<PAGE>
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                 FORM 10-Q/A1
                              AMENDMENT NO.1 TO

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


                  For the quarterly period ended JUNE 29, 2002
                         Commission file number 1-12082



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


<TABLE>
<S>                                                                 <C>
                            DELAWARE                                           13-0853260
                    (State of incorporation)                        (IRS Employer Identification No.)


     115 RIVER ROAD, BUILDING 10, EDGEWATER, NEW JERSEY                             07020
             (Address of principal executive offices)                          (Zip Code)
</TABLE>


                                 (201) 863-7300
                               (Telephone number)


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

Common stock, par value $.66 2/3 per share: 138,315,800 shares outstanding as of
August 9, 2002.
<PAGE>
                              HANOVER DIRECT, INC.

                                TABLE OF CONTENTS


<TABLE>
<CAPTION>
                                                                                                                      Page
                                                                                                                      ----

<S>                                                                                                                   <C>
Part I - Financial Information

    Item 1.  Financial Statements

       Condensed Consolidated Balance Sheets -
         June 29, 2002 and December 29, 2001 ......................................................................      2

       Condensed Consolidated Statements of Income (Loss) - 13- and 26- weeks ended
         June 29, 2002 and June 30, 2001 ..........................................................................      4

       Condensed Consolidated Statements of Cash Flows - 26- weeks ended
         June 29, 2002 and June 30, 2001...........................................................................      5

       Notes to Condensed Consolidated Financial Statements........................................................      6

    Item 2.  Management's Discussion and Analysis of Consolidated Financial Condition and
         Results of Operations.....................................................................................     17

    Item 3.  Quantitative and Qualitative Disclosures about Market Risk............................................     25

Part II - Other Information

    Item 6.  Exhibits and Reports on Form 8-K......................................................................     26

    Signatures.....................................................................................................     27
</TABLE>


                                       1
<PAGE>
PART I - FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS


                      HANOVER DIRECT, INC. AND SUBSIDIARIES
                      CONDENSED CONSOLIDATED BALANCE SHEETS
                 (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AMOUNTS)


<TABLE>
<CAPTION>
                                                     June 29,      December 29,
                                                       2002           2001
                                                  -------------   -------------
                                                   (UNAUDITED)
<S>                                               <C>            <C>
                                     ASSETS
CURRENT ASSETS:
                                                    $     885      $   1,121
      Cash and cash equivalents
      Accounts receivable, net                         17,860         19,456
      Inventories                                      51,266         59,223
      Prepaid catalog costs                            17,341         14,620
      Deferred tax asset, net                           3,300          3,300
      Other current assets                              3,566          3,000
                                                    ---------      ---------
         Total Current Assets                          94,218        100,720
                                                    ---------      ---------

PROPERTY AND EQUIPMENT, AT COST:
      Land                                              4,509          4,509
      Buildings and building improvements              18,205         18,205
      Leasehold improvements                           12,369         12,466
      Furniture, fixtures and equipment                59,562         59,287
                                                    ---------      ---------
                                                       94,645         94,467

      Accumulated depreciation and amortization       (63,100)       (60,235)
                                                    ---------      ---------
         Property and equipment, net                   31,545         34,232
                                                    ---------      ---------
Goodwill, net                                           9,278          9,278
Deferred tax asset, net                                11,700         11,700
Other assets                                            1,118          1,731
                                                    ---------      ---------
         Total Assets                               $ 147,859      $ 157,661
                                                    =========      =========
</TABLE>


            See notes to Condensed Consolidated Financial Statements.


                                       2
<PAGE>
                      HANOVER DIRECT, INC. AND SUBSIDIARIES
                CONDENSED CONSOLIDATED BALANCE SHEETS (CONTINUED)
                 (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AMOUNTS)



<TABLE>
<CAPTION>
                                                                                         June 29,      December 29,
                                                                                           2002           2001
                                                                                      -------------  -----------------
                                                                                       (UNAUDITED)
<S>                                                                                   <C>            <C>
               LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIENCY)


CURRENT LIABILITIES:
     Current portion of long-term debt and capital lease obligations                    $   3,068        $   3,162
     Accounts payable                                                                      40,510           46,348
     Accrued liabilities                                                                   20,171           25,132
     Customer prepayments and credits                                                       7,396            5,143
                                                                                        ---------        ---------
              Total Current Liabilities                                                    71,145           79,785
                                                                                        ---------        ---------
NON-CURRENT LIABILITIES:
     Long-term debt                                                                        26,492           26,548
     Other                                                                                  8,469           10,233
                                                                                        ---------        ---------
              Total Non-current Liabilities                                                34,961           36,781
                                                                                        ---------        ---------
              Total Liabilities                                                           106,106          116,566
                                                                                        ---------        ---------
SERIES B PARTICIPATING PREFERRED STOCK, authorized, issued and outstanding
     1,622,111 shares at June 29, 2002 and December 29, 2001                               83,230           76,823

SHAREHOLDERS' EQUITY (DEFICIENCY):

     Common Stock, $.66 2/3 par value, 300,000,000 shares authorized; 140,436,729
       shares issued at June 29, 2002 and 140,336,729 shares issued at
       December 29, 2001                                                                   93,625           93,558
     Capital in excess of par value                                                       345,735          351,558
     Accumulated deficit                                                                 (477,491)        (477,497)
                                                                                        ---------        ---------
                                                                                          (38,131)         (32,381)
                                                                                        ---------        ---------
Less:
     Treasury stock, at cost (2,120,929 shares at June 29, 2002 and
        2,100,929 shares at December 29, 2001)                                             (2,996)          (2,942)
     Notes receivable from sale of Common Stock                                              (350)            (405)
                                                                                        ---------        ---------
              Total Shareholders' Equity (Deficiency)                                     (41,477)         (35,728)
                                                                                        ---------        ---------
              Total Liabilities and Shareholders' Equity (Deficiency)                   $ 147,859        $ 157,661
                                                                                        =========        =========
</TABLE>


            See notes to Condensed Consolidated Financial Statements.


                                       3
<PAGE>
                      HANOVER DIRECT, INC. AND SUBSIDIARIES
               CONDENSED CONSOLIDATED STATEMENTS OF INCOME (LOSS)
               (IN THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS)
                                   (UNAUDITED)


<TABLE>
<CAPTION>
                                                                     FOR THE 13- WEEKS ENDED           FOR THE 26- WEEKS ENDED
                                                                     ------------------------          ------------------------
                                                                    JUNE 29,         JUNE 30,          JUNE 29,        JUNE 30,
                                                                      2002             2001             2002             2001
                                                                    ---------        ---------        ---------        ---------

<S>                                                                 <C>              <C>              <C>              <C>
NET REVENUES                                                        $ 113,852        $ 133,507        $ 223,363        $ 277,801
                                                                    ---------        ---------        ---------        ---------

OPERATING COSTS AND EXPENSES:
     Cost of sales and operating expenses                              70,326           83,204          141,489          175,615
     Special charges                                                       --            5,025              233            6,081
     Selling expenses                                                  26,579           37,679           51,199           77,057
     General and administrative expenses                               12,552           15,399           24,972           30,695
     Depreciation and amortization                                      1,481            1,940            2,983            3,899
                                                                    ---------        ---------        ---------        ---------
                                                                      110,938          143,247          220,876          293,347
                                                                    ---------        ---------        ---------        ---------
EARNINGS (LOSS) FROM OPERATIONS                                         2,914           (9,740)           2,487          (15,546)
     Gain on sale of Improvements                                         318           22,818              318           22,818
     Gain on sale of Kindig Lane                                           --            1,529               --            1,529
                                                                    ---------        ---------        ---------        ---------

EARNINGS BEFORE INTEREST AND INCOME TAXES                               3,232           14,607            2,805            8,801
     Interest expense, net                                              1,386            1,845            2,739            3,651
                                                                    ---------        ---------        ---------        ---------
     Earnings before income taxes                                       1,846           12,762               66            5,150
     Income tax provision                                                  30               30               60               60
                                                                    ---------        ---------        ---------        ---------

NET EARNINGS AND COMPREHENSIVE EARNINGS                                 1,816           12,732                6            5,090

     Preferred stock dividends and accretion                            3,503            2,984            6,407            5,864
                                                                    ---------        ---------        ---------        ---------

NET EARNINGS (LOSS) APPLICABLE TO COMMON
SHAREHOLDERS                                                        $  (1,687)       $   9,748)       $  (6,401)       $    (774)
                                                                    =========        =========        =========        =========

NET EARNINGS (LOSS) PER COMMON SHARE:
     Net earnings (loss) per common share - basic and diluted       $    (.01)       $     .05        $    (.05)       $    (.00)
                                                                    =========        =========        =========        =========
     Weighted average common shares outstanding - basic
     (thousands)                                                      138,264          212,186          138,245          212,327
                                                                    =========        =========        =========        =========
     Weighted average common shares outstanding - diluted
     (thousands)                                                      138,264          212,786          138,245          212,327
                                                                    =========        =========        =========        =========
</TABLE>


            See notes to Condensed Consolidated Financial Statements.


                                       4
<PAGE>
                      HANOVER DIRECT, INC. AND SUBSIDIARIES
                 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                            (IN THOUSANDS OF DOLLARS)
                                   (UNAUDITED)

<TABLE>
<CAPTION>
                                                                                                 FOR THE 26- WEEKS ENDED
                                                                                                 -----------------------
                                                                                                 JUNE 29,         JUNE 30,
                                                                                                   2002            2001
                                                                                                 --------        --------
<S>                                                                                              <C>             <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings                                                                                     $      6        $  5,090
Adjustments to reconcile net earnings to net cash provided (used) by operating activities:
     Depreciation and amortization, including deferred fees                                         3,696           4,212
     Provision for doubtful accounts                                                                   83             283
     Special charges                                                                                   --           2,388
     Gain on sale of Improvements                                                                      --         (22,818)
     Gain on sale of Kindig Lane                                                                       --          (1,529)
     Compensation expense related to stock options                                                    627           1,379
Changes in assets and liabilities, net of sale of business:
     Accounts receivable                                                                            1,513           7,928
     Inventories                                                                                    7,957           5,382
     Prepaid catalog costs                                                                         (2,721)         (3,824)
     Accounts payable                                                                              (5,838)         (2,377)
     Accrued liabilities                                                                           (4,961)         (9,241)
     Customer prepayments and credits                                                               2,253           1,051
     Other non-current liabilities                                                                 (1,764)         (1,577)
     Other, net                                                                                      (662)           (248)
                                                                                                 --------        --------
Net cash provided (used) by operating activities                                                      189         (13,901)
                                                                                                 --------        --------
CASH FLOWS FROM INVESTING ACTIVITIES:
     Acquisitions of property and equipment                                                          (300)           (734)
     Proceeds from sale of Improvements                                                                --          30,235
     Proceeds from sale of Kindig Lane                                                                 --           4,671
                                                                                                 --------        --------
Net cash provided (used) by investing activities                                                     (300)         34,172
                                                                                                 --------        --------
CASH FLOWS FROM FINANCING ACTIVITIES:
     Net borrowings (payments) under Congress revolving loan facility                               1,477         (15,029)
     Payments under Congress term loan facility                                                    (1,531)         (4,746)
     Payments under capital lease obligations                                                         (96)             --
     Other, net                                                                                        25             (88)
                                                                                                 --------        --------
Net cash (used) by financing activities                                                              (125)        (19,863)
                                                                                                 --------        --------
Net increase (decrease) in cash and cash equivalents                                                 (236)            408
Cash and cash equivalents at the beginning of the year                                              1,121           1,691
                                                                                                 --------        --------
Cash and cash equivalents at the end of the period                                               $    885        $  2,099
                                                                                                 ========        ========

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid for:
     Interest                                                                                    $  1,706        $  2,946
                                                                                                 ========        ========
     Income taxes                                                                                $    137        $     85
                                                                                                 ========        ========
Non-cash investing and financing activities:
     Series B Participating Preferred Stock redemption price increase                            $  6,407        $     --
                                                                                                 ========        ========
     Stock dividend and accretion of Series A Cumulative Participating Preferred Stock           $     --        $  5,864
                                                                                                 ========        ========
</TABLE>


            See notes to Condensed Consolidated Financial Statements.


                                       5
<PAGE>
                         HANOVER DIRECT, INC. AND SUBSIDIARIES
                  NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                      (UNAUDITED)

1.  BASIS OF PRESENTATION

      The accompanying unaudited interim condensed consolidated financial
statements have been prepared in accordance with the instructions for Form 10-Q
and, therefore, do not include all information and footnotes necessary for a
fair presentation of financial condition, results of operations and cash flows
in conformity with generally accepted accounting principles. Reference should be
made to the annual financial statements, including the footnotes thereto,
included in the Hanover Direct, Inc. (the "Company") Annual Report on Form 10-K
for the fiscal year ended December 29, 2001. In the opinion of management, the
accompanying unaudited interim condensed consolidated financial statements
contain all material adjustments, consisting of normal recurring accruals,
necessary to present fairly the financial condition, results of operations and
cash flows of the Company and its consolidated subsidiaries for the interim
periods. Operating results for interim periods are not necessarily indicative of
the results that may be expected for the entire year. Certain prior year amounts
have been reclassified to conform to the current year presentation. Pursuant to
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information," the consolidated operations of Hanover Direct, Inc. are reported
as one segment.

2.  RETAINED EARNINGS RESTRICTIONS

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

3.  NET EARNINGS (LOSS) PER SHARE

      Net earnings (loss) per share is computed using the weighted average
number of common shares outstanding in accordance with the provisions of
Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per
Share." The weighted average number of shares used in the calculation for both
basic and diluted net (loss) per share for the 13-week period ended June 29,
2002 was 138,264,152. For the 13-week period ended June 30, 2001, the weighted
average number of shares used in the calculation for basic and diluted net
earnings per share were 212,186,331 and 212,786,467 shares, respectively. The
weighted average number of shares used in the calculation for both basic and
diluted net (loss) per share for the 26-week periods ended June 29, 2002 and
June 30, 2001 was 138,244,591 and 212,327,375 shares, respectively. Diluted net
(loss) per share equals basic net (loss) per share as the inclusion of
potentially dilutive securities would have an anti-dilutive impact on the
diluted calculation as a result of the net losses incurred during the 13-week
period ended June 29, 2002 and 26-week periods ended June 29, 2002 and June 30,
2001. The number of potentially dilutive securities excluded from the
calculation of diluted net (loss) per share was 1,442,642 common share
equivalents for the 13-week period ended June 29, 2002. The number of
potentially dilutive securities excluded from the calculation of diluted net
(loss) per share was 1,702,238 and 1,186,056 common share equivalents for the
26-week periods ended June 29, 2002 and June 30, 2001, respectively.

4.  COMMITMENTS AND CONTINGENCIES

      A class action lawsuit was commenced on March 3, 2000 entitled Edwin L.
Martin v. Hanover Direct, Inc. and John Does 1 through 10, bearing case no.
CJ2000-177 in the State Court of Oklahoma (District Court in and for Sequoyah
County). Plaintiff commenced the action on behalf of himself and a class of
persons who have at any time purchased a product from the Company and paid for
an "insurance charge." The complaint sets forth claims for breach of contract,
unjust enrichment, recovery of money paid absent consideration, fraud and a
claim under the New Jersey Consumer Fraud Act. The complaint alleges that the
Company charges its customers for delivery insurance even though, among other
things, the Company's common carriers already provide insurance and the
insurance charge provides no benefit to the Company's customers. Plaintiff also
seeks a declaratory judgment as to the validity of the delivery insurance. The
damages sought are (i) an order directing the Company to return to the plaintiff
and class members the "unlawful revenue" derived from the insurance charges,
(ii) declaring the rights of the parties, (iii) permanently enjoining the
Company from imposing the insurance charge, (iv) awarding threefold damages of
less than $75,000 per plaintiff and per class member, and (v) attorneys' fees
and costs. The Company's motion to dismiss is pending and discovery has
commenced. The plaintiff has deposed a number of individuals. On April 12, 2001,
the Court held a hearing on plaintiff's class certification motion. Subsequent
to the April 12, 2001 hearing on plaintiff's


                                       6
<PAGE>
class certification motion, plaintiff filed a motion to amend the definition of
the class. On July 23, 2001, plaintiff's class certification motion was granted,
defining the class as "All persons in the United States who are customers of any
catalog or catalog company owned by Hanover Direct, Inc. and who have at any
time purchased a product from such company and paid money which was designated
to be an `insurance' charge." On August 21, 2001 the Company filed an appeal of
the order with the Oklahoma Court of Appeals and subsequently moved to stay
proceedings in the district court pending resolution of the appeal. The appeal
has been fully briefed. At a subsequent status hearing, the parties agreed that
issues pertaining to notice to the class would be stayed pending resolution of
the appeal, that certain other issues would be subject to limited discovery, and
that the issue of a stay for any remaining issues would be resolved if and when
such issues arise. The Company believes it has defenses against the claims. It
is too early to determine the outcome or range of potential settlement, which
could have a material impact on the Company's results of operations when settled
in a future period. Defense counsel to the Company will seek to have the
resolution of the five class action cases (Martin, Teichman, Wilson, and the two
Argonaut cases which are discussed below) combined, or their effects lessened,
in that there are common issues and a substantially similar class sought to be
defined in the five cases.

      On August 15, 2001, the Company was served with a summons and four-count
complaint filed in Superior Court for the City and County of San Francisco,
California, entitled Teichman v. Hanover Direct, Inc., Hanover Brands, Inc.,
Hanover Direct Virginia, Inc., and Does 1-100. The complaint was filed by a
California resident, seeking damages and other relief for herself and a class of
all others similarly situated, arising out of the $0.50 insurance fee charged by
catalogs and internet sites operated by subsidiaries of the Company. Defendants,
including the Company, have filed motions to dismiss based on a lack of personal
jurisdiction over them. In January 2002, plaintiff sought leave to name six
additional entities: International Male, Domestications Kitchen & Garden,
Silhouettes, Hanover Company Store, Kitchen & Home, and Domestications as
co-defendants. On March 12, 2002, the Company was served with the First Amended
Complaint in which plaintiff named as defendants the Company, Hanover Brands,
Hanover Direct Virginia, LWI Holdings, Hanover Company Store, Kitchen and Home,
and Silhouettes, and in which all causes of action related to state sales tax
have been removed. With the removal of sales tax issues, the Teichman case
concerns issues identical to the Martin case and may make it easier to stay the
Teichman case pending the outcome of the Martin case. On April 15, 2002, the
Company filed a Motion to Stay the Teichman action in favor of the previously
filed Martin action and also filed a Motion to quash service of summons for lack
of personal jurisdiction on behalf of defendants Hanover Direct, Inc., Hanover
Brands, Inc. and Hanover Direct Virginia, Inc. On May 14, 2002, the Court (1)
granted the Company's Motion to Quash service on behalf of Hanover Direct,
Hanover Brands, and Hanover Direct Virginia, leaving only LWI Holdings, Hanover
Company Store, Kitchen & Home, and Silhouettes, as defendants, and (2) granted
the Company's Motion to Stay the action in favor of the previously filed
Oklahoma action, so nothing will proceed on this case against the remaining
entities until the Oklahoma case is decided. The Company believes it has
defenses against the claims. It is too early to determine the outcome or range
of potential settlement, which could have a material impact on the Company's
results of operations when settled in a future period. Defense counsel to the
Company will seek to have the resolution of the five class action cases (Martin,
Teichman, Wilson, and the two Argonaut cases which are discussed below)
combined, or their effects lessened, in that there are common issues and a
substantially similar class sought to be defined in the five cases.

      On June 28, 2001, Rakesh K. Kaul, the Company's former President and Chief
Executive Officer, filed a five-count complaint (the "Complaint") in New York
State Court against the Company, seeking damages and other relief arising out of
his separation of employment from the Company, including severance payments of
$2,531,352 plus the cost of employee benefits, attorneys' fees and costs
incurred in connection with the enforcement of his rights under his employment
agreement with the Company, payment of $149,325 for 13 weeks of accrued and
unused vacation, damages in the amount of $3,583,800, or, in the alternative, a
declaratory judgment from the court that he is entitled to all change of control
benefits under the "Hanover Direct, Inc. Thirty-Six Month Salary Continuation
Plan," and damages in the amount of $1,396,066 due to the Company's purported
breach of the terms of the "Long-Term Incentive Plan for Rakesh K. Kaul" by
failing to pay him a "tandem bonus" he alleges was due and payable to him on the
30th day following his termination of employment.

      The Company removed the case to the U.S. District Court for the Southern
District of New York on July 25, 2001. Mr. Kaul filed an Amended Complaint
("Amended Complaint") in the U.S. District Court for the Southern District of
New York on September 18, 2001. The Amended Complaint repeats many of the claims
made in the original Complaint and adds ERISA claims. On October 11, 2001, the
Company filed its Answer, Defenses and Counterclaims to the Amended Complaint,
denying liability under each of Mr. Kaul's causes of action, raising several
defenses and


                                       7
<PAGE>
stating nine counterclaims against Mr. Kaul. The counterclaims include (1)
breach of contract; (2) breach of the Non-Competition and Confidentiality
Agreement with the Company; (3) breach of fiduciary duty; (4) unfair
competition; and (5) unjust enrichment. The Company seeks damages, including,
without limitation, the $341,803 in severance pay and car allowance Mr. Kaul
received following his resignation, $412,336 for amounts paid to Mr. Kaul for
car allowance and related benefits, the cost of a long-term disability policy,
and certain payments made to personal attorneys and consultants retained by Mr.
Kaul during his employment, $43,847 for certain services the Company provided
and certain expenses the Company incurred, relating to the renovation and
leasing of office space occupied by Mr. Kaul's spouse at 115 River Road,
Edgewater, New Jersey, the Company's current headquarters, $211,729 on a tax
loan to Mr. Kaul outstanding since 1997 and interest, compensatory and punitive
damages and attorneys' fees. The case is pending. The discovery period has
closed, the Company has moved to amend its counterclaims, and the parties have
each moved for summary judgment. The Company requests summary judgment
dismissing Mr. Kaul's claims including, without limitation, Mr Kaul's claim for
damages in the amount of $3,583,800, or, in the alternative, a declaratory
judgment from the court that he is entitled to all change of control benefits
under the "Hanover Direct, Inc. Thirty-Six Month Salary Continuation Plan," and
summary judgment awarding damages on the Company's claim for reimbursement of a
tax loan. Mr. Kaul requests summary judgment dismissing certain of the Company's
counterclaims and defenses. The briefing on the motions is completed. No trial
date has been set. It is too early to determine the potential outcome, which
could have a material impact on the Company's results of operations when
resolved in a future period.

      In January 2000 and May 2001, the Company provided its full cooperation in
an investigation by the Federal Trade Commission ("FTC") into the marketing of
discount buying clubs to see whether any of the entities investigated engaged in
(1) unfair or deceptive acts or practices in violation of Section 5 of the FTC
Act and/or (2) deceptive or abusive telemarketing acts or practices in violation
of the FTC's Telemarketing Sales Rule. It was subsequently revealed to the
Company that the FTC was conducting an investigation into the activities of
entities owned or controlled by Ira Smolev. On October 24, 2001, the FTC made
final its "Stipulated Final Judgment And Order For Permanent Injunction And
Monetary Settlement" against Ira Smolev and named defendant companies in the
case of Federal Trade Commission v. Ira Smolev, et al. (USDC So. Dist. FL, Ft.
Lauderdale Div.) (the "Order"). The named defendants included The Shopper's
Edge, LLC (the Company's private label discount buying club which is owned by
Mr. Smolev), FAR Services, LLC (the Smolev-owned contracting party to the
Company's Marketing Agreement which was terminated in January 2001) and Consumer
Data Depot, LLC (the Smolev-owned contracting party to the Company's Paymentech
Processing Agreement). The Order will directly affect only those activities of
the Company, which are "in active concert or participation with the named
defendants [i.e., The Shopper's Edge, LLC, FAR Services, LLC and Consumer Data
Depot, LLC]." The most important implication of the Order was that the Company,
as bookkeeper to the club for sustaining members of The Shopper's Edge, may not
process payments from members of The Shopper's Edge club for membership renewals
where the purported authorization of the membership occurred prior to the
effective date of the Order, without first obtaining, within 60 days prior to
the date on which the consumer is billed, an "express verifiable authorization"
of such renewal that complies with the specifications of the Order. All choices
specified for "express verifiable authorization" contained in the Order are
effectively "positive opt-in," would have required some direct mail or
technology expenditures and would have severely hurt response rates, which could
have had a material impact on the Company's profits from discount buying club
membership revenues. The last renewals of Shopper's Edge memberships were
processed in October, 2001 by agreement between the Company and Ira Smolev.
During April 2002, the Company received an inquiry from the FTC asking for an
explanation of how the Company is complying with the Order and, if the Company
is asserting that it is not subject to the Order, to provide an explanation of
the basis for such assertion. The Company has replied in writing to the FTC that
it is not subject to the Order, and has provided an explanation of its
relationship with Mr. Smolev.

      The Company was named as one of 88 defendants in a patent infringement
complaint filed on November 23, 2001 by the Lemelson Medical, Education &
Research Foundation, Limited Partnership (the "Lemelson Foundation"). The
complaint, filed in the U.S. District Court in Arizona, was not served on the
Company until March 2002. In the complaint, the Lemelson Foundation accuses the
named defendants of infringing seven U.S. patents which allegedly cover
"automatic identification" technology through the defendants' use of methods for
scanning production markings such as bar codes. The Company received a letter
dated November 27, 2001 from attorneys for the Lemelson Foundation notifying the
Company of the complaint and offering a license. The Court entered a stay of the
case on March 20, 2002, requested by the Lemelson Foundation, pending the
outcome of a related case in Nevada being fought by bar code manufacturers. The
Nevada case is scheduled to go to trial in November 2002. The Order for the stay
provides that the Company need not answer the complaint, although it has the
option to do so. The Company has been invited to join a common
interest/joint-defense group consisting of defendants named in the complaint as
well as in other actions brought by the Lemelson Foundation. The Company is
currently in the process of analyzing the merits of


                                       8
<PAGE>
the issues raised by the complaint, notifying vendors of its receipt of the
complaint and letter, evaluating the merits of joining the joint-defense group,
and having discussions with attorneys for the Lemelson Foundation regarding the
license offer. A preliminary estimate of the royalties and attorneys' fees which
the Company may pay if it decides to accept the license offer from the Lemelson
Foundation range from about $125,000 to $400,000. The Company has decided to
gather further information, but will not agree to a settlement at this time.

      A class action lawsuit was commenced on February 13, 2002 entitled Jacq
Wilson, suing on behalf of himself, all others similarly situated, and the
general public v. Brawn of California, Inc. dba International Male and
Undergear, and Does 1-100 ("Brawn") in the Superior Court of the State of
California, City and County of San Francisco. Does 1-100 are internet and
catalog direct marketers offering a selection of men's clothing, sundries, and
shoes who advertise within California and nationwide. The complaint alleges that
for at least four years, members of the class have been charged an unlawful,
unfair, and fraudulent insurance fee and tax on orders sent to them by Brawn;
that Brawn was engaged in untrue, deceptive and misleading advertising in that
it was not lawfully required or permitted to collect insurance, tax and sales
tax from customers in California; and that Brawn has engaged in acts of unfair
competition under the state's Business and Professions Code. Plaintiff and the
class seek (i) restitution and disgorgement of all monies wrongfully collected
and earned by Brawn, including interest and other gains made on account of these
practices, including reimbursement in the amount of the insurance, tax and sales
tax collected unlawfully, together with interest, (ii) an order enjoining Brawn
from charging customers insurance and tax on its order forms and/or from
charging tax on the delivery, shipping and insurance charges, (iii) an order
directing Brawn to notify the California State Board of Equalization of the
failure to pay the correct amount of tax to the state and to take appropriate
steps to provide the state with the information needed for audit, and (iv)
compensatory damages, attorneys' fees, pre-judgment interest, and costs of the
suit. The claims of the individually named plaintiff and for each member of the
class amount to less than $75,000. On April 15, 2002, the Company filed a Motion
to Stay the Wilson action in favor of the previously filed Martin action. On May
14, 2002, the Court heard the argument in the Company's Motion to Stay the
action in favor of the Oklahoma action, denying the motion. The Court decided
that the California sales tax issue should be resolved in California. Discovery
is proceeding and the Company plans to conduct a vigorous defense of this
action. The Company believes it has defenses against the claims and intends to
file a motion for summary judgment in the case. It is too early to determine the
outcome or range of potential settlement, which could have a material impact on
the Company's results of operations when settled in a future period. Defense
counsel to the Company will seek to have the resolution of the five class action
cases (Martin, Teichman, Wilson, and the two Argonaut cases which are discussed
below) combined, or their effects lessened, in that there are common issues and
a substantially similar class sought to be defined in the five cases.

      A class action lawsuit was commenced on February 20, 2002 entitled
Argonaut Consumer Rights Advocates Inc., suing on behalf of the General Public
v. Gump's By Mail, Inc. ("Gump's"), and Does 1-100 in the Superior Court of the
State of California, City and County of San Francisco. The plaintiff is a
non-profit public benefit corporation suing under the California Business and
Profession Code. Does 1-100 would include persons whose activities include the
direct sale of tangible personal property to California consumers including the
type of merchandise that Gump's -- the store and the catalog -- sell, by
telephone, mail order, and sales through the web sites www.gumpsbymail.com and
www.gumps.com. The complaint alleges that for at least four years members of the
class have been charged an unlawful, unfair, and fraudulent tax and "sales tax"
on their orders in violation of California law and court decisions, including
the state Revenue and Taxation Code, Civil Code, and the California Board of
Equalization; that Gump's engages in unfair business practices; that Gump's
engaged in untrue and misleading advertising in that it was not lawfully
required to collect tax and sales tax from customers in California; is not
lawfully required or permitted to add tax and sales tax on separately stated
shipping or delivery charges to California consumers; and that it does not add
the appropriate or applicable or specific correct tax or sales tax to its
orders. Plaintiff and the class seek (i) restitution of all tax and sales tax
charged by Gump's on each transaction and/or restitution of tax and sales tax
charged on the shipping charges; (ii) an order enjoining Gump's from charging
customers for tax on orders or from charging tax on the shipping charges; and
(iii) attorneys' fees, pre-judgment interest on the sums refunded, and costs of
the suit. On April 15, 2002, the Company filed an Answer and Separate
Affirmative Defenses to the complaint, generally denying the allegations of the
complaint and each and every cause of action alleged, and denying that plaintiff
has been damaged or is entitled to any relief whatsoever. During June, 2002, the
Company filed its Answers and Objections to Plaintiff's First Set of
Interrogatories, Responses and Objections to Plaintiff's First Request for
Production of Documents, and a Stipulation and Protective Order. At a status
conference held on July 26, 2002, plaintiff moved to have the court strike a
January 2003 trial date, and re-set trial for a later date. Company counsel
filed no objection to the motion. No new trial date has


                                       9
<PAGE>
been set. Discovery is now proceeding. The Company plans to conduct a vigorous
defense of this action. The Company believes it has defenses against the claims
and intends to file a motion for summary judgment in the case. It is too early
to determine the outcome or range of potential settlement, which could have a
material impact on the Company's results of operations when settled in a future
period. Defense counsel to the Company will seek to have the resolution of the
five class action cases combined, or their effects lessened, in that there are
common issues and a substantially similar class sought to be defined in the five
cases.

      A class action lawsuit was commenced on March 5, 2002 entitled Argonaut
Consumer Rights Advocates Inc., suing on behalf of the General Public v.
Domestications LLC, and Does 1-100 ("Domestications") in the Superior Court of
the State of California, City and County of San Francisco. The plaintiff is a
non-profit public benefit corporation suing under the California Business and
Profession Code. Does 1-100 would include persons responsible for the conduct
alleged in the complaint, including the direct sale of tangible personal
property to California consumers including the type of merchandise that
Domestications sells, by telephone, mail order, and sales through the web site
www.domestications.com. The plaintiff claims that for at least four years
members of the class have been charged an unlawful, unfair, and fraudulent tax
and sales tax for different rates and amounts on the catalog and internet orders
on the total amount of goods, tax and sales tax on shipping charges, which are
not subject to tax or sales tax under California law, in violation of California
law and court decisions, including the state Revenue and Taxation Code, Civil
Code, and the California Board of Equalization; that Domestications engages in
unfair business practices; and that Domestications engaged in untrue and
misleading advertising in that it was not lawfully required to collect tax and
sales tax from customers in California. Plaintiff and the class seek (i)
restitution of all sums, interest and other gains made on account of these
practices; (ii) prejudgment interest on all sums wrongfully collected; (iii) an
order enjoining Domestications from charging customers for tax on their orders
and/or from charging tax on the shipping charges; and (iv) attorneys' fees and
costs of the suit. The Company filed an Answer and Separate Affirmative Defenses
to the Complaint, generally denying the allegations of the Complaint and each
and every cause of action alleged, and denying that plaintiff has been damaged
or is entitled to any relief whatsoever. On June 20, 2002, the Company filed its
Answers and Objections to plaintiff's first set of form interrogatories and
request for production of documents. The Company also submitted to plaintiff a
draft of a proposed Stipulation and Protective Order for comment. Once the
Protective Order has been agreed upon by the parties and entered by the Court,
the Company will produce the documents responsive to plaintiff's requests.
Discovery is proceeding and the Company plans to conduct a vigorous defense. The
Company believes it has defenses against the claims. It is too early to
determine the outcome or range of potential settlement, which could have a
material impact on the Company's results of operations when settled in a future
period. Defense counsel to the Company will seek to have the resolution of the
five class action cases combined, or their effects lessened, in that there are
common issues and a substantially similar class sought to be defined in the five
cases.

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

5.  SPECIAL CHARGES

      In December 2000, the Company began a strategic business realignment
program that resulted in the recording of special charges for severance,
facility exit costs and fixed asset write-offs. Special charges recorded in
fiscal years 2000 and 2001 relating to the strategic business realignment
program were $19.1 million and $11.3 million, respectively. The actions related
to the strategic business realignment program were taken in an effort to direct
the Company's resources primarily towards a loss reduction and return to
profitability.

      In the first quarter of 2002, special charges relating to the strategic
business realignment program were recorded in the amount of $0.2 million. These
charges consisted primarily of severance costs related to the elimination of an
additional 10 FTE positions and costs associated with the Company's decision to
close a product manufacturing facility located in San Diego, California. In the
second quarter of 2002, no additional special charges relating to the strategic
business realignment program were recorded.

      As of the end of the second quarter of 2002, a liability is included on
the Company's balance sheet related to future costs in connection with the
Company's strategic business realignment program consisting of the following
(in thousands):


                                       10
<PAGE>
                              Severance &
                               Personal    Lease &
                                Costs     Exit Costs  IT Leases   Total
                               --------   ----------  ---------   -----
Balance at December 30, 2000   $ 4,324    $ 7,656    $ 1,043    $ 13,023

2001 Expenses                    3,828      4,135          -       7,963
Paid in 2001                    (5,606)    (3,654)      (670)     (9,930)
                               -------    -------    -------    --------
Balance at December 29, 2001     2,546      8,137        373      11,056

2002 Expenses                      122        111          -         233
Paid in 2002                    (2,008)    (3,540)      (114)     (5,662)
                               -------    -------    -------    --------
Balance at June 29, 2002       $   660    $ 4,708    $   259    $  5,627
                               =======    =======    =======    ========


      The Company entered into an agreement with the landlord and the
sublandlord to terminate its sublease of the Company's closed 497,200 square
foot warehouse and telemarketing facility located in Maumelle, Arkansas. The
agreement provided for the payment by the Company to the sublandlord of
$1,600,000, plus taxes through April 30, 2002 in the amount of $198,000. The
Company made all of the payments in four weekly installments between May 2, 2002
and May 24, 2002. Upon the satisfaction by the Company of all of its obligations
under the agreement, the sublease terminated and the Company was released from
all further obligations under the sublease. The Company's previously established
reserves for Maumelle, Arkansas were adequate based upon the terms of the final
settlement agreement.

6.  SALE OF IMPROVEMENTS BUSINESS

      On June 29, 2001, the Company sold certain assets and liabilities of its
Improvements business to HSN, a division of USA Networks, Inc.'s Interactive
Group for approximately $33.0 million. In conjunction with the sale, the
Company's Keystone Internet Services, Inc. subsidiary agreed to provide
telemarketing and fulfillment services for the Improvements business under a
services agreement with the buyer for a period of three years.

      The asset purchase agreement between the Company and HSN provides that if
Keystone Internet Services, Inc. fails to perform its obligations during the
first two years of the services contract, the purchaser can receive a reduction
in the original purchase price of up to $2.0 million. An escrow fund of $3.0
million, which was withheld from the original proceeds of the sale, has been
established for a period of two years under the terms of an escrow agreement
between LWI Holdings, Inc., HSN and The Chase Manhattan Bank as a result of
these contingencies. As of June 29, 2002, the balance in the escrow fund is $2.6
million.

      The Company recognized a net gain on the sale of approximately $23.2
million, including a non-cash goodwill charge of $6.1 million, in fiscal year
2001, which represents the excess of the net proceeds from the sale over the net
assets assumed by HSN, the goodwill associated with the Improvements business
and expenses related to the transaction. In June 2002, the Company recognized
$0.3 million of the deferred gain consistent with the terms of the escrow
agreement. Proceeds of $0.3 million relating to the deferred gain were received
July 2, 2002. The recognition of an additional gain of up to approximately $2.3
million has been deferred until the contingencies described above expire, which
will occur no later than the middle of the 2003 fiscal year.

7.  SALE OF KINDIG LANE PROPERTY

      On May 3, 2001, as part of the Company's strategic business realignment
program, the Company sold its fulfillment warehouse in Hanover, Pennsylvania
(the "Kindig Lane Property") and certain equipment located therein for $4.7
million to an unrelated third party. Substantially all of the net proceeds of
the sale were paid to Congress Financial Corporation ("Congress"), pursuant to
the terms of the Congress Credit Facility, and applied to a partial repayment of
the Tranche A Term Loan made by Congress to Hanover Direct Pennsylvania, Inc.,
an affiliate of the Company, and to a partial repayment of the indebtedness
under the Congress Credit Facility. The Company realized a net gain on the sale
of approximately $1.5 million. The Company has continued to use the Kindig Lane
Property under a lease agreement


                                       11
<PAGE>
with the third party, and will continue to lease a portion of the Kindig Lane
Property on a month-to-month basis. The Company intends to transition the
activities of the Kindig Lane Property into the Company's fulfillment center in
Roanoke, Virginia at a future date.


8.  CHANGES IN EMPLOYMENT AGREEMENTS

      Shull Employment Agreement. Effective December 5, 2000, Thomas C. Shull,
Meridian Ventures, LLC, a limited liability company controlled by Mr. Shull
("Meridian"), and the Company entered into a Services Agreement (the "December
2000 Services Agreement"). The December 2000 Services Agreement was replaced by
a subsequent services agreement, dated as of August 1, 2001 (the "August 2001
Services Agreement"), among Mr. Shull, Meridian and the Company, and a Services
Agreement, dated as of December 14, 2001 (the "December 2001 Services
Agreement"), among Mr. Shull, Meridian, and the Company. The December 2001
Services Agreement is being replaced effective September 1, 2002 by an
Employment Agreement between Mr. Shull and the Company, dated as of September 1,
2002 (the "Shull Employment Agreement"), pursuant to which Mr. Shull is to be
employed by the Company as its President and Chief Executive Officer, as
described below.

      The term of the Shull Employment Agreement will begin on September 1, 2002
and will terminate on September 30, 2004 (the "Shull Employment Agreement
Term").

      Under the Shull Employment Agreement, Mr. Shull is to receive from the
Company base compensation equal to $900,000 per annum, payable at the rate of
$75,000 per month ("Base Compensation"). Mr. Shull is to be provided with
participation in the Company's employee benefit plans, including but not limited
to the Company's Key Executive Eighteen Month Compensation Continuation Plan
(the "Change of Control Plan") and its transaction bonus program. The Company is
also to reimburse Mr. Shull for his reasonable out-of-pocket expenses incurred
in connection with his employment by the Company.

      Under the Shull Employment Agreement, the Company shall pay the remaining
unpaid $300,000 of Mr. Shull's fiscal 2001 bonus under the Company's 2001
Management Incentive Plan by no later than December 28, 2002 (or on the date of
closing of any transaction which constitutes a "change of control" thereunder,
if earlier). Mr. Shull shall receive the same bonus amount for fiscal 2002 under
the Company's 2002 Management Incentive Plan as all other Class 8 participants
(as defined in such Plan) receive under such Plan for such period, subject to
all of the terms and conditions applicable generally to Class 8 participants
thereunder. Mr. Shull shall earn annual bonuses for fiscal 2003 and 2004 under
such plans as the Company's Compensation Committee may approve in a manner
consistent with bonuses awarded to other senior executives under such plans.

     Under the Shull Employment Agreement, the Company shall, on December 28,
2002 (or the date of closing of any transaction which constitutes a "change of
control" thereunder, if earlier), make the lump sum cash payment of $450,000 to
Mr. Shull previously due to be paid to Meridian on June 30, 2002.  In addition,
the Company has agreed to make two equal lump sum cash payments of $225,000 each
to Mr. Shull on March 31, 2003 and September 30, 2004, notwithstanding any
"change of control."

      Under the Shull Employment Agreement, upon the closing of any transaction
which constitutes a "change of control" thereunder, provided that Mr. Shull is
then employed by the Company, the Company shall make a lump sum cash payment to
Mr. Shull on the date of such closing of $1,350,000 pursuant to the Change of
Control Plan, $450,000 pursuant to the Company's transaction bonus program and
such bonuses as may be payable pursuant to the Company's Management Incentive
Plans for the applicable fiscal year. Any such lump sum payment would be in lieu
of (i) any cash payment under the Shull Employment Agreement as a result of a
termination thereof upon the first day after the acquisition of the Company
(whether by merger or the acquisition of all of its outstanding capital stock)
or the tenth day after the sale or any series of sales since April 27, 2001
involving an aggregate of 50% or more of the market value of the Company's
assets (for this purpose under the Shull Employment Agreement, such 50% amount
shall be deemed to be $107.6 million), and (ii) the aggregate amount of Base
Compensation to which Mr. Shull would have otherwise been entitled through the
end of the Shull Employment Agreement Term.

      Under the Shull Employment Agreement, additional amounts are payable to
Mr. Shull by the Company under certain circumstances upon the termination of the
Shull Employment Agreement. If the termination is on account of the expiration
of the Shull Employment Agreement Term, Mr. Shull shall be entitled to receive
such amount of bonus as may be payable pursuant to the Company's applicable
bonus plan as well as employee benefits such as accrued vacation


                                       12
<PAGE>
and insurance in accordance with the Company's customary practice. If the
termination is on account of the Company's material breach of the Shull
Employment Agreement or the Company's termination of the Shull Employment
Agreement where there has been no Willful Misconduct (as defined in the Shull
Employment Agreement) or material breach thereof by Mr. Shull, Mr. Shull shall
be entitled to receive (i) a lump sum payment equal to the aggregate amount of
Base Compensation to which he would have otherwise been entitled through the end
of the Shull Employment Agreement Term, plus (ii) $900,000 in severance pay and
such amount of bonus as may be payable pursuant to the Company's applicable
bonus plan as well as employee benefits such as accrued vacation and insurance
in accordance with the Company's customary practice. If the termination is on
account of the acquisition of the Company (whether by merger or the acquisition
of all of its outstanding capital stock) or the sale or any series of sales
since April 27, 2001 involving an aggregate of 50% or more of the market value
of the Company's assets (for this purpose under the Shull Employment Agreement,
such 50% amount shall be deemed to be $107.6 million) and the amount realized in
the transaction is less than $0.50 per common share (or the equivalent of $0.50
per common share), and if and only if the Change of Control Plan shall not then
be in effect, Mr. Shull shall be entitled to receive a lump sum payment equal to
the aggregate amount of Base Compensation to which he would have otherwise been
entitled through the end of the Shull Employment Agreement Term. If the
termination is on account of the acquisition of the Company (whether by merger
or the acquisition of all of its outstanding capital stock) or the sale or any
series of sales since April 27, 2001 involving an aggregate of 50% or more of
the market value of the Company's assets (for this purpose under the Shull
Employment Agreement, such 50% amount shall be deemed to be $107.6 million) and
the amount realized in the transaction equals or exceeds $0.50 per common share
(or the equivalent of $0.50 per common share), and if and only if the Change of
Control Plan shall not then be in effect, Mr. Shull shall be entitled to receive
a lump sum payment equal to the greater of the Base Compensation to which he
would have otherwise been entitled through the end of the Shull Employment
Agreement Term or $1,000,000. If the termination is on account of an acquisition
or sale of the Company (whether by merger or the acquisition of all of its
outstanding capital stock) or the sale or any series of sales since April 27,
2001 involving an aggregate of 50% or more of the market value of the Company's
assets (for this purpose under the Shull Employment Agreement, such 50% amount
shall be deemed to be $107.6 million) and the Change of Control Plan shall then
be in effect, Mr. Shull shall only be entitled to receive his benefit under the
Change of Control Plan.

      Under the Shull Employment Agreement, the Company is required to maintain
directors' and officers' liability insurance for Mr. Shull during the Shull
Employment Agreement Term. The Company is also required to indemnify Mr. Shull
in certain circumstances.

      Amended Thomas C. Shull Stock Option Award Agreements. During December
2000, the Company entered into a stock option agreement with Thomas C. Shull to
evidence the grant to Mr. Shull of an option to purchase 2.7 million shares of
the Company's common stock (the "Shull 2000 Stock Option Agreement"). Effective
as of September 1, 2002, the Company has amended the Shull 2000 Stock Option
Agreement to (i) extend the final expiration date for the stock option under the
Shull 2000 Stock Option Agreement to June 30, 2005, and (ii) replace all
references therein to the December 2000 Services Agreement with references to
the Shull Employment Agreement.

      During December 2001, the Company entered into a stock option agreement
with Mr. Shull to evidence the grant to Mr. Shull of an option to purchase
500,000 shares of the Company's common stock under the Company's 2000 Management
Stock Option Plan (the "Shull 2001 Stock Option Agreement"). Effective as of
September 1, 2002, the Company has amended the Shull 2001 Stock Option Agreement
to (i) provide that any shares purchased by Mr. Shull under the Shull 2001 Stock
Option Agreement would not be saleable until September 30, 2004, and (ii)
replace all references therein to the December 2001 Services Agreement with
references to the Shull Employment Agreement.

      Amended Thomas C. Shull Transaction Bonus Letter. During May 2001, Thomas
C. Shull entered into a letter agreement with the Company (the "Shull
Transaction Bonus Letter") under which he would be paid a bonus on the
occurrence of certain transactions involving the sale of certain of the
Company's businesses. Effective as of September 1, 2002, the Company has amended
the Shull Transaction Bonus Letter to (i) increase the amount of Shull's agreed
to base salary for purposes of the transaction bonus payable thereunder from
$600,000 to $900,000, and (ii) replace all references therein to the December
2000 Services Agreement with references to the Shull Employment Agreement.



                                       13
<PAGE>

9.  RECENTLY ISSUED ACCOUNTING STANDARDS

      In July 2001, the Financial Accounting Standards Board (the "FASB") issued
SFAS No. 141, "Business Combinations" ("FAS 141"), and No. 142, "Goodwill and
Other Intangible Assets" ("FAS 142"). FAS 141 requires all business combinations
initiated after June 30, 2001 to be accounted for using the purchase method.
Under FAS 142, goodwill and intangible assets with indefinite lives are no
longer amortized but are reviewed annually (or more frequently if impairment
indicators arise) for impairment. Separable intangible assets that are not
deemed to have indefinite lives will continue to be amortized over their useful
lives (but with no maximum life). Goodwill relates to the International Male and
the Gump's brands and the net balance at June 29, 2002 is $9.3 million. The
Company adopted FAS 142 effective January 1, 2002 and, as a result, the first
and second quarters ended March 30, 2002 and June 29, 2002 did not include an
amortization charge for goodwill. The Company obtained the services of an
independent appraisal firm during the second quarter ended June 29, 2002 to
evaluate whether there was any goodwill impairment upon adoption of FAS 142. The
results of the appraisal indicated no goodwill transition impairment based upon
the requirements set forth in FAS 142.

       If the provisions of FAS 142 had been implemented for the 13-week period
ended June 30, 2001 and the Company had not included an amortization charge for
goodwill, the Company's net earnings would have increased by $0.1 million to
$12.9 million. If the provisions under FAS 142 had been implemented for the
26-week period ended June 30, 2001 and the Company had not included an
amortization charge for goodwill, the Company's net (loss) would have decreased
by $0.3 million to $(5.4) million. Net earnings (loss) per share for the 13-week
and 26-week periods


                                       14
<PAGE>
ended June 30, 2001 would have remained unchanged at $.05 and $(.00) for both
basic and diluted earnings (loss) per share calculations.

       In July 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations" ("FAS 143"). FAS 143 requires entities to record the
fair value of a liability for an asset retirement obligation in the period in
which it is incurred. When the liability is initially recorded, the entity is
required to capitalize the cost by increasing the carrying value of the related
long-lived asset. Over time, the liability is accreted to its present value
each period, and the capitalized cost is depreciated over the useful life of
the related asset. FAS 143 is effective for fiscal years beginning after June
15, 2002 and will be adopted by the Company effective fiscal 2003. The Company
believes adoption of FAS 143 will not have a material effect on its financial
statements.

       In October 2001, the FASB issued SFAS No. 144, "Accounting for Impairment
or Disposal of Long-Lived Assets" ("FAS 144"). FAS 144 addresses financial
accounting and reporting for the impairment or disposal of long-lived assets.
FAS 144 also extends the reporting requirements to report separately, as
discontinued operations, components of an entity that have either been disposed
of or classified as held-for-sale. The Company adopted the provisions of FAS 144
in fiscal 2002, and such adoption has had no effect on the Company's results of
operations or financial position.

       In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB SFAS No. 13, and Technical
Corrections" ("FAS 145"). FAS 145 rescinds FASB SFAS No. 4, 44, and 64 and
amends FASB SFAS No. 13, "Accounting for Leases," to eliminate an inconsistency
between the required accounting for sale-leaseback transactions and the required
accounting for certain lease modifications that have economic effects that are
similar to sale-leaseback transactions. FAS 145 also amends other existing
authoritative pronouncements to make various technical corrections, clarify
meanings, or describe their applicability under changed conditions. The Company
adopted the provisions of FAS 145 in fiscal 2002, and such adoption has had no
effect on the Company's results of operations or financial position.

      In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" ("FAS 146"). FAS 146 nullifies
Emerging Issues Task Force Issue No. 94-3 ("EITF 94-3"). FAS 146 requires that
a liability for a cost associated with an exit or disposal activity be
recognized when the liability is incurred, whereas under EITF 94-3, the
liability was recognized at the commitment date to an exit plan. The Company is
required to adopt the provisions of FAS 146 effective for exit or disposal
activities initiated after December 31, 2002. The Company is currently
evaluating the impact of adoption of this statement.

10. AMENDMENT TO CONGRESS LOAN AND SECURITY AGREEMENT

      In March 2002, the Company amended the Congress Credit Facility to amend
the definition of Consolidated Net Worth such that, effective July 1, 2002, to
the extent that the goodwill or intangible assets of the Company and its
subsidiaries were impaired under the provisions of FAS 142, such write-off of
assets would not be considered a reduction of total assets for the purposes of
computing consolidated net worth. The Company obtained the services of an
independent appraisal firm during the second quarter ended June 29, 2002 to
evaluate whether there has been any goodwill transition impairment. The results
of the appraisal indicated no goodwill transition impairment based upon the
requirements set forth in FAS 142. The consolidated net working capital,
consolidated net worth and earnings before interest, taxes, depreciation,
amortization and certain non-cash charges covenants were also amended. In
addition, the amendment required the payment of a fee of $100,000.

      On August 16, 2002, the Company amended the Congress Credit Facility to
(i) extend the term of the Tranche B Term Loan from March 31, 2003 to January
31, 2004, (ii) increase by $3,500,000 the borrowing reflected by the Tranche B
Term Note from $4,910,714 to $8,410,714, and (iii) make certain related
technical amendments to the Congress Credit Facility. The amendment required the
payment of fees in the amount of $410,000. Pursuant to this amendment, the
Company has reflected the Tranche B borrowings outstanding of $4.0 million at
June 29, 2002 in Long-term debt on the Condensed Consolidated Balance Sheet.
Achievement of the cost savings and other objectives of the Company's strategic
business realignment program is critical to the maintenance of adequate
liquidity as is compliance with the terms and provisions of the Congress Credit
Facility.

11. SERIES B PARTICIPATING PREFERRED STOCK

      On December 19, 2001, the Company consummated a transaction with Richemont
(the "Richemont Transaction") in which the Company issued to Richemont Finance
S.A. ("Richemont") 1,622,111 shares of Series B Participating Preferred Stock
("Series B Preferred Stock"). The Series B Preferred Stock has a par value of
$0.01 per share.

      The holders of the Series B Preferred Stock are entitled to ten votes per
share on any matter on which the Common Stock votes. In addition, in the event
that the Company defaults in its obligations arising in connection with the
Richemont Transaction, the Certificate of Designations of the Series B Preferred
Stock or its agreements with Congress, or in the event that the Company fails to
redeem at least 811,056 shares of Series B Preferred Stock by August 31, 2003,
then the holders of the Series B Preferred Stock, voting as a class, shall be
entitled to elect two members to the Board of Directors of the Company.

      In the event of the liquidation, dissolution or winding up of the Company,
the holders of the Series B Preferred Stock are entitled to a liquidation
preference (the "Liquidation Preference") which was initially $47.36 per share
and which increases quarterly, commencing March 1, 2002. As of March 1, 2002 and
June 1, 2002, the Liquidation Preference was $49.15 and $51.31 per share,
respectively. As of September 1, 2002 and December 1, 2002, the Liquidation
Preference will be $53.89 and $56.95 per share, respectively. As of March 1,
2003, June 1, 2003 and September 1, 2003, the Liquidation Preference will be
$60.54, $64.74 and $69.64 per share, respectively. As a result, beginning
November 30, 2003, the aggregate Liquidation Preference of the Series B
Preferred Stock will be effectively equal to the aggregate liquidation
preference of the Class A Preferred Stock previously held by Richemont. As of
December 1, 2003, March 1, 2004, June 1, 2004, September 1, 2004 and December 1,
2004, the Liquidation Preference


                                       15
<PAGE>
will be $72.25, $74.96, $77.77, $80.69 and $83.72 per share, respectively. As of
March 1, 2005 and June 1, 2005, the Liquidation Preference will be $86.85 and
$90.11 per share, respectively.

       Dividends on the Series B Preferred Stock are required to be paid
whenever a dividend is declared on the Common Stock. The amount of any dividend
on the Series B Preferred Stock shall be determined by multiplying (i) the
amount obtained by dividing the amount of the dividend on the Common Stock by
the then current fair market value of a share of Common Stock and (ii) the
Liquidation Preference of the Series B Preferred Stock.

      The Series B Preferred Stock must be redeemed by the Company on August 23,
2005. The Company may redeem all or less than all of the then outstanding shares
of Series B Preferred Stock at any time prior to that date. At the option of the
holders thereof, the Company must redeem the Series B Preferred Stock upon a
Change of Control or upon the consummation of an Asset Disposition or Equity
Sale (all as defined in the Certificate of Designations of the Series B
Preferred Stock). The redemption price for the Series B Preferred Stock upon a
Change of Control or upon the consummation of an Asset Disposition or Equity
Sale is the then applicable Liquidation Preference of the Series B Preferred
Stock plus the amount of any declared but unpaid dividends on the Series B
Preferred Stock. The Company's obligation to redeem the Series B Preferred Stock
upon an Asset Disposition or an Equity Sale is subject to the satisfaction of
certain conditions set forth in the Certificate of Designations of the Series B
Preferred Stock.

      Pursuant to the terms of the Certificate of Designations of the Series B
Preferred Stock, the Company's obligation to pay dividends on or redeem the
Series B Preferred Stock is subject to its compliance with its agreements with
Congress.

      The Certificate of Designations of the Series B Preferred Stock provides
that, for so long as Richemont is the holder of at least 25% of the then
outstanding shares of Series B Preferred Stock, it shall be entitled to appoint
a non-voting observer to attend all meetings of the Board of Directors and any
committees thereof. To date, Richemont has not appointed such an observer.


                                       16
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION
        AND RESULTS OF OPERATIONS

      The following table sets forth, for the fiscal periods indicated, the
percentage relationship to net revenues of certain items in the Company's
Condensed Consolidated Statements of Income (Loss):


<TABLE>
<CAPTION>
                                             13-WEEKS ENDED               26-WEEKS ENDED
                                             --------------               --------------
                                          JUNE 29,      JUNE 30,       JUNE 29,      JUNE 30,
                                            2002          2001           2002          2001
                                           ------        ------         ------        ------

<S>                                       <C>           <C>            <C>           <C>
Net revenues                                100.0%        100.0%         100.0%        100.0%
Cost of sales and operating expenses         61.8          62.3           63.4          63.2
Special charges                               0.0           3.8            0.1           2.2
Selling expenses                             23.3          28.2           22.9          27.7
General and administrative expenses          11.0          11.5           11.2          11.1
Depreciation and amortization                 1.3           1.5            1.3           1.4
Earnings (loss) from operations               2.6          (7.3)           1.1          (5.6)
Gain on sale of Improvements
  and Kindig Lane Property                    0.3          18.2            0.1           8.8
Interest expense, net                         1.2           1.4            1.2           1.3
Net earnings and comprehensive
  earnings                                    1.6%          9.5%           0.0%          1.8%
</TABLE>

RESULTS OF OPERATIONS - 13-WEEKS ENDED JUNE 29, 2002 COMPARED WITH THE
13-WEEKS ENDED JUNE 30, 2001

      Net Earnings and Comprehensive Earnings. The Company reported net earnings
of $1.8 million for the 13-weeks ended June 29, 2002 compared with net earnings
of $12.7 million for the comparable period last year. In addition to measures of
operating performance determined in accordance with generally accepted
accounting principles, management also uses earnings before interest, income
taxes, depreciation and amortization expense ("EBITDA") to evaluate performance.
EBITDA is measured because management believes that such information is useful
in evaluating the results relative to other entities that operate within its
industries. EBITDA is an alternative to, and not a replacement measure of,
operating performance as determined in accordance with generally accepted
accounting principles. EBITDA decreased by $18.2 million to $5.0 million for the
13-weeks ended June 29, 2002 as compared with $23.2 million for the comparable
period in 2001. The results for the 13-week periods ended June 29, 2002 and June
30, 2001 include $0.3 million and $24.3 million, respectively, in after tax
gains resulting from the sale of the Improvements business and the Kindig Lane
Property. Net earnings (loss) and EBITDA for the 13-weeks ended June 29, 2002
increased $13.1 million and $12.0 million, respectively, over the comparable
period in 2001 prior to the recognition of these gains. Net earnings (loss) per
share was $(.01) applied to common shareholders for the 13-weeks ended June 29,
2002 and $.05 for the 13-weeks ended June 30, 2001. The per share amounts were
calculated after deducting the Series B Preferred Stock redemption price
increase of $3.5 million for the 13-weeks ended June 29, 2002 and the Series A
Preferred Stock dividends and accretion of $3.0 million for the comparable
period in 2001. The weighted average number of shares outstanding used in both
the basic and diluted net (loss) per share calculation was 138,264,152 for the
13-week period ended June 29, 2002. For the 13-week period ended June 30, 2001,
the weighted average number of shares used in the calculation for the basic and
diluted net earnings per share was 212,186,331 and 212,786,467 shares,
respectively. This decrease in weighted average shares was primarily due to the
transaction consummated with Richemont in December 2001, where the Company
repurchased and retired 74,098,769 shares of Common Stock then held by
Richemont.

      Compared with the comparable period last year, the $10.9 million decrease
in net earnings was primarily due to:

(i)   gain on sale of the Improvements business of $22.8 million in the year
      2001; and

(ii)  gain on sale of the Kindig Lane Property of $1.5 million in the year 2001;

partially offset by:

(i)   decreased cost of sales and operating expenses;

(ii)  decreased selling expenses;

(iii) decreased general and administrative expenses; and

(iv)  decreased special charges associated with the Company's strategic business
      realignment program.


                                       17
<PAGE>
      Net Revenues. Net revenues decreased $19.6 million (14.7%) for the 13-week
period ended June 29, 2002 to $113.9 million from $133.5 million for the
comparable period in 2001. This decrease was due in part to the sale of the
Improvements business on June 29, 2001, which accounted for $15.2 million of the
reduction in revenues for the 13-week period ended June 29, 2002. The
discontinuance of the Domestications Kitchen & Garden, Kitchen & Home and Encore
catalogs contributed $1.2 million to the reduction in net revenues for the
13-week period ended June 29, 2002. The remaining balance of the decrease in net
revenues can be attributed to softness in demand primarily related to certain
brands and planned reductions in unprofitable circulation.

      Cost of Sales and Operating Expenses. Cost of sales and operating expenses
decreased to 61.8% of net revenues for the 13- week period ended June 29, 2002
as compared with 62.3% of net revenues for the comparable period in 2001. This
change was due primarily to reductions in spending related to the information
technology systems area that have resulted from actions taken in connection with
the Company's strategic business realignment program.

      Special Charges. In December 2000, the Company developed a plan to
strategically realign its business and direct the Company's resources primarily
towards a loss reduction and return to profitability. As a result of the
continued actions needed to execute the plan, the Company recorded special
charges of $5.0 million for the 13- week period ended June 30, 2001 to primarily
cover additional charges related to the exit of the Maumelle and Kindig Lane
buildings including the write-down for impairment of remaining assets. Also
included were severance costs relating to the elimination of associates employed
at the Kindig Lane Property, in addition to 32 FTE positions across all
divisions of the Company's business as part of the strategic business
realignment program. For the 13-week period ended June 29, 2002, the Company did
not incur any additional special charges relating to the strategic business
realignment program.

      Selling Expenses. Selling expenses decreased by $11.1 million to $26.6
million for the 13- weeks ended June 29, 2002 as compared with $37.7 million for
the comparable period in the year 2001. As a percentage relationship to net
revenues, selling expenses decreased to 23.3% for the 13- weeks ended June 29,
2002 versus 28.2% for the comparable period in the year 2001. This decrease was
due primarily to reductions in catalog paper pricing, postage costs, and
circulation. In addition, decreases in catalog printing and preparation costs
also contributed to the lower percentage relationship to net revenues.

      General and Administrative Expenses. General and administrative expenses
decreased by $2.8 million to $12.6 million for the 13- weeks ended June 29, 2002
as compared with $15.4 million for the comparable period last year. As a
percentage relationship to net revenues, general and administrative expenses
were 11.0% of net revenues for the 13- weeks ended June 29, 2002 versus 11.5% of
net revenues for the comparable period in the year 2001. The reductions in costs
are primarily attributable to the elimination of a significant number of FTE
positions across all departments which began late in 2000 as part of the
Company's strategic business realignment program and has continued throughout
the 13- weeks ended June 29, 2002. This decrease is partially offset by
additional professional and legal fees associated with the Company's engagement
in legal proceedings as mentioned in Note 4, Commitments and Contingencies, to
the Condensed Consolidated Financial Statements.

      Depreciation and Amortization. Depreciation and amortization decreased by
$0.5 million for the 13- weeks ended June 29, 2002 versus the comparable period
in the year 2001. The decrease is primarily due to the elimination of goodwill
amortization of $0.1 million resulting from the implementation of FAS 142 and
the complete amortization of computer software in the year 2001. As a percentage
relationship to net revenues, depreciation and amortization was 1.3% for the
13- weeks ended June 29, 2002 and 1.5% for the comparable period in the year
2001.

      Earnings (Loss) from Operations. The Company's earnings from operations
increased by $12.6 million to $2.9 million for the 13- weeks ended June 29, 2002
from a loss of ($9.7) million for the comparable period in the year 2001.

      Gain on sale of the Improvements business and the Kindig Lane Property.
Gain on sale of the Improvements business and the Kindig Lane Property was 18.2%
of net revenues for the 13- weeks ended June 30, 2001. The Company realized a
net gain on the sale of the Improvements business of approximately $22.8 million
in the second quarter of 2001, which represents the excess of the net proceeds
from the sale over the net assets assumed by HSN, the goodwill associated with
the Improvements business and expenses related to the transaction. In June 2002,
the Company


                                       18
<PAGE>
recognized $0.3 million of the deferred gain consistent with the terms of the
escrow agreement. The Company realized a net gain on the sale of the Kindig Lane
Property of approximately $1.5 million.

      Interest Expense, Net. Interest expense, net decreased $0.4 million to
$1.4 million for the 13- weeks ended June 29, 2002 as compared with $1.8 million
for the comparable period in the year 2001. The decrease in interest expense in
the second quarter of 2002 is primarily due to lower average borrowings, coupled
with lower interest rates. This decrease is partially offset by an increase in
amortization from additional deferred financing costs relating to the Company's
credit facility with Congress.

RESULTS OF OPERATIONS - 26- WEEKS ENDED JUNE 29, 2002 COMPARED WITH THE
26- WEEKS ENDED JUNE 30, 2001

      Net Earnings and Comprehensive Earnings. The Company reported net earnings
of $0.0 million for the 26- weeks ended June 29, 2002 compared with net earnings
of $5.1 million for the comparable period last year. EBITDA decreased by $13.8
million to $6.4 million for the 26- weeks ended June 29, 2002 as compared with
$20.2 million for the comparable period in 2001. The results for the 26-week
periods ended June 29, 2002 and June 30, 2001 include $0.3 million and $24.3
million, respectively, in after tax gains resulting from the sale of the
Improvements business and the Kindig Lane Property. Net earnings and EBITDA for
the 26- weeks ended June 29, 2002 increased $18.9 million and $16.4 million,
respectively, over the comparable period in 2001 prior to the recognition of
these gains. Net (loss) per share was $(.05) applied to common shareholders for
the 26- weeks ended June 29, 2002 and $(0.0) for the 26- weeks ended June 30,
2001. The per share amounts were calculated after deducting the Series B
Preferred Stock redemption price increase of $6.4 million for the 26- weeks
ended June 29, 2002 and the Series A Preferred Stock dividends and accretion of
$5.9 million for the comparable period in 2001. The weighted average number of
shares outstanding used in both the basic and diluted net (loss) per share
calculation was 138,244,591 for the 26-week period ended June 29, 2002 and
212,327,375 for the 26-week period ended June 30, 2001. This decrease in
weighted average shares was primarily due to the transaction consummated with
Richemont in December 2001, where the Company repurchased and retired 74,098,769
shares of Common Stock then held by Richemont.

      Compared with the comparable period last year, the $5.1 million decrease
in net earnings was primarily due to:

(i)   gain on sale of the Improvements business of $22.8 million in the year
      2001; and

(ii)  gain on sale of the Kindig Lane Property of $1.5 million in the year 2001;

partially offset by:

(i)   decreased cost of sales and operating expenses;

(ii)  decreased selling expenses;

(iii) decreased general and administrative expenses; and

(iv)  decreased special charges associated with the Company's strategic business
      realignment program.

      Net Revenues. Net revenues decreased $54.4 million (19.6%) for the 26-week
period ended June 29, 2002 to $223.4 million from $277.8 million for the
comparable period in 2001. This decrease was due in part to the sale of the
Improvements business on June 29, 2001, which accounted for $34.1 million of the
reduction in revenues for the 26-week period ended June 29, 2002. The
discontinuance of the Domestications Kitchen & Garden, Kitchen & Home, Encore
and Turiya catalogs contributed $6.0 million to the reduction in net revenues
for the 26-week period ended June 29, 2002. An additional portion of the drop in
revenues amounting to $0.7 million can be attributed to the Company's decision
to scale back on its third-party fulfillment business by focusing only on
profitable operations. The remaining balance of the decrease in net revenues can
be attributed to softness in demand primarily related to certain brands and
planned reductions in unprofitable circulation.

      Cost of Sales and Operating Expenses. Cost of sales and operating expenses
increased to 63.4% of net revenues for the 26-week period ended June 29, 2002 as
compared with 63.2% of net revenues for the comparable period in 2001. This
change is due to an increase in merchandise inventory costs, which accounted for
0.6% of the percentage increase, partially offset by decreases in operating
costs that have resulted from actions taken in connection with the Company's
strategic business realignment program. These decreases occurred primarily in
the areas of fixed telemarketing and


                                       19
<PAGE>
distribution costs and information systems costs associated with the Company's
fulfillment centers, which accounted for 0.4% of the offsetting percentage
decrease.

      Special Charges. In December 2000, the Company developed a plan to
strategically realign its business and direct the Company's resources primarily
towards a loss reduction and return to profitability. As a result of the
continued actions needed to execute the plan, the Company recorded special
charges of $6.1 million for the 26-week period ended June 30, 2001. These
special charges were recorded to primarily cover severance costs related to the
elimination of 78 FTE positions across all departments of the Company's business
and additional charges related to the exit of the Maumelle and Kindig Lane
buildings including the write-down for impairment of remaining assets. For the
26-week period ended June 29, 2002, the Company recorded an additional $0.2
million of special charges relating to the strategic business realignment
program. These charges consisted primarily of severance costs related to the
elimination of an additional 10 FTE positions in various levels of catalog
operations and costs associated with the Company's decision to close the San
Diego product manufacturing facility.

      Selling Expenses. Selling expenses decreased by $25.9 million to $51.2
million for the 26- weeks ended June 29, 2002 as compared with $77.1 million for
the comparable period in the year 2001. As a percentage relationship to net
revenues, selling expenses decreased to 22.9% for the 26- weeks ended June 29,
2002 versus 27.7% for the comparable period in the year 2001. This decrease was
due primarily to reductions in catalog paper pricing, catalog preparation costs
and circulation. In addition, decreases in catalog printing and postage costs
also contributed to the lower percentage relationship to net revenues.

      General and Administrative Expenses. General and administrative expenses
decreased by $5.7 million to $25.0 million for the 26- weeks ended June 29, 2002
as compared with $30.7 million for the comparable period last year. As a
percentage relationship to net revenues, general and administrative expenses
were 11.2% of net revenues for the 26- weeks ended June 29, 2002 versus 11.1% of
net revenues for the comparable period in the year 2001. This increase is
primarily due to additional professional and legal fees associated with the
Company's engagement in legal proceedings as mentioned in Note 4, Commitments
and Contingencies, to the Condensed Consolidated Financial Statements. This
increase is partially offset by reductions in costs primarily attributable to
the elimination of a significant number of FTE positions across all departments
which began late in 2000 as part of the Company's strategic business realignment
program and have continued throughout the 26- weeks ended June 29, 2002.

      Depreciation and Amortization. Depreciation and amortization decreased by
$0.9 million for the 26- weeks ended June 29, 2002 versus the comparable period
in the year 2001. The decrease is primarily due to the elimination of goodwill
amortization of $0.3 million resulting from the implementation of FAS 142 and
the complete amortization of computer software in the year 2001. As a percentage
relationship to net revenues, depreciation and amortization was 1.3% for the
26- weeks ended June 29, 2002 and 1.4% for the comparable period in the year
2001.

      Earnings (Loss) from Operations. The Company's earnings from operations
increased by $18.0 million to $2.5 million for the 26- weeks ended June 29, 2002
from a loss of ($15.5) million for the comparable period in the year 2001.

      Gain on sale of the Improvements business and the Kindig Lane Property.
Gain on sale of the Improvements business and the Kindig Lane Property was 8.8%
of net revenues for the 26- weeks ended June 30, 2001. The Company realized a
net gain on the sale of the Improvements business of approximately $22.8 million
in the second quarter of 2001, which represents the excess of the net proceeds
from the sale over the net assets assumed by HSN, the goodwill associated with
the Improvements business and expenses related to the transaction. In June 2002,
the Company recognized $0.3 million of the deferred gain consistent with the
terms of the escrow agreement. The Company realized a net gain on the sale of
the Kindig Lane Property of approximately $1.5 million.

      Interest Expense, Net. Interest expense, net decreased $1.0 million to
$2.7 million for the 26- weeks ended June 29, 2002 as compared with $3.7 million
for the comparable period in the year 2001. The decrease in interest expense is
primarily due to lower average borrowings, coupled with lower interest rates.
This decrease is partially offset by an increase in amortization from additional
deferred financing costs relating to the Company's credit facility with
Congress.


                                       20
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES

      Net cash provided by operating activities. During the 26-week period ended
June 29, 2002, net cash provided by operating activities was $0.2 million. Net
cash provided by operating activities, when adjusted for depreciation,
amortization and other non-cash items, resulted in positive cash flow of $4.4
million for the period. These funds were primarily used to reduce accounts
payable and accrued liabilities.

      Net cash used by investing activities. During the 26-week period ended
June 29, 2002, net cash used by investing activities was $0.3 million, which was
due to capital expenditures primarily relating to upgrades in equipment located
at the Roanoke, Virginia distribution center and various computer software
applications.

      Net cash used by financing activities. During the 26-week period ended
June 29, 2002, net cash used by financing activities was $0.1 million, which was
primarily due to payments made under the Congress term loan facility, partially
offset by net borrowings under the Congress revolving credit facility.

      Congress Credit Facility. On March 24, 2000, the Company amended its
credit facility with Congress to provide the Company with a maximum credit line,
subject to certain limitations, of up to $82.5 million (the "Congress Credit
Facility"). The Congress Credit Facility, as amended, expires on January 31,
2004 and comprises a revolving loan facility, a $17.5 million Tranche A Term
Loan and a $7.5 million Tranche B Term Loan. Total cumulative borrowings,
however, are subject to limitations based upon specified percentages of eligible
receivables and eligible inventory, and the Company is required to maintain $3.0
million of excess credit availability at all times. The Congress Credit
Facility, as amended, is secured by all the assets of the Company and places
restrictions on the incidence of additional indebtedness and on the payment of
Common Stock dividends. As of June 29, 2002, the Company had $29.5 million of
borrowings outstanding under the amended Congress Credit Facility consisting of
$15.0 million under the revolving credit facility and $9.4 million and $5.1
million of Tranche A Term Loans and Tranche B Term Loans, respectively. The
Company may draw upon the amended Congress Credit Facility to fund working
capital requirements as needed.

      In March 2002, the Company amended the Congress Credit Facility to amend
the definition of Consolidated Net Worth such that, effective July 1, 2002, to
the extent that the goodwill or intangible assets of the Company and its
subsidiaries are impaired under the provisions of FAS 142, such write-off of
assets would not be considered a reduction of total assets for the purposes of
computing consolidated net worth. The Company obtained the services of an
independent appraisal firm during the second quarter ended June 29, 2002 to
evaluate whether there has been any goodwill transition impairment. The results
of the appraisal indicated no goodwill transition impairment based upon the
requirements set forth in FAS 142. The consolidated net working capital,
consolidated net worth and EBITDA covenants were also amended. In addition, the
amendment required the payment of a fee of $100,000.

      On August 16, 2002, the Company amended the Congress Credit Facility to
(i) extend the term of the Tranche B Term Loan from March 31, 2003 to January
31, 2004, (ii) increase by $3,500,000 the borrowing reflected by the Tranche B
Term Note from $4,910,714 to $8,410,714, and (iii) make certain related
technical amendments to the Congress Credit Facility. The amendment required the
payment of fees in the amount of $410,000. Pursuant to this amendment, the
Company has reflected the Tranche B borrowings outstanding of $4.0 million at
June 29, 2002 in Long-term debt on the Condensed Consolidated Balance Sheet.
Achievement of the cost savings and other objectives of the Company's strategic
business realignment program is critical to the maintenance of adequate
liquidity as is compliance with the terms and provisions of the Congress Credit
Facility as mentioned in Note 10, Amendment to Congress Loan and Security
Agreement, to the Condensed Consolidated Financial Statements.

      Sale of Improvements Business. On June 29, 2001, the Company sold certain
assets and liabilities of its Improvements business to HSN, a division of USA
Networks, Inc.'s Interactive Group for approximately $33.0 million. In
conjunction with the sale, the Company's Keystone Internet Services, Inc.
subsidiary agreed to provide telemarketing and fulfillment services for the
Improvements business under a services agreement with the buyer for a period of
three years.

      The asset purchase agreement between the Company and HSN provides that if
Keystone Internet Services, Inc. fails to perform its obligations during the
first two years of the services contract, the purchaser can receive a reduction
in the original purchase price of up to $2.0 million. An escrow fund of $3.0
million, which was withheld from the original proceeds of the sale, has been
established for a period of two years under the terms of an escrow agreement
between LWI Holdings, Inc., HSN and The Chase Manhattan Bank as a result of
these contingencies. As of June 29, 2002, the balance in the escrow fund is $2.6
million.

      The Company recognized a net gain on the sale of approximately $23.2
million, including a non-cash goodwill charge of $6.1 million, in fiscal year
2001, which represents the excess of the net proceeds from the sale over the net
assets assumed by HSN, the goodwill associated with the Improvements business
and expenses related to the


                                       21
<PAGE>
transaction. In June 2002, the Company recognized $0.3 million of the deferred
gain consistent with the terms of the escrow agreement. Proceeds of $0.3 million
relating to the deferred gain were received July 2, 2002. The recognition of an
additional gain of up to approximately $2.3 million has been deferred until the
contingencies described above expire, which will occur no later than the middle
of the 2003 fiscal year.

      General. At June 29, 2002, the Company had $0.9 million in cash and cash
equivalents compared with $2.1 million at June 30, 2001. Working capital and
current ratios at June 29, 2002 were $23.1 million and 1.32 to 1 versus $17.1
million and 1.18 to 1 at June 30, 2001. Total cumulative borrowings, including
financing under capital lease obligations, as of June 29, 2002, aggregated $29.6
million, $26.5 million of which is classified as long-term. Remaining
availability under the Congress Credit Facility as of June 29, 2002 was $7.3
million. There were nominal capital commitments (less than $0.1 million) at June
29, 2002.

      The Company entered into an agreement with the landlord and the
sublandlord to terminate its sublease of the Company's closed 497,200 square
foot warehouse and telemarketing facility located in Maumelle, Arkansas. The
agreement provided for the payment by the Company to the sublandlord of
$1,600,000, plus taxes through April 30, 2002 in the amount of $198,000. The
Company made all of the payments in four weekly installments between May 2, 2002
and May 24, 2002. Upon the satisfaction by the Company of all of its obligations
under the agreement, the sublease terminated and the Company was released from
all further obligations under the sublease.

      On March 22, 2002, the Postal Rate Commission approved a settlement that
allowed postal rates to increase an average of 7.7% on June 30, 2002. The
Company had anticipated this action in its 2002 planning process and will
accommodate the increased cost as part of normal business operations. The
Company has implemented cost conservation measures, such as reduced paper
weights and trim size changes, as a way of mitigating such cost increases.

      Management believes that the Company has sufficient liquidity and
availability under its credit agreements to fund its planned operations through
at least December 28, 2002. Achievement of the cost saving and other objectives
of the Company's strategic business realignment program is critical to the
maintenance of adequate liquidity as is compliance with the terms and provisions
of the Congress Credit Facility as mentioned in Note 10, Amendment to Congress
Loan and Security Agreement, to the Condensed Consolidated Financial Statements.

USES OF ESTIMATES AND OTHER CRITICAL ACCOUNTING POLICIES

      During the second quarter ended June 29, 2002, there were no changes in
the Company's policies regarding the use of estimates and other critical
accounting policies. See "Management's Discussion and Analysis of Consolidated
Financial Condition and Results of Operations," found in the Company's Annual
Report on Form 10-K for the fiscal year ended December 29, 2001, for additional
information relating to the Company's uses of estimates and other critical
accounting policies.

NEW ACCOUNTING PRONOUNCEMENTS

      The Company adopted FAS 142 effective January 1, 2002 and, as a result,
the first and second quarters ended March 30, 2002 and June 29, 2002 did not
include an amortization charge for goodwill. The Company obtained the services
of an independent appraisal firm during the second quarter ended June 29, 2002
to evaluate whether there has been any goodwill transition impairment. The
results of the appraisal indicated no goodwill transition impairment based upon
the requirements set forth in FAS 142.

       If the provisions of FAS 142 had been implemented for the 13-week period
ended June 30, 2001 and the Company had not included an amortization charge for
goodwill, the Company's net earnings would have increased by $0.1 million to
$12.9 million. If the provisions under FAS 142 had been implemented for the
26-week period ended June 30, 2001 and the Company had not included an
amortization charge for goodwill, the Company's net (loss) would have decreased
by $0.3 million to $(5.4) million. Net earnings (loss) per share for the 13-week
and 26-week periods ended June 30, 2001 would have remained unchanged at $.05
and $(.00) for both basic and diluted earnings (loss) per share calculations.


                                       22
<PAGE>
      See "Management's Discussion and Analysis of Consolidated Financial
Condition and Results of Operations," found in the Company's Annual Report on
Form 10-K for the fiscal year ended December 29, 2001 and Note 9 herein for
additional information relating to new accounting pronouncements which the
Company has adopted.

SEASONALITY

      The revenues and business for the Company are seasonal. The Company
processes and ships more catalog orders during the fourth quarter holiday season
than in any other quarter of the year. Accordingly, the Company recognizes a
disproportionate share of annual revenue during the last three months of the
year.

FORWARD-LOOKING STATEMENTS

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

      "Management believes that the Company has sufficient liquidity and
availability under its credit agreements to fund its planned operations through
at least December 28, 2002."

CAUTIONARY STATEMENTS

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

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

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

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

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

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

      The recent general deterioration in economic conditions in the United
States leading to key vendors and suppliers reducing or withdrawing trade credit
to companies in the retail and catalog and direct marketing industries. The risk
that key vendors or suppliers may reduce or withdraw trade credit to the
Company, convert the Company to a


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<PAGE>
cash basis or otherwise change credit terms, or require the Company to provide
letters of credit or cash deposits to support its purchase of inventory,
increasing the Company's cost of capital and impacting the Company's ability to
obtain merchandise in a timely manner. Vendors beginning to withhold shipments
of merchandise to the Company. The ability of the Company to find alternative
vendors and suppliers on competitive terms if vendors or suppliers who exist
cease doing business with the Company.

      The inability of the Company to timely obtain and distribute merchandise,
as a result of foreign sourcing or otherwise, leading to an increase in
backorders and cancellations.

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

      Continued compliance by the Company with and the enforcement by Congress
of financial and other covenants and limitations contained in the Congress
Credit Facility, including net worth, net working capital, capital expenditure
and EBITDA covenants, and limitations based upon specified percentages of
eligible receivables and eligible inventory, and the requirement that the
Company maintain $3.0 million of excess credit availability at all times,
affecting the ability of the Company to continue to make borrowings under the
Congress Credit Facility as needed.

      Continuation of the Company's history of operating losses, and the
incidence of costs associated with the Company's strategic business realignment
program, resulting in the Company failing to comply with certain financial and
other covenants contained in the Congress Credit Facility, including net worth,
net working capital, capital expenditure and EBITDA covenants and the ability of
the Company to obtain waivers from Congress in the event that future internal
and/or external events result in performance which results in noncompliance by
the Company with the terms of the Congress Credit Facility requiring
remediation.

      The ability of the Company to complete the Company's strategic business
realignment program within the time periods anticipated by the Company. The
ability of the Company to realize the aggregate cost savings and other
objectives anticipated in connection with the strategic business realignment
program, or within the time periods anticipated therefor. The aggregate costs of
effecting the strategic business realignment program may be greater than the
amounts anticipated by the Company.

      The ability of the Company to obtain advance rates under the Congress
Credit Facility which are at least as favorable as those obtained in the past.

      The ability of the Company to extend the term of the Congress Credit
Facility beyond January 31, 2004, its scheduled expiration date, or obtain other
credit facilities on the expiration of the Congress Credit Facility on terms at
least as favorable as those under the Congress Credit Facility.

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

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

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

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

      The inability of the Company to sell assets at industry multiples or at
all due to market conditions generally, as a result of market conditions
following the events of September 11, 2001 and otherwise


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

      The ability of the Company to maintain the listing of its Common Stock on
the American Stock Exchange.

      The continued willingness of customers to place and receive mail orders in
light of worries about bio-terrorism.

      The ability of the Company to sublease or terminate or renegotiate the
leases of its vacant facilities in Weehawken, New Jersey, San Francisco,
California and certain other locations.

      The Company undertakes no obligation to publicly update any
forward-looking statement whether as a result of new information, future events
or otherwise. Readers are advised, however, to consult any further disclosures
the Company may make on related subjects in its Forms 10-Q, 8-K, 10-K or any
other reports filed with the Securities and Exchange Commission.

ITEM 3.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

      INTEREST RATES: The Company's exposure to market risk relates to interest
rate fluctuations for borrowings under the Congress revolving credit facility
and its term financing facility, which bear interest at variable rates. At June
29, 2002, outstanding principal balances under these facilities subject to
variable rates of interest were approximately $24.4 million. If interest rates
were to increase by one percent from current levels, the resulting increase in
interest expense, based upon the amount outstanding at June 29, 2002, would be
approximately $0.24 million on an annual basis.


                                       25
<PAGE>
PART II - OTHER INFORMATION
ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K

(a)         Exhibits

<TABLE>
<S>         <C>
10.1        Employment Agreement dated as of September 1, 2002 between the Company
            and Thomas C. Shull.

10.2        Amendment Number 1 to Agreement dated May 14, 2001 between Thomas C. Shull
            and the Company.

10.3        Form of letter agreement between the Company and certain Level 8 executive
            officers.

10.4        Twenty-Second Amendment to Loan and Security Agreement, dated as of
            August 16, 2002, among Congress Financial Corporation and certain
            Subsidiaries of the Company.

99.1        Certification signed by Thomas C. Shull.

99.2        Certification signed by Edward M. Lambert.
</TABLE>




                                  26
<PAGE>
                                   SIGNATURES

      Pursuant to the requirements 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 in the City of Edgewater, State of New
Jersey.




                                         HANOVER DIRECT, INC.

                                         Registrant




                                         By:  /s/ Edward M. Lambert
                                         -------------------------------------
                                                  Edward M. Lambert
                                             Executive Vice President and
                                               Chief Financial Officer
                                         (On behalf of the Registrant and as
                                             principal financial officer)



Date: August 19, 2002


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