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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 28, 1996

                         Commission file number 1-12082

                              HANOVER DIRECT, INC.
             (Exact name of registrant as specified in its charter)

        DELAWARE                                       13-0853260
(State of incorporation)                    (I.R.S. Employer Identification No.)

1500 HARBOR BOULEVARD, WEEHAWKEN, NEW JERSEY               07087
  (Address of principal executive offices)               (Zip Code)

Registrant's telephone number, including area code: (201) 863-7300

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

                                                             Name of each
                                                               exchange
       Title of each class                                 which registered

Common Stock, $.66 2/3 Par Value                        American Stock Exchange

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.
                             ---

As of March 24, 1997, the aggregate market value of the voting stock held by
non-affiliates of the registrant was $38,280,286 (based on the closing price of
the Common Stock on the American Stock Exchange on March 24, 1997).

As of March 24, 1997, the registrant had 144,318,452 shares of Common Stock
outstanding.


                       DOCUMENTS INCORPORATED BY REFERENCE

The Company's definitive proxy statement to be filed by the Company pursuant to
Regulation 14A is incorporated into items 10, 11, 12 and 13 of Part III of this
Form 10-K.
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                                    P A R T I

ITEM 1. BUSINESS

GENERAL

         Hanover Direct, Inc. (the "Company") is a leading direct specialty
retailer that markets, via a portfolio of branded specialty catalogs, home
fashions, general merchandise, men's and women's apparel and gifts. In December
1996, the Company regrouped its catalog titles so that all significant
decisions, including those regarding market positioning and strategy,
merchandising, circulation levels, catalog design, inventory management and cash
management, are made by six newly-created strategic business units -- Home
Fashions- Mid-Market, Home Fashions-Upscale, General Merchandise, Women's
Apparel, Men's Apparel and Gifts -- consisting of one or more catalog
operations. All of these business units will continue to utilize the Company's
central purchasing, telemarketing, fulfillment, distribution and administrative
functions.

         The Company's home fashions-mid-market strategic business unit includes
Domestications(R), a leading specialty home textile catalog. The home
fashions-upscale group includes The Company Store(R), an upscale direct marketer
of down comforters and other down and related products for the home, and Kitchen
& Home(R), an upscale kitchen and home product catalog. The general merchandise
group includes Improvements(R), a do-it-yourself home improvements catalog, The
Safety Zone(R), a direct marketer of safety, prevention and protection products,
and Colonial Garden Kitchens(R), featuring work saving and lifestyle enhancing
items for the kitchen and home. The women's apparel group includes
Silhouettes(R), featuring everyday, workout, special occasion and career
fashions for larger sized women, and Tweeds(R), the European inspired women's
fashion catalog. The men's apparel group includes International Male(R),
offering unique men's fashions with an international flair, Austad's(R), a
direct marketer of golf equipment, apparel and accessories (the remaining
interest which the Company did not own was acquired in February 1996 in an asset
exchange), and Undergear(R), a leader in activewear, workout wear and fashion
underwear for men. The gifts group includes Gump's By Mail(R), a leading upscale
catalog of luxury gifts, and Gump's, a leading retail store based in San
Francisco.

         The Company reviews its portfolio of catalogs as well as new
opportunities to acquire or develop catalogs from time to time. In 1995, the
Company discontinued six catalogs, One 212(R), Simply Tops(R), Essence By
Mail(R), Hanover House(R), Mature Wisdom(R), and Tapestry(R). No catalogs were
discontinued during the 1996 fiscal year. The Company is developing a new
version of the Hanover House(R) catalog which will be test mailed in the second
quarter of 1997.

         During 1996, the Company mailed approximately 332.0 million catalogs.
The Company maintains a proprietary customer list currently containing
approximately 14 million names of customers (down from 18 million names in 1995
and 19 million names in 1994)

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who have made purchases from at least one of the Company's catalogs within the
past 36 months. Over 6 million of the names on the list represent customers who
have made purchases from at least one of the Company's catalogs within the last
12 months (down from approximately 7 million names in each of 1995 and 1994).

         During 1996, the Company, in connection with its venture with Sears,
Roebuck and Co. ("Sears"), mailed several versions of its catalogs to the more
than 20 million mail order and credit card customers of Sears. Sears exercised
its right to terminate the venture in December 1996, but the Company and Sears
each retain the right to mail catalogs to customers of the venture.

         In December 1996, the Company announced a plan to reduce its annual
operating costs on continuing catalogs by approximately $50 million starting
January 1, 1997. Under the plan, the Company's fixed overhead would be reduced
by approximately $16 million, its marketing expenditures would be reduced by
approximately $21 million and other operating costs would be reduced by
approximately $13 million. The fixed overhead reductions would result primarily
from the shutdown of excess telemarketing capacity in the Company's Roanoke,
Virginia facility. The Company also announced a reduction in permanent positions
of approximately 550. The marketing expenditures reduction is primarily driven
by elimination of unprofitable circulation and improved customer retention and
target segmentation, but does not contemplate the discontinuance of any of the
current core catalogs. Because of lower prepaid catalog costs and inventory
purchases, working capital requirements are anticipated to be reduced by
approximately $16 million. In December 1996, the Company formulated a plan to
further reduce costs by consolidating its apparel distribution facility in
Roanoke, Virginia and its warehouse operations in Hanover, Pennsylvania with and
into its home fashions distribution center in Roanoke, Virginia.

         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. NAR Group Limited, a British Virgin Islands
corporation (together with its affiliates, "NAR"), owns approximately 55.7% of
the Company's common stock on a fully diluted basis. NAR, a private investment
holding company, is a joint venture between the family of Alan G. Quasha, a
Director and the Chairman of the Board of the Company, and Compagnie Financiere
Richemont, A.G., a Swiss public company engaged in luxury goods, tobacco and
other business ("Richemont"). 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.

1997 RIGHTS OFFERING

         On March 26, 1997, the Company announced that it entered into a Standby
Purchase Agreement with an affiliate of Richemont under which such affiliate
agreed to purchase all unsubscribed shares pursuant to a $50 million Rights
Offering to be conducted by the

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Company as soon as practicable following regulatory clearance. In connection
with such offering, NAR has agreed to apply $10 million of the Company's
indebtedness held by it to acquire $10 million of the Company's Common Stock
pursuant to such Rights Offering. NAR has not indicated whether it will exercise
Rights to be distributed to it to acquire additional shares. See "Financing --
Future Financing."

The Company's Catalogs

         Each of the Company's specialty catalogs targets distinct market
segments offering a focused assortment of merchandise designed to meet the needs
and preferences of its target customers. Through market research and ongoing
testing of new products and concepts, each strategic business unit determines
each catalog's own merchandise strategy, including the appropriate price points,
mailing plans and presentation of its products. The Company is continuing its
development of exclusive or private label products for a number of its catalogs,
including Domestications, Tweeds, Austad's and The Company Store, to further
enhance the brand identity of the catalogs.

         The Company's specialty catalogs typically range in size from 32 to 96
pages with four to twelve new editions per year depending on the seasonality and
fashion content of the products offered. Each edition may be mailed several
times each season with variations in format and content. Each catalog employs
the services of an outside creative agency or has its own creative staff which
is responsible for the design, layout, copy, feel and theme of the book.
Generally, the initial sourcing of new merchandise for a catalog begins two to
six months before the catalog is mailed.

         In December 1996, the Company's operations were divided into six
strategic business units -- Home Fashions-Mid-Market, Home Fashions-Upscale,
General Merchandise, Women's Apparel, Men's Apparel and Gifts -- so that all
significant decisions, including those regarding market positioning and
strategy, merchandising, circulation levels, catalog design, inventory
management and cash management, could be made by the newly-created units in
order to create efficiency and bottom-line accountability. Revenues and the
percent of total revenues for 1996 and 1995 for each business unit are set forth
below; all revenues are net of returns:


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<TABLE>
<CAPTION>
                                        1996                            1995
                           1996      Percent of          1995        Percent of
                         Revenues   Total Revenues     Revenues    Total Revenues
                         --------   --------------     --------    --------------
                                            (in thousands)
<S>                      <C>        <C>                <C>         <C>
Home Fashions -
  Mid-Market              $202.2        28.9%            $223.7        29.8%
  Upscale                   97.2        13.9               81.8        10.9
General Merchandise         79.3        11.3               73.5         9.8
Women's Apparel             82.7        11.8               76.7        10.2
Men's Apparel               78.4        11.2               77.9        10.4
Gifts                       57.7         8.2               50.7         6.8
                          ------       -----             ------       -----
Total Continuing           597.5        85.3              584.3        77.9
Discontinued               102.8        14.7              165.5        22.1
                          ------       -----             ------       -----
Total Company             $700.3       100.0%            $749.8       100.0%
                          ======       =====             ======       =====
</TABLE>

         As a result of the Company's plan to reduce annual operating costs,
revenues from continuing catalogs are expected to stay flat in 1997. Total
revenues are expected to decline by 14% in 1997, primarily due to the loss of
revenues from catalogs discontinued in fiscal 1995 and 1996.

         The following is a description of the Company's core catalogs in each
of the Company's six strategic business units:

         Home Fashions - Mid-Market

         Domestications is a leading specialty home textile catalog and a
fashion decorating source book for today's value-oriented and style-conscious
consumer. Domestications features sheets, towels, comforters, tablecloths,
draperies and other items for the home, and offers coordinated decorating ideas
for the home at value prices. During 1996, Domestications was also mailed to
Sears customers under the name Show Place.

         Home Fashions-Upscale

         The Company Store is an upscale direct marketer of down comforters and
other down and related products for the home. The Company Store also features
designer brand name sheets, towels and other bedding accessories.

         Kitchen & Home features upscale kitchen and home products.


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         General Merchandise

         Improvements is a leading do-it-yourself home improvement catalog
featuring home improvement accessories. During 1996, Improvements was also
mailed to Sears customers under the name Sears Improvements.

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

         Colonial Garden Kitchens features work saving and lifestyle enhancing
items for the kitchen and home. During 1996, Colonial Garden Kitchens was also
mailed to Sears customers under the name Great Kitchens.

         The Company is developing a new version of the Hanover House(R) catalog
which will be test mailed in the second quarter of 1997.

         Women's Apparel

         Silhouettes is a women's fashion catalog featuring everyday, workout,
special occasion and career fashions for larger sized women.

         Tweeds is a European inspired women's fashion catalog featuring
relaxed, cosmopolitan fashions uniquely designed by its in-house staff.

         Men's Apparel

         International Male is an authority for unique men's fashion with an
international flair.

         Undergear is a leader in activewear, workout wear and fashion underwear
for men.

         Austad's, the remaining interest in which was acquired in February
1996, is a direct marketer of golf equipment and related apparel and
accessories.

         Gifts

         Gump's By Mail is a leading upscale catalog marketer of luxury gifts,
specialized housewares and other unique items.

         Gump's is the well-known San Francisco retailer.

SEARS

         In January 1994, the Company entered into a licensing agreement with
the direct marketing subsidiary of Sears to produce specialty catalogs for the
more than 20 million mail order and credit card customers of Sears. The catalogs
mailed under the program were



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based on existing Company catalogs and contained a title page with the Sears
name and logo. The specialty catalogs included: Show Place, based on the
Domestications catalog, Great Kitchens, based on the Colonial Garden Kitchens
catalog, and Sears Improvements, based on the Improvements catalog. The Sears
Agreement had an initial three-year term with automatic renewals thereafter
unless commencing December 31, 1996 either party gave at least 12 months prior
written notice that the agreement would terminate at the end of the initial term
or any extended term. The Company was obligated to meet various operational
performance standards under the Sears Agreement. If the Company was unable to
meet these standards (after written notice and a 30-day cure period), Sears
would be entitled to terminate the Sears Agreement. The Company was also
entitled to terminate the Sears Agreement in certain circumstances, including if
Sears failed to comply with any material provision of the Sears Agreement. Sears
exercised its right to terminate the venture in December 1996, since the Company
was not meeting certain of the operational standards, namely the order
fulfillment and reporting standards. The last catalogs were mailed in the first
quarter of 1997. The Company estimates that the termination of the venture will
not have a material impact on the Company's earnings for 1997.

MARKETING AND DATABASE MANAGEMENT

         The Company maintains a proprietary customer list currently containing
approximately 14 million names of customers (down from 18 million names in 1995
and 19 million names in 1994) who have purchased from one of the Company's
catalogs within the past 36 months. The list contains name, gender, residence
and historical transaction data. This database is selectively enhanced with
demographic, socioeconomic, lifestyle and purchase behavior overlays from other
sources.

         The Company utilizes proprietary modeling and sophisticated
segmentation analysis, on a catalog by catalog basis, to devise catalog
marketing and circulation strategies that are intended to maximize customer
contribution by catalog. This analysis is the basis for the Company's
determination of which of the Company's catalogs will be mailed and how
frequently to a particular customer, as well as the promotional incentive
content of the catalog(s) such customer receives. As part of its plan to reduce
annual operating costs, the Company intends to reduce catalog circulation and
improve customer retention and target segmentation.

         The primary source of new customers for the Company's catalogs is lists
rented from other mailers and compilers. Prior to mailing these non-proprietary
lists, the lists are edited using statistical segmentation tools to enhance
their probable performance. Other sources of new customers include space
advertisements and promotional inserts in outbound merchandise packages.



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TELEMARKETING

         The Company receives approximately 80% of its orders through its
toll-free telephone service which offers customer access seven days per week, 24
hours per day. The Company has created a telephone network to link its two
primary telemarketing facilities in Hanover, Pennsylvania and LaCrosse,
Wisconsin. 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. A satellite
telemarketing center is also located in San Diego, California. The Company
handled approximately 7 million telephone order calls in 1996. As part of its
December 1996 plan to reduce operating costs, the Company shut down its
telemarketing capacity in its Roanoke, Virginia facility in February 1997. In
the first quarter of 1997, the Company entered into a call center services
agreement with MCI Communications Corp. See "Purchasing."

         The Company trains its telemarketing service representatives to be
courteous, efficient and knowledgeable about the Company's products.
Telemarketing service representatives generally receive 40 hours of training in
selling products, services, systems and communication skills through simulated
as well as actual phone calls. A substantial portion of the evaluation of
telemarketing service representatives' performance is based on how well the
representative meets customer service standards. While primarily trained with
product knowledge to serve customers of one or more specific catalogs,
telemarketing service representatives also receive cross-training that enables
them to take overflow calls from other catalogs. The Company utilizes customer
surveys as an important measure of customer satisfaction.

DISTRIBUTION

         The Company presently operates four distribution centers in three
principal locations: two in Roanoke, Virginia for home fashions and apparel, one
in Hanover, Pennsylvania for general merchandise including giftware and other
hardgoods, and one in LaCrosse, Wisconsin for home fashions. The Company's
facilities processed approximately 12.7 million packages in 1996. The Company's
plan to maximize efficiencies in merchandise handling and distribution by
consolidating its warehouse and fulfillment centers continued in 1996. The
relocation of Austad's fulfillment operations from Sioux Falls, South Dakota to
other Company facilities was completed by mid-July 1996. The Company incurred
operating inefficiencies in the new facilities and operating expenses related to
maintaining duplicate facilities in 1995 which continued in 1996.

         As part of its plan to reduce annual operating costs, the Company
intends to consolidate its Roanoke, VA and its Hanover, PA fulfillment
operations into its home fashions distribution center in Roanoke, VA. These
moves are expected to be completed in the second half of 1997. However, there is
no assurance that the Company will be able to complete such moves on a timely
basis, or that it will be executed without disruption to the business of one or
more of the Company's catalogs.



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         The Company mails it catalogs through the United States Postal Service
("USPS") utilizing pre-sort, bulk mail and other discounts. Most of the
Company's packages are shipped through the USPS. Overall, catalog mailing and
package shipping costs approximated 18% of the Company's net revenues in 1996.
The Company obtains rate discounts from the USPS by automatically weighing each
parcel and sorting and trucking packages to a number of USPS drop points
throughout the country. Some packages are shipped using a consolidator for less
frequently used drop points. On July 1, 1996, the USPS reclassification of
postal rates became effective. The Company also utilizes the United Parcel 
Service, Federal Express and other delivery services.

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 as
independent companies. Major goods and services used by the Company are
purchased or leased from selected suppliers by its central buying staff. These
goods and services include: paper, catalog printing and printing related
services such as order forms and color separations, communication systems
including telephone time and switching devices, packaging materials, expedited
delivery services, computers and associated network software and hardware.

         The Company's telephone telemarketing costs (both inbound and outbound
calls) are typically contracted for a three-year period. In the first quarter of
1997, the Company entered into a three-year call center services agreement with
MCI Communications Corp. under which it will obtain a material reduction in the
rate which it has been paying pursuant to the telecommunications contract now in
effect and savings with respect to certain database services to be provided to
it, which savings are expected to aggregate approximately $3 million over the
term of the contract. In that connection, the Company agreed to guarantee
certain levels of call volume with certain exceptions. See "Telemarketing".

         The Company generally enters into annual arrangements for paper and
printing with a limited number of suppliers. These arrangements permit periodic
price increases or decreases based on prevailing market conditions, changes in
supplier costs and continuous productivity improvements. For 1996, paper costs
approximated 8% of the Company's net revenues. The Company anticipates that
paper prices will increase modestly in the second half of 1997.

MANAGEMENT INFORMATION SYSTEMS

         The Company is continuing to upgrade its management information systems
by implementing new integrated software and migrating from a centralized
mainframe to mid-range-mini-computers. The migration of the Company's business
applications to mid-range mini-computers is an important part of the Company's
overall systems plan which defines the mid and long-term systems and computing
strategy for the Company. The Company is



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continuing to modify and install, on a catalog by catalog basis, these new
integrated systems for use in managing all phases of the Company's operations.
These systems have been designed to meet the Company's requirements as a high
volume publisher of multiple catalogs.

         The new software system is an on-line, real-time system which includes
order processing, fulfillment, inventory management, list management and
reporting. The software, where implemented, provides the Company with a flexible
system that offers data manipulation and in-depth reporting capabilities. The
new management information systems are designed to permit the Company to achieve
substantial improvements in the way its financial, merchandising, inventory,
telemarketing, fulfillment and accounting functions are performed. Until the new
system is installed Company-wide, the Company will not achieve the full benefits
of the new system. Two catalogs were brought on-line in 1994. The Company
brought eight additional catalogs on-line in 1995, and one in 1996. The balance
of its catalogs are scheduled to be brought on-line in 1997. As of December 28,
1996, the Company invested approximately $17.9 million of capitalized costs in 
such systems and anticipates capital expenditures of approximately $1 million 
to complete the conversion.

CREDIT MANAGEMENT

         Several of the Company's catalogs, including Domestications,
International Male and Gump's, offer their own credit cards. The Company also
offers, for use with almost all catalogs, the use of the Hanover Shop At Home
credit card. The Company has a five year $75 million credit facility with
General Electric Credit Corporation ("GECC") expiring in the year 2000, which
provides for the sale and servicing of accounts receivable originating from the
Company's revolving credit cards. GECC's servicing responsibilities include
credit processing, collections, billing/payment processing, reporting and credit
card issuance. The Company is required to maintain certain financial covenants
related to this agreement which the Company failed to maintain, but has 
received a waiver for the event of default at December 28, 1996.

INVENTORY MANAGEMENT

         Although 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's inventory levels at the end
of 1996 were in excess of planned amounts. The Company has initiated additional
procedures to reduce its inventory position. The Company manages inventory
levels by monitoring sales and fashion trends, making purchasing adjustments as
necessary and by promotional sales. Additionally, the Company sells excess
inventory in its special sale catalogs, its outlet stores and to jobbers. Due in
part to the transition to new management information systems, the Company is
currently operating with different systems which increases the difficulty of
optimizing inventory levels.

         The Company acquires products for resale in its catalogs from numerous
domestic and foreign vendors. No single source supplied more than 5% of the
Company's products in 1996. The Company's vendors are selected based on their
ability to reliably meet the



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Company's production and quality requirements, as well as their financial
strength and willingness to meet the Company's needs on an ongoing basis.

RECENT ACQUISITIONS

         Austad's. In May 1995, the Company acquired 67.5% of the outstanding
common stock of Austad Holdings, Inc. ("AHI"), which owned The Austad Company
("TAC"), the publisher of the Austad's catalog featuring golf equipment, apparel
and gifts. In February 1996, David Austad and certain family members surrendered
to AHI their AHI shares, amounting to 32.5% of the outstanding shares, and paid
approximately $1.1 million in exchange for all the outstanding shares of AGS,
Inc. ("AGS"), a South Dakota corporation newly formed by TAC to hold the
existing retail assets and liabilities of TAC. As a result of the
reorganization, AHI became a wholly owned subsidiary of the Company. AGS will
operate the four existing retail stores acquired from TAC, located in Illinois,
Minnesota and South Dakota, as Austad's stores under license from AHI. The
customer service and fulfillment operations of TAC were transferred to other
Company facilities in the first quarter of 1996 and the Company sold the TAC
warehouse and distribution facility in July 1996 for $2.1 million, which
approximated its book value. The net proceeds were used to pay the outstanding
mortgage on the property. In connection with the purchase of TAC, goodwill of
$4.5 million and mailing lists of $1.2 million were acquired. In December 1996,
the Company wrote off these assets.

FINANCING

         Credit Facility. In November 1995, the Company entered into a $75
million secured credit facility (the "Credit Facility") with Congress Financial
Corporation ("Congress") consisting of a three-year revolving line of credit of
up to $65 million and two two-year term loans aggregating $10 million. The
revolving facility carries an interest rate of 1.25% above prime and the term
loan carries an interest rate of 1.5% above prime. The Credit Facility is
secured by all assets of the Company. At December 28, 1996, the Company had
approximately $18.2 million of outstanding borrowings under the revolving credit
facility (including documentary and standby letters of credit) and approximately
$8.9 million outstanding under the term loans, which are due in November 1997.
Remaining availability under the Congress facility was $26.0 million at 
December 28, 1996. In April 1996, Congress provided the Company with an 
additional $4 million over the borrowing base formula up to the maximum $75 
million limit of the Credit Facility until the closing of the distribution of 
transferable subscription rights (the "Rights") to subscribe for and purchase 
additional shares of Common Stock and the sale of shares of Common Stock upon 
the exercise of the Rights or pursuant to the Standby Purchase Agreement 
executed on and dated as of July 18, 1996 between the Company and NAR (the 
"Standby Purchase Agreement"). This distribution and sale of Common Stock is 
referred to herein as the "Rights Offering." Under the Credit Facility, the
Company was required to comply with certain restrictive debt covenants including
maintaining minimum net worth of $80 million and working capital of $26 million
as of December 30, 1995. In April 1996, these restrictive debt covenants were
revised to $75 million and $21 million, respectively, in an amendment to the
Credit Facility and, upon the closing of the Rights


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Offering, returned to their previous levels. In December 1996, the minimum net
worth covenant was lowered to $70 million and Congress also agreed to address
the 1997 net worth covenant level after a review of the Company's business plan.
Congress also began lowering the advance rate for inventories in November 1996
and continued to reduce it monthly until a new appraisal was completed in March
1997. The current advance rate for inventories is 52%. On March 26, 1997, the
Company reached an agreement in principle with Congress under which Congress
would waive certain defaults and amend the Credit Facility to (a) reduce the
aggregate amount of required net worth and working capital to be maintained by
the Company and (b) amend the covenant relating to material adverse changes so
that measurement thereunder will commence from December 28, 1996.

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

         On December 19, 1996, the Company finalized its agreement (the
"Reimbursement Agreement") with Richemont Finance S.A., an affiliate of
Richemont, together with the family of Alan G. Quasha, Chairman of the Board of
the Company, jointly own NAR, that provided the Company with up to approximately
$28 million of letters of credit which were issued under the Credit Facility.
The letters of credit will expire on February 18, 1998 and carry an interest
rate of 3.5% above the prime rate, currently 11.75%, payable to Richemont
quarterly on amounts drawn under the letters of credit. The Company has agreed
to pay a facility fee equal to 5% of the principal amount of the letters of
credit as well as all other fees incurred in connection with providing the
facility. In the event that the Company has not paid in full, by the expiration
date, any outstanding balances under the letters of credit, Richemont shall have
the option, exercisable at any time prior to payment in full of all amounts
outstanding under the letters of credit to convert such amount into Common Stock
of the Company at the mean of the bid and ask prices of the Company's Common
Stock on November 8, 1996, or the mean of the bid and ask prices of the
Company's Common Stock on each of the thirty days immediately prior to the date
of exercise of the conversion privilege. The Reimbursement Agreement is
subordinate to the Credit Facility. On December 5, 1996, Richemont advanced the
Company $10 million against the anticipated $28 million line of credit. The
Company repaid the $10 million loan after the letter of credit agreement was in
place on December 19, 1996.

         Rights Offering. The Company commenced a $50 million rights offering
(the "Rights Offering") on July 19, 1996. Holders of record of the Company's
Common Stock, 6% Series A Convertible Additional Preferred Stock and Series B
Convertible Additional



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Preferred Stock as of July 18, 1996, the record date, were eligible to
participate in the Rights Offering. The Rights were exercisable at a price of
$1.03 per share. Shareholders received .51 Rights for each share of Common
Stock held, 3.72 rights for each share of Series A Convertible Additional
Preferred Stock held and .77 rights for each share of Series B Convertible
Additional Preferred Stock held as of the record date. The Rights Offering
closed on August 23, 1996.

         Due to the Company's continued operating losses, the Company requested
that NAR advance up to $25 million against all the Rights distributed to it
and/or its commitment to purchase all of the unsubscribed shares. In May 1996,
NAR advanced the Company $25 million under a promissory note. Under the
provisions of such promissory note, the Company repaid NAR the $25 million
advance plus accrued interest upon the closing of the Rights Offering.

         The Company issued 48,748,785 shares as a result of the Rights Offering
which generated proceeds of approximately $48 million, net of expenses. NAR
received Rights entitling it to purchase 24,015,964 shares in the Rights
Offering and exercised such Rights. In addition, the Company and NAR entered
into a Standby Purchase Agreement, pursuant to which NAR purchased 6,898,866
shares not subscribed by shareholders and received approximately $.5 million as
a fee. The proceeds of the Rights Offering were used by the Company: (i) to
repay the $14 million principal amount of 9.25% Senior Subordinated Notes
("9.25% Notes") due on August 1, 1998 held by an affiliate of NAR plus accrued
interest, (ii) to repay the $25 million principal amount advanced under the
promissory note plus accrued interest and (iii) to repay approximately $9
million under the credit facility with Congress. The Company recorded an
extraordinary expense related to the early extinguishment of the 9.25% Notes,
representing a write-off of the unamortized debt issuance costs of approximately
$1.1 million.

         Future Financing. The Company has announced that it intends to
distribute transferable subscription rights to subscribe for and purchase
additional shares of Common Stock to the holders of record of the Company's
Common Stock and Series B Convertible Additional Preferred Stock (the "1997
Rights Offering") as soon as it has filed with and has declared effective by the
SEC a registration statement with respect thereto. The Rights will be
exercisable at a price of $.90 per share. NAR has agreed to subscribe for and
purchase shares of Common Stock having a value of at least $10 million and to
pay for such shares by the surrender of the NAR Promissory Note in the principal
amount of $10 million held by its affiliate. Richemont has agreed to purchase
all shares of Common Stock which have not been subscribed for and purchased by
shareholders in the 1997 Rights Offering. Richemont has agreed to advance up to
$30 million against its commitment to purchase all of the unsubscribed shares.
In connection with the agreement the Company named two Richemont
representatives, Messrs. Jan du Plessis and Howard Tanner, to its Board of
Directors (the "Board") and Executive Committee, and will nominate a third
Richemont representative to the Board at the next annual meeting. The new Board
members fill positions vacated by the recent resignations of Geraldine Stutz and
Jeffery R. Laikind. In addition, Mr. du Plessis has been named to the Audit
Committee of the Board.


                                       13
<PAGE>   14
EMPLOYEES

         The Company currently employs approximately 2,800 persons on a full
time basis and approximately 900 persons on a part time basis. In December 1996,
the Company announced a plan to reduce annual operating costs which included a
plan to reduce permanent positions by approximately 550. Approximately 160
employees at one of the Company's subsidiaries are represented by a union. The
Company believes its relations with its employees are good.

SEASONALITY

         The Company has experienced substantially increased sales in the fourth
quarter of each year as compared to the first three quarters, due in part to the
Company mailing more catalogs in the second part of the year and decreasing
apparel sales as a percentage of total sales.

COMPETITION

         The Company believes that the principle basis upon which it competes
are quality, value, service, product offerings, catalog design, convenience and
efficiency. The Company's catalogs compete with other mail order catalogs, both
specialty and general, and retail stores, including department stores, specialty
stores and discount stores. Competitors also exist in each of the Company's
catalog specialty areas of women's apparel, home fashions, general merchandise,
men's apparel and gifts. A number of the Company's competitors have
substantially greater financial, distribution and marketing resources than the
Company.

TRADEMARKS

         Each of the Company's catalogs has its own federally registered
trademark. The Company also owns numerous trademarks, copyrights and service
marks on its logos, products and catalog offerings. The Company has also
protected various trademarks internationally. The Company vigorously protects
such marks and believes there is substantial goodwill associated with them. Show
Place and Great Kitchens are trademarks of Sears.

GOVERNMENT REGULATION

         The Company is subject to Federal Trade Commission regulations
governing its advertising and trade practices, Consumer Product Safety
Commission and Food and Drug Administration regulations governing the safety of
the products it sells in its catalogs and other regulations relating to the sale
of merchandise to its customers. The Company is also subject to the Department
of Treasury-Customs regulations with respect to any goods it directly imports.


                                       14
<PAGE>   15
         The imposition of a sales and use tax collection obligation on
out-of-state catalog companies in states to which they ship products was the
subject of a case decided in 1994 by the United States Supreme Court. While the
Court reaffirmed an earlier decision that allowed direct marketers to make sales
into states where they do not have a physical presence without collecting sales
taxes with respect to such sales, the Court further noted that Congress has the
power to change this law. The Company believes that it collects sales tax in all
jurisdictions where it is currently required to do so.

ITEM 2. PROPERTIES

         The Company's corporate headquarters are located in a modern
85,000-square-foot facility in Weehawken, New Jersey. The facility houses
merchandising and marketing personnel, catalog production personnel and
corporate and administrative officers. The Weehawken facility is leased for a
15-year term expiring in 2005. The Company intends to vacate these premises in
1997 as part of its plan to further reduce costs. The Company operates four
warehouses and fulfillment facilities in three principal locations: two in
Roanoke, Virginia for home fashions and apparel, one in Hanover, Pennsylvania
for general merchandise, including giftware and other hardgoods, and one in
LaCrosse, Wisconsin for upscale home fashions.

         In Roanoke, the Company owns a newly completed 530,000 square-foot home
fashions distribution center. The facility became operational in the second half
of 1995 and handles all of Domestications' fulfillment processing. Also in
Roanoke, the Company leases a 175,000 square-foot apparel distribution center
from a partnership in which it owns a 50% interest. As part of the Company's
plan to further reduce costs, the Company intends to consolidate the apparel
distribution facility in Roanoke, Virginia and the Hanover, PA distribution
facility with and into the home fashions distribution center in Roanoke,
Virginia in the third quarter of 1997. See "Distribution."

         In Hanover, the Company owns a distribution center of approximately
265,000 square feet and leases a telemarketing and administrative office
facility of 123,000 square feet and a warehouse facility of 433,000 square feet.
Renewal terms on the telemarketing center extend through 2009. The warehouse
lease expires in May 1997 with two short-term renewal periods.

         In LaCrosse, Wisconsin, the Company also owns a 150,000 square-foot
home fashions manufacturing and assembly facility and a 58,000 square-foot
telemarketing and customer service facility, and leases a warehouse and
fulfillment center of 185,000 square feet under a short-term lease.

         In addition to these principal facilities, the Company leases
administrative facilities for men's apparel in San Diego, California. The San
Diego facility also serves as a telemarketing and customer service facility.

                                       15
<PAGE>   16
         The Company's principle retail operations consist of the Gump's retail
store, which occupies approximately 30,000 square feet in a building in downtown
San Francisco, California. The Gump's facility, which is leased pursuant to a
15-year lease, also includes approximately 15,000 square feet of administrative
offices. The Company also operates and leases 9 other retail and outlet stores
at various locations.

         The Company leases premises in Edgewater, New Jersey and owns a
building subject to a lease in Cleveland, Ohio. The Company is actively seeking
to sell its interest in the Cleveland facility. The Company has sublet a portion
of the Edgewater facility and is actively seeking to sub-lease the remainder.



                                       16
<PAGE>   17
<TABLE>
<CAPTION>
                                                                             APPROXIMATE
LOCATION(a)                                STATUS                            SQUARE FOOTAGE
-----------                                ------                            --------------
<S>                                        <C>                               <C>
Warehouse and Fulfillment
Centers:
Roanoke, VA                                Owned                             530,000
Roanoke, VA                                Leased                            175,000
Hanover, PA                                Leased                            433,000
Hanover, PA                                Leased/Owned(c)                   265,000
LaCrosse, WI                               Leased                            185,000

Corporate and
Administrative Offices:
Weehawken, NJ                              Leased                            85,000
San Diego, CA                              Leased                            30,000(b)
San Francisco, CA                          Leased                            15,000(c)
Beachwood, OH                              Leased                            7,740

Telemarketing and
Customer Service:
Hanover, PA                                Leased                            123,000
LaCrosse, WI                               Owned                             58,000
San Diego, CA                              Leased                            30,000(b)

Retail Stores:
San Francisco, CA                          Leased                            30,000(c)
San Diego, CA                              Leased                            3,800
West Hollywood, CA                         Leased                            3,600
Tysons Corner, VA                          Leased                            1,700
Mayfield Heights, OH                       Leased                            3,750
Hanover, PA                                Leased                            24,000
Kenosha, WI                                Leased                            4,708
LaCrosse, WI                               Leased                            13,326
Madison, WI                                Leased                            5,206
Oshkosh, WI                                Leased                            2,000

Manufacturing and
Assembly:
LaCrosse, WI                               Owned                             150,000
</TABLE>

(a)      Does not include the Sioux Falls, South Dakota (closed 1996),
         Cleveland, Ohio (closed 1995) or Edgewater, New Jersey (closed 1995),
         in conjunction with the consolidation of the Company's warehouse
         facilities.


                                       17
<PAGE>   18
(b)      Telemarketing and corporate/administrative functions are all located
         and performed at the one facility. Square footage stated represents the
         entire facility.

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


ITEM 3. LEGAL PROCEEDINGS

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

         On or about September 2, 1994, a complaint was filed in the United
States District Court for the District of New Jersey by Veronica Zucker, an
individual who allegedly purchased shares of Common Stock of the Company in the
public offering completed on April 7, 1994, against the Company, all of its
directors, certain of its officers, Sun Life Insurance Company of America,
Merrill Lynch, Pierce, Fenner & Smith Incorporated and Alex. Brown & Sons,
Incorporated. The complaint, which was purportedly filed on behalf of a class of
all persons who purchased the Common Stock of the Company in the public offering
or thereafter through and including August 14, 1994, sought to recover monetary
damages the class had allegedly suffered as a result of certain alleged false
and materially misleading statements contained in the Company's public offering
prospectus dated March 30, 1994. In lieu of an answer, defendants filed a motion
to dismiss the complaint in its entirety for failure to state a claim upon which
relief could be granted. On May 23, 1995, the United States District Court for
the District of New Jersey dismissed the plaintiff's claim, with prejudice, for
failure to state a claim upon which relief could be granted. On June 22, 1995,
plaintiff filed a notice of appeal of the May 23, 1995 decision to the United
States Court of Appeals for the Third Circuit. On March 26, 1996, the Court of
Appeals rendered its decision affirming the District Court's decision. On or
about July 8, 1996, a petition for certiorari was filed by plaintiff with the
United States Supreme Court. The Company filed a brief in opposition to the
petition on August 13, 1996. On October 7, 1996, the United States Supreme Court
denied the plaintiff's petition.


                                       18
<PAGE>   19
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

         The Board of Directors of the Company and NAR Group Limited, the holder
of 54.3% of the Company's Common Stock, approved on September 26, 1996, pursuant
to Sections 242 and 228 of the Delaware Business Corporation Law, an amendment
to the Company's Certificate of Incorporation increasing the number of shares of
Common Stock which the Company shall have authority to issue from 150,000,000 to
225,000,000 shares. This action became effective upon the filing of a
Certificate of Amendment to the Certificate of Incorporation on October 31,
1996. The increase in authorized shares was necessary to provide enough shares
of Common Stock for issuance pursuant to options and warrants previously granted
by the Company to directors and officers, including options to purchase an
aggregate of 7,530,000 shares granted by the Company on August 23, 1996 to the
Company's President and Chief Executive Officer, Rakesh K. Kaul. The additional
shares of Common Stock not used for such purpose, together with the shares of
Common Stock held in treasury, are available for general corporate purposes, as
determined by the Board of Directors, without (except as otherwise required by
law) further authority from shareholders.

         As of September 26, 1996, the record date for the action (the "Record
Date"), there were 143,044,492 shares of Common Stock and 634,900 shares of
Series B Convertible Additional Preferred Stock, par value $.01 and stated value
$10.00 per share (the "Series B Preferred Stock"), outstanding. The approval of
the holders of a majority of the outstanding shares of Common Stock and Series B
Preferred Stock, voting together as a single class, was necessary to adopt the
amendment to the Certificate of Incorporation. Each outstanding share of Common
Stock was entitled to one vote on the proposal to adopt the amendment and each
outstanding share of Series B Preferred Stock was entitled to 1.5 votes on the
amendment. NAR, as the holder of 78,004,954 shares of Common Stock, or 54.3% of
the voting power of the Common Stock and the Series B Preferred Stock voting
together as a class, therefore, had the requisite power to approve the amendment
by written consent. Such consent was executed and delivered on September 26,
1996. Under Delaware law, shareholders who did not consent to the amendment did
not have appraisal rights with respect to the shares held by them.




                                       19
<PAGE>   20
                                   P A R T II

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

         The Common Stock is traded on the American Stock Exchange (Symbol:
HNV). The following table sets forth, for the periods shown, the high and low
sale prices of the Common Stock reported on the American Stock Exchange
Composite Tape.

<TABLE>
<CAPTION>
1995                                HIGH           LOW
----                              --------       --------
<S>                              <C>            <C>

         First Quarter            $3 5/8         $2 1/2
         Second Quarter            3 1/16         2 5/16
         Third Quarter             2 13/16        1 15/16
         Fourth Quarter            2 1/16         1 1/2

1996
         First Quarter              1 3/4         1 1/8
         Second Quarter             2             1 1/8
         Third Quarter              1 5/8           7/8
         Fourth Quarter             1               5/8
</TABLE>


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

         As of March 24, 1997, there were approximately 4,600 holders of record
of Common Stock.



                                       20
<PAGE>   21
ITEM 6. SELECTED FINANCIAL DATA

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

<TABLE>
<CAPTION>
                                                1992               1993            1994               1995                1996
                                                ----               ----            ----               ----                ----
                                                                 (in thousands, except share and per share data)
<S>                                        <C>                <C>             <C>                <C>                <C>
Income Statement Data:
Revenues                                   $   586,562        $   642,511     $   768,884        $   749,767        $     700,314
Depreciation and amortization                    2,681              3,279           6,157              9,020               12,192
Operating (loss) income                         14,402             19,076          15,975            (22,619)             (94,497)
Interest expense, net                           13,135              2,757           2,813              4,531                8,398
Income (loss) before extraordinary
  items and cumulative effect of
  accounting change for income taxes             1,048             17,337          14,838            (28,153)            (103,895)
Extraordinary items                              9,201                 --              --             (1,837)              (1,134)
Cumulative effect of accounting
change for income taxes                         10,000                 --              --                 --                   --
                                           -----------        -----------     -----------        -----------        -------------
Net income (loss)                               20,249             17,337          14,838            (29,990)            (105,029)
Preferred stock dividends                       (3,197)            (4,093)           (135)              (240)                (225)
                                           -----------        -----------     -----------        -----------        -------------
Net income (loss) applicable to
  common stockholders                      $    17,052        $    13,244     $    14,703        $   (30,230)       $    (105,254)
                                           ===========        ===========     ===========        ===========        =============
Per share:
Income (loss) before extraordinary
 items and cumulative effect of
 accounting change for income
 taxes                                     $      (.06)       $      0.17     $      0.16        $      (.30)       $        (.93)
Extraordinary  items                               .24                 --              --               (.02)                (.01)
Cumulative effect of accounting
change for income taxes                            .26                 --              --                 --                   --
                                           -----------        -----------     -----------        -----------        -------------

Net income (loss)                          $       .44        $       .17     $       .16        $      (.32)       $        (.94)
                                           ===========        ===========     ===========        ===========        =============
Weighted average number of shares
  outstanding:
Primary                                     38,467,015         75,625,330      93,285,190         93,029,816          111,441,247
                                           ===========        ===========     ===========        ===========        =============
Fully diluted                               38,467,015         77,064,131      93,235,190         93,029,816          111,441,247
                                           ===========        ===========     ===========        ===========        =============
Balance Sheet Data (end of period):
Working capital (deficit)                       31,566             25,180          58,501             28,774               (1,507)
Total assets                                   134,352            188,838         262,246            279,009              220,827
Total debt                                      43,362             36,160          37,915             62,802               65,189
Preferred stock of subsidiary                   32,842                 --              --                 --                   --
Shareholders' (deficit) equity                 (19,758)            45,868         109,725             87,210               31,740
</TABLE>


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

See Notes to Consolidated Financial Statements.


                                       21

<PAGE>   22
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION
AND RESULTS OF OPERATIONS

The following table sets forth, for the fiscal years indicated, the percentage
relationship to revenues of certain items in the Company's Consolidated
Statements of Income:

<TABLE>
<CAPTION>
                                                        FISCAL YEAR
                                             ---------------------------------
                                              1994          1995          1996
                                             -----         -----         -----
<S>                                          <C>           <C>           <C>
Revenues                                     100.0%        100.0%        100.0%
  Cost of sales and operating expenses        62.9          64.5          68.4
  Write-down of inventory of
  discontinued catalogs                         --           1.1            .2
  Special charges                               --            .3           5.2
Selling expenses                              25.7          27.4          27.9
General and administrative expenses            8.5           8.5          10.1
Depreciation and amortization                   .8           1.2           1.7
                                             -----         -----         -----
Income (loss) from operations                  2.1          (3.0)        (13.5)
Interest expense, net                           .4            .6           1.2
Other income (expense)                         (.2)           --            --
Net income (loss)                              1.9%         (4.0%)       (15.0%)
</TABLE>

RESULTS OF OPERATIONS

1996 COMPARED WITH 1995

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

        In December 1996, after a review of its fourth quarter and year-to-date
operating results and in connection with formulating its 1997 business plan, the
Company announced its intentions to realign its operating units into six
decentralized operating units, Home Fashions - Upscale, Home Fashions - Mid-
Market, General Merchandise, Gifts, Women's Apparel, and Men's Apparel. The
Company believes that this new business structure will increase business unit
accountability, through improved working capital management, and provide
increased service levels to the Company's core customers. This new structure
will also result in reduced fixed overhead costs as the Company's centralized
services will be utilized more efficiently. During the latter part of the year,
the Company began to implement this plan, completed an assessment of
recoverability of long-lived assets for certain underperforming catalogs and
recorded special charges that totaled $36.7 million. These charges included a
provision for the consolidation of distribution centers and relocation of
facilities and severance expenses approximating $14.7 million. Also included in
these charges was the write-off of certain long-lived assets that Company's
management determined were impaired of approximately $22.0 million.




                                       22
<PAGE>   23
      The net loss in 1996, after considering special charges, was primarily the
result of (i) increased inventory write-downs due to the Company's inability to
properly sustain its inventory in-stock position due to liquidity problems, and,
in certain instances, the purchase of inventory quantities in excess of demand
(ii) lower response rates as a result of increased order cancellations, (iii)
increased fulfillment and telemarketing costs due to inventory handling costs
associated with the higher backorder levels and increased merchandise returns
and (iv) the fixed cost infrastructure which the Company's continuing catalogs
could not fully absorb. The Company does not expect these problems to continue
in 1997, however, there is no assurance that these or similar problems will not
recur in 1997.

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

      The following table summarizes the Company's revenues and the percent of
total revenues for 1996 and 1995 for each business unit; all revenues are net of
returns:


<TABLE>
<CAPTION>
                                                 1996                     1995
                                                PERCENT                  PERCENT
                                     1996       OF TOTAL      1995       OF TOTAL
Business Unit (in thousands)       REVENUES     REVENUES    REVENUES     REVENUES
<S>                                <C>          <C>         <C>          <C>
Home Fashions -
     Mid-Market                     $202.2        28.9%      $223.7        29.8%
     Upscale                          97.2        13.9         81.8        10.9
General Merchandise                   79.3        11.3         73.5         9.8
Woman's Apparel                       82.7        11.8         76.7        10.2
Men's Apparel                         78.4        11.2         77.9        10.4
Gifts                                 57.7         8.2         50.7         6.8
                                    ------       -----       ------       -----
Total Continuing                     597.5        85.3        584.3        77.9
Discontinued                         102.8        14.7        165.5        22.1
                                    ------       -----       ------       -----
Total Company                       $700.3       100.0%      $749.8       100.0%
                                    ======       =====       ======       =====
</TABLE>

      Revenues from the Home Fashions - Mid Market group decreased 10% to $202.2
million for the current year from $223.7 million in 1995. Domestications'
revenues decreased in 1996 due to a 6% increase in order cancellation, while
filling backorders resulted in a 3% increase in merchandise returns and a
decrease in average order size. This decrease was partially offset by an
increase in response rates. Revenues from the Home Fashions-Upscale group
increased 19% to $97.2 million as customer response rates and average order size
increased in the current year. The General Merchandise group's revenues
increased 8% due mainly to an increase in



                                       23
<PAGE>   24
Improvements revenues which were partially offset by decreases in Colonial
Garden Kitchens and The Safety Zone revenues. The increase in Improvements
revenues is due to increased average order size and a 29% increase in
circulation which was partially offset by a decrease in response rates. Revenues
generated by the Men's Apparel group increased .5% to $78.4 million. Revenues
for the Women's Apparel group increased 7.8% to $82.7 million due to a 12%
increase in circulation, increased response rates, and average order size.
Revenues for the Gifts group increased 14% to $57.7 million mainly due to
increased response rates and average order size of the Gump's By Mail catalog.

      Revenues from the catalogs discontinued in 1995 and the discontinued Sears
venture decreased by $62.6 million to $102.9 million in 1996.

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

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

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

      Selling expenses decreased $10.6 million but increased to 27.9% of
revenues in 1996 from 27.4% of revenues in 1995. The total expense decreased
mainly due to a 10% reduction in catalog circulation. This decrease was offset
by increased catalog postage expense and lower response rates in the current
year for the discontinued catalogs. This expense as a percentage of



                                       24
<PAGE>   25
revenues increased due to lower response rates as a result of weak customer
demand and increased order cancellations. Catalog postage and paper expense
increased as the Company increased the number of sale pages in its catalogs
which was designed to speed the sale of slow moving inventory.

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

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

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

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

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

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

      Shareholders' Equity. The number of shares of Common Stock outstanding
increased by 51,195,130 in 1996 due to shares issued in connection with the
Company's Right's Offering, its equity and incentive plans, the exchange of the
6% Series A Convertible Preferred Stock and other activities. At December 28,
1996, there were 144,647,898 shares of Common Stock outstanding compared to
93,452,768 shares of Common Stock outstanding at December 30, 1995.

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




                                       25
<PAGE>   26
1995 COMPARED WITH 1994

      Net Income (Loss). The Company reported a net loss before extraordinary
items of $28.2 million or $(.30) per share for the year ended December 30, 1995
compared to net income of $14.8 million or $.16 per share in 1994. Including the
effect of the extraordinary loss of $1.8 million for the early extinguishment of
debt, the Company reported a net loss of $30 million or $(.32) per share for the
year ended December 30, 1995. Per share amounts are expressed after deducting
preferred dividends of $.2 million in 1995 and $.1 million in 1994. The weighted
average number of shares outstanding was 93,029,816 for the year ended December
30, 1995 compared to 93,285,190 in 1994.

      The net loss in 1995 was primarily the result of the cumulative impact on
the Company of the 14% to 18% increase in USPS rates, a 43% increase in paper
prices and weak consumer demand. As a result of these factors, the Company
discontinued six poorly performing catalogs in 1995 which incurred substantial
losses. The Company believed that the discontinued catalogs could not overcome
these obstacles. Including an incremental write-down of inventory associated
with discontinuing these catalogs of $8.6 million, these catalogs lost $20
million in 1995 compared to $4.7 million in the prior year. In addition, the
Company also incurred costs, aggregating $2.7 million, in connection with the
consolidation of facilities into its new Roanoke, VA fulfillment center. These
costs included operating expenses related to maintaining duplicate facilities of
$1.0 million and $1.7 million of costs related to start-up problems, operating
down-time and inefficiencies in the new facility. Due to these cost pressures,
the Company implemented a cost reduction program in 1995 whereby the Company
instituted a salary freeze, reduced its work force by approximately 10%, closed
5 facilities and reduced other administrative and overhead expenses. In
connection with the closing of these 5 facilities, the Company incurred
non-recurring costs of $1.5 million. The Company also incurred one-time
severance and employee separation expenses of $2.0 million.

      Revenues. Revenues decreased 2.5% in 1995 to $750 million from $769
million in 1994. Revenues of continuing catalogs increased approximately 2% from
$651 million in 1994 to $662 million in 1995, which was offset by a 26% decline
to $88 million in revenues from discontinued catalogs. The Company circulated
370 million catalogs in 1995, a 2% reduction from the prior year.

      Non-Apparel continuing catalog revenues increased 1% to $528 million, due
to a 14% increase in revenues from the Company's venture with Sears to $81
million and $68 million of revenues from the 1995 acquisitions of Improvements,
The Safety Zone and Austad's which offset revenue reductions in the other
Non-Apparel catalogs, principally Domestications and Colonial Garden Kitchens.
Domestications revenues were down 28% as improved customer response rates
partially offset a decline in the average order and a 31% reduction in
circulation. Revenues from discontinued catalogs decreased $11.7 million from
$77.7 million in 1994 to $66 million in 1995. The Company discontinued the
Mature Wisdom catalog in mid-1995 and the Tapestry and Hanover House catalogs in
the fourth quarter of 1995.

      Apparel continuing catalog revenues increased $5 million, or approximately
4%, from $129 million in 1994 to $134 million in 1995, as all continuing
catalogs, International Male, Undergear, Silhouettes and Tweeds reported higher
sales than the prior year. Revenues from



                                       26
<PAGE>   27
discontinued Apparel catalogs declined 46% from $40 million in 1994 to $22
million in 1995, including the effect of discontinuing Essence by Mail, One 212
and Simply Tops.

      Operating Costs and Expenses. Cost of sales and operating expenses as a
percentage of revenues increased from 62.9% in 1994 to 64.5% in 1995. This
increase is primarily attributable to lower overall product margins due to
greater sale activity as a result of the generally weak consumer demand and the
impact of write-downs for the discontinued catalogs. In addition, fulfillment
costs were higher in 1995 due to the start up of the new facility in Roanoke and
higher outbound freight expenses of approximately $7 million or 15% as a result
of the increase in USPS rates.

      The write-down of inventory for the discontinuance of six of the Company's
catalogs of $8.6 million primarily consisted of incremental inventory
write-downs in excess of normal seasonal write-downs and severance expenses.
During 1995, the Company recorded a Provision for Facility Closings totalling
$1.5 million consisting primarily of facility exit costs ($.7 million), lease
termination fees ($.3 million) and severance expenses ($.5 million),
substantially all of which were paid in 1995. No such charges were recorded in
1994.

      Selling expenses increased $8.2 million or 4.2% in 1994 to 27.4% of
revenues for the current year, primarily due to a 43% increase in average paper
costs and a 15% increase in the average cost of mailing a catalog which more
than offset the 2.0% reduction in catalog circulation and higher customer
response rates. As a result of these price increases, the Company incurred
approximately $18.0 million of higher costs to prepare and deliver its catalogs
in 1995.

      General and administrative expenses declined $1.1 million or 2% in 1995
although they remained constant as a percentage of revenues at 8.5% in both
years. Excluding the impact of one-time severance expenses of $2.0 million,
these expenses declined as a percentage of sales to 8.3% due to the Company's
cost reduction program instituted in early 1995. This reduction was partially
offset by higher bad debt expenses, reflecting increased losses on major credit
cards and the Company's private label credit card.

      Depreciation and amortization increased $2.8 million from $6.2 million in
1994 to $9.0 million in 1995. The increase was attributable to new amortization
charges associated with the Roanoke, Virginia fulfillment facility, the
management information system, the new Gump's retail store and the goodwill and
mailing lists associated with the 1995 acquisitions.

      Income (Loss) from Operations. Income from operations declined from $16.0
million in 1994 to a loss of $22.6 million in 1995. Losses from discontinued
catalogs increased from $4.7 million in 1994 to $20 million in 1995.

      Non-Apparel income from operations decreased from $20.5 million in 1994 to
a loss of $7.8 million in 1995. The most significant contributor to the decrease
in profitability was Domestications, which in addition to being significantly
impacted by the higher postage and paper costs also incurred additional costs in
connection with the move of its operations into the new Roanoke facility. These
costs included start-up costs, down time due to equipment problems, temporary
labor costs, higher shipping, damages and replacement costs. Additionally,
Domestications' product margin was adversely impacted by product mix changes,
increased





                                       27
<PAGE>   28
promotional activities and higher obsolescence charges. The loss from
discontinued Non-Apparel catalogs increased from $1.3 million in 1994 to $10.1
million in 1995. Profitability from the Sears venture increased by $.1 million
to $3 million in 1995 and the 1995 acquisitions contributed income of $2.5
million. The Company Store and Gump's also had higher operating profits in 1995
compared to 1994.

      Apparel results of operations declined $7.7 million from a loss of $.5
million in 1994 to a loss of $8.2 million in 1995. This decrease is mainly
attributable to the discontinued Apparel catalogs whose losses increased $6.5
million from $3.4 million in 1994 to $9.9 million in 1995. Mens Apparel
operating income increased 35% to $2.6 million which offset lower earnings at
Tweeds and an operating loss at Silhouettes, where credit problems in the fourth
quarter of 1995 contributed to its loss.

      Interest Income (Expense). Interest expense increased approximately $1.5
million from $3.5 million in 1994 to $5.0 million in 1995. This increase was due
to higher average borrowings outstanding under the Company's revolving credit
facility in 1995 as well as an increase in the basis point of approximately 3%
in the Company's borrowing rate which is attributable to the Company's
deteriorating financial performance in 1995. Interest income declined by $.2
million to $.5 million in 1995 because the Company had less cash available for
investment.

      Other Income (Expense). Other expenses in 1994 totaled a net $1.8 million
while there were no similar expenses in 1995. The loss in 1994 was comprised of
$1.2 million related to the Company's investment in Boston Publishing Company
and $1.3 million related to its investment in Regal Communications, Inc. offset
by other income of $.7 million. The Company acquired a 20% ownership in Boston
Publishing Company in February 1994. The Company made this investment with the
intention of possibly acquiring Boston Publishing Company at some point in the
future. During 1994 the Company made an investment in debt securities of Regal
Communications, Inc. It was the Company's intention to hold these debt
securities as a long-term investment and perhaps at some point in the future
obtain certain operating subsidiaries of Regal in exchange for such securities.

      Income Taxes. The Company did not record a Federal income tax provision in
1995 based on the current year net operating loss. The Federal income tax
provision of $5.9 million in 1994 was offset by the utilization of net operating
loss carry forwards. The Company's state tax provision was $1.0 million and $.9
million in 1995 and 1994, respectively.

      Shareholders' Equity. The number of shares of Common Stock outstanding
increased by 714,928 in 1995 due to shares issued in connection with the
Company's equity and incentive plans, the exchange of the 6% Series A
Convertible Preferred Stock and other activities. At December 30, 1995 there
were 93,452,768 shares of Common Stock outstanding compared to 92,737,840 shares
of Common Stock outstanding at December 31, 1994.

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




                                       28
<PAGE>   29
LIQUIDITY AND CAPITAL RESOURCES

      Liquidity. The Company had $5.2 million and $2.7 million in cash and cash
equivalents at December 28, 1996 and December 30, 1995, respectively. Working
capital deficit and the current ratio were ($1.5) million and .99 to 1 at
December 28, 1996 versus working capital of $28.8 million and current ratio of
1.22 to 1 at December 30, 1995.

      The primary sources of cash in 1996 were the $10.0 million of proceeds
from the issuance of debt, the $11.7 million of borrowings under the Company's
credit facility, the $50 million of proceeds from the Rights Offering and $25.4
million due to a reduction in inventories and prepaid catalog costs. Cash was
used primarily to fund: (i) the Company's 1996 operating loss, (ii) $8.9 million
of capital expenditures, (iii) $13.7 million for the reduction of accounts
payable, and (iv) $19.6 million for payments of long-term debt and debt issuance
costs.

      Due to the Company's continued poor financial performance it was necessary
to obtain an equity infusion in 1996 which would (i) restore the Company's
equity base, (ii) reduce long-term debt and (iii) provide the Company with
additional liquidity. As a result, the Company conducted a $50 million Rights
Offering which was completed in August 1996. The proceeds of the Rights Offering
were used by the Company to (i) repay the $14 million principal amount of the
9.25% Notes held by an affiliate of NAR plus accrued interest, (ii) to repay the
$25 million principal amount advanced under the promissory note plus accrued
interest and (iii) to repay approximately $9 million under the Congress
Facility. The Company continued to experience operating losses in 1996 which
have eroded the recently increased equity base. This resulted in continued high
levels of back orders (unfilled orders) and increased order cancellations due to
the Company's poor in-stock position throughout 1996. In December 1996, the
Company closed its agreement (the "Reimbursement Agreement") with Richemont
Finance S.A. ("Richemont") that provides the Company with approximately $28
million of letters of credit to replace letters of credit which were issued
under the Credit Facility with Congress. Although this agreement provided the
Company added liquidity, its timing, December 19, 1996, had a minimal effect on
reducing back orders in the 1996 fiscal year. This agreement will expire in
February 1998. When the final 1996 results became known to the Company, it
concluded such results would have further negative impact on the Company's
ability to conduct business on normal trade terms. Therefore, the Company
decided that it was necessary to obtain an equity infusion which would restore 
the Company's equity base that had deteriorated in 1996 and provide the Company 
with additional liquidity. As a result of the equity infusion, the $10 million
NAR Promissory Note would also be satisfied.

      On March 26, 1997, the Company announced that it intends to distribute
subscription rights to subscribe for and purchase additional shares of
Common Stock to the holders of record of the Company's Common Stock and
Series B Convertible Additional Preferred Stock (the "1997 Rights Offering") as
soon as it has filed with and had declared effective by the SEC a registration
statement with respect thereto. The Rights will be exercisable at a price of
$.90 per share. NAR has agreed to apply $10 million of the Company's
indebtedness to acquire $10 million of the Company's Common Stock. Richemont has
agreed to purchase all shares of Common Stock which have not been subscribed for
and purchased by shareholders other than NAR in the 1997 Rights Offering. Any
offering will be made solely by means of a prospectus. Richemont has agreed to 
advance $30 million against its commitment to purchase all of the unsubscribed 
shares. In connection with the agreement the Company named two Richemont





                                       29
<PAGE>   30
representatives, Messrs. Jan du Plessis and Howard Tanner, to its Board of
Directors (the "Board) and Executive Committee, and it is intended that a third
Richemont representative for election to the Board at the next annual meeting.
The new Board members fill vacancies created by the recent resignations of
Geraldine Stutz and Jeffery R. Laikind. In addition, Mr. du Plessis has been
named to the Audit Committee of the Board.

      At December 28, 1996, the Company had outstanding $11.5 million of
current borrowings. This balance, consisting primarily of the $8.9 million
Revolving Term Notes under the Congress Facility, will be paid down with cash
generated from operations in 1997.

      The Company has received waivers for the December 1996 events of default
under the Congress Facility related to the working capital and net worth
covenants as of and through December 28, 1996. In addition, the Company received
a waiver for any event of default relating to the material adverse change
provision that was in effect through and including December 28, 1996. The
Company received working capital and net worth covenant amendments for fiscal
1997 which are less restrictive.

       The Company is required to maintain certain financial covenants
related to this agreement which the Company failed to maintain, but has 
received a waiver for the event of default at December 28, 1996.

      The Company believes that the 1997 Rights Offering (with Richemont's
commitment to advance $30 million against its purchase of all unsubscribed
shares) together with the Congress Facility financial covenant modifications
will ease vendor/credit concerns about the Company's viability. The Company
believes that upon the conclusion of the 1997 Rights Offering, the Company will
return to normal trade terms with all suppliers and will be able to obtain
normal trade terms with its suppliers and obtain sufficient merchandise on a
timely basis to satisfy customer demand. The Company's ability to sufficiently
improve upon its prior year's performance and implement its business strategy,
including realignment of business units and expense reductions, is critical to
maintaining adequate liquidity.

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

      The Company experiences seasonality in its working capital requirements
and fluctuations in the revolving Credit Facility which occur usually within the
first and fourth quarters of the year.

      Infrastructure Investments. In early 1995, the Company completed the
construction of a new fulfillment facility on a 53 acre site in Roanoke,
Virginia to support the Domestications catalog. The total cost of the facility
was $18.3 million. The Company experienced operating inefficiencies and start-up
problems in conjunction with bringing this facility into service. The Company
continued to experience inefficiencies in 1996, and made an additional
investment of approximately $3 million to help improve these operating problems
before the end of 1996.



                                       30
<PAGE>   31
      The Company's plan to restructure its catalog's into strategic business
groups and concentrate its mailing efforts on profitable customers will result
in excess capacity throughout its fulfillment centers. Therefore, the Company
intends to consolidate certain of its fulfillment operations into its new
Roanoke fulfillment center. This will require a capital investment of
approximately $5.0 million.

      The Company continued its management information systems up-grade in 1996.
The new system was operational in ten catalogs at the end of 1996. The Company
expects to complete the roll-out of the system to the remaining catalogs in 1997
for an additional capital investment of approximately $1 million. The Company
incurred higher MIS costs in 1996 due to the continued transition to the new
system. As of December 28, 1996, the Company had incurred capitalized costs of
approximately $17.9 million as part of this plan, including $2.0 million in
1996. Such costs included hardware and software costs aggregating $14.2 million
and internal costs of $3.7 million related to production of this new system. 
The Company began to amortize these costs over 5 years in 1995.

      Effects of Inflation and Cost Increases. The Company normally experiences
increased costs of sales and operating expenses as a result of the general rate
of inflation in the economy. Operating margins are generally maintained through
internal cost reductions and operating efficiencies and then through selective
price increases where market conditions permit. The Company's inventory is
mail-order merchandise which undergoes sufficiently high turnover so that the
costs of goods sold approximate replacement cost. Because sales are not
dependent upon a particular supplier or product brand, the Company can adjust
product mix to mitigate the effects of inflation on its overall merchandise
base.

      Paper and Postage. The Company mails its catalogs and ships most of its
merchandise through the United States Postal Service ("USPS"), with catalog
mailing and product shipment expenses representing approximately 18% of revenues
in 1996. Paper costs represented approximately 8% of revenues in 1995.

      Cautionary Statements

      The following statements constitute forward looking statements which
involve risks and uncertainties:
        
        This new structure will also result in reduced fixed overhead costs as
the Company's centralized services will be utilized more efficiently.

        The Company is moving to a decentralized structure whereby the
individual catalogs will be better able to manage their resources and
capitalize on business opportunities.
 
      The following are important factors, among others, that could cause the
Company's actual results to differ materially from those expressed in any
forward-looking statements made by, or on behalf, of the Company:

         The Company's new decentralized structure represents a significant
         change in the manner in which management of the newly created business
         units are accustomed to operate and the principal managers of the
         business units may not be able to effectively manage their businesses
         in a decentralized environment, particularly with respect to monitoring
         and implementing financial controls adequately to maintain appropriate
         working capital levels due to their limited experience or because of
         other factors which the Company may not have anticipated.

         Many of the managers of the Company's business units have not operated
         in a decentralized environment in the past and it may take substantial
         time before they are able to take advantage of the business
         opportunities, if any, that may inhere in the new structure.

         A general deterioration in the economic conditions in the United States
         leading to increased competitive activity including a business failure
         of a substantial size company in the retail industry, a reduction in
         consumer spending generally or specifically with reference to the types
         of merchandise that the Company offers in its catalogs.

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



                                       31
<PAGE>   32
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 28, 1996
and December 30, 1995, and the related consolidated statements of income (loss),
shareholders' (deficit) equity and cash flows for each of the three fiscal years
in the period ended December 28, 1996. These consolidated financial statements
and the schedule referred to below are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements and schedule based on our audits.

      We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

      In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Hanover Direct, Inc. and
subsidiaries as of December 28, 1996 and December 30, 1995, and the results of
their operations and their cash flows for each of the three fiscal years in the
period ended December 28, 1996 in conformity with generally accepted accounting
principles.

      Our audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedule listed in the index to
financial statement schedule 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

March 26, 1997




                                       32
<PAGE>   33
HANOVER DIRECT, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
As of December 30, 1995 and December 28, 1996

<TABLE>
<CAPTION>
                                               December 30,    December 28,
                                                  1995             1996
                                                 --------        --------
                                                      (in thousands)
<S>                                            <C>             <C>
ASSETS

Current Assets:
 Cash and cash equivalents                       $  2,682        $  5,173
 Accounts receivable, net of allowance for
  doubtful accounts of $2,597 in 1995 and
  $5,030 in 1996                                   30,176          29,399
 Inventories                                       79,281          67,610
 Prepaid catalog costs                             37,118          23,401
 Deferred tax asset, net                            3,300           3,300
 Other current assets                               6,170           3,148
                                                 --------        --------

        Total Current Assets                      158,727         132,031
                                                 --------        --------

Property and Equipment, at cost:
 Land                                               4,811           4,797
 Buildings and building improvements               19,353          16,554
 Leasehold improvements                            14,001           9,956
 Furniture, fixtures and equipment                 39,508          31,510
 Construction in progress                           5,479           8,315
                                                 --------        --------
                                                   83,152          71,132
 Accumulated depreciation and amortization        (26,090)        (22,523)
                                                 --------        --------

        Property and Equipment, net                57,062          48,609
                                                 --------        --------

Goodwill                                           36,586          17,901
Deferred tax asset, net                            11,700          11,700
Other assets                                       14,934          10,586
                                                 --------        --------
        Total Assets                             $279,009        $220,827
                                                 ========        ========
</TABLE>


See Notes to Consolidated Financial Statements.



                                       33
<PAGE>   34
HANOVER DIRECT, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (CONTINUED)
As of December 30, 1995 and December 28, 1996

<TABLE>
<CAPTION>
                                                                 DECEMBER 30,     DECEMBER 28,
                                                                     1995             1996
                                                                 ------------     ------------
                                                      (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
<S>                                                            <C>                <C>
 LIABILITIES AND SHAREHOLDERS' EQUITY

 Current Liabilities:
  Current portion of long-term debt and capital
    lease obligations                                              $  3,546        $ 11,452
  Accounts payable                                                   93,291          79,587
  Accrued liabilities                                                25,969          37,782
  Customer prepayments and credits                                    7,147           4,717
                                                                   --------        --------
     Total Current Liabilities                                      129,953         133,538
                                                                   --------        --------
Noncurrent Liabilities:
  Long-term debt                                                     57,283          53,255
  Capital lease obligations                                           1,973             482
  Other                                                               2,590           1,812
                                                                   --------        --------
    Total Noncurrent Liabilities                                     61,846          55,549
                                                                   --------        --------

    Total Liabilities                                               191,799         189,087
                                                                   --------        --------
Commitments and Contingencies (Note 17)
Shareholders' Equity
 Preferred Stock:
  6% Series A Convertible Additional
   Preferred Stock, $10 stated value,
   authorized 5,000,000 shares; issued and
   outstanding 78,300 shares in 1995                                    795              --
  Series B Convertible Additional Preferred Stock,
   $.01 par value, authorized, issued and outstanding
   634,900 shares in 1995 and 1996                                    5,558           5,748
  Common Stock, $.66 2/3 par value, authorized
   225,000,000 shares; issued 93,693,162 shares in
  1995 and 145,039,915 shares in 1996                                62,461          96,693
  Capital in excess of par value                                    255,390         270,097
  Accumulated deficit                                              (231,332)       (336,586)
                                                                   --------        --------
                                                                     92,872          35,952
  Less:
  Treasury stock, at cost (1,157,061 shares in 1995
   and 392,017 shares in 1996)                                       (3,345)           (813)
    Notes receivable from sale of Common Stock                       (2,023)         (3,399)
    Deferred compensation                                              (294)             --
                                                                   --------        --------
       Total Shareholders' Equity                                    87,210          31,740
                                                                   --------        --------

 Total Liabilities and Shareholders' Equity                        $279,009        $220,827
                                                                   ========        ========
</TABLE>

See Notes to Consolidated Financial Statements





                                       34
<PAGE>   35
HANOVER DIRECT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (LOSS)
For the years ended December 31, 1994, December 30, 1995 and December 28, 1996

<TABLE>
<CAPTION>
                                                 1994            1995             1996
                                                 ----            ----             ----
                                                (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

<S>                                            <C>             <C>             <C>
Revenues                                       $768,884        $749,767        $ 700,314
                                               --------        --------        ---------
Operating costs and expenses:
 Cost of sales and operating expenses           484,059         483,493          479,155
 Write-down of inventory of
   discontinued catalogs                             --           8,580            1,100
 Special charges                                     --           1,563           36,724
 Selling expenses                               197,436         205,618          195,032
 General and administrative expenses             65,257          64,112           70,608
 Depreciation and amortization                    6,157           9,020           12,192
                                               --------        --------        ---------
                                                752,909         772,386          794,811
                                               --------        --------        ---------

INCOME (LOSS) FROM OPERATIONS                    15,975         (22,619)         (94,497)

 Interest expense                                (3,544)         (5,050)          (8,858)
 Interest income                                    731             519              460
 Other income (expense)                          (1,833)             --               --
                                               --------        --------        ---------

Income (loss) before income taxes                11,329         (27,150)        (102,895)
 Income tax provision (benefit)                  (3,509)          1,003            1,000
                                               --------        --------        ---------

Income (loss) before extraordinary item          14,838         (28,153)        (103,895)
 Extraordinary item (Note 8)                         --          (1,837)          (1,134)
                                               --------        --------        ---------

NET INCOME (LOSS)                                14,838         (29,990)        (105,029)
Preferred stock dividends                          (135)           (240)            (225)
                                               --------        --------        ---------
 Net income (loss) applicable to
 Common Shareholders                           $ 14,703        $(30,230)       $(105,254)
                                               ========        ========        =========

Net income (loss) per share:
 Income (loss) before extraordinary item       $    .16        $   (.30)       $    (.93)

Extraordinary item                                   --            (.02)            (.01)
                                               --------        --------        ---------
NET INCOME (LOSS) PER SHARE                    $    .16        $   (.32)       $    (.94)
                                               ========        ========        =========

Weighted average common shares
outstanding                                      93,285          93,030          111,441
                                               ========        ========        =========
</TABLE>


See Notes to Consolidated Financial Statements.



                                       35
<PAGE>   36
                     HANOVER DIRECT, INC. AND SUBSIDIARIES
           CONSOLIDATED STATEMENTS OF SHAREHOLDERS' (DEFICIT) EQUITY
 FOR THE YEARS ENDED DECEMBER 31, 1994, DECEMBER 30, 1995 AND DECEMBER 28, 1996
                      (in thousands, except share amounts)



<TABLE>
<CAPTION>


                                                                          Preferred Stock           Preferred Stock
                                                                       Series B, Cumulative          Series A, 6.0%
                                                                         Shares    Amount          Shares     Amount
                                                                       ----------------------------------------------
<S>                                                                    <C>        <C>             <C>         <C>
Balance at January 1, 1994                                                   0     $    0         234,900      $2,378
Net income applicable to common shareholders
Exercise of warrants
Shares issued in Stock Offering
Preferred stock dividends                                                                                          (6)
Conversion of one-third of the 6% Preferred Stock                                                 (78,300)       (783)
Conversion of note payable
Issuance of  Common Stock for Employee Benefit Plans, net
                                                                       ----------------------------------------------
Balance at December 31, 1994                                                 0     $    0         156,600      $1,589
Net income/(loss) applicable to common shareholders
Issuance of Preferred Stock                                            634,900      5,400
Fair market value of warrant extensions
Preferred stock dividends and accretion                                               158                          83
Conversion of one-third of the 6% Preferred Stock                                                 (78,300)       (877)
Issuance of  Common Stock for Employee Benefit Plans, net
                                                                       ----------------------------------------------
Balance at December 30, 1995                                           634,900     $5,558          78,300      $  795
Net income/(loss) applicable to common shareholders
Shares issued in Rights Offering
Preferred stock dividends and accretion                                               190                          35
Conversion of the 6% Preferred Stock                                                              (78,300)       (830)
Purchase of treasury stock
Transfer of treasury stock related to employement agreement
Sale of treasury stock
Issuance of  Common Stock for Employee Benefit Plans, net
                                                                       ----------------------------------------------
Balance at December 28, 1996                                           634,900     $5,748               0      $    0
                                                                       ==============================================
</TABLE>

<TABLE>
<CAPTION>

                                                                                                       Capital
                                                                              Common Stock             in Excess
                                                                           $.66 2/3 par value            of Par         Accum.
                                                                          Shares           Amount        Value        (Deficit)
                                                                       --------------------------------------------------------
<S>                                                                    <C>                <C>         <C>             <C>
Balance at January 1, 1994                                              83,136,542        $55,423      $209,834       $(215,805)
Net income applicable to common shareholders                                                                             14,703
Exercise of warrants                                                     1,309,207            873          (873)
Shares issued in Stock Offering                                          8,045,296          5,364        42,136
Preferred stock dividends
Conversion of one-third of the 6% Preferred Stock                          189,818            126           657
Conversion of note payable                                                  13,945              9           162
Issuance of  Common Stock for Employee Benefit Plans, net                  283,426            190         1,294
                                                                       --------------------------------------------------------
Balance at December 31, 1994                                            92,978,234        $61,985      $253,210       $(201,102)
Net income/(loss) applicable to common shareholders                                                                     (30,230)
Issuance of Preferred Stock
Fair market value of warrant extensions                                                                   1,200
Preferred stock dividends and accretion
Conversion of one-third of the 6% Preferred Stock                          427,785            285           592
Issuance of  Common Stock for Employee Benefit Plans, net                  287,143            191           388
                                                                       --------------------------------------------------------
Balance at December 30, 1995                                            93,693,162        $62,461      $255,390       $(231,332)
Net income/(loss) applicable to common shareholders                                                                    (105,254)
Shares issued in Rights Offering                                        48,748,785         32,499        16,467
Preferred stock dividends and accretion
Conversion of the 6% Preferred Stock                                       819,733            546           284
Purchase of treasury stock
Transfer of treasury stock related to employement agreement                                              (2,750)
Sale of treasury stock                                                                                       28
Issuance of  Common Stock for Employee Benefit Plans, net                1,778,235          1,187           678
                                                                       --------------------------------------------------------
Balance at December 28, 1996                                           145,039,915        $96,693      $270,097       $(336,586)
                                                                       ========================================================
</TABLE>

<TABLE>
<CAPTION>
                                                                                                    Notes
                                                                                                 Receivable
                                                                                                  From Sale
                                                                            Treasury Stock        of Common  Deferred
                                                                         Shares      Amount         Stock       Comp.      Total
                                                                       ----------------------------------------------------------
<S>                                                                    <C>            <C>        <C>         <C>        <C>
Balance at January 1, 1994                                             (1,120,032)    $(3,130)    $(1,774)   $(1,058)   $  45,868
Net income applicable to common shareholders                                                                               14,703
Exercise of warrants                                                                                                            0
Shares issued in Stock Offering                                                                                            47,500
Preferred stock dividends                                                                                                      (6)
Conversion of one-third of the 6% Preferred Stock                                                                               0
Conversion of note payable                                                                                                    171
Issuance of  Common Stock for Employee Benefit Plans, net                 (37,029)       (215)       (138)       358        1,489
                                                                       ----------------------------------------------------------
Balance at December 31, 1994                                           (1,157,061)    $(3,345)    $(1,912)   $  (700)   $ 109,725
Net income/(loss) applicable to common shareholders                                                                       (30,230)
Issuance of Preferred Stock                                                                                                 5,400
Fair market value of warrant extensions                                                                                     1,200
Preferred stock dividends and accretion                                                                                       241
Conversion of one-third of the 6% Preferred Stock                                                                              (0)
Issuance of  Common Stock for Employee Benefit Plans, net                                            (111)       406          874
                                                                       ----------------------------------------------------------
Balance at December 30, 1995                                           (1,157,061)    $(3,345)    $(2,023)   $  (294)   $  87,210
Net income/(loss) applicable to common shareholders                                                                      (105,254)
Shares issued in Rights Offering                                                                                           48,966
Preferred stock dividends and accretion                                                                                       225
Conversion of the 6% Preferred Stock                                                                                            0
Purchase of treasury stock                                               (301,623)       (396)                               (396)
Transfer of treasury stock related to employement agreement               916,667       2,750                                   0
Sale of treasury stock                                                    150,000         178                                 206
Issuance of  Common Stock for Employee Benefit Plans, net                                          (1,376)       294          783
                                                                       ----------------------------------------------------------
Balance at December 28, 1996                                             (392,017)    $ (813)     $(3,399)   $     0    $  31,740
                                                                       ==========================================================
</TABLE>



See Notes to Consolidated Financial Statements.




                                       36


<PAGE>   37
HANOVER DIRECT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
  For the years ended December 31, 1994, December 30, 1995, and December 28,
1996

<TABLE>
<CAPTION>
                                                              1994          1995             1996
                                                              ----          ----             ----
                                                                           (in thousands)
<S>                                                        <C>             <C>             <C>
Cash flows from operating activities:
Net income (loss)                                          $ 14,838        $(29,990)       $(105,029)
Adjustments to reconcile net income (loss) to net
 cash provided (used) by  operating activities:
  Depreciation and amortization including
   deferred fees                                              6,499           9,419           13,277
  Provision for doubtful accounts                             3,697           4,448            6,805
  Provision for catalog and facility closings                    --          10,143           14,720
  Write-off of long-lived assets                                 --             500           22,000
  Extraordinary item - early extinguishment of
   debt                                                          --           1,837            1,134
  Provision for losses on notes receivable and
   marketable securities                                      2,121              --              888
  Deferred transaction costs                                   (837)             --           (1,211)
  Deferred taxes                                             (4,369)             --               --
  Other, net                                                     43              76               94
Changes in assets and liabilities, net of effects of
 acquired businesses and dispositions of assets:
  Accounts receivable, net                                   (9,901)         (6,161)          (7,863)
  Inventories                                                (3,424)          8,679           11,671
  Prepaid catalog costs                                      (8,154)            206           13,717
  Other current assets                                       (1,220)         (3,131)           1,332
  Accounts payable                                           10,518          (8,671)         (13,704)
  Accrued liabilities                                           185          (1,583)           1,219
  Customer prepayments and credits                           (1,389)          3,134           (2,430)
                                                           --------        --------        ---------

Net cash provided (used) by operating activities              8,607         (11,094)         (43,380)
                                                           --------        --------        ---------

Cash flows from investing activities:
Acquisitions of property and equipment                      (23,856)        (13,686)          (8,862)
Purchase of businesses                                           --         (13,008)              --
Proceeds from sales of businesses                                --              --            1,980
Proceeds from investment                                         --              --              794
Purchase of convertible debt securities                      (2,693)             --               --
Investments in affiliates                                    (3,183)             --               --
Advances                                                     (2,300)             --               --
Other, net                                                   (3,293)         (1,387)              --
                                                           --------        --------        ---------

Net cash (used by) investing activities                     (35,325)        (28,081)          (6,088)
                                                           --------        --------        ---------
</TABLE>


See Notes to Consolidated Financial Statements.



                                       37
<PAGE>   38
HANOVER DIRECT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
Years ended December 31, 1994, December 30, 1995 and December 28, 1996

<TABLE>
<CAPTION>
                                                             1994            1995           1996
                                                             ----            ----           ----
                                                                        (in thousands)
<S>                                                        <C>            <C>             <C>
Cash flows from financing activities:
  Net proceeds (payments) under revolving credit
   facility                                                $  (230)       $     --        $ 11,699
  Proceeds from issuance of debt                            10,000          20,685          10,000
  Payments of long-term debt and capital lease
   obligations                                              (8,015)         (1,419)        (17,625)
  Cash dividends paid                                       (1,027)             --              --
  Payment of debt issuance costs                            (1,458)         (2,202)         (1,990)
  Repurchase of Common Stock                                  (215)             --              --
  Proceeds from issuance of Common Stock                    49,305             400          50,653
  Other, net                                                  (172)            340            (778)
                                                           -------        --------        --------

Net cash provided by financing activities                   48,188          17,804          51,959
                                                           -------        --------        --------


Net increase (decrease) in cash and cash equivalents        21,470         (21,371)          2,491
Cash and cash equivalents, beginning of year                 2,583          24,053           2,682
                                                           -------        --------        --------
Cash and cash equivalents, end of year                     $24,053        $  2,682        $  5,173
                                                           =======        ========        ========

Supplemental cash flow disclosure:
  Interest paid                                            $ 2,923        $  4,586        $  6,224
  Income taxes paid                                        $   701        $  1,318        $  1,096
</TABLE>



See Notes to Consolidated Financial Statements.



                                       38
<PAGE>   39
HANOVER DIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1994, DECEMBER 30, 1995 AND DECEMBER 28, 1996

1.     BACKGROUND OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES.

       Nature of Operations - Hanover Direct, Inc., a Delaware company, ("HDI")
is a direct specialty retailer in the United States that publishes a portfolio
of branded specialty catalogs offering home fashions, general merchandise, men's
and women's apparel and gifts. HDI also operates several retail operations in
the United States which comprised approximately 4% of HDI's net revenues for the
year ended December 28, 1996.

       The Company has experienced significant operating losses during 1995 and
1996 which resulted in numerous issues, including liquidity and vendor
concern. The Company completed a Rights Offering in August 1996 (Note 9) which
helped to alleviate these issues and concerns, however, continued operating
losses through the remainder of fiscal 1996 has resulted in the Company
proceeding with a 1997 Rights Offering and a modification of the Congress
Facility financial covenants to less restrictive terms (Note 18). The Company's
ability to significantly improve upon its prior year's performance and
implement its business strategy, including realignment of business units and
expense reductions, is critical to maintaining adequate liquidity.

       Principles of Consolidation - The Consolidated Financial Statements
include the accounts of HDI and all subsidiaries (the "Company"). Intercompany
transactions and balances have been eliminated. Certain prior year amounts have
been reclassified to conform to the current year presentation.

       Fiscal Year - The Company operates on a 52 or 53 week fiscal year. The
years ended December 28, 1996, December 30, 1995 and December 31, 1994 were 52
week years.

       Use of Estimates - The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities, the disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.

       Inventories - Inventories consist principally of merchandise held for
resale and are stated at the lower of cost or market. Cost is determined using
the first-in, first-out (FIFO) method. The Company considers slow moving
inventory to be surplus and calculates a loss on the impairment as the
difference between an individual item's cost and the net proceeds anticipated to
be received upon disposal. Such inventory is written down to its net realizable
value. The costs capitalized by the Company are the costs of the product and
freight-in charges.

       Prepaid Catalog Costs - Costs related to mail order catalogs and
promotional material are capitalized and amortized over their estimated
productive lives, generally not exceeding six months. Total catalog expense was
$193.5 million, $197.3 million and $191.8 million, respectively, in 1996, 1995
and 1994.

       Depreciation and Amortization - Depreciation and amortization of property
and equipment is provided on the straight-line method over the following lives:
buildings and building improvements, 30-40 years; furniture, fixtures and
equipment, 3-10 years; and leasehold improvements, over the shorter of the
estimated useful lives or the terms of the related leases. Expenditures for
maintenance and repairs are charged to operations as incurred.



                                       39
<PAGE>   40
       Capitalized development costs for the Company's new management
information systems aggregated $6.4 million at December 30, 1995. Such costs are
included in Other assets and are being amortized over a five year period
commencing July 1995. No such costs were capitalized during 1996.

       Goodwill - Excess of cost over the net assets of acquired businesses is
amortized on a straight-line basis over periods of up to forty years.
Accumulated amortization was $3.0 million and $5.6 million at December 28, 1996
and December 30, 1995, respectively.

       Mailing Lists - The costs of acquired mailing lists are amortized over a
five year period. Mailing lists, included in Other assets, amounted to $1.2
million and $3.5 million at December 28, 1996 and December 30, 1995,
respectively, and are carried net of accumulated amortization of $1.5 million
and $1.6 million, respectively.

       Accounting for the Impairment of Long-Lived Assets - Statement of
Financial Accounting Standards (SFAS) No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long- Lived Assets to Be Disposed Of" was issued by
the Financial Accounting Standards Board in March 1995. This Statement
establishes accounting standards for the impairment of long-lived assets,
certain identifiable intangibles, and goodwill related to those assets to be
held and used and for long-lived assets and certain identifiable intangibles to
be disposed of. The Company reviews the carrying values of its long-lived and
identifiable intangible assets for possible impairment whenever events or
changes in circumstances indicate that the carrying amount of assets may not be
recoverable. Based upon the assessment of cash flows for certain underperforming
catalogs, the Company recorded a charge related to impaired assets of $22.0
million for the fiscal year ended December 28, 1996 (Note 3).

       Accounting for Stock Based Compensation - In October 1995, the Financial
Accounting Standards Board issued SFAS No. 123, "Accounting for Stock-Based
Compensation," which is effective in 1996. The Statement encourages entities to
adopt the fair value-based method of accounting for employee stock option plans,
as opposed to the method which measures compensation cost for those plans using
the intrinsic value-based accounting prescribed by APB Opinion No. 25,
"Accounting for Stock Issued to Employees." In accordance with the provisions of
SFAS No. 123, the Company recorded a compensation charge of $.5 million in
fiscal 1996.

       Accounting for Income Taxes - The Company accounts for income taxes in
accordance with SFAS No. 109, "Accounting for Income Taxes." This pronouncement
established financial accounting and reporting standards for the effects of
income taxes that result from the Company's activities during the current and
preceding years. It requires an asset and liability approach for financial
accounting and reporting for income taxes. The provision for income taxes is
based upon income after adjustment for those temporary and permanent items which
are not considered in the determination of taxable income. Deferred taxes result
when the Company recognizes revenue or expenses for income tax purposes in a
different year than for financial reporting purposes.

       Cash and Cash Equivalents - Cash and cash equivalents include cash and
all highly liquid investments with original maturities of ninety days or less.



                                       40
<PAGE>   41
       Net Income Per Share - Net income per share is computed using the
weighted average number of common shares outstanding. The weighted average
number of shares used in the calculation for both primary and fully diluted net
income per share in 1996, 1995 and 1994 was 111,441,247, 93,029,816 and
93,285,190, shares, respectively. Common share equivalents for purposes of net
income per share consist of stock options and warrants.

       Recently Issued Accounting Standard - Subsequent to December 28, 1996,
the Financial Accounting Standards Board issued SFAS No. 128, "Earnings Per
Share." This statement establishes standards for computing and presenting
earnings per share ("EPS"), replacing the presentation of currently required
primary EPS with a presentation of Basic EPS. For entities with complex capital
structures, the statement requires the dual presentation of both Basic EPS and
Diluted EPS on the face of the statement of operations. Under this new standard,
Basic EPS is computed based on weighted average shares outstanding and excludes
any potential dilution. Diluted EPS reflects potential dilution from the
exercise or conversion of securities into common stock or from other contracts
to issue common stock and is similar to the currently required fully diluted
EPS. SFAS No. 128 is effective for financial statements issued for periods
ending after December 15, 1997, including interim periods, and earlier
application is not permitted. When adopted, the Company will be required to
restate its EPS data for all periods presented. The Company does not expect the
impact of the adoption of this statement to be material to previously reported
EPS amounts.

       Revenues - The Company recognizes revenue at the time the merchandise is
shipped to the customer. Amounts billed to customers for postage and handling
charges are recognized as revenue at the time that the revenues on the product
shipment are recognized. The Company provides a reserve for expected future
returns at the time the sale is recorded based upon historical experience.

       Fair Value of Financial Instruments - The fair value of financial
instruments does not materially differ from their carrying values.

Supplemental Disclosure of Noncash Activities

<TABLE>
<CAPTION>
                                            1994          1995            1996
                                           ------       --------        -------
                                                   (IN THOUSANDS)
<S>                                        <C>          <C>             <C>
Capital lease obligations ..........       $   --       $  1,155        $    --
                                           ======       ========        =======
Other equity issuances and exchanges       $1,823       $  1,456        $ 2,855
                                           ======       ========        =======

Acquisition of businesses:
  Fair value of assets acquired ....       $   --       $ 45,165        $    --
  Fair value of liabilities assumed            --        (26,757)            --

  Preferred stock issued ...........           --         (5,400)            --
                                           ------       --------        -------

  Net cash paid ....................       $   --       $ 13,008        $    --
                                           ======       ========        =======
</TABLE>



                                       41
<PAGE>   42
2.     ACQUISITIONS AND INVESTMENTS

       ACQUISITIONS - During fiscal 1995, the Company acquired the entities
described below, which were accounted for by the purchase method of accounting.
The operating results of these acquired businesses have been included in the
consolidated statements of income from the date of acquisition:

       Improvements--In January 1995, the Company acquired substantially all of
the assets of Leichtung, Inc., a direct marketer of wood-working and home
improvement tools and related products sold under the Improvements and Leichtung
Workshops names, for a purchase price of approximately $12.8 million in cash and
the assumption of certain liabilities. The excess purchase price over the fair
values of the net assets acquired (goodwill) was $7.3 million. Approximately
$1.4 million of customer mailing list intangible assets were also purchased in
this transaction.

       In the first quarter of 1996, the Company sold the assets of the
Leichtung Workshops catalog for $.9 million in cash and short-term notes and
relocated all Improvements' telemarketing and fulfillment operations to the
Company's Hanover, PA facility. There was no gain or loss recognized on the sale
of the assets of the Leichtung Workshops catalog. The distribution facility in
Ohio, which is being held for sale, was written down to its estimated net
realizable value of $.1 million, as of December 28, 1996. In 1996, the Company
provided $.7 million, included as a component of special charges, to write-down
this facility (Note 3).

       The Safety Zone--In February 1995, the Company acquired the remaining 80%
of the outstanding common stock it did not already own of Aegis Safety Holdings,
Inc. ("Aegis"), publisher of The Safety Zone catalog, through the issuance of
634,900 shares of a newly-created Series B Convertible Additional Preferred
Stock ("Series B Stock") of the Company with a stated value of $10 per share.
Dividends are payable on the Series B Stock at various rates and times and are
contingent on specific earnings targets. The Series B Stock is also convertible,
subject to antidilution, as discussed in Note 10. The excess purchase price over
the fair values of the net assets acquired (goodwill) was $7.1 million. In
December 1996, the Company wrote-off the goodwill related to this acquisition
in accordance with SFAS No. 121 (Note 3).

       Austad's--In May 1995, the Company acquired 67.5% of the outstanding
shares of Austad's Holdings, Inc. ("Austad's"), which owned The Austad Company
("TAC"), the publisher of the Austad's catalog featuring golf equipment, apparel
and gifts, for a purchase price of $1.8 million in cash. The Company also lent
TAC, on a subordinated basis, $2.2 million which bears interest at the rate of
10% per annum and is due by May 2000. The Company also provided a $.4 million
loan to TAC which bears interest at a fluctuating rate (8.75% at December 28,
1996 and December 30, 1995) and is secured by a second mortgage on TAC's office
and warehouse. The excess purchase price over the fair values of the net assets
acquired (goodwill) was $4.5 million. Approximately $1.2 million of customer
mailing list intangible assets were also acquired in this transaction. In
December 1996, the Company wrote-off the goodwill and mailing lists in
accordance with SFAS No. 121 (Note 3).



                                       42
<PAGE>   43
       On February 16, 1996, former minority shareholders surrendered to
Austad's their Austad's shares, amounting to 32.5% of the outstanding shares,
and paid approximately $1.1 million in exchange for all the outstanding shares
of AGS, Inc. ("AGS"), a South Dakota corporation formed by TAC to hold the
existing retail assets and liabilities of TAC. The transaction assumed a value
for Austad's and TAC based on the Company's purchase price in the May 1995
acquisition, as adjusted by adding the net income of Austad's and TAC from May
25, 1995 through February 16, 1996.

       As a result of the reorganization, Austad's became a wholly owned
subsidiary of the Company. In connection with the reorganization, TAC was
released from all future obligations under all store leases. AGS will operate
the four existing retail stores acquired from TAC as Austad's stores under
license from Austad's. The customer service and fulfillment operations of
Austad's were transferred to other Company facilities in the first quarter of
1996, and the Company sold the Austad's South Dakota warehouse and distribution
facility in July 1996 for $2.1 million which approximated its book value. The
net proceeds were used to pay the outstanding mortgage on the property (Note 8).

       TAC had a revolving credit facility that was secured by substantially all
of TAC's assets that expired on February 26, 1996. Such facility was paid off at
the February 16th closing with the proceeds from the sale of the retail
operations and from the Company's revolving credit facility (Note 8).

       The following represents the unaudited pro forma results of operations
for the years ended December 31, 1994 and December 30, 1995 as if these
acquisitions had occurred at the beginning of fiscal year 1994.

<TABLE>
<CAPTION>
                                             (In thousands, except per share amounts)
                                                          (Unaudited)
                                                      1994           1995
                                                    --------       --------
<S>                                                <C>             <C>
 Revenues                                           $840,295       $763,786
                                                    ========       ========

 Income (loss) before extraordinary item            $ 14,305       $(28,083)
                                                    ========       ========

 Net income  (loss)                                 $ 14,170       $(30,160)
                                                    ========       ========

 Per Share:
 Income (loss) before extraordinary item            $    .15       $   (.30)
 Extraordinary item                                       --           (.02)
                                                    --------       --------
 Net income (loss)                                  $    .15       $   (.32)
                                                    ========       ========
</TABLE>

       The pro forma information does not purport to be indicative of the
results that actually would have been obtained if the operations were combined
during the periods presented and is not intended to be a projection of future
results or trends. Per share amounts are expressed after deducting preferred
stock dividends of $.1 and $.2 million in 1994 and 1995, respectively.

       OTHER INVESTMENTS - Other investments, which are recorded in Other assets
in the accompanying consolidated balance sheets, include the following:



                                       43
<PAGE>   44
       Blue Ridge Associates - In January 1994, the Company purchased for $1.1
million, a 50% interest in Blue Ridge Associates ("Blue Ridge"), a partnership
which owns the apparel distribution center in Roanoke, Virginia. The remaining
50% interest is held by an unrelated third party. This investment is accounted
for by the equity method of accounting. The Company made annual rent payments to
the partnership of approximately $.7 million in both 1996 and 1995 as part of a
15 year lease through 2008. The Company also recorded $.1 million in income for
its portion of the partnership income in both 1996 and 1995. The Company's
investment in Blue Ridge was approximately $.9 million and $1 million at
December 28, 1996 and December 30, 1995, respectively. In December 1996, the
Company decided to consolidate this facility into its new Roanoke, Virginia
distribution facility.

       Regal Communications, Inc. - During 1994, the Company invested
approximately $2.7 million in convertible debt securities of Regal
Communications, Inc. ("Regal"). In September 1994, Regal filed for protection
under Chapter 11 of the United States Code. As a result, during 1994, the
Company wrote down the convertible debentures to the estimated fair value of
$1.7 million. The $1 million decline in fair value of the investment was
considered an other- than-temporary impairment and included in the income
statement in 1994. The convertible debt matures on June 15, 2008. In December
1995, a plan of reorganization was confirmed by the Bankruptcy Court and the
Company expected to recover the $1.7 million carrying value of its investment,
however, only $.8 million of distributions were received through 1996. During
1996, a federal income tax refund due to Regal was reviewed by the Internal
Revenue Service (the "IRS"), and the results of this review have been submitted
to the Joint Committee of the IRS for approval. Due to the uncertainty that
recoverability of substantially all of the remaining investment balance is
subject to a favorable outcome, in December 1996, the Company wrote-off the
remaining $.9 million balance as the decline in fair value was considered an
other than temporary impairment.

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

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

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



                                       44
<PAGE>   45
In 1995, the Company received inventory and the customer mailing list of BPC in
payment of its $1.2 million loan and subsequently realized $.3 million upon
disposition of these assets and wrote-off the remaining assets.

3.     SPECIAL CHARGES

       In December 1996, the Company recorded special charges aggregating
approximately $36.7 million. These charges consist of severance ($3.2 million)
and facility exit/relocation costs and fixed asset write-offs ($11.5 million)
related to the previously announced downsizing of the Company, as discussed in
its December 1996 press release. In addition, the Company's review of the
impairment of its long-lived assets of certain under-performing catalogs led to
a write-off of $22.0 million.

       Severance - The cost of employee severance includes termination benefits
for line and supervisory personnel in fulfillment, telemarketing, MIS,
merchandising, and various levels of corporate and catalog management. These
costs are recorded in Accrued liabilities in the accompanying consolidated
balance sheet at December 28, 1996.

       Facility Exit/Relocation Costs and Fixed Asset Write-Offs - These costs
are primarily composed of the Company's decision to relocate from its Weehawken,
NJ corporate facility, and consolidate its Roanoke, VA apparel distribution
center and Hanover, PA distribution center into its Roanoke home fashion
distribution center. The consolidation of these distribution centers and the
relocation of the corporate operations is expected to be completed by the end of
fiscal 1997. Approximately $6.3 million of these costs are recorded in Accrued
liabilities in the accompanying consolidated balance sheet at December 28, 1996.

       In 1995, the Company incurred costs, aggregating approximately $1.5
million, in connection with the consolidation of its fulfillment facilities.
These costs include moving expenses, lease termination fees and severance
expenses, substantially all of which were paid in 1995. There were no such
charges incurred by the Company in 1994.

       Impairment of long-lived assets - The Company considers a history of
catalog operating losses to be its primary indicator of potential impairment.
Assets are grouped and evaluated for impairment at the lowest level for which
there are identifiable cash flows that are independent of the cash flows of
other groups of assets. The Company has identified the appropriate grouping of
assets to be individual catalogs, except where certain catalogs are a part of a
group that, together, generate joint cash flows. The assets are deemed to be
impaired if a forecast of undiscounted future operating cash flows is less than
the carrying amounts. The loss is measured as the amount by which the carrying
amount of the assets exceeds its fair value. The Company generally measures fair
value by discounting estimated future cash flows. Considerable management
judgment is necessary to estimate discounted future cash flows and, accordingly,
actual results could vary significantly from such estimates. The impairment loss
was approximately $22.0 million and is primarily composed of the write-off of
goodwill and mailing lists associated with Tweeds, Austad's and The Safety Zone
(Note 2). No such charges were recorded by the Company in 1995 and 1994.



                                       45

<PAGE>   46
4.     WRITE-DOWN OF INVENTORY OF DISCONTINUED CATALOGS

       In 1995, the Company made a decision to discontinue six catalogs. The six
discontinued catalogs generated revenues of $20 million, $88 million and $118
million and losses of $5.1 million, $20 million and $4.7 million in 1996, 1995
and 1994, respectively. These losses are attributable to falling revenues due to
poor sales on the discontinued catalogs, increasing operating costs and expenses
and increasing selling expenses predominantly incurred to create liquidation
catalogs. The losses in 1996 and 1995 include provisions of approximately $1.1
million and $8.6 million, respectively, primarily related to the write-down of
inventory associated with these catalogs to their net realizable value based on
the planned liquidation of such inventory. The $8.6 million write-down in 1995
occurred because the Company anticipated mailing fewer catalogs than originally
planned for 1996, which resulted in significantly more merchandise on-hand that
needed to be moved through non-catalog channels. The inventory write-down of
$1.1 million in 1996 was required due to lower than anticipated recovery rates
on liquidation of such inventory. The Company utilizes various methods to
dispose of the inventory related to discontinued catalogs, including special
sale catalogs, sales sections in other catalogs and liquidations of remaining
inventory through off-price merchants. This liquidation process typically takes
from six to nine months. These losses represent an incremental provision in
excess of the original provision included in cost of sales expense. There were
no such charges incurred by the Company in 1994. Fixed overhead expenses,
primarily telemarketing and fulfillment costs, that were allocated to the six
discontinued catalogs have been absorbed by the operations of the 1995
acquisitions and through cost containment measures instituted by the Company.

5.     SEARS LICENSING AGREEMENT.

       In January 1994, the Company entered into a licensing agreement (the
"Sears Agreement") with the direct marketing subsidiary of Sears Roebuck and Co.
("Sears") to produce specialty catalogs for customers of the discontinued Sears
catalog. The specialty catalogs included: Show Place, based on the
Domestications catalog, Great Kitchens, based on the Colonial Garden Kitchens
catalog, and Sears Improvements, based on the Improvements catalog. The Sears
Agreement had an initial three-year term and was to continue thereafter unless
terminated. In December 1996, the Sears Agreement was terminated by Sears with
the last catalogs to be mailed in the first quarter of 1997. Sears terminated
the agreement based on the Company's non-compliance with certain operating
standards in order fulfillment and certain reporting standards.

        Profits and losses from the venture are shared between the parties on an
equal basis until the venture is completed in the first quarter of 1997. In
accordance with the Sears Agreement, earnings before interest and taxes ("EBIT")
generated by the Sears catalogs is the basis for dividing these profits. The
Sears specialty catalogs generated revenues of $82 million, $81 million and $71
million and EBIT of $.3 million, $3.0 million and $2.9 million in 1996, 1995 and
1994, respectively.

       The Company also issued to Sears a performance warrant to purchase 3.5
million shares of Common Stock in 1999 if the licensed business with Sears had
revenues of at least $250 million and EBIT of at least $30 million in 1998.
Alternately, Sears would have been entitled to purchase 7 million shares of
Common Stock in 1999 if the licensed business with Sears had revenues of at
least $500 million and EBIT of at least $60 million in 1998. The warrant
exercise



                                       46
<PAGE>   47
price was $10.57 per share. Through 1996, no charges have been recorded in
connection with the warrants. Due to the termination of the Sears Agreement, the
Company believes that the venture wind-up activities will not generate
sufficient financial performance to enable Sears to exercise these warrants. The
Company believes that the termination of this venture will not have a material
impact on the Company's 1997 operating results.

6.     ACCOUNTS RECEIVABLE, NET.

       The Company currently maintains an agreement with an unrelated third
party which provides for the sale and servicing of accounts receivable
originating from the Company's revolving credit cards. The agreement expires in
December 2000. The Company remains obligated to repurchase uncollectible
accounts pursuant to the recourse provisions of the agreement and is required to
maintain a specified percentage of all outstanding receivables sold under the
program as a deposit with the third party to secure its obligations under the
agreement. The Company is required to maintain certain financial covenants
related to this agreement and has received a waiver for the events of default at
December 28, 1996.

       The proceeds to the Company relating to the sale of receivables for 1996,
1995 and 1994 were $39.2 million, $46.2 million and $56.1 million, respectively.
At December 28, 1996 and December 30, 1995, the uncollected balances under this
program were $33.5 million and $38.6 million, respectively, of which $4.8
million, and $5.5 million respectively, represent deposits under the agreement
which are included in Accounts receivable, net. The total reserve balance
maintained for the repurchase of uncollectible accounts was $2.5 million and
$2.4 million at December 28, 1996 and December 30, 1995, respectively, of which
$1.4 million in both years is included in Accrued liabilities and the remaining
balance is included in the allowance for doubtful accounts.

       Receivables sold under this agreement are considered financial
instruments with off-balance sheet risk as defined in Statement of Financial
Accounting Standards No. 105. Because the Company's sales are primarily made to
individual customers located throughout the United States, the Company believes
there are no concentrations of credit risks.



                                       47
<PAGE>   48
7.     ACCRUED LIABILITIES.

       Accrued liabilities consist of the following (in thousands):

<TABLE>
<CAPTION>
                                            December 30,   December 28,
                                               1995           1996
                                               ----           ----
<S>                                         <C>            <C>
Restructuring                                 $    --       $ 9,504
Reserve for future sales returns                5,535         9,036
Compensation                                    5,795         3,968
Taxes                                           3,007         2,696
Reserve for repurchase of accounts
   receivable sold with recourse                1,391         1,389
Other                                          10,241        11,189
                                              -------       -------
     Total                                    $25,969       $37,782
                                              =======       =======
</TABLE>


8.   LONG-TERM DEBT.

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

<TABLE>
<CAPTION>
                                                         December 30,  December 28,
                                                              1995          1996
                                                              ----          ----
<S>                                                      <C>           <C>
Congress Facility                                           $ 9,931       $22,627
Term Financing Facility                                      20,000        19,000
TAC Revolving Credit Facility                                 2,011            --
NAR Promissory Note                                              --        10,000
6% Mortgage Notes Payable due 1998                            3,139         2,969
Industrial Revenue Bonds with variable interest rates
 averaging 4.1% in 1995 and 3.6% in 1996 due
 2003                                                         8,000         8,000
7.5% Convertible Subordinate Debentures due
 2007                                                           751           751
8.75% Mortgage Note Payable due 2003                          1,718            --
9.25% Senior Subordinated Notes due 1998                     14,000            --
Other                                                            19            16
                                                            -------       -------
                                                             59,569        63,363
Less current portion                                          2,286        10,108
                                                            -------       -------
                                                            $57,283       $53,255
                                                            =======       =======
</TABLE>


         In November 1995, the Company replaced their previous $80 million
unsecured revolving credit facility (the "Revolver") with a new $75 million
secured credit facility (the "Congress Facility") with Congress Financial
Corporation ("Congress"), and repaid all amounts outstanding under the Revolver.
In addition, all standby letters of credit issued under the previous arrangement
were replaced with letters of credit issued by Congress under the Congress
Facility.



                                       48
<PAGE>   49
         Congress Facility - The Congress Facility is comprised of a revolving
line of credit of up to $65 million with a three year term ("Congress Revolving
Credit Facility") and two year term loans aggregating $10 million ("Revolving
Term Notes"). The amount that can be borrowed under the Congress Facility is
based on percentages of eligible inventory and accounts receivable from time to
time. Beginning in November 1996, Congress lowered the advance rate by which the
available inventory is calculated by $4.4 million. This calculation was further
reduced by $2.0 million, pending completion of a new inventory appraisal which
was completed in March 1997. The Congress Revolving Credit Facility bears
interest at 1.25% above CoreStates' prime rate and the Revolving Term Notes
bears interest at 1.5% above CoreStates' prime rate. The Congress Facility is
secured by all assets of the Company, and the Company was required to maintain a
minimum net worth of $80 million, and working capital of $26 million. In
addition, the Congress Facility places limitations on the incurrence of
additional indebtedness. The rates of interest related to the Congress Revolving
Credit Facility and Revolving Term Notes at such dates were 9.50% and 9.75%,
respectively. At December 28, 1996 and December 30, 1995, the Company had $13.7
million and no outstanding borrowings under the Congress Revolving Credit
Facility and $8.9 million and $9.9 million outstanding under the Revolving Term
Notes, respectively. The face amount of unexpired documentary letters of credit
at December 28, 1996 and December 30, 1995, were $4.5 million and $4.2 million,
respectively. At December 28, 1996 unused borrowing capacity under the Congress
Facility was $26.0 million. In 1995, the Company issued under the Congress 
Facility, $31.2 million of standby letters of credit which included 
$8.6 million related to the Industrial Revenue Bonds due 2003, and 
$20.3 million related to the Term Financing Facility.

         The Congress Facility was amended in February 1996 to permit the
reorganization of Austad's (Note 2) and was further amended in April 1996 to
permit borrowings of an additional $4 million over the borrowing base formula
until the closing of the Company's $50 million rights offering (the "Rights
Offering") in August 1996 (Note 9), subject to the $75 million limit of the
Congress Facility. Also in April 1996, the minimum working capital and net worth
requirements contained in the Congress Facility and in the indenture relating to
the 9.25% Senior Subordinated Notes due 1998 ("9.25% Notes") were reduced by $5
million to $21 million and $75 million, respectively. In May 1996, the net worth
and working capital covenants were further amended to take into account a $25
million advance by NAR Group Limited ("NAR") until its repayment with the
proceeds of the Rights Offering in August 1996 (Note 9). In September 1996,
working capital was amended again to take into account the $10 million advance
by Intercontinental Mining & Resources Incorporated, an affiliate of NAR
("IMR"). The net worth covenant was further amended to $70 million in December
1996 and Congress agreed to address the 1997 net worth covenant level after a
review of the Company's business plan. As a result of the operating losses
incurred in 1996, the Company was not in compliance with the working capital and
net worth covenants for which the Company received waivers from Congress (Note
18).

         Term Financing Facility - The Company borrowed $10 million in each of
1994 and 1995 under a Term Financing Facility. The interest rate on the Term
Financing Facility is based on the equivalent rate of A-1 commercial paper
existing at the time of each borrowing. The face rate ranged from 5.47% to
5.73%, and 5.73% to 6.02% at December 28, 1996 and December 30, 1995,
respectively. The Term Financing Facility was reduced by an annual sinking fund
payment of $1.0 million in October 1996 and requires annual sinking fund
payments of $1.0 million from October 1997 though October 1999 with this amount
increasing to $1.6 million for each of the ten years thereafter. The Term
Financing Facility continues to be outstanding and in effect under its original
terms.



                                       49
<PAGE>   50
         In December 1996, the Company finalized its agreement (the
"Reimbursement Agreement") with Richemont Finance S.A. ("Richemont"), who along
with the family of Alan G. Quasha, Chairman of the Board of the Company, jointly
own NAR, that provided the Company with approximately $27.9 million of letters
of credit through Swiss Bank Corporation's, New York Branch, to replace letters
of credit which were issued under the Congress Facility. These letters of credit
were issued for $8.6 million related to the Industrial Revenue Bonds due 2003
and $19.3 million related to the Term Financing Facility. The letters of credit
will expire on February 18, 1998 and carry an interest rate of 3.5% above the
prime rate, currently 11.75%, payable to Richemont quarterly on amounts drawn
under the letters of credit. The Company paid a facility fee of $1.4 million
which was equal to 5% of the principle amount of the letters of credit as well
as other fees incurred in connection with providing the facility as of December
28, 1996. In the event that the Company has not paid in full, by the expiration
date, any outstanding balances under the letters of credit, Richemont shall have
the option, exercisable at any time prior to payment in full of all amounts
outstanding under the letters of credit to convert such amount into common stock
of the Company at the mean of the bid and ask prices of the Company's Common
Stock on November 8, 1996, or the mean of the bid and ask prices of the
Company's Common Stock on each of the thirty days immediately prior to the date
of exercise of the conversion privilege. The Reimbursement Agreement is
subordinate to the Congress Facility. On December 5, 1996, Richemont advanced
the Company $10 million against the anticipated $27.9 million line of credit.
The Company repaid the $10 million loan after the letter of credit agreement was
in place on December 19, 1996.

         The TAC Revolving Credit Facility - The TAC Revolving Credit Facility
was paid off with the proceeds from the Congress Facility and with the proceeds
from the sale of the retail operations, on February 16, 1996 (Note 2), and was
classified as a long-term obligation at December 30, 1995.

         NAR Promissory Note - In September 1996, IMR loaned the Company $10
million as evidenced by a subordinated promissory note (the "NAR Promissory
Note"). This loan bears interest at prime plus 1.5%, was due on November 14,
1996 and, if it is not repaid before May 15, 1997, is convertible at the option
of NAR into shares of Common Stock at the lower of the fair market value thereof
on the date of execution or the then current fair market value thereof. The NAR
Promissory Note is subordinate to the Congress Facility and is excluded from the
working capital covenant calculation. NAR has agreed to apply $10 million of the
Company's indebtedness to acquire $10 million of the Company's Common Stock
pursuant to the 1997 Rights Offering (Note 18). As a result, the classification
of this debt remains long-term.

         6% Mortgage Notes Payable due 1998 - In connection with The Company
Store acquisition, subsidiaries of the Company executed and delivered two
secured notes in the aggregate amount of $3.5 million with interest at 6% per
annum with principal and interest payments payable monthly on a fifteen-year
amortization schedule with the remaining balance due in August 1998. The
mortgage notes payable are non-recourse notes and are not guaranteed by the
Company. The mortgage notes payable are secured by the manufacturing and office
facilities of The Company Store. The amounts outstanding were $3.0 million and
$3.1 million at December 28, 1996 and December 30, 1995, respectively.

         Industrial Revenue Bonds due 2003 - The Industrial Revenue Bonds are
due on December 1, 2003 and are secured by the related assets purchased from the
proceeds of the bonds and by



                                       50
<PAGE>   51
an irrevocable letter of credit in the amount of $8.6 million. The obligations
are guaranteed by the Company.

         8.75% Mortgage Note Payable due 2003 - TAC's 8.75% Mortgage Note
Payable is reflected as an obligation of the Company at December 30, 1995 in
consequence of the corporate reorganization, completed in February 1996 (Note
2). Pursuant to the reorganization, TAC's retail business was split off to Mr.
David Austad and certain of his family members, in exchange for their 32.5%
interest in Austad's (and a cash payment of $1.1 million) and the Company became
the owner of all the outstanding capital shares of TAC. The 8.75% Mortgage Note
Payable was secured by the TAC warehouse and distribution facility in South
Dakota. That facility's operations were largely transferred to other Company
facilities. This note was paid in July 1996 from the proceeds of the sale of the
facility.

         9.25% Senior Subordinated Notes due 1998 - At December 28, 1996 and
December 30, 1995, the Company had $0 and $14.0 million of 9.25% Notes
outstanding, respectively. In August 1996, the principal amount due under the
9.25% Notes was repaid from the proceeds of the Rights Offering (Note 9).

         In November 1995, IMR purchased the 9.25% Notes from a third party in
connection with the refinancing of the indebtedness under the Congress Facility.
The Company paid NAR a commitment fee of $105,000 upon the signing of a
repurchase and option agreement and a fee of $210,000 (1.5% of the outstanding
principal amount of the 9.25% Notes acquired by IMR) upon the funding, as well
as all expenses incurred by NAR in performing its obligation. The Company also
extended by two years the terms of the warrants to purchase 5,033,735 shares
held by NAR and IMR to August 1, 1998. The Company recorded as debt issuance
costs approximately $1.2 million, representing the fair value of the warrant
extensions as determined using the Black Scholes model. Such costs were being
amortized over the life of the 9.25% Notes. The Company has also agreed to
indemnify NAR against any and all claims or losses asserted against it or
incurred by it relating to the transactions contemplated by the repurchase and
option agreement.

         Extraordinary Items - As a result of the replacement of the Revolver,
the purchase by IMR of the 9.25% Notes and early repayment of 9.25% Notes from
the proceeds of the Rights Offering, the Company wrote-off approximately $1.8
million and $1.1 million of unamortized debt issuance costs as extraordinary
items due to the early extinguishment of debt for 1995 and 1996, respectively.

         General - At December 28, 1996, the aggregate annual principal and
sinking fund payments required on all long-term debt instruments are as follows
(in thousands): 1997 - $10,102; 1998 - $27,497; 1999 - $1,000; 2000 - $1,600;
2001 - $1,600 and thereafter - $21,551.

9.  RIGHTS OFFERING.

         The Company commenced its $50 million Rights Offering on July 19, 1996.
Holders of record of the Company's Common Stock, 6% Series A Convertible
Additional Preferred Stock and Series B Convertible Additional Preferred Stock
as of July 18, 1996, were eligible to participate in the Rights Offering. The
Rights were exercisable at a price of $1.03 per share.



                                       51
<PAGE>   52
Shareholders received 0.51 Rights for each share of Common Stock held, 3.72
rights for each share of Series A Convertible Additional Preferred Stock held
and 0.77 rights for each share of Series B Convertible Additional Preferred
Stock held as of the record date. The Rights Offering closed on August 23, 1996.

         Due to the Company's continued operating losses, the Company requested
that NAR advance up to $25 million against all the Rights distributed to it
and/or its commitment to purchase all of the unsubscribed shares. In May 1996,
NAR advanced the Company $25 million under a promissory note (Note 8). Under the
provisions of the promissory note, the Company repaid NAR the $25 million
advance plus accrued interest upon the closing of the Rights Offering.

         The Company issued 48,748,785 shares pursuant to the Rights Offering
which generated proceeds of approximately $48 million, net of expenses. NAR
received rights entitling it to purchase 24,015,964 shares in the Rights
Offering and exercised such rights. In addition, the Company and NAR entered
into a Standby Purchase Agreement, pursuant to which NAR purchased 6,898,866
shares not subscribed by shareholders and received approximately $.5 million as
a fee. The proceeds of the Rights Offering were used by the Company: (i) to
repay the $14 million principal amount of 9.25% Notes held by an affiliate of
NAR plus accrued interest, (ii) to repay the $25 million principal amount
advanced under the promissory note plus accrued interest and (iii) to repay
approximately $9 million under the Congress Facility. The Company recorded an
extraordinary expense related to the early extinguishment of the 9.25% Notes,
representing a write-off of the unamortized debt issuance costs of approximately
$1.1 million.

10.  CAPITAL STOCK.

         6% Series A Convertible Additional Preferred Stock - In December 1993,
in connection with the Company's acquisition of Tweeds, Inc. ("Tweeds"), the
Company entered into an exchange agreement with a major vendor of Tweeds. Under
the exchange agreement, the Company issued 234,900 shares of its 6% Series A
Convertible Additional Preferred Stock ("6% Preferred Stock") for an installment
note, dated March 29, 1993, as amended, in the amount of approximately $2.4
million previously issued by Tweeds. Dividends began accruing on September 30,
1993.

         The 6% Preferred Stock was convertible into Common Stock of the Company
over a three year period in equal amounts on September 30, 1994, 1995 and 1996.
The conversion price was an amount equal to the average of the per share closing
prices for the five trading days preceding the conversion dates. The Company
converted each of the one third equal portions of the 234,900 issued shares of
the 6% Preferred Stock into 819,733, 427,785 and 189,818 shares of Common Stock
plus accrued dividends on September 30, 1996,1995 and 1994, respectively. The
Company elected to pay cash dividends of $.1 million related to the September
1994 conversion.

         Series B Convertible Additional Preferred Stock - In February 1995, the
Company issued 634,900 shares of its Class B Convertible Additional Preferred
Stock ("Series B Stock") to acquire the remaining 80% of the outstanding common
stock of Aegis Safety Holdings, Inc. ("Aegis"), publisher of The Safety Zone
catalog. The Series B Stock has a stated value of $10



                                       52
<PAGE>   53
per share. Non-cumulative dividends will accrue and be paid at 5% per annum
during each of the first three years if Aegis attains at least $1 million in
earnings before interest and taxes each year. In years four and five, dividends
are cumulative and will accrue and be paid at 7% per annum and are not
contingent on the achievement of any earnings target. Dividends were not paid in
1996 and 1995 based on The Safety Zone catalog's operating results in each
respective year.

         The Series B Stock is convertible at any time, at $6.66 per share,
subject to antidilution, at the option of the holder and is convertible at the
Company's option if the market value of the Company's Common Stock is greater
than $6.66 per share, subject to antidilution, for 20 trading days in any
consecutive 30 day trading period or at the holder's option from time to time.
If, after five years, the Series B Stock is not converted, it is mandatorily
redeemable, at the Company's option, in cash or for 952,352 shares of the
Company's Common Stock provided the market value of the stock is at least $6.33
per share, subject to antidilution. If the market value of the Company's Common
Stock does not meet this minimum, the redemption rate is subject to adjustment
which would increase the number of shares for which the Series B Stock is
redeemed. In December 1996, the Company filed a registration statement on form
S-3 with the Securities and Exchange Commission registering 952,352 shares of
the Company's Common Stock related to the future conversion of the Series B
Stock.

         The fair value of the Series B Stock, which is based on an independent
appraisal, was $.9 million less than the stated value at February 1995. This
discount is being amortized over a five year period and resulted in a charge of
$.2 million to preferred stock dividends in the statement of income in 1996 and
1995.

         Warrants - The warrants outstanding at December 28, 1996 are as
follows:

<TABLE>
<CAPTION>
           WARRANTS       EXERCISE    EXPIRATION
            ISSUED         PRICE        DATE
           ---------      --------    ----------
<S>                       <C>         <C>
           1,728,923       $2.16        8/01/98
           3,542,292        2.59        8/01/98
             375,275        1.95        8/01/98
           ---------
           5,646,490
           =========
</TABLE>

         All of the above issued warrants are held by NAR and its affiliates.
The Company agreed to extend the terms of the warrants held by NAR and its
affiliates by two years in consideration of IMR's purchase of the 9.25% Notes
from a third party in November of 1995 (Note 8). The original terms of these
warrant agreements contain certain antidilution provisions which increased, in
aggregate, the warrants by 612,755 from 5,033,735 to 5,646,490 due to the Rights
Offering (Note 9). The antidilution provisions resulted in an adjustment to the
previous exercise prices of $2.42, $2.91 and $2.49, respectively.

         General - At December 28, 1996, there were 144,647,898 shares of Common
Stock and 634,900 shares of Series B Stock outstanding. Additionally, an
aggregate of 18,810,956 shares of Common Stock were reserved for issuance
pursuant to (i) the exercise of outstanding options 11,045,000, (ii) the
exercise of outstanding warrants 5,646,490, (iii) the Executive Equity Incentive
Plan 640,498, and (iv) the All Employee Equity Investment Plan 1,478,968.



                                       53
<PAGE>   54
         Dividend Restrictions - The Company is restricted from paying dividends
on its Common Stock or from acquiring its capital stock by certain debt
covenants contained in agreements to which the Company is a party.


11.   STOCK BASED COMPENSATION PLANS

         At December 28, 1996, the Company has thirteen stock based compensation
plans. In accordance with the provisions of SFAS No.123, the Company has
recorded a compensation charge of $.5 million. The effects of applying SFAS No.
123 for recognizing compensation costs are not indicative of future amounts.
SFAS No. 123 does not apply to awards prior to 1996 and additional awards in the
future are anticipated. The information below details each of the respective
plans, including the changes during the years presented.

         1978 Stock Option Plan - Pursuant to the Company's Stock Option Plan
(the "1978 Plan"), an aggregate of 2,830,519 shares were approved for issuance
to employees and consultants of the Company. The option price and the periods
over which an option is exercisable are specified by the Compensation Committee
of the Board of Directors.

         Options expire five years from the date of grant and generally vest
over three to four years. Payment for shares purchased upon the exercise of an
option shall be in cash or stock of the Company. If paid in cash, a partial
payment may be made with the remainder in installments evidenced by promissory
notes at the discretion of the Compensation Committee. Changes in options
outstanding, expressed in numbers of shares, are as follows:

<TABLE>
<CAPTION>
                                  1994            1994       1995            1995        1996         1996
                                  ----            ----       ----            ----        ----         ----
                                                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             365,250           $3.95     496,050           $3.60     90,000      $2.42
Granted                         162,000           $3.50      70,000           $2.11         --         --
Exercised                        (1,000)          $5.00          --              --         --         --
Forfeited                        (9,500)          $5.00    (142,000)          $3.50         --         --
Expired                         (20,700)          $8.29    (334,050)          $3.65    (20,000)     $3.50
                                -------                    --------                    ------- 
Options outstanding,
end of period                   496,050           $3.60      90,000           $2.42     70,000      $2.11
                                ========                   ========                    =======
Options exercisable, end
of period                       334,050           $3.65      20,000           $3.50     23,333      $2.11
                                ========                   ========                    =======
</TABLE>



                                       54
<PAGE>   55
         The options outstanding at December 28, 1996 have exercise prices
between $1.75 and $2.25 with a weighted average contractual life of 3.8 years.

         In June 1994, one director was granted non-qualified options to
purchase shares at an exercise price of $6.125 per share, of which 50,000 shares
will expire in March 2000. In September 1992, six directors were granted options
to purchase 20,000 shares each, at the market price, which at the time was $1.75
per share. These option grants were approved at the 1993 Annual Meeting of
Shareholders and the options expire in 1997.


         Executive Equity Incentive Plan - In December 1992, the Board of
Directors adopted the 1993 Executive Equity Incentive Plan (the "Incentive
Plan"). The Incentive Plan was approved by shareholders at the 1993 Annual
Meeting. Pursuant to the Incentive Plan, options to purchase shares of the
Company's Common Stock will be granted from time to time by the Compensation
Committee of the Board of Directors to selected executives of the Company or its
affiliates. For each such option granted up to a maximum of 250,000, the
selected executive will receive the right to purchase on a specified date (the
"Tandem Investment Date") a number of shares of the Company's Common Stock
("Tandem Shares") equal to one-half the maximum number of shares of the
Company's Common Stock covered by such option. An aggregate of 2,400,000 shares
of



                                       55
<PAGE>   56
the Company's Common Stock have been reserved for issuance under the Incentive
Plan. Company financing is available under the Incentive Plan to pay for the
purchase price of the Tandem Shares. Changes in shares and options outstanding,
expressed in numbers of shares, for the Incentive Plan are as follows:

<TABLE>
<CAPTION>
                                           1994           1994            1995           1995           1996             1996
                                           ----           ----            ----           ----           ----             ----
                                                        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                      663,830                       753,830                       877,163
  Shares purchased                          90,000                       143,333                       200,000
  Shares forfeited                              --                       (20,000)                      (16,667)
                                         ---------                     ---------                    ----------
  Shares outstanding, end
  of period                                753,830                       877,163                     1,060,496
                                         =========                     =========                    ==========
  Options outstanding,
  beginning of period                    1,101,000        $2.69        1,073,836        $2.98        1,021,170          $2.66
  Granted                                  180,000        $4.56          286,666        $2.53          350,000          $1.00
  Forfeited                              (207,164)        $2.70        (339,332)        $3.59        (730,672)          $2.68
                                         ---------                     ---------                    ----------
  Options outstanding, end
  of period                              1,073,836        $2.98        1,021,170        $2.66          640,498          $1.73
                                         =========                     =========                    ==========
  Options exercisable, end
  of period                                     --           --               --           --          173,832          $2.56
                                         =========                     =========                    ==========

  Weighted average fair
  value of options granted
  during the year                                                                                   $      .67             --
</TABLE>


         The fair value of each option granted is estimated on the date of grant
using the Black-Scholes option-pricing model with the following weighted average
assumptions for grants in 1996: risk free interest rate of 6.06% - 6.37%,
expected lives of 6 years, expected volatility of 39.07% - 40.81%, expected
dividends of $0.




                                       56

<PAGE>   57
  The following table summarizes information about stock options outstanding at
December 28, 1996:

<TABLE>
<CAPTION>
                                       Options Outstanding                             Options Exercisable
                                         Weighted Average
Range of           Number Outstanding      Remaining       Weighted Average    Number Exercisable   Weighted Average
Exercise Prices       at 12/28/96       Contractual Life     Exercise Price        at 12/28/96        Exercise Price
---------------       -----------       ----------------     --------------        -----------        --------------
<S>                <C>                  <C>                <C>                 <C>                  <C>
     $1.00             350,000               5.5                 $1.00                    0              $1.00
$2.50 to $3.00         290,498               3.1                 $2.61              173,832              $2.56
$1.00 to $3.00         640,498               4.4                 $1.73              173,832              $2.56
</TABLE>


         Options granted under the Incentive Plan become exercisable three years
after the dates of grant and expire six years from the dates of grant. The
purchase price shall be paid in full at the time of purchase in cash or shares
of the Company's Common Stock valued at their fair market value or in a
combination thereof. The amount of amortization charged to expense was
approximately $(.3) million, $.1 million and $.1 million for 1996, 1995 and
1994, respectively, net of forfeitures.

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

<TABLE>
<CAPTION>
                                                       1994         1995          1996
                                                   ----------   ----------    ----------
<S>                                                <C>          <C>           <C>
Notes receivable balance beginning of period       $1,424,000   $1,522,000    $1,651,000
Additions                                             328,000      229,000       200,000
Payments                                             (230,000)    (100,000)     (111,000)
                                                   ----------   ----------    ----------
Notes receivable end of period                     $1,522,000   $1,651,000    $1,740,000
                                                   ==========   ==========    ==========
</TABLE>


         Under the terms of the Incentive Plan, the purchase price for shares is
based upon the market price at the date of purchase, and payment is made in the
form of a 20% cash down payment and a six year note that bears interest at the
mid-term applicable federal rate, as determined by the Internal Revenue Service,
as of the month of grant of such shares. The Incentive Plan participants
purchased shares at prices ranging from $1.00 to $4.94 with the Company
accepting notes bearing interest at rates ranging from 5.00% to 7.75%.

         All Employee Equity Investment Plan - In December 1992, the Board of
Directors adopted the 1993 All Employee Equity Investment Plan (the "Investment
Plan"). Such plan was approved by the shareholders at the 1993 Annual Meeting.
Each full-time or permanent part-time employee of the Company or its affiliates
who has attained the age of 18, has met certain standards of continuous service
with the Company or an affiliate of the Company and is not covered by a
collective bargaining agreement may participate in the Investment Plan.

         An eligible employee will be granted a right to purchase a specific
number of shares of the Company's Common Stock by the Compensation Committee,
based on the eligible employee's salary level. The purchase price of the
Company's Common Stock in the Investment Plan shall be the average



                                       57

<PAGE>   58
market value of a share of the Company's Common Stock during the 20 days prior
to the first day of the subscription period, less a 40% discount. The shares
received by such participants are not transferable (other than by will or the
laws of descent and distribution) until the vesting date or when such
participant attains the age of 65, dies or becomes permanently disabled, and are
subject to forfeiture in the event the participant ceases to be an employee
prior to that date. The employees who choose to participate in the Investment
Plan vest in their shares equally over a three-year period beginning with the
first anniversary of the day subsequent to the final day of the subscription
period or when they reach the age of 65, die or become permanently disabled. An
aggregate of 2,000,000 shares of the Company's Common Stock have been reserved
for issuance under the Investment Plan.

         Changes in shares outstanding and available for grant, expressed in
numbers of shares for the Investment Plan are as follows:

<TABLE>
<CAPTION>
                                            1994             1995             1996
                                         ---------        ---------        ---------
<S>                                      <C>              <C>              <C>
Shares outstanding, beginning of
 period                                    211,883          380,563          508,134
Shares purchased                           260,124          216,931           80,550
Shares Forfeited                           (91,444)         (89,360)         (67,652)
                                         ---------        ---------        ---------
Shares outstanding end of period           380,563          508,134          521,032
                                         =========        =========        =========
Shares available for grant, end of
 period                                  1,619,437        1,491,866        1,478,968
                                         =========        =========        =========
</TABLE>


         The difference between the market price and the discounted price
aggregated approximately $0, $.2 million and $.4 million in 1996, 1995 and 1994,
respectively. These amounts have been reduced by approximately $.3 million in
1996 and $.2 million in 1995 and have been charged to amortization expense.

         Restricted Stock Award Plan - In December 1992, the Board of Directors
adopted the 1993 Restricted Stock Award Plan (the "Restricted Stock Plan"). An
aggregate of 500,000 shares of the Company's Common Stock have been reserved for
issuance under the Restricted Stock Plan. During 1993, 224,300 shares were
awarded to participants aggregating $.8 million. Such amount has been amortized
over a three-year vesting period. The amount of amortization charged to expense
was approximately $.2 million in 1995, net of forfeitures.

         Incentive Compensation Plan - Bonus arrangements with certain
executives and key employees generally provide for additional compensation based
upon the attainment of certain profit levels, as well as other performance
measures. These bonuses approximated an aggregate of $.5 million, $1.5 million
and $1.1 million in 1996, 1995 and 1994, respectively. Under the bonus plan, 25%
of the bonus is deferred and payable in cash or restricted stock that vests over
a three year period.



                                       58
<PAGE>   59
         The Chief Executive Officer (the "CEO") Tandem Plan - Pursuant to the
Company's Tandem Plan (the "Tandem Plan") the right to purchase an aggregate of
1,000,000 shares of Common Stock and an option to purchase 2,000,000 shares of
Common Stock was approved for issuance to the CEO. The option price represents
the average of the low and high fair market value of the common stock on August
23, 1996, the date of the closing of the Rights Offering. The option is subject
to antidilution provisions and due to the Company's 1996 Rights Offering were
adjusted to 1,510,000 shares of Common Stock and 3,020,000 options.

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

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

<TABLE>
<CAPTION>
                                                                    1996
                                                                    ----
                                                                  Weighted
                                                                   Average
                                                                  Exercise
                                               Shares               Price
                                               ------               -----
<S>                                          <C>                 <C>
Options outstanding, beginning of period              --
Granted                                        3,020,000            1.16
Forfeited                                             --              --
Expired                                               --              --
                                              ----------

Options outstanding, end of period             3,020,000            1.16
                                              ==========
Options exercisable, end of period                    --              --
Weighted average fair value of options,
granted during year                           $      .77              --
</TABLE>

         The options outstanding at December 28, 1996 have an exercise price of
$1.16 with a weighted average contractual life of 9.25 years.

         The fair value of each option granted is estimated on the date of grant
using the Black- Scholes option-pricing model with the following weighted
average assumptions for grants in 1996: risk free interest rate of 6.79%,
expected lives of 9.85 years, expected volatility of 45.02% and expected
dividends of $0.

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



                                       59
<PAGE>   60
         The options expire 10 years from the date of grant and vest over four
years. The options are based upon performance as defined by the Compensation
Committee of the Board of Directors. Should a performance target not be
attained, the option is carried over to the succeeding year in conjunction with
that year's option until the expiration date. Payment for shares purchased upon
the exercise of the options shall be in cash or stock of the Company.

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

<TABLE>
<CAPTION>
                                                               1996
                                                               ----
                                                             Weighted
                                                              Average
                                                             Exercise
                                                Shares         Price
                                                ------         -----
<S>                                          <C>            <C>
Options outstanding, beginning of period              --          --
Granted                                        1,000,000       $1.16
Forfeited                                             --          --
Expired                                               --          --
                                              ----------
Options outstanding, end of period             1,000,000       $1.16
                                              ==========

Options exercisable, end of period                    --          --

Weighted average fair value of options
 granted during the year                      $      .77          --
</TABLE>

         The options outstanding at December 28, 1996 have an exercise price of
$1.16 with a weighted average contractual life of 9.25 years.

         The fair value of each option granted is estimated on the date of grant
using the Black- Scholes option-price model with the following weighted average
assumptions or grants in 1996: risk free interest rate of 6.79%, expected lives
of 9.85 years, expected volatility of 45.02% and expected dividends of $0.

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

         The options expire 10 years from the date of grant and vest based upon
the performance of the Company's stock price over a consecutive 91 calendar day
period as defined by the Compensation Committee of the Board of Directors. The
performance period has a range of 6 years beginning August 23, 1996, the date of
the closing Rights Offering. Payment for shares purchased upon the exercise of
the options shall be in cash or stock of the Company.



                                       60
<PAGE>   61
         Options outstanding, granted and the weighted average exercise prices
are as follows:

<TABLE>
<CAPTION>
                                                               1996
                                                               ----
                                                              Weighted
                                                              Average
                                                              Exercise
                                                Shares         Price
                                                ------         -----
<S>                                           <C>           <C>
Options outstanding, beginning of period              --          --
Granted                                        2,000,000       $1.16
Cancelled                                             --          --
Expired                                               --          --
                                              ----------
Options outstanding, end of period             2,000,000       $1.16
                                              ==========
Options exercisable, end of period                    --          --


Weighted average fair value of  options
granted during the year                       $      .17          --
</TABLE>


         The options outstanding at December 28, 1996 have an exercise price of
$1.16 with a weighted average contractual life of 9.25 years.

         The fair value of each option granted is estimated on the date of grant
using the Black Scholes option-price model utilizing a Monte Carlo simulation
with the following weighted average assumptions for grants in 1996: risk free
interest rate of 6.79%, expected lives of 9.85 years, expected volatility of
45.02% and expected dividends of $0.

         The CEO Six Year Stock Option Plan - Pursuant to the Company's Six Year
Stock Option Plan (the "Six Year Plan") an option to purchase an aggregate of
250,000 shares of Common Stock was approved for issuance to the CEO from NAR.
The option price represents the average of the low and high fair market value of
the Common Stock on August 23, 1996, the date of the closing of the Rights
Offering. The option is subject to antidilution provisions and due to the
Company's 1996 Rights Offering was adjusted to 377,500 options.

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



                                       61
<PAGE>   62
         Options outstanding, granted and the weighted average exercise prices
are as follows:

<TABLE>
<CAPTION>
                                                             1996
                                                             ----
                                                           Weighted
                                                           Average
                                                           Exercise
                                                Shares       Price
                                                ------       -----
<S>                                          <C>           <C>
Options outstanding, beginning of period            --          --
Granted                                        377,500       $1.16
Forfeited                                           --          --
Expired                                             --          --
                                              --------
Options outstanding, end of period             377,500       $1.16
                                              ========
Options exercisable, end of period                  --          --

Weighted average fair value of options              --          --
granted during the year                       $    .60          --
</TABLE>


         The options outstanding at December 28, 1996 have an exercise price of
$1.16 with a weighted average contractual life of 5.25 years.

         The fair value of each option granted is estimated on the date of grant
using the Black-Scholes option-pricing model with the following weighted average
assumptions for grants in 1996: risk free interest rate of 6.42%, expected lives
of 5.85 years, expected volatility of 45.02% and expected dividends of $0.

         The CEO Seven Year Stock Option Plan - Pursuant to the Company's Seven
Year Stock Option Plan (the "Seven Year Plan") an option to purchase an
aggregate of 250,000 shares of Common Stock was approved for issuance to the CEO
from NAR. The option price represents the average of the low and high fair
market value of the Common Stock on August 23, 1996, the date of the closing of
the Rights Offering. The option is subject to antidilution provisions and due to
the Company's 1996 Rights Offering was adjusted to 377,500 options.

         The options expire 7 years from the date of grant and vest after two
years. Payment for shares purchased upon the exercise of the options shall be in
cash or stock of the Company.



                                       62
<PAGE>   63
         Options outstanding, granted and the weighted average exercise 
prices are as follows:

<TABLE>
<CAPTION>
                                                            1996
                                                            ----
                                                           Weighted
                                                           Average
                                                           Exercise
                                               Shares        Price
                                               ------        -----
<S>                                          <C>          <C>
Options outstanding, beginning of period            --          --
Granted                                        377,500       $1.16
Forfeited                                           --          --
Expired                                             --          --
                                              --------
Options outstanding, end of period             377,500       $1.16
                                              ========
Options exercisable, end of period                  --          --
Weighted average fair value of options
 granted during the year                      $    .65          --
</TABLE>


         The options outstanding at December 28, 1996 have an exercise price of
$1.16 with a weighted average contractual life of 6.25 years.

         The fair value of each option granted is estimated on the date of grant
using the Black - Scholes option-pricing model with the following weighted
average assumptions for grants in 1996: risk free interest rate of 6.53%,
expected lives of 6.85 years, expected volatility of 45.02% and expected
dividends of $0.

         The CEO Eight Year Stock Option Plan - Pursuant to the Company's Eight
Year Stock Option Plan (the "Eight Year Plan") an option to purchase an
aggregate of 250,000 shares of Common Stock was approved for issuance to the CEO
from NAR. The option price represents the average of the low and high fair
market value of the Common Stock on August 23, 1996, the date of the closing of
the Rights Offering. The option is subject to antidilution provisions and due to
the Company's 1996 Rights Offering was adjusted to 377,500 options.

         The options expire 8 years from the date of grant and vest after three
years. Payment for shares purchased upon the exercise of the options shall be in
cash or stock of the Company.



                                       63
<PAGE>   64
         Options outstanding, granted and the weighted average exercise prices
are as follows:


<TABLE>
<CAPTION>
                                                             1996
                                                             ----
                                                            Weighted
                                                            Average
                                                            Exercise
                                              Shares          Price
                                              ------          -----
<S>                                          <C>           <C>
Options outstanding, beginning of period            --          --

Granted                                        377,500       $1.16
Forfeited                                           --
Expired                                             --          --
                                              --------

Options outstanding, end of period             377,500       $1.16
                                              ========
Options exercisable, end of period                  --          --
Weighted average fair value of options
granted during the year                       $    .69          --

</TABLE>

         The options outstanding at December 28, 1996 have an exercise price of
$1.16 with a weighted average contractual life of 7.25 years.

         The fair value of each option granted is estimated on the date of grant
using the Black-Scholes option-pricing model with the following weighted average
assumptions for grants in 1996: risk free interest rate of 6.62%, expected lives
of 7.85 years, expected volatility of 45.02% and expected dividends of $0.

         The CEO Nine Year Stock Option Plan - Pursuant to the Company's Nine
Year Stock Option Plan (the "Nine Year Plan") an option to purchase an aggregate
of 250,000 shares of common stock was approved for issuance to the CEO from NAR.
The option price represents the average of the low and high fair market value of
the common stock on August 23, 1996, the date of the closing of the Rights
Offering. The option is subject to antidilution provisions and due to the
Company's 1996 Rights Offering was adjusted to 377,500 options.

         The options expire 9 years from the date of grant and vest after four
years. Payment for shares purchased upon the exercise of the options shall be in
cash or stock of the Company.



                                       64

<PAGE>   65
         Options outstanding, granted and the weighted average exercise prices
are as follows:


<TABLE>
<CAPTION>
                                                            1996
                                                            ----
                                                          Weighted
                                                           Average
                                                          Exercise
                                               Shares       Price
                                               ------       -----
<S>                                           <C>        <C>
Options outstanding, beginning of period            --          --
Granted                                        377,500       $1.16
Forfeited                                           --          --
Expired                                             --         
                                              --------

Options outstanding, end of period             377,500       $1.16
                                              ========
Options exercisable, end of period                  --          --
Weighted average fair value of options
 granted during the year                      $    .74          --
</TABLE>

         The options outstanding at December 28, 1996 have an exercise price of
$1.16 with a weighted average contractual life of 8.25 years.

         The fair value of each option granted is estimated on the date of grant
using the Black-Scholes option-pricing model with the following weighted average
assumptions for grants in 1996: risk free interest of 6.73%, expected lives of
8.85 years, expected volatility of 45.02% and expected dividends of $0.

         1996 Stock Option Plan - Pursuant to the Company's 1996 Stock Option
Plan (the "1996 Plan"), an aggregate of 3,445,000 shares were approved for
issuance to employees of the Company. The option exercise price shall be the
fair market value as of the date of grant. The total options granted to an
employee is one half performance based. The changes for each type of option
(performance based and non-performance based) are presented in separate tables
that follow.

         Options expire after 10 years, unless an employee owns stock possessing
more than 10% of the total combined voting power of all classes of stock, in
which case the option would expire after 5 years. Payment for shares purchased
upon the exercise of an option shall be in cash or stock of the Company.



                                       65

<PAGE>   66
NON-PERFORMANCE BASED


<TABLE>
<CAPTION>
                                                              1996
                                                              ----
                                                            WEIGHTED
                                                             AVERAGE
                                                            EXERCISE
                                                SHARES        PRICE
                                                ------        -----
<S>                                          <C>            <C>
Options outstanding, beginning of period              --         --
Options granted                                1,722,500       $.98
Options forfeited                                     --         --
Options expired                                       --         --
                                              ----------
Options outstanding, end of period             1,722,500       $.98
                                              ==========

Options exercisable, end of period                    --         --

Weighted average fair value of options
   granted during the year                    $      .67         --
</TABLE>


         The options outstanding at December 28, 1996 have exercise prices
between $.69 and $1.00 with a weighted average contractual life of 9.9 years.

         The fair value of each option granted is estimated on the date of grant
using the Black-Scholes option-pricing model with the following weighted average
assumptions for grants in 1996: risk free interest rate of 6.80%, expected lives
of 7 years, expected volatility of 45.35% and expected dividends of $0.



                                       66

<PAGE>   67
PERFORMANCE BASED
<TABLE>
<CAPTION>
                                                              1996
                                                              ----
                                                            WEIGHTED
                                                            AVERAGE
                                                            EXERCISE
                                                SHARES        PRICE
                                                ------        -----
<S>                                          <C>            <C>
Options outstanding, beginning of period              --         --
Options granted                                1,722,500       $.98
Options forfeited                                     --         --
Options expired                                       --         --
                                              ----------
Options outstanding, end of period             1,722,500       $.98
                                              ==========

Options exercisable, end of period                    --         --

Weighted average fair value of options
  granted during the year                     $      .67         --
</TABLE>


         The options outstanding at December 28, 1996 have exercise prices
between $.69 and $1.00 with a weighted average contractual life of 9.9 years.

         The fair value of each option granted is estimated on the date of grant
using the Black-Scholes option-pricing model with the following weighted average
assumptions for grants in 1996: risk free interest rate of 6.80%, expected lives
of 7 years, expected volatility of 45.35% and expected dividends of $0.

12.   EMPLOYEE BENEFIT PLANS.

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

         The Company's contributions charged to expense for 1996, 1995 and 1994
were approximately $.4 million, $.6 million and $.6 million, respectively.

         Supplemental Retirement Plan - The Supplemental Retirement Plan (the
"Retirement Plan") allows eligible employees to make contributions to a trust
where the contributions are invested by the trust for each participant in a tax
free money market fund. The Company makes matching contributions. Company
contributions charged to expense in 1996, 1995 and 1994 amounted to
approximately $.1 million, $.2 million and $.2 million, respectively.



                                       67

<PAGE>   68
         The Retirement Plan permits eligible employees to contribute up to 4%
of their salary. The Company matches all participant contributions, up to 50% of
their contributions with a cap of 2%. The Retirement Plan is not tax-qualified
under the applicable provisions of the Internal Revenue Code of 1986, as
amended.

13. INCOME TAXES - At December 28, 1996, the Company had net operating loss
carryfowards ("NOLs") totalling $241.2 million, which expire as follows: In the
year 2001 - $17.3 million, 2003 - $14.6 million, 2004 - $14.3 million, 2005 -
$20.6 million, 2006 - $46.9 million, 2007 - $27.7 million, 2010 - $22.7 million
and 2011 - $77.1 million. The Company also has $1 million of general business
tax credit carryforwards that expire in 2000 through 2009. The Company's
available NOLs for tax purposes consists of $91.4 million of NOLs subject to a
$4 million annual limitation under Section 382 of the Internal Revenue Code of
1986 and $149.8 million of NOLs not subject to a limitation. The unused portion
of the $4 million annual limitation for any year may be carried forward to
succeeding years to increase the annual limitation for those succeeding years.

         SFAS No. 109 requires that the future tax benefit of such NOLs be
recorded as an asset to the extent that management assesses the utilization of
such NOLs to be "more likely than not". Despite incurring additional NOLs of
$22.7 million in 1995 and $77.1 million in 1996, management believes that the
Company will be able to utilize up to $43 million of NOLs based upon the
Company's assessment of numerous factors, including its planned restructuring
and future operating plans.

         For the years ended December 30, 1995 and December 28, 1996, the
Company maintained its deferred tax asset of $15 million (net of a valuation
allowance of $48.5 million in 1995 and $82.6 million in 1996). Management
believes that the $15 million net deferred tax asset still represents a
reasonable, conservative estimate of the future utilization of the NOLs and the
reversal of timing items and will continue to routinely evaluate the likelihood
of future profits and the necessity of future adjustments to the deferred tax
asset valuation allowance.

         Realization of the future tax benefits is dependent on the Company's
ability to generate taxable income within the carryforward period and the
periods in which net temporary differences reverse. Future levels of operating
income and taxable income are dependent upon general economic conditions,
competitive pressures on sales and margins, postal and other delivery rates, and
other factors beyond the Company's control. Accordingly, no assurance can be
given that sufficient taxable income will be generated for utilization of NOLs
and reversals of temporary differences.

         The Company's Federal income tax provision was $4.2 million in 1994 and
zero in 1995 and 1996. The 1994 provision was offset by utilization of the NOLs.
The Company's provision for state income taxes was $.9 million in 1994, $1.0
million in 1995 and $1.0 million in 1996.



                                       68

<PAGE>   69
         A reconciliation of the Company's net income for financial statement
purposes to taxable income (loss) for the years ended January 1, 1994, December
31, 1994 and December 30, 1995 is as follows (in thousands):

<TABLE>
<CAPTION>
                                                    1994            1995             1996
                                                  --------        --------        ---------
<S>                                               <C>             <C>             <C>
Net income (loss)                                 $ 14,838        $(30,230)       $(105,254)
Income tax provision (benefit)                      (3,509)          1,003            1,000
Income  (loss) before income taxes                  11,329         (29,227)        (104,254)
Differences between income before taxes
for financial statement purposes and
taxable income:
 State income taxes                                   (860)         (1,003)          (1,000)
 Utilization of carryovers                         (12,652)             --               --
 Differences attributable to subsidiary not
   included in Company's tax return                     --            (313)              --
 Permanent differences                                 717           1,011            7,630
 Net change in temporary
  differences                                        1,466           6,881           20,484
                                                  --------        --------        ---------
                                                   (11,329)          6,576           27,114
                                                  --------        --------        ---------
Taxable income (loss)                             $     --        $(22,651)       $ (77,140)
                                                  --------        --------        ---------
</TABLE>


         The components of the net deferred tax asset at December 28, 1996 are
as follows (in millions):


<TABLE>
<CAPTION>
                                                                       Non-
                                                        Current      current        Total
                                                        -------      -------        -----
<S>                                                     <C>          <C>          <C>
Federal tax NOL and business tax credit
 carryforwards ...................................       $  --        $85.5        $85.5
Allowance for doubtful accounts ..................         1.6           --          1.6
Inventories ......................................         1.9           --          1.9
Prepaid catalog costs ............................        (3.1)          --         (3.1)
Property and equipment ...........................          --         (1.2)        (1.2)
Excess of net assets of acquired business ........          --         (2.9)        (2.9)
Accrued liabilities ..............................        11.3           --         11.3
Customer prepayments and credits .................         3.0           --          3.0
Tax basis in net assets of discontinued operations
 in excess of financial statement amount .........         0.8           --          0.8
Other ............................................          --          0.7          0.7
                                                         -----        -----        -----
Deferred Tax Asset ...............................        15.5         82.1         97.6
  Valuation allowance ............................       (12.2)       (70.4)       (82.6)
                                                         -----        -----        -----
Deferred Tax Asset, net ..........................         3.3        $11.7        $15.0
                                                         =====        =====        =====
</TABLE>

         The Company has established a valuation allowance for a portion of the
deferred tax asset, due to the limitation on the utilization of the NOLs and its
estimate of the future utilization of the NOLs.



                                       69
<PAGE>   70
         The Company's tax returns for years subsequent to 1984 have not been
examined by the Internal Revenue Service ("IRS"). Availability of the NOLs might
be challenged by the IRS upon examination of such returns which could affect the
availability of NOLs. The Company believes, however, that IRS challenges that
would limit the utilization of NOLs will not have a material adverse effect on
the Company's financial position.

         Total tax expense for each of the three fiscal years presented differ
from the amount computed by applying the Federal statutory tax rate due to the
following:



<TABLE>
<CAPTION>
                                                            1994       1995          1996
                                                          PERCENT     PERCENT       PERCENT
                                                         OF PRE-TAX  OF PRE-TAX   OF PRE-TAX
                                                           INCOME       LOSS         LOSS
                                                         ----------  ----------   ----------
<S>                                                      <C>         <C>          <C>
Tax (benefit) at Federal statutory rate ...........        35.0%      (35.0%)      (35.0%)

State and local taxes .............................         4.9          2.2         0.6
Reversal of valuation allowance ...................       (38.5)         --           --
Net increase in (reversal of) temporary differences
     Depreciation and amortization ................        3.5         (5.4)         0.3
     Deferred compensation ........................       11.4           --         (0.2)
     Restructuring reserves .......................         --           --          8.7
     Other ........................................       (10.4)       15.1         (2.0)
Utilization of contribution and NOL carryover .....       (39.1)         --           --
Tax NOLs for which no benefit could be recognized .         --         25.3         25.9
Other .............................................        2.2          1.2          2.7
                                                          ----         ----         ----
                                                          (31.0%)       3.4%         1.0%
                                                          ====         ====         ====
</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>
                        1994          1995          1996
                      -------       -------       -------
<S>                   <C>           <C>           <C>
Minimum rentals       $13,572       $13,070       $12,931
                      =======       =======       =======
</TABLE>




                                       70

<PAGE>   71
         Future minimum lease payments under noncancellable operating and
capital leases relating to continuing operations that have initial or remaining
terms in excess of one year, together with the present value of the net minimum
lease payments as of December 28, 1996, are as follows (in thousands):


<TABLE>
<CAPTION>
                                                 OPERATING     CAPITAL
YEAR ENDING                                        LEASES       LEASES
-----------                                      ---------     -------
<S>                                              <C>           <C>
1997 ......................................       $10,646       $1,438
1998 ......................................         7,493          482
1999 ......................................         6,257           21
2000 ......................................         5,129           --
2001 ......................................         4,817           --
Thereafter ................................        33,792           --
                                                  -------       ------
Total minimum lease payments ..............       $68,134        1,941
                                                  =======       ======
Less amount representing interest (a) .....                        115
                                                                ------
Present value of minimum lease payments (b)                     $1,826
                                                                ======
</TABLE>

     (a) Amount necessary to reduce net minimum lease payments to present value
calculated at the Company's incremental borrowing rate at the inception of the
leases.

     (b) Reflected in the balance sheet as current and noncurrent capital lease
obligations of $1,260,000 and $1,973,000 at December 30, 1995 and $1,344,000 and
$482,000 at December 28, 1996, respectively.

         The future minimum lease payments under noncancellable leases that
remain from the discontinued restaurant operations as of December 28, 1996 are
as follows: 1997 - $.9 million; 1998 - $.8 million; 1999 - $.8 million; 2000 -
$.8 million; 2001 - $.8 million; and thereafter $2.5 million. The above amounts
exclude annual sublease income of $1.0 million from subleases which have the
same expiration as the underlying leases.

         In connection with the Company's investment in Blue Ridge, a subsidiary
of the Company is contingently liable with respect to the lease obligation
related to the apparel distribution center in Roanoke, Virginia. The Company
does not guarantee the indebtedness associated with the Roanoke apparel center
held by Blue Ridge Associates.

15.    CHANGES IN MANAGEMENT AND EMPLOYMENT AGREEMENTS

         Jack E. Rosenfeld resigned as President and Chief Executive Officer and
as a Director of the Company effective December 30, 1995. In connection with
such resignation, the Company and Mr. Rosenfeld entered into a Termination of
Employment Agreement, dated December 30, 1995 (the "Termination Agreement"),
providing for the termination of (i) the Employment Agreement, dated as of
October 25, 1991, between the Company and Mr. Rosenfeld, and (ii) all benefits,
salary and prerequisites provided for therein except for (a) benefits, salary
and prerequisites earned and accrued up to December 30, 1995, (b) salary of
$500,000 through December 31, 1996, and (c) benefits including (I) continued
disability and term life insurance in amounts not less than the amounts in force



                                       71

<PAGE>   72
on the date of the Termination Agreement for a three-year period and (II) the
right to continue to participate in the Company's medical plans to the extent he
is eligible for up to three years from the date of the Termination Agreement.
The Termination Agreement calls for Mr. Rosenfeld to serve as a Director
Emeritus of the Company and will allow Mr. Rosenfeld to attend meetings of the
Board of Directors and participate in Board discussions for a one-year period,
but Mr. Rosenfeld has no right to vote on any matters that come before the Board
of Directors. The Termination Agreement will preclude Mr. Rosenfeld for a
one-year period from competing with the Company under certain circumstances.

         On March 7, 1996, Rakesh K. Kaul was named President and Chief
Executive Officer and elected to the Board of Directors of the Company.
Effective that date, Mr. Kaul entered into an Executive Employment Agreement
(the "Employment Agreement") which provides for an "at will" term commencing on
March 7, 1996 at a base salary of $525,000 per year. The Employment Agreement
also provides for Mr. Kaul's participation in the Short-Term Incentive Plan for
Rakesh K. Kaul. That plan, which was approved by the shareholders at the June
20, 1996 shareholders meeting, provides for an annual bonus of between 0% and
125% of Mr. Kaul's base salary, depending on the attainment of various
performance objectives as determined in accordance with the objective formula or
standard to be adopted by the Compensation Committee as part of the performance
goals for each such year. The Employment Agreement also provides for Mr. Kaul's
participation in the Long-Term Incentive Plan for Rakesh K. Kaul. That plan,
which was approved by the shareholders at the June 20, 1996 shareholders
meeting, provides for the purchase by Mr. Kaul of 1,000,000 shares of Common
Stock at their fair market value; an option expiring March 7, 2006 for the
purchase of 2,000,000 shares of (the "Tandem Stock Purchase Right") Common
Stock; an option expiring March 7, 2006 to purchase 2,000,000 shares of Common
Stock (the "Tandem Option") exercisable only upon satisfaction of the condition
that the closing price of the Common Stock has attained an average of $7.00 per
share during a 91-day period ending on or before March 7, 2002; an option
expiring March 7, 2006 to purchase 1,000,000 shares of Common Stock at their
fair market value, subject to the attainment of certain objective performance
goals to be set by the Compensation Committee; and four options expiring March
7, 2002, and the first three anniversaries thereof, respectively, for the
purchase of 250,000 shares of Common Stock each, to be granted by NAR, the
Company's majority shareholder ("the NAR Options"). As a result of the Rights
Offering, Mr. Kaul was granted an additional .51 shares for each share of Common
Stock he was granted under the Tandem Stock Purchase Right, the Tandem Option,
and the NAR Options (collectively, the "Award Shares") which resulted in his
being granted 1,510,000 shares, 3,020,000 options and 1,510,000 options,
respectively. The Employment Agreement also provides for the grant of
registration rights under the Securities Act of 1993, as amended (the
"Securities Act"), for shares of Common Stock owned by Mr. Kaul. Pursuant to the
Employment Agreement, the Company will make Mr. Kaul whole, on an after-tax
basis, for various relocation and temporary living expenses related to his
employment with the Company. In the event that Mr. Kaul's employment is actually
or constructively terminated by the Company, other than for cause, he will be
entitled for a 12-month period commencing on the date of his termination to (i)
a continuation of his base salary, (ii) continued participation in the Company's
medical, dental, life insurance and retirement plans offered to senior
executives of the Company, and (iii) a bonus, payable in 12 equal installments,
equal to 100% of his base salary (at the rate in effect immediately prior to
such termination). In addition, Mr. Kaul will be entitled to receive (i) to the
extent not previously paid, the short-term bonus payable to Mr. Kaul



                                       72

<PAGE>   73
for the year preceding the year of termination and (ii) for the year in which
Mr. Kaul's employment is terminated, an additional bonus equal to his annual
base salary for such year, pro-rated to reflect the portion of such year during
which Mr. Kaul is employed. Mr. Kaul's employment will be deemed to be
constructively terminated by the Company in the event of a change in control (as
defined in the Employment Agreement), the Company's bankruptcy, a material
diminution of his responsibilities, or a relocation of the Company's
headquarters outside the New York metropolitan area without his prior written
consent. In the event that Mr. Kaul's employment terminates other than as a
result of a termination by the Company, Mr. Kaul will not be entitled to any
payment or bonus, other than any short-term bonus he is entitled to receive from
the year prior to termination.

         In April 1996, the Executive Vice President, Secretary and General
Counsel resigned. Also, in April 1996, the Executive Vice President and Chief
Financial Officer indicated his intention to resign his position in order to
pursue other interests. He remained with the Company until the closing of the
Rights Offering. In connection therewith, the Company entered in a settlement of
his employment agreement. The Chief Information Officer resigned in June 1996.
The General Counsel position is currently being filled on a part-time basis by
an individual who has served as a service provider to the Company. The Company
has hired a new Chief Financial Officer and promoted an executive to the
position of Chief Information Officer.

16.   RELATED PARTY TRANSACTIONS

         At December 28, 1996, current and former officers and executives of the
Company owed the Company approximately $3.1 million of which approximately $1.7
million relates to receivables under the Executive Equity Incentive Plan. These
amounts due to the Company bear interest at rates ranging from 5.00% to 7.75%
and are due from 1999 to 2002. The remaining $1.4 million relates to a
receivable under the Long Term Incentive Plan for Rakesh K. Kaul.

         In May 1996, NAR advanced the Company $25 million under a promissory
note against all the Rights distributed to it /or its commitment to purchase all
unsubscribed shares in the Rights Offering (Notes 8 and 9). NAR purchased
24,015,964 shares available to it pursuant to the terms of the Rights Offering
and received a fee of $.5 million for purchasing an additional 6,898,866 shares
not subscribed to by other shareholders. On August 23, 1996, the Rights Offering
closing date, the Company paid the principle and interest amounts outstanding
under the $25 million promissory note and the $14 million of 9.25% Notes held by
IMR (Notes 8 and 9).

         In September 1996, IMR loaned the Company $10 million as evidenced by a
subordinated promissory note which is subordinate to the Credit Facility. Such
loan bears interest at prime plus 1.5%, was due on November 14, 1996, and, if it
is not repaid before May 15,1997, is convertible at the option of IMR into
shares of Common Stock (Note 8). NAR has agreed to apply $10 million of the
Company's indebtedness to acquire $10 million of the Company's Common Stock
pursuant to the 1997 Rights Offering (Note 18).

         In December 1996, Richemont finalized its agreement with the Company
that will provide approximately $27.9 million of letters of credit to replace
letters of credit which were issued under the Congress Facility. The Company
paid a facility fee of $1.4 million to Richemont in connection



                                       73

<PAGE>   74
with providing the facility. On December 5, 1996, Richemont advanced the Company
$10 million against the anticipated $27.9 million line of credit which was
repaid after the letter of credit facility was in place on December 19, 1996
(Note 8).

         Since January 1993, pursuant to a consulting arrangement, a subsidiary
of NAR renders management consulting, business advisory and investment banking
services to the Company for an annual fee of $750,000. NAR did not collect such
a fee in 1996 as no such services were performed and will not collect such a fee
in 1997.

         At December 28, 1996, NAR owned approximately 54% of the Company's
outstanding Common Stock and would own 56% upon exercising all of their
outstanding warrants.

17.   COMMITMENTS AND CONTINGENCIES

         On or about September 2, 1994, a complaint was filed in the United
States District Court for the District of New Jersey by Veronica Zucker, an
individual who allegedly purchased shares of Common Stock of the Company in the
public offering completed on April 7, 1994, against the Company, all of its
directors, certain of its officers, Sun Life Insurance Company of America,
Merrill Lynch, Pierce Fenner & Smith Incorporated and Alex. Brown & Sons,
Incorporated. The complaint, which was purportedly filed on behalf of a class
of all persons who purchased the Common Stock of the Company in the public
offering or thereafter through and including August 14, 1994, sought to recover
monetary damages the class had allegedly suffered as a result of certain alleged
false and materially misleading statements contained in the Company's public
offering prospectus dated March 30, 1994. In lieu of an answer, defendants filed
a motion to dismiss the complaint in its entirety for failure to state a claim
upon which relief can be granted. On May 23, 1995, the United States District
Court for District of New Jersey dismissed the plaintiff's claim, with
prejudice, for failure to state a claim upon which relief could be granted. On
June 22, 1995, plaintiff filed a notice of appeal of the May 23, 1995 decision
to the United States Court of Appeals for the Third Circuit. On March 26, 1996,
the Court of Appeals rendered its decision affirming the District Court's
decision. On or about June 24, 1996, a petition for certiorari was filed by
plaintiff with the United States Supreme Court. The Company filed a brief in
opposition to the petition on August 12, 1996. In October 7, 1996, the United
States Supreme Court denied the plaintiff's petition.

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

         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.



                                       74

<PAGE>   75
         In connection with certain discontinued restaurant transactions, the
Company remains contingently liable with respect to lease obligations for 6
restaurant properties, should the buyers fail to perform under the agreements.
The future minimum lease payments as of December 28, 1996 are as follows (in
thousands): 1997 - $375; 1998 - $375; 1999 - $375; 2000 - $375; 2001 - $365; and
thereafter $1,185.

18.   SUBSEQUENT EVENTS

         1997 Rights Offering - On March 26, 1997, the Company announced that it
intends to distribute transferable subscription rights to subscribe for and
purchase additional shares of Common Stock to the holders of record of the
Company's Common Stock and Series B Convertible Additional Preferred Stock (the
"1997 Rights Offering") as soon as it has filed with and has declared effective
by the SEC a registration statement with respect thereto. The Rights will be
exercisable at a price of $.90 per share. NAR has agreed to apply $10 million of
the Company's indebtedness to acquire $10 million of the Company's Common Stock
pursuant to the 1997 Rights Offering (Note 18). Richemont has agreed to purchase
all shares of Common Stock which have not been subscribed for and purchased by
shareholders in the 1997 Rights Offering. Due to the Company's liquidity issues
and to alleviate vendor concerns, Richemont has agreed to advance $30 million
against its commitment to purchase all of the unsubscribed shares. In connection
with the agreement the Company named two Richemont representatives, Messrs. Jan
du Plessis and Howard Tanner, to its Board of Directors (the "Board") and
Executive Committee, and will nominate a third Richemont representative to the
Board at the next annual meeting. The new Board members fill positions vacated
by the recent resignations of Geraldine Stutz and Jeffery R. Laikind. In
addition, Mr. du Plessis has been named to the Audit Committee of the Board.

         Waiver and Amendment to the Congress Facility - The Company has
received waivers for the December 1996 events of default under the Congress
Facility related to the working capital and net worth covenants as of and
through December 28, 1996. In addition, the Company received a waiver for any
event of default relating to the material adverse change provision that was in
effect through and including December 28, 1996. The calculation of the working
capital covenant excludes the Congress Revolving Term Notes. The working 
capital and net worth covenants for fiscal 1997 are as follows (in 000's):



<TABLE>
<CAPTION>
      Working Capital                     Amount
      ---------------                     ------
<S>                                     <C>
  January through May 1997               $ (5,000)
  June through November 1997             $(10,000)
  December 1997 thereafter               $(20,000)

        Net Worth                         Amount
        ---------                         ------

  January through May 1997               $14,000
  June 1997 thereafter                   $11,500
</TABLE>



                                       75

<PAGE>   76
19.   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>
  1995
Revenues                        $176,592        $182,774        $169,175        $221,227
Gross profit                      62,905          63,003          54,285          79,565
Loss from operations              (4,147)         (5,988)         (6,042)         (6,442)
                                --------        --------        --------        --------
Net loss                          (4,903)         (7,490)         (9,586)         (8,011)

Preferred stock dividends            (45)            (59)            (66)            (70)
                                --------        --------        --------        --------
Net loss applicable to
 Common Shareholders            $ (4,948)       $ (7,549)       $ (9,652)       $ (8,081)
                                ========        ========        ========        ========

Net loss per share              $   (.05)       $   (.08)       $   (.10)       $   (.09)
                                ========        ========        ========        ========
</TABLE>



<TABLE>
<CAPTION>
                                 First           Second           Third           Fourth
                                Quarter          Quarter         Quarter          Quarter
                                -------          -------         -------          -------
                                           (in thousands, except per share amounts)
<S>                            <C>              <C>            <C>              <C>
  1996
Revenues                        $165,527        $180,195        $156,732        $197,860
Gross profit                      55,989          59,912          41,152          63,006
Loss from operations              (7,733)         (9,896)        (25,621)        (51,247)
                                --------        --------        --------        --------
NET LOSS                          (9,477)        (12,520)        (29,565)        (53,467)

Preferred stock dividends            (59)            (59)            (59)            (48)
                                --------        --------        --------        --------

Net loss applicable to
Common Shareholders             $ (9,536)       $(12,579)       $(29,624)       $(53,515)
                                ========        ========        ========        ========

Net loss per share              $   (.10)       $   (.13)       $   (.26)       $   (.37)
                                ========        ========        ========        ========
</TABLE>



                                       76

<PAGE>   77
                                    PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

(a)      Identification of Directors:

         The information required by this item is incorporated by reference from
the Company's definitive proxy statement to be filed by the Company pursuant to
Regulation 14A.

(b)      Identification of Executive Officers:

<TABLE>
<CAPTION>
                                            TITLE AND OTHER                            OFFICE HELD
NAME                       AGE              INFORMATION(a)                                SINCE
----                       ---              --------------                                -----
<S>                        <C>              <C>                                        <C>    
Rakesh K. Kaul             45               President, Chief Executive Officer            1996
                                            and Director since March 7, 1996.
                                            From 1995 until February 1996, Mr.
                                            Kaul was the Vice Chairman and Chief
                                            Operating Officer of Fingerhut
                                            Companies, Inc. From January 1992
                                            until March 1995, Mr. Kaul was also
                                            the Executive Vice President and
                                            Chief Administrative Officer of
                                            Fingerhut. Prior to January 1992,
                                            Mr. Kaul was the Senior Vice
                                            President, Strategy and Finance and
                                            a director at Shaklee Corporation.

Larry J. Svoboda           48               Senior Vice President and Chief               1996
                                            Financial Officer since September
                                            25, 1996. From 1987 to September
                                            1996, Mr. Svoboda was the Chief
                                            Financial Officer of the Florsheim
                                            Shoe Company. Prior to 1987, Mr.
                                            Svoboda was with the Sara Lee
                                            Corporation.

Michael Lutz               54               Executive Vice President Operations           1994
                                            since September 1994. Prior to
                                            September 1994, Mr. Lutz held
                                            various positions with New Hampton,
                                            Inc./Avon Direct Response.

Chuck Hudson               51               Executive Vice President, Men's               1993
                                            Apparel since September 1993. Mr.
                                            Hudson joined the Company in 1986 as
                                            Vice President, Marketing.
</TABLE>
<PAGE>   78
<TABLE>
<S>                        <C>              <C>                                        <C>    
Edward J. O'Brien          53               Senior Vice President and Treasurer           1991
                                            since March 1991. Mr. O'Brien joined
                                            the Company in 1986 and was elected
                                            Vice President in 1988.

Michael D. Contino         36               Senior Vice President and Chief               1996
                                            Information Officer since December
                                            1996. Mr. Contino joined the Company
                                            in 1995 as Director of Computer
                                            Operations and Telecommunications.
                                            Prior to 1995, Mr. Contino was the
                                            Senior Manager of I.S. Operations at
                                            New Hampton, Inc. a subsidiary of
                                            Spiegel, Inc.

Ralph Bulle                47               Senior Vice President - Human                 1996
                                            Resources since June 1996. Mr. Bulle
                                            joined the Company in 1993 as Vice
                                            President - Human Resources. Prior
                                            to 1993, Mr. Bulle was Senior Vice
                                            President - Operations & Human
                                            Resources for Seaman Furniture
                                            Company.
</TABLE>


(a) All references to dates and positions held by such executive officers prior
to September 1993 refer to the Company's predecessor, The Horn & Hardart Company
("H&H"). H&H merged with and into the Company in September 1993, with the
Company surviving.

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

ITEM 11. EXECUTIVE COMPENSATION

The information required by this item is incorporated by reference from the
Company's definitive proxy statement to be filed by the Company pursuant to
Regulation 14A.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

         The information required by this item is incorporated by reference from
the Company's definitive proxy statement to be filed by the Company pursuant to
Regulation 14A.
<PAGE>   79
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.

                                     PART IV

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

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

<TABLE>
<CAPTION>
                                                                                     PAGE NO.
                                                                                     --------
<S>                                                                                  <C>    
         1.       Index to Financial Statements

                  Report of Independent Public Accountants Hanover Direct, Inc.
                  and Subsidiaries Financial Statements                                 32

                  Consolidated Balance Sheets as of December 30, 1995 and
                  December 28, 1996                                                     33

                  Consolidated Statements of Income (Loss) for the three years
                  ended December 28, 1996                                               35

                  Consolidated Statements of Shareholders' (Deficit) Equity for
                  the three years ended December 28, 1996                               36

                  Consolidated Statements of Cash Flows for the three years
                  ended December 28, 1996                                               37

                  Notes to Consolidated Financial Statements                            39

                  Supplementary Data:

                  Selected quarterly financial information (unaudited) for the
                  two fiscal years ended December 28, 1996                              76

         2.       Index to Financial Statement Schedule

                  Schedule II -- Valuation and Qualifying Accounts
</TABLE>
<PAGE>   80
                  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.

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

         See Exhibit Index.

(c)      Financial Statement Schedules

         See (a) 2. above.
<PAGE>   81
                                   SIGNATURES

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

                                        HANOVER DIRECT, INC.
                                        (registrant)

Date:  March 28, 1997                   By: /s/ Rakesh K. Kaul
                                        ----------------------
                                        Rakesh K. Kaul
                                        President and Chief
                                        Executive Officer

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

         Principal Financial Officer:

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

         Board of Directors:

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


         ----------------------------------       ------------------------------
         J. David Hakman, Director                Jan du Plessis, Director


         /s/ Rakesh K. Kaul                       
         ----------------------------------       ------------------------------
         Rakesh K. Kaul, Director                 Alan G. Quasha, Director


         /s/ S. Lee Kling                         /s/ Howard Tanner
         ----------------------------------       ------------------------------
         S. Lee Kling, Director                   Howard Tanner, Director

                                                  /s/ Robert F. Wright
         ----------------------------------       ------------------------------
         Theodore H. Kruttschnitt, Director       Robert F. Wright, Director

         /s/ Elizabeth Valk Long
         ----------------------------------       
         Elizabeth Valk Long, Director

         Date:  March 28, 1997

<PAGE>   82
                                                                     SCHEDULE II

                                 HANOVER DIRECT
                        VALUATION AND QUALIFYING ACCOUNTS
      YEARS ENDED DECEMBER 28, 1996, DECEMBER 30,1995 AND DECEMBER 31,1994

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------------------------
               COLUMN A              COLUMN B           COLUMN C                                  COLUMN D              COLUMN E
-----------------------------------------------------------------------------------------------------------------------------------
                                                                 ADDITIONS
                                                      ----------------------------------
                                    BALANCE AT         CHARGED TO           CHARGED TO
                                     BEGINNING          COSTS AND         OTHER ACCOUNTS         DEDUCTIONS             BALANCE AT
              DESCRIPTION            OF PERIOD          EXPENSES             DESCRIBE             DESCRIBE            END OF PERIOD
-----------------------------------------------------------------------------------------------------------------------------------
<S>                                <C>               <C>                  <C>                    <C>                  <C>
1996:
-------------------------------
ALLOWANCE FOR DOUBTFUL
   ACCOUNTS RECEIVABLE, CURRENT      $ 3,988,000        2,431,000                                                       $ 6,419,000

RESERVES FOR
   DISCONTINUED OPERATIONS             1,639,000                 (2)              83,000                                  1,722,000

RESTRUCTURING RESERVE                                   9,504,000                                                         9,504,000

RESERVES FOR
   SALES RETURNS                       5,535,000      106,836,000                       (2)       103,335,000             9,036,000

DEFERRED TAX ASSET
   VALUATION ALLOWANCE                48,500,000                  (5)         34,100,000                                 82,600,000

ALLOWANCE FOR NET UNREALIZED
   LOSSES ON CONVERTIBLE
   DEBT SECURITIES                     1,000,000          888,000                                                         1,888,000


1995:
-------------------------------
ALLOWANCE FOR DOUBTFUL
   ACCOUNTS RECEIVABLE, CURRENT      $ 3,912,000         4,796,00(3)              42,000(1)         4,762,000          $  3,988,000

RESERVES FOR
   DISCONTINUED OPERATIONS             1,668,000                                        (2)            29,000             1,639,000

RESERVES FOR
   SALES RETURNS                       6,023,000      103,602,000                       (2)       104,090,000             5,535,000

DEFERRED TAX ASSET
   VALUATION ALLOWANCE                38,600,000                  (5)          9,900,000                                 48,500,000

ALLOWANCE FOR NET UNREALIZED
   LOSSES ON CONVERTIBLE
   DEBT SECURITIES                     1,000,000                                                                          1,000,000


1994:
-------------------------------
ALLOWANCE FOR DOUBTFUL
   ACCOUNTS RECEIVABLE, CURRENT      $ 4,244,000        3,931,000                       (1)         4,263,000          $  3,912,000

RESERVES FOR
   DISCONTINUED OPERATIONS             2,558,000                                        (2)           890,000             1,668,000

RESERVES FOR
   SALES RETURNS                       4,911,000      114,665,000                       (2)       113,553,000             6,023,000

DEFERRED TAX ASSET
   VALUATION ALLOWANCE                49,700,000                                         (4)        11,100,000            38,600,000

ALLOWANCE FOR NET UNREALIZED
   LOSSES ON CONVERTIBLE
   DEBT SECURITIES                                      1,000,000                                                         1,000,000
-----------------------------------------------------------------------------------------------------------------------------------
</TABLE>

(1)   Accounts written -off.

(2)   Utilization of reserves.

(3)   Represents acquired allowance for doubtful accounts receivable.

(4)   Represents decrease due to: utilization of valuation allowance and
      recognition of NOL's estimated to be utilized by future operating results.

(5)   Represents the increase in the valuation allowance offset by an increase
      in the gross tax asset.
<PAGE>   83
                                  EXHIBIT INDEX

<TABLE>
<CAPTION>
EXHIBIT NUMBER      
ITEM 601 OF         DESCRIPTION OF DOCUMENT AND INCORPORATION
REGULATION S-K      BY REFERENCE WHERE APPLICABLE
--------------      -----------------------------
                                                                                     PAGE
                                                                                     NO.
                                                                                     ---
<S>                 <C>                                                              <C>    
     2.1            Asset Purchase Agreement dated as of December 1, 1994 among
                    the Company, LWI Holdings, Inc., Bankers Trust Company,
                    Leichtung, Inc. and DRI Industries, Inc. Incorporated by
                    reference to the Company's Annual Report on Form 10-K for
                    the year ended December 31, 1994.

     2.2            Stock Purchase Agreement dated as of February 16, 1995 among
                    the Company, Hanover Holdings, Inc., Aegis Safety Holdings,
                    Inc., F.L. Holdings, Inc., Roland A.E. Franklin, Martin E.
                    Franklin, Jonathan Franklin, Floyd Hall, Frederick Field,
                    Homer G. Williams, Frank Martucci, Norm Thompson Outfitters,
                    Inc. and Capital Consultants, Inc. (as agent) (collectively,
                    the "Aegis Sellers"). Incorporated by reference to the
                    Company's Annual Report on Form 10-K for the year ended
                    December 31, 1994.

     2.3            Stock Purchase Agreement dated as of May 19, 1995 by and
                    among the Company, Austad Holdings, Inc. ("AHI"), The Austad
                    Company ("TAC"), David B. Austad ("DBA"), Denise Austad
                    ("DA"), David Austad, as custodian ("DBAC"), Oscar Austad,
                    Dorothy Austad, Randall Austad, Kristi Austad, Lori Miller,
                    Robin Miller, Kerri Derenge, Sharon Stahl, Lori Miller, as
                    custodian, Dorothy Austad, as attorney-in-fact, and
</TABLE>
<PAGE>   84
                    Kara Miller (collectively, the "Austad Individuals").
                    Incorporated by reference to the Company's Annual Report on
                    Form 10-K for the year ended December 30, 1995.

     2.4            Agreement and Plan of Corporate Separation and
                    Reorganization dated as of February 16, 1996 by and among
                    the Company, AHI, TAC, DBA, DBAC, and DA. Incorporated by
                    reference to the Company's Annual Report on Form 10-K for
                    the year ended December 30, 1995.

     3.1            Restated Certificate of Incorporation. FILED HEREWITH.

     3.2            By-laws. FILED HEREWITH.

     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.
<PAGE>   85
     4.4            Registration Rights Agreement dated as of February 16, 1995
                    among the Company and the Aegis Sellers. Incorporated by
                    reference to the Company's Annual Report on Form 10-K for
                    the year ended December 31, 1994.

     4.5            Warrant Agreement dated as of July 8, 1991 between the
                    Company and IMR for 1,750,000 shares of Common Stock.
                    Incorporated by reference to the Company's Current Report on
                    form 8-K dated July 10, 1991.

     4.6            Warrant Agreement dated as of October 25, 1991 between the
                    Company and NAR for 931,791 shares of Common Stock.
                    Incorporated by reference to the Company's Current Report on
                    form 8-K dated October 25, 1991.

     4.7            Second Amendment to Warrant Agreement and Warrant
                    Certificate for 931,791 shares of Common Stock, between the
                    Company and NAR dated as of November 13, 1995. Incorporated
                    by reference to the Company's Annual Report on Form 10-K for
                    the year ended December 30, 1995.

     4.8            First Amendment to Warrant Agreement and Warrant Certificate
                    for 1,750,000 shares of Common Stock, between the Company
                    and IMR dated as of November 13, 1995. Incorporated by
                    reference to the Company's Annual Report on Form 10-K for
                    the year ended December 30, 1995.

     4.9            First Amendment to Warrant Agreement and Warrant Certificate
                    for 279,110 shares of Common Stock, between the Company and
                    NAR dated as of November
<PAGE>   86
                    13, 1995. Incorporated by reference to the Company's Annual
                    Report on Form 10-K for the year ended December 30, 1995.

     4.10           [Numbered in error]

     4.11           Second Amendment to Warrant Agreement between the Company
                    and NAR dated as of August 23, 1996. FILED HEREWITH.

     4.12           Third Amendment to Warrant Agreement between the Company and
                    NAR dated as of August 23, 1996. FILED HEREWITH.

     10.1           Stock Option Plan, as amended. Incorporated by reference to
                    the Company's* Annual Report on Form 10-K for the fiscal
                    year ended December 28, 1991.

     10.2           Account Purchase Agreement dated as of December 21, 1992
                    among the Company*, Hanover Direct Pennsylvania, Inc.
                    ("HDPI"), Brawn of California, Inc. ("Brawn") and General
                    Electric Capital Corporation ("GECC"). Incorporated by
                    reference to the Company's* Annual Report on Form 10-K for
                    the fiscal year ended December 26, 1992.

     10.3           Amendment No. 1 to the Account Purchase Agreement dated as
                    of July 12, 1993 among the Company*, HDPI, Brawn, Gump's By
                    Mail, Gump's, Gump's Holdings and GECC. Incorporated by
                    reference to the Company's* Current Report on Form 8-K dated
                    July 12, 1993.
<PAGE>   87
     10.4           Amendment No.2 to the Account Purchase Agreement dated as of
                    June 1, 1995 among the Company, HDPI, Brawn, Gump's, Gump's
                    By Mail, Gump's Holdings and GECC. Incorporated by reference
                    to the Company's Annual Report on Form 10-K for the year
                    ended December 30, 1995.

     10.5           Waiver and Amendment No. 3 to the Account Purchase Agreement
                    dated as of December 14, 1995 among the Company, HDPI, Brawn
                    and GECC. Incorporated by reference to the Company's Annual
                    Report on Form 10-K for the year ended December 30, 1995.

     10.6           Amendment No. 4 to the Amended and Restated Account Purchase
                    Agreement dated as of June 28, 1996 among the Company, HDPI,
                    Brawn, Gump's, Gump's by Mail, Gump's Holdings and GECC.***

     10.7           Form of Stock Option Agreement between the Company* and
                    certain Directors of the Company, as amended. Incorporated
                    by reference to the Company's* Annual Report on Form 10-K
                    for the fiscal year ended December 28, 1991.

     10.8           Termination of Employment Agreement and Employment and
                    Consulting Agreement dated as of December 31, 1995 between
                    the Company and Jack E. Rosenfeld. FILED HEREWITH.

     10.9           Registration Rights Agreement 
                    between the Company and Rakesh K. Kaul, dated as of August
                    23, 1996.***
<PAGE>   88
     10.10          Form of Indemnification Agreement among the Company* and
                    each of the Company's directors and executive officers.
                    Incorporated by reference to the Company's* Current Report
                    on Form 8-K dated October 25, 1991.

     10.11          Letter Agreement dated May 5, 1989 among the Company*,
                    Theodore H. Kruttschnitt, J. David Hakman and Edmund R.
                    Manwell. Incorporated by reference to the Company's* Current
                    Report on Form 8-K dated May 10, 1989.

     10.12          Hanover Direct, Inc. Savings Plan as amended. Incorporated
                    by reference to the Company's Annual Report on Form 10-K for
                    the year ended January 1, 1994.

     10.13          Restricted Stock Award Plan. Incorporated by reference to
                    the Company's* Registration Statement on Form S-8 filed on
                    February 24, 1993, Registration No. 33-58760.

     10.14          All Employee Equity Investment Plan. Incorporated by
                    reference to the Company's* Registration Statement on Form
                    S-8 filed on February 24, 1993, Registration No. 33-58756.

     10.15          Executive Equity Incentive Plan, as amended. FILED HEREWITH.

     10.16          Form of Supplemental Retirement Plan. Incorporated by
                    reference to the Company's Annual Report on Form 10-K for
                    the year ended January 1, 1994.
<PAGE>   89
     10.17          1996 Stock Option Plan. Incorporated by reference to the
                    Company's 1996 Proxy Statement.

     10.18          Loan and Security Agreement dated as of November 14, 1995 by
                    and among Congress Financial Corporation ("Congress"),
                    Hanover Direct Pennsylvania, Inc. ("HDPA"), Brawn of
                    California, Inc. ("Brawn"), Gump's by Mail, Inc. ("Gump's by
                    Mail"), Gump's Corp.("Gump's"), The Company Store, Inc.
                    ("The Company Store") , Tweeds, Inc. ("Tweeds"), LWI
                    Holdings, Inc.("LWI"), Aegis Catalog Corporation ("Aegis"),
                    Hanover Direct Virginia, Inc. ("HDVA") and Hanover Realty
                    Inc. ("Hanover Realty"). Incorporated by reference to the
                    Company's Annual Report on Form 10-K for the year ended
                    December 30, 1995.

     10.19          First Amendment to Loan and Security Agreement dated as of
                    February 22, 1996 by and among Congress, HDPI, Brawn, Gump's
                    by Mail, Gump's, The Company Store, Tweeds, LWI, Aegis, HDVA
                    and Hanover Realty.***

     10.20          Second Amendment to Loan and Security Agreement dated as of
                    April 16, 1996 by and among Congress, HDPI, Brawn, Gump's by
                    Mail, Gump's, The Company Store, Tweeds, LWI, Aegis, HDVA
                    and Hanover Realty.***


     10.21          Third Amendment to Loan and Security Agreement dated as of
                    May 24, 1996 by and among Congress, HDPI, Brawn, Gump's by
                    Mail, Gump's, The Company Store, Tweeds, LWI, Aegis, HDVA
                    and Hanover Realty.***
<PAGE>   90
     10.22          Fourth Amendment to Loan and Security Agreement dated as of
                    May 31, 1996 by and among Congress, HDPI, Brawn, Gump's
                    by Mail, Gump's, The Company Store, Tweeds, LWI, Aegis, HDVA
                    and Hanover Realty. ***

     10.23          Fifth Amendment to Loan and Security Agreement dated as of
                    September 11, 1996 by and among Congress, HDPI, Brawn,
                    Gump's by Mail, Gump's, The Company Store, Tweeds, LWI,
                    Aegis, HDVA and Hanover Realty. ***

     10.24          Sixth Amendment to Loan and Security Agreement dated as of
                    December 5, 1996 by and among Congress, HDPI, Brawn, Gump's
                    by Mail, Gump's, The Company Store, Tweeds, LWI, Aegis, HDVA
                    and Hanover Realty. ***

     10.25          Seventh Amendment to Loan and Security Agreement dated as of
                    December 18, 1996 by and among Congress, HDPI, Brawn, Gump's
                    by Mail, Gump's, The Company Store, Tweeds, LWI, Aegis, HDVA
                    and Hanover Realty. ***

     10.26          Subordination Agreement, dated as of November 14, 1995,
                    among Congress, IMR, and the Trustee. Incorporated by
                    reference to the Company's Annual Report on Form 10-K for
                    the year ended December 30, 1995.

     10.27          Long-Term Incentive Plan for Rakesh K. Kaul. ***

     10.28          Short-Term Incentive Plan for Rakesh K. Kaul.  Filed
                    herewith.
<PAGE>   91
     10.29          Employment Agreement dated as of March 7, 1996 between the
                    Company and Rakesh K. Kaul. FILED HEREWITH.

     10.30          Tandem Option Plan dated as of August 23, 1996 between the
                    Company and Rakesh K. Kaul. FILED HEREWITH.

     10.31          Closing Price Option dated as of August 23, 1996 between the
                    Company and Rakesh K. Kaul. FILED HEREWITH.

     10.32          Performance Price Option dated as of August 23, 1996 between
                    the Company and Rakesh K. Kaul. FILED HEREWITH.

     10.33          Six-Year Stock Option dated as of August 23, 1996 between
                    NAR and Rakesh K. Kaul. FILED HEREWITH.

     10.34          Seven-Year Stock Option dated as of August 23, 1996 between
                    NAR and Rakesh K. Kaul. FILED HEREWITH.

     10.35          Eight-Year Stock Option dated as of August 23, 1996 between
                    NAR and Rakesh K. Kaul. FILED HEREWITH.

     10.36          Nine-Year Stock Option dated as of August 23, 1996 between
                    NAR and Rakesh K. Kaul. FILED HEREWITH.

     10.37          Letter of Credit, dated December 18, 1996, from Swiss Bank
                    Corporation, New York Branch ("Swiss Bank") in favor of
                    Fleet National Bank, as trustee ("Fleet Bank"). FILED
                    HEREWITH.

     10.38          Reimbursement Agreement, dated as of December 18, 1996, by
                    and among Swiss Bank and the Company. FILED HEREWITH.
<PAGE>   92
     10.39          Hanover Indemnity Agreement, dated as of December 18, 1996,
                    between Richemont Finance S.A. ("Richemont") and the
                    Company, HDPI, Brawn, Gump's, Gump's by Mail, The Company
                    Store, Tweeds, LWI, Aegis, HDVA and Hanover Realty. FILED
                    HEREWITH.

     10.40          Subordination Agreement, dated as of December 18, 1996,
                    between Congress and Swiss Bank. ***

     10.41          Subordination Agreement, dated as of December 18, 1996
                    between Congress and Richemont. ***

     10.42          Series A Note Agreement, dated as of November 9, 1994,
                    between the Company and Norwest Bank Minnesota, N.A.
                    ("Norwest"), as trustee. ***

     10.43          Placement Agreement, dated as of November 9, 1994, by and
                    between the Company and NationsBank of North Carolina, N.A.
                    ***

     10.44          Remarketing and Interest Services Agreement, dated as of
                    November 9, 1994, by and between the Company and NationsBank
                    of North Carolina, N.A. ***

     10.45          First Supplemental Series A Note Agreement, dated as of
                    December 29, 1995, between the Company and Norwest. ***

     10.46          First Amendment to Placement Agreement, dated as of December
                    29, 1995 by and between the Company and NationsBank of North
                    Carolina, N.A. ***
<PAGE>   93
     10.47          First Amendment to Remarketing and Interest Services
                    Agreement, dated as of December 29, 1995 by and between the
                    Company and NationsBank of North Carolina, N.A. ***

     10.48          Second Supplemental Series A Note Agreement, dated as of
                    December 18, 1996, between the Company and Norwest. FILED
                    HEREWITH.

     10.49          Second Amendment to Series A Note, dated December 18, 1996
                    made by the Company. FILED HEREWITH.

     10.50          Second Amendment to Placement Agreement, dated as of
                    December 18, 1996 by and between the Company and NationsBank
                    of North Carolina, N.A. FILED HEREWITH.

     10.51          Second Amendment to Remarketing Agreement, dated as of
                    December 18, 1996 by and between the Company and NationsBank
                    of North Carolina, N.A. FILED HEREWITH.

     10.52          Series B Note Agreement dated as of April 25, 1995, between
                    the Company and Norwest. ***

     10.53          Placement Agreement, dated as of April 25, 1995, by and
                    between the Company and NationsBank of North Carolina, N.A.
                    ***

     10.54          Remarketing and Interest Services Agreement, dated as of
                    April 25, 1995, by and between the Company and NationsBank
                    of North Carolina, N.A. ***

     10.55          First Amendment to Series B Note Agreement, dated as of
                    December 29, 1995, between the Company and Norwest. ***
<PAGE>   94
     10.56          Second Supplemental to Series B Note Agreement, dated as of
                    December 18, 1996, between the Company and Norwest. ***

     10.57          Second Amendment to Series B Note, dated December 18, 1996
                    made by the Company. FILED HEREWITH.

     10.58          Series B Letter of Credit, dated as of December 18, 1996,
                    issued by Swiss Bank. FILED HEREWITH.

     10.59          Series A Letter of Credit, dated as of December 18, 1996.
                    ***

     10.60          NAR Promissory Note dated as of September 11, 1996. FILED
                    HEREWITH.

     10.61          Series A Letter of Credit, dated as of December 18, 1996,
                    issued by Swiss Bank. FILED HEREWITH.

     10.62          First Amendment to Series A Note, dated as of December 29,
                    1995 made by Hanover Direct, Inc. ***

     10.63          $10,000,000 Series B Note, dated as of April 27, 1995 and
                    made by Hanover Direct, Inc. ***

     10.64          First Supplemental Series B Note Agreement, dated as of
                    December 29, 1995. ***

     11             Computation of Per Share Earnings. FILED HEREWITH.

     21.1           Subsidiaries of the Registrant. FILED HEREWITH
       
     23.1           Consent of Independent Public Accountants. FILED HEREWITH.

     27.1           Financial Data Schedule. FILED HEREWITH.**

--------------

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

  **  EDGAR filing only.

 ***  To be filed by amendment.