These options have
been allocated as follows: Thomas C. Shull, 2,700,000 shares; Paul Jen, 500,000
shares; John F. Shull, 500,000 shares; Evan M. Dudik, 200,000 shares; and Peter
Schweinfurth, 100,000 shares. The Meridian Options terminate in the event that
the Services Agreement is terminated (i) upon written notice by

                                        48
<PAGE>   50
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     YEARS ENDED DECEMBER 30, 2000, DECEMBER 25, 1999 AND DECEMBER 26, 1998

the Company to Meridian and Mr. Shull of material breach of the Services
Agreement by Meridian or Mr. Shull or willful misconduct by Meridian or Mr.
Shull, or (ii) upon the death or permanent disability of Mr. Shull. The Meridian
Options vest and become exercisable in the event of the following terminations
of the Services Agreement: (i) upon written notice by Meridian and Mr. Shull to
the Company that the Company is in material breach of the Services Agreement (a
"Company Breach"); (ii) December 4, 2001; (iii) the first day after the
acquisition of the Company (whether by merger or the acquisition of all of its
outstanding capital stock) or the tenth day after the sale of at least
two-thirds ( 2/3) of the assets of each of the Company's two primary businesses
(a "Liquidation Termination"); and (iv) on the day the Company terminates the
engagement of Meridian and Mr. Shull when there has been no willful misconduct
or material breach of the Agreement by either Meridian or Mr. Shull (a "Company
Termination"). When the Meridian Options vest and become exercisable upon a
termination of the Services Agreement, they shall remain exercisable until their
termination on the second anniversary of the termination of the Services
Agreement (or their earlier exercise). In the event of a vesting resulting from
a Liquidation Termination, such vesting shall take place sufficiently in advance
of such termination to permit such optionee to take all steps reasonably
necessary to exercise his options and to deal with the common shares purchased
under the options so that those common shares may be treated in the same manner
as the common shares of other shareholders. The fair value of these options was
estimated to be $0.07 cents per share at the date of grant based on the
following assumptions: risk-free interest rate of 6.0%, expected life of 1.5
years, expected volatility of 54.0% and no expected dividends.

12.  EMPLOYEE BENEFIT PLANS

     The Company maintains several defined contribution (401K) plans that
collectively cover all employees of the Company and provide employees with the
option of investing in the Company's stock. The Company matches a percentage of
employee contributions to the plans up to $10,000 per employee. Matching
contributions for all plans were $.8 million, $.7 million and $.6 million for
fiscal 2000, 1999 and 1998, respectively.

13.  INCOME TAXES

     At December 30, 2000, the Company had net operating loss carry forwards
("NOLs") totaling $365.2 million which expire as follows: 2001 -- $18.1 million,
2003 -- $14.6 million, 2004 -- $14.3 million, 2005 -- $20.6 million,
2006 -- $46.9 million, 2007 -- $27.7 million, 2010 -- $24.6 million,
2011 -- $64.9 million 2012 - $30.0 million, 2018 -- $24.4 million, 2019 -- $19.5
million and 2020 -- $59.6 million. The Company also has $0.3 million of general
business tax credit carry forwards that expire as follows: 2001 -- $0.2 million
and 2009 -- $0.1 million. The Company's available NOLs for tax purposes consist
of $92.2 million of NOLs subject to a $4.0 million annual limitation under
Section 382 of the Internal Revenue Code of 1986 and $273.0 million of NOLs not
subject to a limitation. The unused portion of the $4.0 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, "Accounting for Income Taxes," 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 an additional NOL of $59.6 million in 2000, management believes that
the Company will be able to utilize up to $43.0 million of NOLs based upon the
Company's assessment of numerous factors, including its future operating plans.

     For the years ended December 30, 2000 and December 25, 1999, the Company
maintained its deferred tax asset of $15.0 million (net of a valuation allowance
of $123.9 million in 2000 and $97.5 million in 1999). Management believes that
the $15.0 million net deferred tax asset still represents a reasonable estimate
of the future utilization of the NOLs and the reversal of timing items.
Management 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 carry forward period and the
periods in which net temporary differences reverse. Future levels of operating
income and taxable income are dependent upon general economic conditions,
competitive pressures

                                        49
<PAGE>   51
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     YEARS ENDED DECEMBER 30, 2000, DECEMBER 25, 1999 AND DECEMBER 26, 1998

on sales and margins, postal and other delivery rates, and other factors beyond
the Company's control. Accordingly, no assurance can be given that sufficient
taxable income will be generated for utilization of NOLs and reversals of
temporary differences.

     The Company's Federal income tax provision was zero for fiscal 2000, 1999
and 1998. The Company's provision for state income taxes was $0.2 million in
2000, $0. 5 million in 1999 and $1.0 million in 1998.

     A reconciliation of the Company's net loss for financial statement purposes
to taxable loss for the years ended December 30, 2000, December 25, 1999 and
December 26, 1998 is as follows (in thousands):

<TABLE>
<CAPTION>
                                                           2000          1999          1998
                                                           ----          ----          ----
<S>                                                      <C>           <C>           <C>
(Loss) before income taxes.............................  $(80,635)     $(15,784)     $(24,585)
Differences between income before taxes for financial
  statement purposes and taxable income:
State income taxes.....................................      (165)         (530)       (1,000)
Permanent differences..................................     5,733         1,313           376
Net change in temporary differences....................    15,435        (4,516)          837
                                                         --------      --------      --------
     Taxable (loss)....................................  $(59,632)     $(19,517)     $(24,372)
                                                         ========      ========      ========
</TABLE>

     The components of the net deferred tax asset at December 30, 2000 are as
follows (in millions):

<TABLE>
<CAPTION>
                                                             NON-
                                               CURRENT      CURRENT      TOTAL
                                               -------      -------      -----
<S>                                            <C>          <C>          <C>
Federal tax NOL and business tax credit carry
  forwards...................................   $  --       $127.9       $127.9
Allowance for doubtful accounts..............     2.0           --          2.0
Inventories..................................     1.0           --          1.0
Prepaid catalog costs........................    (4.0)          --         (4.0)
Property and equipment.......................      --          2.0          2.0
Excess of net assets of acquired business....      --         (2.2)        (2.2)
Mailing lists................................      --          2.0          2.0
Accrued liabilities..........................     3.1           --          3.1
Customer prepayments and credits.............     1.7           --          1.7
Deferred credits.............................      --          0.5          0.5
Tax basis in net assets of discontinued
  operations in excess of financial statement
  amount.....................................     4.8           --          4.8
Other........................................      --          0.1          0.1
                                                -----       ------       ------
Deferred tax asset...........................     8.6        130.3        138.9
Valuation allowance..........................     5.3        118.6        123.9
                                                -----       ------       ------
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 the
Company's estimate of the future utilization of the NOLs.

     The Internal Revenue Service ("IRS") has not examined the Company's tax
returns for years subsequent to 1984. The IRS, upon examination of such returns,
might challenge the availability of the NOLs. The Company believes, however,
that the IRS challenges that would limit the utilization of the NOLs will not
have a material adverse effect on the Company's financial position.

                                        50
<PAGE>   52
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     YEARS ENDED DECEMBER 30, 2000, DECEMBER 25, 1999 AND DECEMBER 26, 1998

     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>
                                               2000          1999           1998
                                             PERCENT       PERCENT        PERCENT
                                            OF PRE-TAX    OF PRE-TAX     OF PRE-TAX
                                               LOSS          LOSS           LOSS
                                            ----------    ----------     ----------
<S>                                         <C>           <C>           <C>
Tax (benefit) at Federal statutory rate...    (35.0)%       (35.0)%        (35.0)%
State and local taxes.....................      0.1           2.2            2.6
Net increase in (reversal of) temporary
  differences:
  Depreciation and amortization...........      1.2          (3.2)           3.1
  Deferred compensation...................      0.4           9.1            0.9
  Restructuring reserves..................      7.8          (5.8)          (7.8)
  Customer allowance and return
     reserves.............................     (0.2)          0.7           (0.5)
  Inventory...............................      0.9          (7.2)           4.8
  Prepaid catalog costs...................     (2.1)         (1.5)           2.0
  Allowance for doubtful accounts.........      0.7          (0.6)          (1.2)
  Gain (loss) on asset disposal...........     (1.8)          1.7             --
  Other...................................     (0.3)         (3.2)          (0.1)
  Tax NOLs, for which no benefit could be
     recognized...........................     25.9          43.3           34.7
  Permanent differences...................      2.5           2.9            0.5
                                              -----         -----          -----
                                                0.2%          3.4%           4.0%
                                              =====         =====          =====
</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>
                                              2000         1999         1998
                                              ----         ----         ----
<S>                                          <C>          <C>          <C>
Minimum rentals............................  $13,810      $10,168      $9,297
                                             -------      -------      ------
</TABLE>

     Future minimum lease payments under non-cancelable operating and capital
leases relating to continuing operations, together with the present value of the
net minimum lease payments as of December 30, 2000, are as follows (in
thousands):

<TABLE>
<CAPTION>
                                                            OPERATING    CAPITAL
YEAR ENDING                                                  LEASES      LEASES
-----------                                                 ---------    -------
<S>                                                         <C>          <C>
2001......................................................   $11,309      $140
2002......................................................    10,153        68
2003......................................................     7,313        --
2004......................................................     6,366        --
2005......................................................     4,277        --
Thereafter................................................    16,875        --
                                                             -------      ----
Total minimum lease payments..............................   $56,293       208
                                                             =======
Less amount representing interest (a).....................                 (16)
                                                                          ----
Present value of minimum lease payments (b)...............                $192
                                                                          ====
</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.

                                        51
<PAGE>   53
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     YEARS ENDED DECEMBER 30, 2000, DECEMBER 25, 1999 AND DECEMBER 26, 1998

(b) Reflected in the balance sheet as current and non-current capital lease
    obligations of $126 and $66 at December 30, 2000 and $157 and $192 at
    December 25, 1999, respectively.

     The future minimum lease payments under non-cancelable leases that remain
from the discontinued restaurant operations as of December 30, 2000 are as
follows: 2001 -- $0.5 million; 2002 -- $0.5 million; 2003 -- $0.4 million;
2004 -- $0.4 million; and 2005 -- $0.3 million. The above amounts exclude annual
sublease income from subleases which have the same expiration as the underlying
leases as follows: 2001 -- $0.4 million; 2002 -- $0.4 million; 2003 -- $0.3
million; 2004 -- $0.3 million; and 2005 -- $0.2 million.

15.  CHANGES IN MANAGEMENT AND EMPLOYMENT AGREEMENTS

     On December 5, 2000, Rakesh K. Kaul resigned as President and Chief
Executive Officer, and resigned from the Board of Directors of the Company.

     On December 5, 2000, Thomas C. Shull was named President and Chief
Executive Officer and was elected to the Board of Directors of the Company.
Effective on that date, Mr. Shull, Meridian Ventures, LLC, a limited liability
company controlled by Mr. Shull ("Meridian"), and the Company entered into a
Services Agreement (the "Services Agreement"). Under the Services Agreement,
Meridian will provide for the benefit of the Company the services of Mr. Shull
and the services of two (or more, at Meridian's discretion) additional
consultants (the "Consultants"). The term of the Services Agreement, and the
term for the services of Mr. Shull, began on December 5, 2000 and terminate on
December 4, 2001 (the "Agreement Term"), while the term for the services of the
Consultants terminates on June 4, 2001.

     Under the Services Agreement, Meridian is to receive from the Company
$75,000 per month for the services of Mr. Shull and, during the first six months
of the Agreement Term, an additional $75,000 per month for the services of the
Consultants (collectively, the "Base Fees"). The Company also is required to pay
Meridian $30,000 per month during the first six months of services and $15,000
per month during the remaining six months of services (collectively, the "Flat
Fees"). The Company also reimburses Mr. Shull and the Consultants for reasonable
out-of-pocket expenses incurred on behalf of the Company.

     Pursuant to the Services Agreement, the Company has granted Mr. Shull and
the Consultants stock options (the "Meridian Options") for an aggregate four
million (4,000,000) shares of the Company's Common Stock. Each option has an
exercise price of $0.25 per share. The options have been allocated as follows:
Mr. Shull, 2,700,000 shares; Paul Jen, 500,000 shares; John F. Shull, 500,000
shares; Evan M. Dudik, 200,000 shares; and Peter Schweinfurth, 100,000 shares.
The terms of these options have been described in Note 11.

     Under the Services Agreement, additional amounts are payable to Meridian
under certain circumstances on the termination of the Services Agreement. If the
termination is pursuant to a Company Breach or a Company Termination, Meridian
shall be entitled to receive a lump sum payment equal to the greater of (i)
$540,000 or (ii) the aggregate amount of Base Fees and Flat Fees to which it
would have otherwise been entitled through the end of the Agreement Term. If the
termination is a Liquidation Termination and the amount realized in the related
transaction equals or exceeds $0.50 per common share (or the equivalent of $0.50
per common share), Meridian shall be entitled to receive a lump sum payment
equal to the aggregate amount of Base Fees and Flat Fees to which it would have
otherwise been entitled through the end of the Agreement Term. If the
termination is a Liquidation Termination and the amount realized in the related
transaction is less than $0.50 per common share (or the equivalent of $0.50 per
common share), Meridian shall be entitled to receive a lump sum payment equal to
the greater of the aggregate amount of Base Fees and Flat Fees to which it would
have otherwise been entitled through the end of the Agreement Term, or
$1,000,000.

     The Company is required, under the Services Agreement, to maintain
directors' and officer's liability insurance during the term of the Services
Agreement. The Company is also required to indemnify Meridian, Mr. Shull and any
employee of Meridian who acts as a consultant to the Company.

                                        52
<PAGE>   54
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     YEARS ENDED DECEMBER 30, 2000, DECEMBER 25, 1999 AND DECEMBER 26, 1998

16.  RELATED PARTY TRANSACTIONS

     At December 30, 2000, Richemont Finance S.A. ("Richemont"), a Luxembourg
company, owned approximately 47.9% of the Company's Common Stock through direct
ownership. On June 1, 1998, Richemont entered into an agreement with a third
party whereby Richemont was granted an irrevocable proxy to vote approximately
4.3 million shares of Common Stock currently held by the third party.
Accordingly, Richemont has voting control of approximately 49.9% of the
Company's Common Stock.

     At December 30, 2000, current and former officers and executives of the
Company, excluding Rakesh K. Kaul, owed the Company approximately $0.3 million,
excluding accrued interest, under the 1993 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 2000 to 2002. An additional $0.7 million, excluding
accrued interest, relates to a receivable under the CEO Incentive ("Tandem")
Plan for Rakesh K. Kaul and is included in Notes Receivable from Sale of Common
Stock in the accompanying consolidated balance sheet.

     On August 24, 2000, the Company issued 1.4 million shares of preferred
stock designated as Series A Cumulative Participating Preferred Stock (the
"Series A Preferred Stock") to Richemont for $70.0 million. The Company used the
proceeds of the issuance of the Series A Preferred Stock to repay in full all
borrowings outstanding under the Richemont $10 million Line of Credit and the
Richemont $25 million Line of Credit, plus accrued and unpaid interest thereon,
and for working capital purposes.

     From March 24, 2000 through August 24, 2000, the Company was a party to a
$10.0 million unsecured line of credit facility (the "Richemont $10.0 million
Line of Credit") with Richemont. The Richemont $10.0 million Line of Credit
facility provided the Company with financing from Richemont should the excess
availability under the Congress Credit Facility fall below $3.0 million.
Additionally, the Company could have borrowed up to $5.0 million under the
Richemont $10.0 million Line of Credit to pay trade creditors in the ordinary
course of business. On August 24, 2000, the Richemont $10.0 million Line of
Credit was terminated and all borrowings outstanding as of August 24, 2000 of
approximately $5.0 million, plus accrued and unpaid interest and fees, were
repaid and retired from a portion of the net proceeds obtained from the issuance
of the Company's Series A Preferred Stock to Richemont.

     From March 1, 2000 through August 24, 2000, the Company was a party to a
$25.0 million unsecured line of credit facility (the "Richemont $25.0 million
Line of Credit") with Richemont which provided the Company with funding from
Richemont to continue the development and expansion of the Company's B-to-B
e-commerce transaction services operation. On August 24, 2000, the Richemont
$25.0 million Line of Credit was terminated and all borrowings outstanding as of
August 24, 2000 of approximately $25.0 million, plus accrued and unpaid interest
and fees, were repaid and retired from a portion of the net proceeds obtained
from the issuance of the Company's Series A Preferred Stock to Richemont.

     On July 31, 1998, Richemont acquired 5,646,490 additional shares of Common
Stock of the Company pursuant to the exercise of certain common stock purchase
warrants with exercise prices from $1.95 to $2.59 per share and an aggregate
total exercise price of $13.6 million. The Company used the proceeds of the
warrant exercise to reduce the amounts outstanding under the Congress Credit
Facility.

     On December 5, 2000, the Company, Mr. Shull and Meridian Ventures, LLC
entered into a Services Agreement. See Note 15.

17.  COMMITMENTS AND CONTINGENCIES

     A class action lawsuit was commenced on March 3, 2000 entitled Edwin L.
Martin v. Hanover Direct, Inc. and John Does 1 through 10, bearing case no.
CJ2000-177 in the State Court of Oklahoma (District Court in and for Sequoyah
County). Plaintiff commenced the action on behalf of himself and a class of
persons who have at any time purchased a product from the Company and paid for
an "insurance charge." The complaint sets forth claims for breach of contract,
unjust enrichment, recovery of money paid absent consideration, fraud and a
claim under the New Jersey Consumer Fraud Act. The complaint alleges that the
Company charges its customers for delivery insurance even though, among other
things, the Company's

                                        53
<PAGE>   55
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     YEARS ENDED DECEMBER 30, 2000, DECEMBER 25, 1999 AND DECEMBER 26, 1998

common carriers already provide insurance and the insurance charge provides no
benefit to the Company's customers. Plaintiff also seeks a declaratory judgment
as to the validity of the delivery insurance. The damages sought are (i) an
order directing the Company to return to plaintiff and class members the
"unlawful revenue" derived from the insurance charges, (ii) declaring the rights
of the parties, (iii) permanently enjoining the Company from imposing the
insurance charge, (iv) awarding threefold damages of less than $75,000 per
plaintiff and per class member, and (v) attorneys' fees and costs. The Company's
motion to dismiss is pending and the discovery commenced; the Company believes
it has defenses against the claims, however, it is too early to determine the
outcome or range of potential settlement, which could have a material impact on
the Company's results of operations when settled in a future period.

     At the end of January 2000, the Company received a letter from the Federal
Trade Commission ("FTC") conducting an inquiry into the marketing of The
Shopper's Edge club to determine whether, in connection with such marketing, any
entities have engaged in (1) unfair or deceptive acts or practices in violation
of Section 5 of the FTC Act and/or (2) deceptive or abusive telemarketing acts
or practices in violation of the FTC's Telemarketing Sales Rule. The inquiry was
undertaken pursuant to the provisions of Sections 6, 9 and 10 of the FTC Act.
Following such an investigation, the FTC may initiate an enforcement action if
it finds "reason to believe" that the law is being violated. When there is
"reason to believe" that a law violation has occurred, the FTC may issue a
complaint setting forth its charges. If the respondent elects to settle the
charges, it may sign a consent agreement (without admitting liability) by which
it consents to entry of a final order and waives all right to judicial review.
If the FTC accepts such a proposed consent, it places the order on the record
for sixty days of public comment before determining whether to make the order
final. The Company believes that it complied with all enumerated aspects of the
investigation. It has not received notice of an enforcement action or a
complaint against it.

     Pursuant to a contract with Triad Marketing Group, Inc. ("Triad"), the
Company maintains the books and records for The Shopper's Edge up-sell program
which includes responsibility for collecting revenues and paying both Triad and
the Company their appropriate fees and profits. As a result of a Florida
Temporary Restraining Order ("TRO"), directed at an individual associated with
Triad and not the Company, all fees and profits have been frozen with the result
that there is a receivable of $1.1 million from Triad at December 30, 2000,
representing amounts due the Company for solicitation fees earned. The Company's
outside counsel has commenced discussions with the Florida Attorney General's
office. In the opinion of management, these funds will eventually be released
and the Company will ultimately recover the amount due it for fees earned.

     The Company is involved in negotiations with Rakesh K. Kaul, the Company's
former President and Chief Executive Officer, regarding the amount of cash and
benefits to which Mr. Kaul is entitled as a result of his resignation on
December 5, 2000. The Company agrees with certain claims made on behalf of Mr.
Kaul, including Mr. Kaul's entitlement to receive in excess of $3,000,000 as
payment of short-term bonus, severance payable to Mr. Kaul under his Employment
Agreement, and benefits continuation. The Company disagrees with other claims
made on behalf of Mr. Kaul, including that Mr. Kaul is entitled to benefits
under the Key Executive Thirty-Six Month Salary Continuation Plan, the valuation
of Mr. Kaul's options in erizon, and whether Mr. Kaul is entitled to a bonus in
connection with the Tandem Plan. The Company does not intend to make any
payments to Mr. Kaul, other than salary and benefits continuation, until all
outstanding issues are resolved and Mr. Kaul executes a general release in favor
of the Company. No legal proceedings have been commenced to date with respect to
this matter.

     In addition, the Company is involved in various routine lawsuits of a
nature, which are deemed customary and incidental to its businesses. In the
opinion of management, the ultimate disposition of these actions will not have a
material adverse effect on the Company's financial position or results of
operations.

                                        54
<PAGE>   56
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     YEARS ENDED DECEMBER 30, 2000, DECEMBER 25, 1999 AND DECEMBER 26, 1998

18.  SELECTED QUARTERLY FINANCIAL INFORMATION (UNAUDITED)

<TABLE>
<CAPTION>
                                           FIRST       SECOND      THIRD       FOURTH
                                          QUARTER     QUARTER     QUARTER     QUARTER
                                          --------    --------    --------    --------
                                            (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S>                                       <C>         <C>         <C>         <C>
2000
Net revenue.............................  $130,150    $143,406    $140,381    $189,077
(Loss) before interest and taxes........   (10,359)    (11,347)    (12,402)    (36,444)
Net (loss)..............................   (13,448)    (13,686)    (14,799)    (38,867)
Preferred stock dividends...............        87          --       1,146       2,782
Net (loss) applicable to common
  shareholders..........................  $(13,535)   $(13,686)   $(15,945)   $(41,649)
                                          ========    ========    ========    ========
Net (loss) per share -- basic and
  diluted...............................  $   (.06)   $   (.06)   $   (.08)   $   (.20)
                                          ========    ========    ========    ========
1999
Net revenue.............................  $127,714    $131,237    $121,656    $169,245
(Loss) before interest and taxes........    (2,884)     (3,260)       (800)     (1,502)
Net (loss)..............................    (4,224)     (5,794)     (2,688)     (3,608)
Preferred stock dividends...............      (159)       (158)       (159)       (158)
Net (loss) applicable to common
  shareholders..........................  $ (4,383)   $ (5,952)   $ (2,847)   $ (3,766)
                                          ========    ========    ========    ========
Net (loss) per share -- basic and
  diluted...............................  $   (.02)   $   (.03)   $   (.01)   $   (.02)
                                          ========    ========    ========    ========
</TABLE>

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

     None

                                        55
<PAGE>   57

                                                                     SCHEDULE II

                              HANOVER DIRECT, INC.

                       VALUATION AND QUALIFYING ACCOUNTS
                YEARS ENDED DECEMBER 30, 2000, DECEMBER 25, 1999
                             AND DECEMBER 26, 1998
                           (IN THOUSANDS OF DOLLARS)

<TABLE>
<CAPTION>
            COLUMN A               COLUMN B             COLUMN C              COLUMN D       COLUMN E
            --------               --------             --------             ----------     ----------
                                                        ADDITIONS
                                               ---------------------------
                                  BALANCE AT   CHARGED TO     CHARGED TO                    BALANCE AT
                                  BEGINNING    COSTS AND    OTHER ACCOUNTS   DEDUCTIONS       END OF
DESCRIPTION                       OF PERIOD     EXPENSES      (DESCRIBE)     (DESCRIBE)       PERIOD
-----------                       ----------   ----------   --------------   ----------     ----------
<S>                               <C>          <C>          <C>              <C>            <C>
2000:
Allowance for Doubtful Accounts
  Receivable, Current              $ 3,912      $ 4,947                       $ 3,191(1)    $    5,668
Reserves for Discontinued
  Operations                           849                                        261(2)           588
Restructuring Reserve                2,299       11,895                         1,172(2)        13,022
Reserves for Sales Returns           4,680        6,101                         7,410(2)         3,371
Deferred Tax Asset Valuation
  Allowance                         97,500                     $26,400(4)                      123,900

1999:
Allowance for Doubtful Accounts
  Receivable, Current                4,035        2,817                         2,940(1)         3,912
Reserves for Discontinued
  Operations                           982                                        133(2)           849
Restructuring Reserve                3,286          607                         1,594(3)         2,299
Reserves for Sales Returns           4,778        9,915                        10,013(2)         4,680
Deferred Tax Asset Valuation
  Allowance                         94,700                       2,800(4)                       97,500

1998:
Allowance for Doubtful Accounts
  Receivable, Current                4,755        3,278                         3,998(1)         4,035
Reserves for Discontinued
  Operations                         1,354                                        372(2)           982
Restructuring Reserve                5,424                                      2,138(2)         3,286
Reserves for Sales Returns           6,043       14,755                        16,020(2)         4,778
Deferred Tax Asset Valuation
  Allowance                         80,100                      14,600(4)                       94,700
</TABLE>

---------------
(1) Accounts written-off.

(2) Utilization of reserves.

(3) Utilization of reserves ($1,131) and reversal of reserves ($463).

(4) Represents the change in the valuation allowance offset by the change in the
    gross tax asset.

                                        56
<PAGE>   58

                                    PART III

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

     (a) Identification of Directors:

     Directors hold office until the next annual meeting or until their
successors have been elected or until their earlier death, resignation,
retirement, disqualification or removal as provided in the Company's Certificate
of Incorporation and Bylaws.

<TABLE>
<CAPTION>
                                                                                       DIRECTOR
NAME                    AGE                TITLE AND OTHER INFORMATION                   SINCE
----                    ---                ---------------------------                -----------
<S>                     <C>    <C>                                                    <C>
Ralph Destino           63     Ralph Destino has been the Chairman Emeritus of           1991
                               Cartier, Inc., a luxury goods business, since
                               January 2000. From 1985 to 1999, Mr. Destino served
                               as Chairman of Cartier, Inc. and from 1974 to 1985
                               he served as President of Cartier (Far East), Ltd.
                               and Cartier, Inc. Cartier, Inc. is a subsidiary of
                               Compagnie Financiere Richemont, A.G., a Swiss
                               public company engaged in the luxury goods and
                               other businesses and an affiliate of Richemont
                               Finance S.A., the holder of approximately 47.9% of
                               the Company's Common Stock and 100% of its
                               Cumulative participating Preferred Stock
                               ("Richemont"). Mr. Destino was elected a director
                               of the Company in October 1991.
Alan Grieve             48     Alan Grieve has been the Company Secretary of             2000
                               Compagnie Financiere Richemont, A.G. and Richemont
                               S.A., affiliates of Richemont, since 1988. Mr.
                               Grieve also serves on the boards of a number of
                               other subsidiaries of Compagnie Financiere
                               Richemont, A.G. Prior to Richemont, Mr. Grieve
                               worked with Price Waterhouse & Co. (now
                               PriceWaterhouseCoopers) and Arthur Young (now Ernst
                               & Young). Mr. Grieve was elected a director of the
                               Company in December 2000.
J. David Hakman         59     J. David Hakman has been the Chief Executive              1991
                               Officer of Hakman Capital Corporation, Burlingame,
                               California, an investment and merchant banking
                               firm, since 1980. Mr. Hakman also serves as a
                               director of Concord Camera Corp., a firm which
                               manufactures and distributes cameras. Mr. Hakman
                               was originally appointed a director of the Company
                               in May 1989 pursuant to a nomination and standstill
                               agreement among the Company and Theodore H.
                               Kruttschnitt, Edmund Manwell, and himself
                               ("Nomination and Standstill Agreement") and was
                               elected a director of the Company in October 1991.
</TABLE>

                                        57
<PAGE>   59

<TABLE>
<CAPTION>
                                                                                       DIRECTOR
NAME                    AGE                TITLE AND OTHER INFORMATION                   SINCE
----                    ---                ---------------------------                -----------
<S>                     <C>    <C>                                                    <C>
June R. Klein           51     June R. Klein has been the Chief Executive Officer        1999
                               of Technology & Marketing Ventures, Inc., a New
                               York-based consultancy to management-funding and
                               distributor businesses, since 1992. From 1989
                               through 1991, Ms. Klein served as a Senior
                               Executive for vertical markets, venture management
                               and subsidiaries at Wang Labs. She was also
                               Managing Director of Global Electronic and
                               Government Products for Chase Bank from 1986 to
                               1989 and Vice President of the Information Business
                               and Global Delivery Services for Citicorp Group
                               from 1983 to 1986. Ms. Klein also served as Manager
                               of Sales, Systems Integration and Development for
                               IBM from 1975 to 1982 and in telecommunications
                               positions for Merrill Lynch from 1970 to 1975. Ms.
                               Klein was elected a director of the Company in May
                               1999.
Kenneth Krushel         48     Kenneth Krushel has been the Executive Vice               1999
                               President of Strategic and Business Development of
                               Blackboard Inc., a provider of e-education software
                               and commerce and access systems, since December
                               2000. From October 1999 to December 2000, Mr.
                               Krushel was the Chairman and Chief Executive
                               Officer of College Enterprises, Inc. From 1996 to
                               1999, Mr. Krushel was the Senior Vice President of
                               Strategic Development for NBC Corp. and from 1994
                               to 1996 was Senior Vice President, Business
                               Development, for King World Productions. Formerly,
                               Mr. Krushel was President and Chief Operating
                               Officer of Think Entertainment and Vice-President
                               of Programming and Marketing for American
                               Cablesystems. Mr. Krushel was elected a director of
                               the Company in May 1999.
Theodore H.             58     Theodore H. Kruttschnitt has been the President and       1991
  Kruttschnitt                 CEO of Limar Realty Group, a real estate investment
                               company, since November 1992. Mr. Kruttschnitt was
                               appointed a director of the Company in May 1989
                               pursuant to the Nomination and Standstill Agreement
                               and was elected a director of the Company in
                               October 1991.
Eloy Michotte           53     Mr. Michotte has been an Executive Director of            2000
                               Richemont S.A., an affiliate of Richemont, since
                               1988. Prior to Richemont, Mr. Michotte held senior
                               management positions with Ford Motor Company,
                               McKinsey & Company and Bankers Trust Company. Mr.
                               Michotte was elected a director of the Company and
                               Chairman of the Board in December 2000.
</TABLE>

                                        58
<PAGE>   60

<TABLE>
<CAPTION>
                                                                                       DIRECTOR
NAME                    AGE                TITLE AND OTHER INFORMATION                   SINCE
----                    ---                ---------------------------                -----------
<S>                     <C>    <C>                                                    <C>
Alan G. Quasha          50     Alan G. Quasha has been President of Quadrant             1991
                               Management, Inc., an investment management company,
                               since 1988. From 1980 to September 1991, he was
                               partner in the New York City law firm of Quasha
                               Wessely & Schneider. Mr. Quasha also serves as a
                               director of NAR Group Limited. In addition, Mr.
                               Quasha served as a director of Richemont S.A., an
                               affiliate of Richemont, until 1999, and was elected
                               to the board of Compagnie Financiere Richemont,
                               A.G., also an affiliate of Richemont, in September
                               2000. Mr. Quasha was elected a director of the
                               Company in October 1991 and served as Chairman of
                               the Board from October 1991 until December 2000.
Thomas C. Shull         49     Thomas C. Shull has been President and Chief              2000
                               Executive Officer and a member of the Board of
                               Directors of the Company since December 5, 2000. In
                               1990, Mr. Shull co-founded Meridian Ventures, a
                               venture management and turnaround firm presently
                               based in Connecticut and has served as chief
                               executive officer since its inception. From 1997 to
                               1999, he served as President and CEO of Barneys New
                               York, a leading luxury retailer, where he led them
                               out of bankruptcy. From 1992 to 1994, Mr. Shull was
                               Executive Vice President of the R.H. Macy Company,
                               Inc., where he was responsible for human resources,
                               information technology, business development,
                               strategic planning and merchandise distribution and
                               led the merger negotiations with Federated
                               Department Stores. Prior to that, he served as a
                               consultant with McKinsey & Company and in the early
                               1980's as a member of the National Security Council
                               Staff in the Reagan White House.
Robert F. Wright        74     Robert F. Wright has been the President of Robert         1991
                               F. Wright Associates, Inc., business consultants,
                               since 1988. Prior thereto, he was a senior partner
                               of the accounting firm Arthur Andersen & Co. Mr.
                               Wright is a director of Reliance Standard Life
                               Insurance Co., a life insurance company, and
                               affiliates, The Navigator Group, Inc., a property
                               insurance company, U.S. Timberlands Company, L.P.,
                               a manager of Western Timberlands, and Quadlogic
                               Controls Corp., a company engaged in the production
                               of electrical metering equipment. Mr. Wright also
                               serves on the board of Deotexis Inc., a company
                               commercializing control release patents, and
                               Universal American Financial Corp., a life
                               insurance holding company. Mr. Wright was elected a
                               director of the Company in October 1991.
</TABLE>

     (b) Identification of Executive Officers:

     Pursuant to the Company's Bylaws, its officers are chosen annually by the
Board of Directors and hold office until their respective successors are chosen
and qualified.

                                        59
<PAGE>   61

<TABLE>
<CAPTION>
                                                                                      OFFICE HELD
NAME                    AGE                TITLE AND OTHER INFORMATION                   SINCE
----                    ---                ---------------------------                -----------
<S>                     <C>    <C>                                                    <C>
Thomas C. Shull         49     President and Chief Executive Officer and a member        2000
                               of the Board of Directors since December 5, 2000.
                               In 1990, Mr. Shull co-founded Meridian Ventures, a
                               venture management and turnaround firm presently
                               based in Connecticut and has served as chief
                               executive officer since its inception. From 1997 to
                               1999, he served as President and CEO of Barneys New
                               York, a leading luxury retailer, where he led them
                               out of bankruptcy. From 1992 to 1994, Mr. Shull was
                               Executive Vice President of the R.H. Macy Company,
                               Inc., where he was responsible for human resources,
                               information technology, business development,
                               strategic planning and merchandise distribution and
                               led the merger negotiations with Federated
                               Department Stores. Prior to that, he served as a
                               consultant with McKinsey & Company and in the early
                               1980s as a member of the National Security Council
                               Staff in the Reagan White House.
Michael Lutz            57     Executive Vice President-Chief Operating Officer          1998
                               since March 1998. From September 1994 to March
                               1998, Mr. Lutz was Executive Vice
                               President -- Operations of the Company. Prior to
                               September 1994, Mr. Lutz held various positions
                               with New Hampton, Inc./Avon Direct Response.
Brian C. Harriss        51     Senior Vice President and Chief Financial Officer         1999
                               since June 1999. From 1998 to 1999, Mr. Harriss was
                               a Managing Director of Dailey Capital Management,
                               LP, a venture capital fund, and Chief Operating
                               Officer of E-Bidding Inc., an Internet e-commerce
                               freight Website. From 1997 to 1998, Mr. Harriss
                               served as the Vice President of Corporate
                               Development at the Reader's Digest Association,
                               Inc. From 1994 to 1996, Mr. Harriss was the Chief
                               Financial Officer of the Thompson Minwax Company.
                               Prior thereto, Mr. Harriss held various financial
                               positions with Cadbury Schweppes PLC, Tambrands,
                               Inc. and Pepsico, Inc.
Michael D. Contino      40     Senior Vice President and Chief Information Officer       1996
                               since December 1996 and President of Keystone
                               Internet Services, Inc. since November 2000. Mr.
                               Contino joined the Company in 1995 as Director of
                               Computer Operations and Telecommunications. Prior
                               to 1995, Mr. Contino was the Senior Manager of IS
                               Operations at New Hampton, Inc., a subsidiary of
                               Spiegel, Inc.
William C. Kingsford    53     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.
Frank J. Lengers        44     Vice President, Treasurer since October 2000. Mr.         2000
                               Lengers joined the Company in November 1988 as an
                               Internal Audit Manager. From 1990 to 1994, Mr.
                               Lengers served as Manager of Corporate Treasury
                               Operations. In 1994, he was promoted to Director of
                               Treasury Operations and in 1997 to Assistant
                               Treasurer, a position he held until October 2000.
                               Prior to joining the Company. Mr. Lengers held
                               various audit positions with R.H. Macy & Co. and
                               The Metropolitan Museum of Art.
</TABLE>

                                        60
<PAGE>   62

<TABLE>
<CAPTION>
                                                                                      OFFICE HELD
NAME                    AGE                TITLE AND OTHER INFORMATION                   SINCE
----                    ---                ---------------------------                -----------
<S>                     <C>    <C>                                                    <C>
Steven Lipner           52     Vice President -- Taxation since October 2000. Mr.        2000
                               Lipner served as Director of Taxes from February
                               1984 to October 2000. Prior thereto, he served as
                               Director of Taxes at Avnet, Inc. and held various
                               positions in public accounting. He holds a license
                               as a Certified Public Accountant in New York.
</TABLE>

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.

                                        61
<PAGE>   63

                                    PART IV

ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

     (a) The following documents are filed as part of this report:

<TABLE>
<CAPTION>
                                                                           PAGE
                                                                           NO.
                                                                           ----
        <C>  <S>                                                           <C>
         1.  Index to Financial Statements
             Report of Independent Public Accountants -- Hanover Direct,
             Inc. and Subsidiaries Financial Statements..................    25
             Consolidated Balance Sheets as of December 30, 2000 and
             December 25, 1999...........................................    26
             Consolidated Statements of Income (Loss) for the years ended
             December 30, 2000, December 25, 1999 and December 26,
             1998........................................................    27
             Consolidated Statements of Cash Flows for the years ended
             December 30, 2000, December 25, 1999 and December 26,
             1998........................................................    28
             Consolidated Statements of Shareholders' Equity (Deficit)
             for the years ended December 30, 2000, December 25, 1999 and
             December 26, 1998...........................................    29
             Notes to Consolidated Financial Statements for the years
             ended December 30, 2000, December 25, 1999 and December 26,
             1998........................................................    30
             Supplementary Data:
             Selected quarterly financial information (unaudited) for the
             two fiscal years ended December 30, 2000 and December 25,
             1999........................................................    55
         2.  Index to Financial Statement Schedule
             Schedule II -- Valuation and Qualifying Accounts for the
             years ended December 30, 2000, December 25, 1999 and
             December 26, 1998...........................................    56
             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 found after the
             Signature page.
</TABLE>

     (b) Reports on Form 8-K:

        1.1 Form 8-K, filed January 19, 2001 -- reporting pursuant to Item 5 of
            such Form termination, effective as of December 30, 2000, of the
            Intercompany Services Agreement effective as of the 27th day of
            December, 1998 by and between erizon, Inc., a Delaware corporation
            which is a subsidiary of the registrant, and Hanover Brands, Inc., a
            Delaware corporation which is a subsidiary of the registrant.

        1.2 Form 8-K, filed January 5, 2001 -- reporting pursuant to Item 5 of
            such Form Hanover Direct, Inc.'s plans for a major restructuring
            program.

        1.3 Form 8-K, filed December 5, 2000 -- reporting pursuant to Item 5 of
            such Form (i) the election of Thomas C. Shull as President, Chief
            Executive Officer and a member of the Board of Directors of Hanover
            Direct, Inc. replacing Rakesh K. Kaul who resigned effective the
            date of filing; (ii) the resignation of Jan P. du Plessis from the
            Board of Directors; (iii) the subsequent election of Eloy Michotte
            and Alan Grieve on December 5, 2000 to the Board of Directors of
            Hanover Direct, Inc.; (iv) a reduction in the size of the Board of
            Directors to 10 members; and (v) Mr. Michotte's election to the
            position of Chairman of the Board succeeding Alan G. Quasha who
            remained as a member of the Board of Directors of Hanover Direct,
            Inc.

                                        62
<PAGE>   64

        1.4 Form 8-K, filed November 3, 2000 -- reporting pursuant to Item 5 of
            such Form information concerning its quarterly conference call with
            management to review the third quarter 2000 results.

        1.5 Form 8-K, filed on October 19, 2000 -- reporting pursuant to Item 5
            of such Form the resignation of: (i) Basil P. Regan as a member of
            the Board of Directors as of October 3, 2000; (ii) Shailesh J. Mehta
            as a member of the Board of Directors as of October 5, 2000; and
            (iii) Howard M.S. Tanner as a member of the Board of Directors as of
            October 16, 2000.

        1.6 Form 8-K, filed on March 28, 2001 -- reporting pursuant to Item 5 of
            such Form information concerning its annual conference call with
            management to review the fiscal year 2000 operating results and
            ongoing strategic restructuring initiatives.

     (c) Exhibits:

         See the accompanying Exhibit Index following the Signature page.

     (d) Financial Statement Schedules:

         See (a) 2. above.

                                        63
<PAGE>   65

                                   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.

Date:  March 30, 2001                     HANOVER DIRECT, INC.
                                          (Registrant)

                                          By:      /s/ THOMAS C. SHULL
                                            ------------------------------------
                                                      Thomas C. Shull,
                                               President and Chief Executive
                                            Officer (On behalf of the registrant
                                            and as principal 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 Officers:

<TABLE>
<S>                                                         <C>
                /s/ BRIAN C. HARRISS
-----------------------------------------------------
                  Brian C. Harriss,
              Senior Vice President and
               Chief Financial Officer
            (principal financial officer)

              /s/ WILLIAM C. KINGSFORD
-----------------------------------------------------
                William C. Kingsford,
                 Vice President and
                Corporate Controller
           (principal accounting officer)
</TABLE>

Board of Directors:

<TABLE>
<S>                                                         <C>
                                                                             /s/ KENNETH KRUSHEL
-----------------------------------------------------       -----------------------------------------------------
                 Ralph Destino, Director                                  Kenneth Krushel, Director
                   /s/ ALAN GRIEVE                                            /s/ ELOY MICHOTTE
-----------------------------------------------------       -----------------------------------------------------
                   Alan Grieve, Director                                   Eloy Michotte, Director
                 /s/ J. DAVID HAKMAN                                         /s/ ALAN G. QUASHA
-----------------------------------------------------       -----------------------------------------------------
                 J. David Hakman, Director                                Alan G. Quasha, Director
                  /s/ JUNE R. KLEIN                                          /s/ THOMAS C. SHULL
-----------------------------------------------------       -----------------------------------------------------
                  June R. Klein, Director                                 Thomas C. Shull, Director
                                                                            /s/ ROBERT F. WRIGHT
-----------------------------------------------------       -----------------------------------------------------
           Theodore H. Kruttschnitt, Director                            Robert F. Wright, Director
</TABLE>

Date:  March 30, 2001

                                        64
<PAGE>   66

                                 EXHIBIT INDEX

<TABLE>
<CAPTION>
EXHIBIT NUMBER
 ITEM 601 OF                                                                               PAGE
REGULATION S-K  DESCRIPTION OF DOCUMENT AND INCORPORATION BY REFERENCE WHERE APPLICABLE    NO.
--------------  -----------------------------------------------------------------------    ----
<C>             <S>                                                                        <C>
     2.1        Asset Sale Agreement, dated as of August 19, 1999 between the Company,
                AHI and TAC and Euclid Logistics, Inc. Incorporated by reference to the
                Company's Annual Report on Form 10-K for the year ended December 25,
                1999.
     2.2        Letter agreement, dated December 21, 1999, between the Company and FAR
                Services, LLC. Incorporated by reference to the Company's Annual Report
                on Form 10-K for the year ended December 25, 1999.
     2.3        The Shopper's Edge, LLC Purchase Agreement, dated as of December 25,
                1999, between Hanover Brands, Inc. and Far Services, LLC. Incorporated
                by reference to the Company's Annual Report on Form 10-K for the year
                ended December 25, 1999.
     3.1        Restated Certificate of Incorporation. Incorporated by reference to the
                Company's Annual Report on Form 10-K for the year ended December 28,
                1996.
     3.2        Certificate of Correction filed to correct a certain error in the
                Restated Certificate of Incorporation. Incorporated by reference to the
                Company's Annual Report on Form 10-K for the year ended December 26,
                1998.
     3.3        Certificate of Amendment to Certificate of Incorporation dated May 28,
                1999. Incorporated by reference to the Company's Annual Report on Form
                10-K for the year ended December 25, 1999.
     3.4        Certificate of Correction Filed to Correct a Certain Error in the
                Restated Certificate of Incorporation dated August 26, 1999.
                Incorporated by reference to the Company's Annual Report on Form 10-K
                for the year ended December 25, 1999. Certificate of Designations,
                Powers, Preferences and Rights of Series A Cumulative Participating
                Preferred Stock. Incorporated by reference to the Company's Current
                Report on Form 8-K filed August 30, 2000.
     3.5        Certificate of Designations, Powers, Preferences and Rights of Series A
                Cumulative Participating Preferred Stock. Incorporated by reference to
                the Company's Current Report on Form 8-K filed August 30, 2000.
     3.6        By-laws. Incorporated by reference to the Company's Quarterly Report on
                Form 10-Q for the quarterly period ended September 27, 1997.
     4.1        Warrant Agreement dated as of October 25, 1991 ("NAR Warrant") between
                the Company* and NAR Group Limited ("NAR") for 279,110 shares of Common
                Stock. Incorporated by reference to the Company's* Current Report on
                Form 8-K dated October 25, 1991.
     4.2        Registration Rights Agreement dated as of July 8, 1991 among the
                Company*, NAR and Intercontinental Mining & Resources Limited ("IMR").
                Incorporated by reference to the Company's* Current Report on Form 8-K
                Dated July 10, 1991.
     4.3        Warrant Agreement dated as of January 1, 1994 between the Company and
                Sears Shop At Home Services, Inc. ("Sears"). Incorporated by reference
                to the Company's Annual Report on Form 10-K for the year ended December
                31, 1994.
     4.4        Registration Rights Agreement dated as of February 16, 1995 among the
                Company and the Aegis Sellers. Incorporated by reference to the
                Company's Annual Report on Form 10-K for the year ended December 31,
                1994.
     4.5        Warrant Agreement dated as of July 8, 1991 between the Company and IMR
                for 1,750,000 shares of Common Stock. Incorporated by reference to the
                Company's Current Report on Form 8-K dated July 10, 1991.
     4.6        Warrant Agreement dated as of October 25, 1991 between the Company and
                NAR for 931,791 shares of Common Stock. Incorporated by reference to
                the Company's Current Report on Form 8-K dated October 25, 1991.
</TABLE>

                                        65
<PAGE>   67

<TABLE>
<CAPTION>
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REGULATION S-K  DESCRIPTION OF DOCUMENT AND INCORPORATION BY REFERENCE WHERE APPLICABLE    NO.
--------------  -----------------------------------------------------------------------    ----
<C>             <S>                                                                        <C>
     4.7        Second Amendment to Warrant Agreement and Warrant Certificate for
                931,791 shares of Common Stock, between the Company and NAR dated as of
                November 13, 1995. Incorporated by reference to the Company's Annual
                Report on Form 10-K for the year ended December 30, 1995.
     4.8        First Amendment to Warrant Agreement and Warrant Certificate for
                1,750,000 shares of Common Stock, between the Company and IMR dated as
                of November 13, 1995. Incorporated by reference to the Company's Annual
                Report on Form 10-K for the year ended December 30, 1995.
     4.9        First Amendment to Warrant Agreement and Warrant Certificate for
                279,110 shares of Common Stock, between the Company and NAR dated as of
                November 13, 1995. Incorporated by reference to the Company's Annual
                Report on Form 10-K for the year ended December 30, 1995.
     4.10       Second Amendment to Warrant Agreement between the Company and IMR dated
                as of August 23, 1996. Incorporated by reference to the Company's
                Annual Report on Form 10-K for the year ended December 28, 1996.
     4.11       Second Amendment to Warrant Agreement between the Company and NAR dated
                as of August 23, 1996. Incorporated by reference to the Company's
                Annual Report on Form 10-K for the year ended December 28, 1996.
     4.12       Third Amendment to Warrant Agreement between the Company and NAR dated
                as of August 23, 1996. Incorporated by reference to the Company's
                Annual Report on Form 10-K for the year ended December 28, 1996.
     4.13       Registration Rights Agreement between the Company and Richemont dated
                as of August 23, 2000. Incorporated by reference to the Company's
                Current Report on Form 8-K filed August 30, 2000.
     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       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.
     10.3       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.
     10.4       Registration Rights Agreement between the Company and Rakesh K. Kaul,
                dated as of August 23, 1996. Incorporated by reference to the Company's
                Annual Report on Form 10-K for the year ended December 28, 1996.
     10.5       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.
     10.6       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.
     10.7       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.
     10.8       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.
     10.9       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.
    10.10       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.
</TABLE>

                                        66
<PAGE>   68

<TABLE>
<CAPTION>
EXHIBIT NUMBER
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REGULATION S-K  DESCRIPTION OF DOCUMENT AND INCORPORATION BY REFERENCE WHERE APPLICABLE    NO.
--------------  -----------------------------------------------------------------------    ----
<C>             <S>                                                                        <C>
    10.11       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.
    10.12       1996 Stock Option Plan, as amended. Incorporated by reference to the
                Company's 1997 Proxy Statement.
    10.13       Stock Option Agreement dated as of February 9, 1996 between the Company
                and Ralph Destino. Incorporated by reference to the Company's Annual
                Report on Form 10-K for the year ended December 25, 1999.
    10.14       Stock Option Agreement dated as of February 9, 1996 between the Company
                and Elizabeth Valk Long. Incorporated by reference to the Company's
                Annual Report on Form 10-K for the year ended December 25, 1999.
    10.15       Stock Option Agreement dated as of February 9, 1996 between the Company
                and Robert F. Wright. Incorporated by reference to the Company's Annual
                Report on Form 10-K for the year ended December 25, 1999.
    10.16       1999 Stock Option Plan for Directors. Incorporated by reference to the
                Company's Annual Report on Form 10-K for the year ended December 25,
                1999.
    10.17       2000 Management Stock Option Plan. Incorporated by reference to the
                Company's Annual Report on Form 10-K for the year ended December 25,
                1999.
    10.18       Loan and Security Agreement dated as of November 14, 1995 by and among
                Congress Financial Corporation ("Congress"), HDPA, Brawn, Gump's by
                Mail, Gump's, The Company Store, Inc. ("The Company Store") , Tweeds,
                Inc. ("Tweeds"), LWI Holdings, Inc. ("LWI"), Aegis Catalog Corporation
                ("Aegis"), Hanover Direct Virginia, Inc. ("HDVA") and Hanover Realty
                Inc. ("Hanover Realty"). Incorporated by reference to the Company's
                Annual Report on Form 10-K for the year ended December 30, 1995.
    10.19       First Amendment to Loan and Security Agreement dated as of February 22,
                1996 by and among Congress, HDPA, Brawn, Gump's by Mail, Gump's, The
                Company Store, Tweeds, LWI, Aegis, HDVA, Hanover Realty and TAC.
                Incorporated by reference to the Company's Annual Report on Form 10-K
                for the year ended December 28, 1996.
    10.20       Second Amendment to Loan and Security Agreement dated as of April 16,
                1996 by and among Congress, HDPA, Brawn, Gump's by Mail, Gump's, The
                Company Store, Tweeds, LWI, Aegis, HDVA, Hanover Realty and TAC.
                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 TAC. 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 TAC.
                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 TAC.
                Incorporated by reference to the Company's Annual Report on Form 10-K
                for the year ended December 28, 1996.
</TABLE>

                                        67
<PAGE>   69

<TABLE>
<CAPTION>
EXHIBIT NUMBER
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REGULATION S-K  DESCRIPTION OF DOCUMENT AND INCORPORATION BY REFERENCE WHERE APPLICABLE    NO.
--------------  -----------------------------------------------------------------------    ----
<C>             <S>                                                                        <C>
    10.24       Sixth Amendment to Loan and Security Agreement dated as of December 5,
                1996 by and among Congress, HDPA, Brawn, Gump's by Mail, Gump's, The
                Company Store, Tweeds, LWI, Aegis, HDVA, Hanover Realty and TAC.
                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 TAC.
                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 TAC.
                Incorporated by reference to the Company's Annual Report on Form 10-K
                for the year ended December 26, 1998.
    10.27       Ninth Amendment to Loan and Security Agreement dated as of April 18,
                1997 by and among Congress, HDPA, Brawn, Gump's by Mail, Gump's, The
                Company Store, Tweeds, LWI, Aegis, HDVA, Hanover Realty and TAC.
                Incorporated by reference to the Company's Annual Report on Form 10-K
                for the year ended December 26, 1998.
    10.28       Tenth Amendment to Loan and Security Agreement dated as of October 31,
                1997 by and among Congress, HDPA, Brawn, Gump's by Mail, Gump's, The
                Company Store, Tweeds, LWI, Aegis, HDVA, Hanover Realty and TAC.
                Incorporated by reference to the Company's Annual Report on Form 10-K
                for the year ended December 26, 1998.
    10.29       Eleventh Amendment to Loan and Security Agreement dated as of 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 TAC.
                Incorporated by reference to the Company's Annual Report on Form 10-K
                for the year ended December 26, 1998.
    10.30       Twelfth Amendment to Loan and Security Agreement dated as of September
                30, 1998 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 25, 1999.
    10.31       Thirteenth Amendment to Loan and Security Agreement dated as of
                September 30, 1998 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 25, 1999.
    10.32       Fourteenth Amendment to Loan and Security Agreement dated as of
                February 28, 2000 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 25, 1999.
    10.33       Fifteenth Amendment to Loan and Security Agreement dated as of March
                24, 2000 by and among Congress, HDPA, Brawn, Gump's by Mail, Gump's,
                LWI, HDVA, Hanover Realty, The Company Store Factory, Inc., The Company
                Office, Inc., Keystone Internet Services, Inc., Tweeds, LLC,
                Silhouettes, LLC, Hanover Company Store, LLC and Domestications, LLC.
                Incorporated by reference to the Company's Quarterly Report of Form
                10-Q for the quarterly period ended March 25, 2000.
</TABLE>

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<TABLE>
<CAPTION>
EXHIBIT NUMBER
 ITEM 601 OF                                                                               PAGE
REGULATION S-K  DESCRIPTION OF DOCUMENT AND INCORPORATION BY REFERENCE WHERE APPLICABLE    NO.
--------------  -----------------------------------------------------------------------    ----
<C>             <S>                                                                        <C>
    10.34       Sixteenth Amendment to Loan and Security Agreement dated as of August
                8, 2000 by and among Congress, HDPA, Brawn, Gump's by Mail, Gump's,
                LWI, HDVA, Hanover Realty, The Company Store Factory, Inc., The Company
                Office, Inc., Keystone Internet Services, Inc., Tweeds, LLC,
                Silhouettes, LLC, Hanover Company Store, LLC and Domestications, LLC.
                Incorporated by reference to the Company's Quarterly Report of Form
                10-Q for the quarterly period ended June 24, 2000.
    10.35       Seventeenth Amendment to Loan and Security Agreement dated as of            71
                January 5, 2001 by and among Congress, HDPA, Brawn, Gump's by Mail,
                Gump's, LWI, HDVA, Hanover Realty, The Company Store Factory, Inc., The
                Company Office, Inc., Keystone Internet Services, Inc., Tweeds, LLC,
                Silhouettes, LLC, Hanover Company Store, LLC and Domestications, LLC.
                FILED HEREWITH.
    10.36       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.
    10.37       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.
    10.38       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.
    10.39       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.
    10.40       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.
    10.41       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.
    10.42       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.
    10.43       Eight-Year Stock Option dated as of August 23, 1996 between NAR and
                Rakesh K. Kaul. Incorporated by reference to the Company's Annual
                Report on Form 10-K for the year ended December 28, 1996.
    10.44       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.
    10.45       Stock Purchase Agreement, dated as of November 4, 1997, by and between
                the Company and SMALLCAP World Fund, Inc. ("SMALLCAP"). Incorporated by
                reference to the Company's Annual Report on Form 10-K for the year
                ended December 26, 1998.
    10.46       Registration Rights Agreement, dated as of November 4, 1997, by and
                between the Company and SMALLCAP. Incorporated by reference to the
                Company's Annual Report on Form 10-K for the year ended December 26,
                1998.
    10.47       Account Purchase and Credit Card Marketing and Services Agreement,
                dated as of March 9, 1999, between the Company and Capital One
                Services, Inc. and Capital One Bank. Incorporated by reference to the
                Company's Annual Report on Form 10-K for the year ended December 25,
                1999.
    10.48       Employment Agreement dated as of March 6, 2000 between the Company and
                Rakesh K. Kaul. Incorporated by reference to the Company's Quarterly
                Report of Form 10-Q for the quarterly period ended March 25, 2000.
</TABLE>

                                        69
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<TABLE>
<CAPTION>
EXHIBIT NUMBER
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--------------  -----------------------------------------------------------------------    ----
<C>             <S>                                                                        <C>
    10.49       Credit Agreement, dated as of March 24, 2000, by and among the Company,
                HDPA, Brawn, Gump's By Mail, Gump's, LWI, HDVA, Keystone Internet
                Services, Inc., Tweeds, LLC, Silhouettes, LLC, Hanover Company Store,
                LLC, Domestications, LLC and Richemont. Incorporated by reference to
                the Company's Quarterly Report of Form 10-Q for the quarterly period
                ended March 25, 2000.
    10.50       Subordination Agreement dated as of March 24, 2000, between Congress
                and Richemont. Incorporated by reference to the Company's Quarterly
                Report of Form 10-Q for the quarterly period ended March 25, 2000.
    10.51       Letter Agreement, dated as of March 24, 2000, between Richemont and
                Congress. Incorporated by reference to the Company's Quarterly Report
                of Form 10-Q for the quarterly period ended March 25, 2000.
    10.52       Amended and Restated Stock Option Agreement dated as of April 14, 2000
                between the Company and Rakesh K. Kaul. Incorporated by reference to
                the Company's Quarterly Report of Form 10-Q for the quarterly period
                ended March 25, 2000.
    10.53       Stock Option Agreement dated as of April 14, 2000 between erizon, Inc.
                and Rakesh K. Kaul. Incorporated by reference to the Company's
                Quarterly Report of Form 10-Q for the quarterly period ended March 25,
                2000.
    10.54       Hanover Direct, Inc. Key Executive Thirty-Six Month Compensation
                Continuation Plan. Incorporated by reference to the Company's Quarterly
                Report of Form 10-Q for the quarterly period ended March 25, 2000.
    10.55       Hanover Direct, Inc. Key Executive Twenty-Four Month Compensation
                Continuation Plan. Incorporated by reference to the Company's Quarterly
                Report of Form 10-Q for the quarterly period ended March 25, 2000.
    10.56       Intercompany Services Agreement by and between erizon, Inc. and Hanover
                Brands, Inc. Incorporated by reference to the Company's Quarterly
                Report of Form 10-Q for the quarterly period ended June 24, 2000.
    10.57       Amendment No. 1 to Intercompany Services Agreement by and between
                Hanover Brands, Inc. and erizon, Inc. effective as of December 27,
                2000. Incorporated by reference to the Company's Current Report on Form
                8-K filed January 19, 2001.
    10.58       Commitment Letter dated August 7, 2000 between the Company and
                Richemont. Incorporated by reference to the Company's Current Report on
                Form 8-K filed August 10, 2000.
    10.59       Securities Purchase Agreement between the Company and Richemont dated
                as of August 23, 2000. Incorporated by reference to the Company's
                Current Report on Form 8-K filed August 30, 2000.
    10.60       Services Agreement dated as of December 5, 2000 among Meriden Ventures      82
                LLC, Thomas C. Shull and the Company. FILED HEREWITH.
     21.1       Subsidiaries of the Registrant. FILED HEREWITH.                             92
     23.1       Consent of Independent Public Accountants. FILED HEREWITH.                  93
</TABLE>

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

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