SECURITIES AND EXCHANGE
COMMISSIONWashington, D.C. 20549 FORM 10-Q QUARTERLY REPORT
PURSUANT TO SECTION 13 OR 15(d)OF
THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly
period ended September 24, 2005 Commission file number
1-08056 HANOVER
DIRECT, INC.(Exact name of registrant as specified in its charter) Delaware
      
      (State of incorporation)
    13-0853260
      
      (IRS Employer Identification No.)1500 Harbor Boulevard,
      Weehawken, New Jersey
      (Address of principal executive offices)
    07086 
      (Zip Code)  (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
|_|     No |X| Indicate by check mark whether the
registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes
|_|     No |X| Indicate by check mark whether the registrant
is a shell company (as defined in Rule 12b-2 of the Exchange Act) Yes
|_|     No |X| Common stock, par value $0.01 per
share: 22,426,296 shares outstanding as of December 9, 2005.    HANOVER
DIRECT, INC.


TABLE OF CONTENTS

PagePart
      I - Financial InformationItem
      1. Financial StatementCondensed
      Consolidated Balance Sheets -September
      24, 2005, December 25, 2004 and September 25, 2004
    2Condensed
      Consolidated Statements of Income - 13 and 39- weeks endedSeptember
      24, 2005 and September 25, 2004
    4Condensed
      Consolidated Statements of Cash Flows - 13 and 39- weeks endedSeptember
      24, 2005 and September 25, 2004
    6Notes
      to Condensed Consolidated Financial Statements
    7Item
      2. Managements Discussion and Analysis of Consolidated Financial Condition
      andResults
      of Operations
    15Item
      3. Quantitative and Qualitative Disclosures about Market Risk
    21Item
      4. Controls and Procedures
    21Part
      II - Other InformationItem
      1. Legal Proceedings
    22Item
      6. Exhibits
    22Signature
      Page
    231
PART I  FINANCIAL
INFORMATION


ITEM 1. FINANCIAL
STATEMENTS


THE FINANCIAL
INFORMATION INCLUDED IN THIS FORM 10-Q HAS NOT BEEN SUBJECTED TO A TIMELY QUARTERLY
REVIEW AS REQUIRED BY RULE 10-01 (D) OF REGULATION S-X.


HANOVER DIRECT, INC.
AND SUBSIDIARIESCONDENSED CONSOLIDATED BALANCE SHEETS(In thousands of dollars, except
share amounts)(Unaudited)


September
      24,
      2005
    
    December
      25,
      2004
    
    September
      25,
      2004ASSETSCURRENT
      ASSETS:Cash
      and cash equivalents
    $
    134
    
    $
    510
    
    $
    418Accounts
      receivable, net of allowance for doubtfulaccounts
      of $911, $1,367 and $1,062, respectively
    
    10,837
    
    
    17,819
    
    
    13,448Inventories
    
    57,315
    
    
    53,147
    
    
    51,102Prepaid
      catalog costs
    
    21,017
    
    
    15,644
    
    
    18,670Other
      current assets
    
    2,777
    
    
    4,482
    
    
    4,748Total
      Current Assets
    
    92,080
    
    
    91,602
    
    
    88,386PROPERTY
      AND EQUIPMENT, AT COST:Land
    
    4,361
    
    
    4,361
    
    
    4,361Buildings
      and building improvements
    
    18,192
    
    
    18,221
    
    
    18,213Leasehold
      improvements
    
    1,118
    
    
    10,156
    
    
    10,197Furniture,
      fixtures and equipment
    
    51,322
    
    
    53,792
    
    
    53,47874,993
    
    
    86,530
    
    
    86,249Accumulated
      depreciation and amortization
    
    (54,337
    )
    
    (61,906
    )
    
    (61,106
    )Property
      and equipment, net
    
    20,656
    
    
    24,624
    
    
    25,143Goodwill
    
    8,649
    
    
    9,278
    
    
    9,278Deferred
      tax assets
    
    2,247
    
    
    2,034
    
    
    1,769Other assets
    
    2,232
    
    
    2,816
    
    
    2,933Total
      Assets
    $
    125,864
    
    $
    130,354
    
    $
    127,509Continued on next page.


2
HANOVER DIRECT, INC.
AND SUBSIDIARIESCONDENSED CONSOLIDATED BALANCE SHEETS (Continued)(In thousands of dollars, except
share amounts)(Unaudited)



September
      24,
      2005
    
    December
      25,
      2004
    
    September
      25,
      2004LIABILITIES
      AND SHAREHOLDERS DEFICIENCYCURRENT
      LIABILITIES:Short-term
      debt and capital lease obligations
    $
    13,749
    
    $
    16,690
    
    $
    12,918Accounts
      payable
    
    26,079
    
    
    29,544
    
    
    33,275Accrued
      liabilities
    
    10,235
    
    
    20,535
    
    
    17,209Customer
      prepayments and credits
    
    14,828
    
    
    12,032
    
    
    17,227Deferred tax liability
    
    2,247
    
    
    2,034
    
    
    1,769Total
      Current Liabilities
    
    67,138
    
    
    80,835
    
    
    82,398NON-CURRENT
      LIABILITIES:Long-term
      debt
    
    12,083
    
    
    11,196
    
    
    11,050Series
      C Participating Preferred Stock, authorized, issuedand
      outstanding 564,819 shares; liquidationpreference
      of $56,482
    
    72,689
    
    
    72,689
    
    
    72,689Other
    
    18
    
    
    3,286
    
    
    3,457Total
      Non-current Liabilities
    
    84,790
    
    
    87,171
    
    
    87,196Total
      Liabilities
    
    151,928
    
    
    168,006
    
    
    169,594SHAREHOLDERS
      DEFICIENCY:Common
      Stock, $0.01 par value, authorized 50,000,000 shares atSeptember
      24, 2005, December 25, 2004 and September 25,2004;
      22,426,296 shares issued and outstanding at September24,
      2005 and December 25, 2004; 22,662,875 shares issuedand 22,450,782
      shares outstanding at September 25, 2004
    
    225
    
    
    225
    
    
    227Capital
      in excess of par value
    
    460,857
    
    
    460,744
    
    
    464,059Accumulated
      deficit
    
    (487,146
    )
    
    (498,621
    )
    
    (503,025
    )(26,064
    )
    
    (37,652
    )
    
    (38,739
    )Less:Treasury
      stock, at cost (0 shares at September 24, 2005 andDecember
      25, 2004 and 212,093 shares at September 25, 2004)
    
    
    
    
    
    
    
    (2,996
    )Notes
      receivable from sale of Common Stock
    
    
    
    
    
    
    
    (350
    )Total
      Shareholders Deficiency
    
    (26,064
    )
    
    (37,652
    )
    
    (42,085
    )Total
      Liabilities and Shareholders Deficiency
    $
    125,864
    
    $
    130,354
    
    $
    127,509See Notes to Condensed
Consolidated Financial Statements.


3
HANOVER
DIRECT, INC. AND SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENTS OF INCOME(In
thousands of dollars, except per share amounts)(Unaudited)



For
      the 13- Weeks Ended
    
    For
      the 39- Weeks EndedSeptember
      24,
      2005
    
    September
      25,
      2004
    September
      24,
      2005
    
    September
      25,
      2004NET
      REVENUES
    $
    96,839
    
    $
    85,443
    
    $
    286,752
    
    $
    254,468OPERATING
      COSTS AND EXPENSES:Cost
      of sales and operating expenses
    
    59,795
    
    
    50,591
    
    
    174,797
    
    
    154,295Special
      charges (income)
    
    (25
    )
    
    476
    
    
    (7
    )
    
    518Selling
      expenses
    
    24,119
    
    
    21,780
    
    
    72,169
    
    
    65,091General
      and administrative expenses
    
    3,275
    
    
    9,695
    
    
    23,108
    
    
    29,249Depreciation
      and amortization
    
    681
    
    
    820
    
    
    2,208
    
    
    2,50187,845
    
    
    83,362
    
    
    272,275
    
    
    251,654INCOME
      BEFORE INTEREST AND INCOME TAXES
    
    8,994
    
    
    2,081
    
    
    14,477
    
    
    2,814Interest
      expense, net
    
    2,208
    
    
    1,641
    
    
    5,963
    
    
    3,166INCOME
      (LOSS) BEFORE INCOME TAXES
    
    6,786
    
    
    440
    
    
    8,514
    
    
    (352
    )Provision
      (benefit) for Federal income taxes
    
    (16
    )
    
    (502
    )
    
    19
    
    
    (503
    )Provision
      (benefit) for state income taxes
    
    6
    
    
    (151
    )
    
    16
    
    
    (156
    )Provision
      (benefit) for income taxes
    
    (10
    )
    
    (653
    )
    
    35
    
    
    (659
    )INCOME
      FROM CONTINUING OPERATIONS
    
    6,796
    
    
    1,093
    
    
    8,479
    
    
    307Gain from
      discontinued operations of Gumpsincluding
      a gain on disposal of $3,576 atSeptember
      24, 2005
    
    
    
    
    267
    
    
    2,996
    
    
    290NET INCOME
      AND COMPREHENSIVE INCOME
    
    6,796
    
    
    1,360
    
    
    11,475
    
    
    597Earnings
      applicable to Preferred Stock
    
    167
    
    
    15
    
    
    282
    
    
    15NET INCOME
      APPLICABLE TO COMMON 
           SHAREHOLDERS
    $
    6,629
    
    $
    1,345
    
    $
    11,193
    
    $
    5824
NET INCOME
      PER COMMON SHARE:From
        continuing operations  basic
    $
    0.30
    
    $
    0.05
    
    $
    0.37
    
    $
    0.02From
        continuing operations  diluted
    $
    0.20
    
    $
    0.03
    
    $
    0.25
    
    $
    0.01From
        discontinued operations  basic
    $
    0.00
    
    $
    0.01
    
    $
    0.13
    
    $
    0.01From
        discontinued operations  diluted
    $
    0.00
    
    $
    0.01
    
    $
    0.09
    
    $
    0.01Net
        income per common share  basic
    $
    0.30
    
    $
    0.06
    
    $
    0.50
    
    $
    0.03Net
        income per common share  diluted
    $
    0.20
    
    $
    0.04
    
    $
    0.34
    
    $
    0.02Weighted
      average common shares outstanding basic
      (thousands)
    
    22,426
    
    
    22,398
    
    
    22,426
    
    
    22,144Weighted
      average common shares outstanding diluted
      (thousands)
    
    32,610
    
    
    31,358
    
    
    32,586
    
    
    25,147See Notes to Condensed
Consolidated Financial Statements.


5
HANOVER
DIRECT, INC. AND SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands of dollars)(Unaudited)





For
      the 39- Weeks EndedSeptember
      25,
      2005
    
    September
      24,
      2004CASH
      FLOWS FROM OPERATING ACTIVITIES:Net income
    $
    11,475
    
    $
    597Adjustments
      to reconcile net income to net cash used by operating activities:Depreciation
      and amortization, including deferred fees
    
    2,853
    
    
    3,394Provision
      for doubtful accounts
    
    368
    
    
    345Special
      charges (income)
    
    (7
    )
    
    518Gain
      on the sale of Gumps
    
    (3,576
    )
    
    Gain
      on the sale of property and equipment
    
    (71
    )
    
    (2
    )Compensation
      expense related to stock options
    
    115
    
    
    154Accretion
        of debt discount
    
    2,426
    
    
    420Changes
      in assets and liabilities:Accounts
      receivable
    
    4,539
    
    
    542Inventories
    
    (10,156
    )
    
    (8,296
    )Prepaid
      catalog costs
    
    (6,433
    )
    
    (6,185
    )Accounts
      payable
    
    (965
    )
    
    (9,467
    )Accrued
      liabilities
    
    (9,000
    )
    
    (397
    )Customer
      prepayments and credits
    
    3,345
    
    
    5,748Other,
      net
    
    1,673
    
    
    (1,945
    )Net cash
      used by operating activities
    
    (3,414
    )
    
    (14,574
    )CASH
      FLOWS FROM INVESTING ACTIVITIES:Acquisitions
      of property and equipment
    
    (1,483
    )
    
    (371
    )Proceeds
      from disposal of property and equipment
    
    80
    
    
    2Proceeds
      from the sale of Gumps
    
    8,921
    
    
    Net cash
      provided (used) by investing activities
    
    7,518
    
    
    (369
    )CASH
      FLOWS FROM FINANCING ACTIVITIES:Net
      (payments) borrowings under Wachovia revolving loan facility
    
    (2,740
    )
    
    1,702Payments
      under Wachovia Tranche A term loan facility
    
    (1,493
    )
    
    (1,171
    )Payments
      under Wachovia Tranche B term loan facility
    
    
    
    
    (6,011
    )Borrowings
      under the Chelsey facility
    
    
    
    
    7,061Issuance
      of Common Stock Warrants to Chelsey Finance
    
    
    
    
    12,939Payments
      of long-term debt and capital lease obligations
    
    (247
    )
    
    (543
    )Payment
      of debt issuance costs
    
    
    
    
    (1,045
    )Payment
      of debt issuance costs to related party
    
    
    
    
    (200
    )Refund
      of estimated Richemont tax obligation on Series B Participating
              Preferred Stock accretion
    
    
    
    
    347Net cash
      (used) provided by financing activities
    
    (4,480
    )
    
    13,079Net decrease
      in cash and cash equivalents
    
    (376
    )
    
    (1,864
    )Cash and
      cash equivalents at the beginning of the year
    
    510
    
    
    2,282Cash and
      cash equivalents at the end of the period
    $
    134
    
    $
    418Supplemental
      Disclosures of Cash Flow Information:Cash paid
      for:Interest
    $
    3,037
    
    $
    1,926Income
      taxes
    $
    160
    
    $
    8Non-cash
      investing and financing activities:Issuance
      of Common Stock to related party for payment of waiver fee
    $
    
    
    $
    563See Notes to Condensed
Consolidated Financial Statements.


6
HANOVER DIRECT, INC.
AND SUBSIDIARIESNOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Unaudited)


1. BASIS OF
PRESENTATION


THE FINANCIAL INFORMATION INCLUDED
IN THIS FORM 10-Q HAS NOT BEEN SUBJECTED TO A TIMELY QUARTERLY REVIEW AS REQUIRED BY RULE
10-01 (D) OF REGULATION S-X.


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 25, 2004. 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.


On
March 14, 2005, the Company sold all of the stock of Gumps Corp. and Gumps By
Mail, Inc. (collectively, Gumps) (See Note 5). The Condensed
Consolidated Statements of Income reflects the Gumps operating results and gain on
sale as discontinued operations. In addition in the Condensed Consolidated Statement of
Cash Flows for the 39- Weeks Ended September 25, 2005 the change in assets and liabilities
reflects Gumps as discontinued operations.


Uses of Estimates and
Other Critical Accounting Policies


The
condensed consolidated financial statements include all subsidiaries of the Company and
all intercompany transactions and balances have been eliminated. The preparation of
financial statements, in conformity with generally accepted accounting principles,
requires management to make estimates and assumptions that affect the reported amounts of
assets and liabilities, the disclosure of contingent assets and liabilities at the date of
the financial statements, and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.


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 25, 2004 for additional information relating to the
Companys use of estimates and other critical accounting policies.


Audit
Committee Investigation; SEC Inquiry


On
November 17, 2004, the Audit Committee of the Board of Directors began an investigation of
matters relating to restatements of the Companys financial statements and other
accounting-related matters with the assistance of independent outside counsel, Wilmer
Cutler Pickering Hale and Dorr LLP (Wilmer Cutler).


On
March 14, 2005, the Audit Committee reported that it had concluded its investigation and,
with the assistance of Wilmer Cutler, reported its findings to the Board of
Directors. The Audit Committee, again with the assistance of Wilmer Cutler, formulated a
series of recommendations to the Company and the Board of Directors concerning potential
improvements in the Companys internal controls and procedures for financial
reporting. The Board of Directors and management have begun implementing these
recommendations.


The
Company was notified on January 11, 2005 by the Securities and Exchange Commission (SEC)
that it was conducting an informal inquiry relating to the Companys financial
results and financial reporting since 1998. The SEC indicated in its letter to the
Company that the inquiry should not be construed as an indication by the SEC that there
has been any violation of the federal securities laws. The Company is cooperating fully
with the SEC in connection with the inquiry and directed Wilmer Cutler to brief the SEC
and the Companys former independent registered public accounting firm, KPMG LLP (KPMG),
on the results of its investigation. Wilmer Cutler has


7
briefed both the SEC and KPMG on the
results of the investigation. The Company intends to continue to cooperate with the SEC
in connection with its informal inquiry concerning the Companys financial
reporting.


2. NET INCOME
PER COMMON SHARE


Net
income per common share is computed using the weighted average number of common shares
outstanding in accordance with the provisions of SFAS No. 128, Earnings Per
Share (SFAS 128). Basic net income per common share is calculated by
dividing net income available to common shareholders, reduced for participatory interests,
by the weighted average number of common shares outstanding during the period. Diluted net
income per common share is calculated using the weighted average number of common shares
outstanding adjusted to include the potentially dilutive effect of stock options and stock
warrants. The computations of basic and diluted net income per common share are as follows
(in thousands except per share amounts):

For
      the 13- Weeks Ended
    
    For
      the 39- Weeks EndedSeptember 24,
      2005
    
    September 26,
      2004
    September 24,
      2005
    
    September 26,
      2004Net
      income
    $
    6,796
    
    $
    1,360
    
    $
    11,475
    
    $
    597Less:Earnings
      applicable to preferred stock
    
    167
    
    
    15
    
    
    282
    
    
    15Net income
      applicable to commonshareholders
    $
    6,629
    
    $
    1,345
    
    $
    11,193
    
    $
    582Basic net
      income per common share
    $
    0.30
    
    $
    0.06
    
    $
    0.50
    
    $
    0.03Weighted-average
      common shares outstanding
    
    22,426
    
    
    22,398
    
    
    22,426
    
    
    22,144Diluted
      net income
    $
    6,629
    
    $
    1,345
    
    $
    11,193
    
    $
    582Diluted
      net income per common share
    $
    0.20
    
    $
    0.04
    
    $
    0.34
    
    $
    0.02Weighted-average
      common shares outstanding
    
    22,426
    
    
    22,398
    
    
    22,426
    
    
    22,144Effect
      of Dilution:Stock options
    
    17
    
    
    1
    
    
    6
    
    
    17Stock warrants
      (issued July 8, 2004)
    
    10,167
    
    
    8,959
    
    
    10,154
    
    
    2,986Weighted-average
      common shares outstandingassuming
      dilution
    
    32,610
    
    
    31,358
    
    
    32,586
    
    
    25,1473.
CONTINGENCIES


Rakesh
K. Kaul v. Hanover Direct, Inc. , No. 04-4410(L)-CV, 2nd Cir.S.D.N.Y.,
affirmed on appeal from 296 F. Supp.2d (S.D. NY 2004). On June 28, 2001, Rakesh K. Kaul,
the former President and Chief Executive Officer of the Company, filed a five-count
complaint in the Federal District Court in New York seeking relief stemming from his
separation of employment from the Company including short-term bonus and severance
payments of $2,531,352, attorneys fees and costs, and damages due to the
Companys failure to pay him a tandem bonus as well as Kauls
alleged rights to benefits under a change in control plan and a long-term incentive plan.
The Company filed a Motion for Summary Judgment and in July 2004, the Court entered a
final judgment dismissing most of Mr. Kauls claims with prejudice and awarded
Mr. Kaul $45,946 in vacation pay and $14,910 in interest which the Company paid in
July 2004. In August 2004, Kaul filed an appeal on three issues: severance and short-term
bonus, tandem bonus and legal fees. On June 28, 2005 the Second Circuit Court of Appeals
denied Kauls appeal, affirming the Summary Judgment decision in the Companys
favor. Mr. Kauls rights to appeal the Second Circuits decision expired in
August 2005.


8
During
the third quarter ended September 24, 2005, the Company reversed an accrual established in
fiscal 2000 of $4.5 million due to the expiration of Kauls rights to further pursue
the claim.


Class
Action Lawsuits:



The
Company was a party to four class action/ representative lawsuits that all involved
allegations that the Companys charges for insurance were invalid, unfair, deceptive
and/or fraudulent. As described in greater detail below, the Company has, in large part,
resolved all of these class action lawsuits.


Jacq
Wilson v. Brawn of California, Inc. , Case No. CGC-02-404454 (Supp. Ct. San
Francisco, CA 2002) (Wilson Case). On February 13, 2002, Jacq Wilson, suing on
behalf of himself and other similarly situated persons, filed a representative suit in the
Superior Court of the State of California, City and County of San Francisco, against the
Company alleging that the Company charged an unlawful, unfair, and fraudulent insurance
fee on orders, was engaged in untrue, deceptive and misleading advertising and unfair
competition under the states Business and Professions Code. In November, 2003, the
Court entered judgment for the plaintiffs, requiring defendants to refund insurance
charges collected from consumers for the period from February 13, 1998 through January 15,
2003, with interest. In April, 2004, the Court awarded plaintiffs counsel
approximately $445,000 of attorneys fees.


The
Company appealed the Courts decision and the order to pay attorneys fees. On
September 2, 2005 the California Court of Appeals reversed both the Courts findings
on the merits and its award of attorneys fees and awarded the Company its cost on
the appeal.


Teichman
v. Hanover Direct, Inc. et. al., No. 3L641 (Supp. Ct. San Francisco, CA 2001). On
August 15, 2001, Randi Teichman filed a summons and four-count complaint in the Superior
Court for the City and County of San Francisco seeking damages and other relief for
herself and a class of similarly situated persons arising out of the insurance fee
charged by catalogs and Internet sites operated by Company subsidiaries. This case
had been stayed since May 2002 pending resolution of the Wilson Case.



The
plaintiffs in both Wilson  and Teichman  were
represented by the same counsel and the plaintiffs in both cases agreed to dismiss the
cases with prejudice in exchange for the Companys agreement to not seek
reimbursement of its appellate costs in the Wilson  case.


John
Morris, individually and on behalf of all other similarly situated person and entities
similarly situated v. Hanover Direct, Inc. and Hanover Brands, Inc., No. L 8830-02
(Sup. Ct. Bergen Co. - Law Div., NJ) October 28, 2002, John Morris, individually
and on behalf of other similarly situated persons in New Jersey filed a class action
alleging that (1) the Company improperly added a charge for insurance and
(2) the Companys conduct was in violation of the New Jersey Consumer Fraud Act
as otherwise deceptive, misleading and unconscionable. On February 14, 2005, the
Court denied class certification which limited the damages being litigated.
Pursuant to a Settlement Agreement effective as of August 29, 2005, the case was
settled with the Company agreeing to pay $39,500 in the aggregate for a nominal amount
of damages and legal fees.



Martin
v. Hanover Direct, Inc., et. al., No. CJ-2000 (D.C. Sequoyah Co., Ok.) (Martin
Case). On March 3, 2000, Edwin L. Martin filed a class action lawsuit against
the Company claiming breach of contract, unjust enrichment, recovery of money
paid absent consideration, fraud and a claim under the New Jersey Consumer Fraud Act.
The allegations stem from insurance charges paid to the Company by
consumers who had placed orders from catalogs published by indirect subsidiaries of
the Company over a number of years. Martin sought relief including (i) a declaratory
judgment as to the validity of the delivery insurance, (ii) an order directing the
Company to return to the plaintiff and class members the unlawful revenue derived
from the insurance charges, (iii) threefold damages for each class member, and (iv)
attorneys fees and costs. In July 2001, the Court certified the class and the
Company filed an appeal of the class certification. On October 25, 2005, the class
certification was reversed. The plaintiff has filed a Motion for Rehearing and may
appeal the decision to the Oklahoma Supreme Court. The Company believes it is remote
that the plaintiff will be successful in obtaining a favorable outcome.



The
Company established a $0.5 million reserve during the third quarter of 2004 for the class
action lawsuits described above for settlements and the Companys current estimate of
future legal fees to be incurred. The balance of the reserve as of September 24, 2005 was
approximately $0.1 million.


9
Claims for
Post-Employment Benefits:


In
first half of 2005, the Company was sued by two former employees who sought change in
control benefits under compensation continuation plans. The Company believes it has
meritorious defenses in both cases.


In
 addition,  in March 2005 the Company  terminated  the  employment  of two former
 officers,  Charles  Blue,  the former Chief Financial  Officer,  and the former Vice
President of Treasury  Operations and Risk  Management.  Both sought change in control
benefits which the Company  denied in  accordance  with the  respective  plans.  During
the fourth  fiscal  quarter of 2005,  the two former  officers  filed complaints  seeking
 compensatory  and punitive  damages and attorneys  fees.  The Company plans to
vigorously  defend its denial of benefits which it believes was proper.



In
addition, the Company is involved in various routine lawsuits of a nature that is 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, results of operations, or cash flows.



4. SPECIAL
CHARGES


2004
Plan



On
June 30, 2004 the Company announced its plan to consolidate the operations of the
LaCrosse, Wisconsin fulfillment center and storage facility into the Roanoke, Virginia
fulfillment center by June 30, 2005. The LaCrosse fulfillment center and the storage
facility were closed in June 2005 and August 2005, upon the expiration of their respective
leases. The Company substantially completed the consolidation into the Roanoke, Virginia
fulfillment center by the end of June 2005. The Company has incurred approximately $0.8
million in facility exit costs from the date of the announcement through September 24, 2005. The Company accrued $0.5
million in severance and related costs during 2004 associated with the LaCrosse operations
and the elimination of 149 full and part-time positions, of which 96 employees have been
or are being provided severance benefits by the Company.


On
November 9, 2004, the Company decided to relocate its International Male and
Undergear catalog operations to its offices in New Jersey. The Company completed
the relocation on February 28, 2005. The relocation was done primarily to consolidate
operations, reduce costs, and leverage its catalog expertise in New Jersey. The Company
accrued $0.9 million in severance and related costs during the fourth quarter 2004
associated with the elimination of 32 California based full-time equivalent positions.


During
the first three quarters of 2005, the reserve activity represents the utilization of the
severance reserves established in 2004 for the Lacrosse fulfillment center and storage
facility and the International MaleandUndergear catalog operations as well
as additional severance charges (net of reductions) of less than $0.1 million.


2000
Plan



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. 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
strategy and return to profitability.


Plan
Summary



At
September 24, 2005, a current liability of approximately $0.1 million was included within
Accrued Liabilities relating to future payments in connection with the Companys 2000
and 2004 plans and consists of the following (in thousands):


10
Severance 
      & Personnel
      Costs
    
    Real
      Estate
      Lease & 
      Exit Costs
    
    Total2004
      Plan
    2000
      PlanBalance
      at December 25, 2004
    $
    1,518
    
    $
    3,360
    
    $
    4,8782005
      expenses (reductions)
    
    (7
    )
    
    
    
    
    (7
    )Paid
      in 2005
    
    (1,400
    )
    
    (538
    )
    
    (1,938
    )Reductions
      due to sale of Gumps
    
    
    
    
    (2,822
    )
    
    (2,822
    )Balance
      at September 24, 2005
    $
    111
    
    $
    
    
    $
    1115. SALE OF GUMPS
BUSINESS


On
March 14, 2005, the Company sold all of the stock of Gumps to Gumps Holdings,
LLC (Purchaser) for $8.9 million, including a purchase price adjustment of
$0.4 million, pursuant to the terms of a February 11, 2005 Stock Purchase Agreement. The
Company recognized a gain of approximately $3.6 million in the quarter ended March 26,
2005. Chelsey Direct, LLC (Chelsey), as the holder of all of the Series C
Participating Preferred Stock (Series C Preferred), consented to the
application of the sales proceeds to reduce the outstanding balance of the credit facility
provided by Wachovia National Bank (Wachovia) in lieu of the current
redemption of a portion of the Series C Preferred. Chelsey expressly retained its right to
require redemption of approximately $6.9 million of the Series C Preferred subject to
Wachovias approval.


After
the sale, the Company continued as the guarantor of one of the two leases for the San
Francisco building where the store is located (the Company was released from liability on
the other lease). The Purchaser is required to use its commercially reasonable efforts to
secure the Companys release from the guarantee within a year of the closing. If the
Purchaser cannot secure the Companys release within a year of the closing, an
affiliate of the Purchaser will either (i) transfer a percentage interest in its business
so that the Company will own, indirectly, 5% interest of the Purchasers common
stock, or (ii) provide the Company with a $2.5 million stand-by letter of credit or other
form of compensation acceptable to the Company to reimburse the Company for any
liabilities the Company may incur under the guarantee until the Company is released from
the guarantee or the lease is terminated.  As of November 9, 2005 there are $7.3 million
(net of $0.5 million in expected sublease income) in lease commitments for which the
Company is the guarantor.  Based on its evaluation, the Company has concluded it is
unlikely any payments will be required under the guarantee, thus has not established a
guarantee liability as of the March 14, 2005 sale date or as of September 24, 2005.



The
Company entered into a Direct Marketing Services Agreement with the Purchaser to provide
telemarketing and fulfillment services for the Gumps catalog and direct
marketing businesses for 18 months. We have the option to extend the term for an
additional 18 months.


Listed
below are the carrying values of the major classes of assets and liabilities of
Gumps included in the Consolidated Balance Sheets:




In
        thousands (000s)
    December
      25,
      2004
    
    September
      25,
      2004Total
      current assets
    $
    10,842
    
    $
    12,362Total
      non-current assets
    $
    3,221
    
    $
    3,397Total
      assets
    $
    14,063
    
    $
    15,759Total
      current liabilities
    $
    6,727
    
    $
    7,686Total
      non-current liabilities
    $
    3,283
    
    $
    3,449Total
      liabilities
    $
    10,010
    
    $
    11,13511
Listed
below are the revenues and income before income taxes included in the Consolidated
Statements of Income (these results exclude certain corporate overhead charges allocated
to Gumps for services provide by the Company to run the business) for the 13- and
39- weeks ended:


In
        thousands (000s)
    13- Weeks Ended
      September 25, 
      2004
    
    39- Weeks Ended
      September 25, 
      2004Net
      revenues
    $
    9,000
    
    $
    27,045Income
      before income taxes
    $
    267
    
    $
    2906. DEBT


The
Company has two credit facilities: a senior secured credit facility (the Wachovia
Facility) provided by Wachovia and a $20.0 million junior secured facility (the
Chelsey Facility), provided by Chelsey Finance, LLC (Chelsey
Finance), of which the entire $20.0 million was borrowed by the Company. Chelsey
Finance is an affiliate of Chelsey, the Companys principal shareholder.


As
of September 24, 2005, December 25, 2004 and September 25, 2004, debt consisted of the
following (in thousands):

September
      24,
      2005
    
    December
      25,
      2004
    
    September
      25,
      2004Wachovia
      facility:Tranche
      A term loans - Current portion, interest rate of 7.0% atSeptember
      24, 2005, 5.5% at December 25, 2004 and 5.0% atSeptember
      25, 2004
    $
    1,992
    
    $
    1,992
    
    $
    1,825Revolver,
      interest rate of 7.0% at September 24, 2005, 5.5% atDecember
      25, 2004 and 5.0% at September 25, 2004
    
    11,668
    
    
    14,408
    
    
    10,699Capital
      lease obligations - Current portion
    
    89
    
    
    290
    
    
    394Short-term
      debt
    
    13,749
    
    
    16,690
    
    
    12,918Wachovia
      facility:Tranche
      A term loans, interest rate of 7.0% at September 24, 2005,5.5%
      at December 25, 2004 and 5.0% at September 25, 2004
    
    1,492
    
    
    2,985
    
    
    3,474Chelsey
      facility - stated interest rate of 11.5% (5.0% above prime rate)at
      September 24, 2005, 10.0% (5.0% above prime rate) at December25,
      2004 and 9.5% (5.0% above prime rate) at September 25, 2004
    
    10,585
    
    
    8,159
    
    
    7,481Capital
      lease obligations
    
    6
    
    
    52
    
    
    95Long-term
      debt
    
    12,083
    
    
    11,196
    
    
    11,050Total
      debt
    $
    25,832
    
    $
    27,886
    
    $
    23,96812
Wachovia
Facility


Wachovia
and the Company are parties to a Loan and Security Agreement dated November 14, 1995 (as
amended by the First through Thirty-Fourth Amendments, the Wachovia Loan
Agreement) pursuant to which Wachovia provided the Company with the Wachovia
Facility which has included, since inception, one or more term loans and a revolving
credit facility (Revolver). The Wachovia Facility expires on July 8, 2007.


Currently,
the Wachovia facility has a Tranche A term loan outstanding which has a principal balance
of approximately $3.5 million as of September 24, 2005, of which approximately $2.0
million is classified as short term and approximately $1.5 million is classified as long
term on the Condensed Consolidated Balance Sheet. The Tranche A term loan bears interest
at 0.5% over the Wachovia prime rate and requires monthly principal payments of
approximately $166,000. As of September 24, 2005, the interest rate on the Tranche A term
loan was 7.0%.


The
Revolver has a maximum loan limit of $34.5 million, subject to inventory and accounts
receivable sublimits that limit the credit available to the Companys subsidiaries,
which are borrowers under the Revolver. The interest rate on the Revolver is currently
0.5% over the Wachovia prime rate. As of September 24, 2005, the interest rate on the
Revolver was 7.0%.


Remaining
availability under the Wachovia Facility as of September 24, 2005 was $7.2 million.


Third Quarter
2005 Amendments to Wachovia Loan Agreement


On
July 29, 2005 the Company and Wachovia amended the Wachovia Loan Agreement to provide the
terms under which the Company could enter into the World Financial Network National Bank
(WFNNB) Credit Card Agreement under WFNNB will issue private label and
co-brand (Visa and MasterCard) credit cards to the Companys customers . The
amendment, among other things, prohibits the use of the proceeds of the Wachovia Facility
to repurchase private label accounts created under the WFNNB Credit Card Agreement should
the Company become obligated to do so, prohibits the Company from terminating WFNNB Credit
Card Agreement without Wachovias consent and restricts the Company from borrowing on
receivables generated under the WFNNB Credit Card Agreement. The amendment also waives
enumerated defaults, resets the financial covenants, reallocates the availability that was
previously allocated to Gumps and Gumps By Mailamong other
Company subsidiaries and, retroactive to June 30, 2005, increases the amount of letter of
credits that the Company can issue to $15.0 million. The Company paid Wachovia a $60,000
fee in connection with this amendment.


On
July 29, 2005 the Company and Chelsey Finance entered into a similar amendment of the
Chelsey Facility.


Chelsey
Facility


The
Chelsey Facility is a $20.0 million junior secured credit facility with Chelsey Finance
that was recorded at net of an un-accreted debt discount of $7.1 million. The Chelsey
Facility has a three-year term, subject to earlier maturity upon the occurrence of a
change in control or sale of the Company (as defined), and carries a stated interest rate
of 5% above the prime rate publicly announced by Wachovia. The Company is not obligated to
make principal payments until July 8, 2007, except if there is a change in control or sale
of the Company. At September 24, 2005, the amount recorded as debt on the Condensed
Consolidated Balance Sheet is $10.6 million, net of the un-accreted debt discount of $9.4
million.


In
accordance with Accounting Principles Board Opinion No. 14, Accounting for
Convertible Debt and Debt Issued with Stock Purchase Warrants (APB 14),
proceeds received from the sale of debt with detachable stock purchase warrants should be
allocated to both the debt and warrants, with the portion allocable to the warrants to be
accounted for as Capital in excess of par value with the remaining portion, or $7.1
million, classified as debt. The fair value of the Common Stock Warrant of $12.9 million
was determined using the Black-Scholes option pricing model and is being treated as debt
discount, which will be accreted as interest expense utilizing the interest method over
the 36-month term of the Chelsey Facility. The assumptions used for the Black-Scholes
option pricing model were as follows: risk-free interest rate of 4.5%, expected volatility
of 80.59%, an expected life of ten years and no expected dividends. A summary of the debt
relating to the Chelsey Facility is as follows (in thousands):


13
September
      24,
      2005
    
    December
      25,
      2004
    
    September
      25,
      2004Amount
      Borrowed Under the Chelsey Facility
    $
    20,000
    
    $
    20,000
    
    $
    20,000Fair Value
      of Common Stock Warrant (Recorded as Capital inexcess
      of par value)
    
    (12,939
    )
    
    (12,939
    )
    
    (12,939
    )Accretion
      of Debt Discount (Recorded as Interest 
          Expense)
    
    3,524
    
    
    1,098
    
    
    420$
    10,585
    
    $
    8,159
    
    $
    7,48114
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:


For
      the 13- Weeks Ended
    
    For
      the 39- Weeks EndedSeptember
      24,
      2005
    
    September
      25,
      2004
    September
      24,
      2005
    
    September
      25,
      2004Net
      revenues
    
    100.0
    %
    
    100.0
    %
    
    100.0
    %
    
    100.0
    %Cost of
      sales and operating expenses
    
    61.7
    
    
    59.2
    
    
    60.9
    
    
    60.6Special
      charges (income)
    
    (0.0
    )
    
    0.6
    
    
    (0.0
    )
    
    0.2Selling
      expenses
    
    24.9
    
    
    25.5
    
    
    25.2
    
    
    25.6General
      and administrative expenses
    
    3.4
    
    
    11.3
    
    
    8.0
    
    
    11.5Depreciation
      and amortization
    
    0.7
    
    
    1.0
    
    
    0.8
    
    
    1.0Income
      from operations
    
    9.3
    
    
    2.4
    
    
    5.1
    
    
    1.1Interest
      expense, net
    
    2.3
    
    
    1.9
    
    
    2.1
    
    
    1.2Provision
      (benefit) for Federal and stateincome
      taxes
    
    (0.0
    )
    
    (0.8
    )
    
    0.0
    
    
    (0.2
    )Gain from
      discontinued operations of Gumps
    
    0.0
    
    
    0.3
    
    
    1.0
    
    
    0.1Net income
      and comprehensive income
    
    7.0
    
    
    1.6
    
    
    4.0
    
    
    0.2Earnings
      applicable to Preferred Stock
    
    0.2
    
    
    0.0
    
    
    0.1
    
    
    0.0Net income
      applicable to common shareholders
    
    6.8
    %
    
    1.6
    %
    
    3.9
    %
    
    0.2
    %Executive Summary


For
the nine months ended September 24 2005, net revenues increased $32.3 million or 12.7% to
$286.8 million from $254.5 million in the comparable period of 2004. The increase was
primarily driven by an increase in catalog circulation levels supported by deeper
inventory positions that enabled higher initial fulfillment rates for customer orders and
lower overall cancellation rates. Higher demand was experienced in The Company Store,
DomesticationsandSilhouettescatalogs, while lower demand was experienced in
the International Malecatalogs which are in the process of being repositioned to
return it to its roots as a young mens lifestyle fashion leader. This
merchandising shift will be evident in catalogs commencing in the fourth quarter of 2005.
The Company is increasing inventory positions for Domesticationsto support the
growth and improve the operating results in this catalog.


We
also completed the implementation of strategies to reduce the infrastructure of the
Company which were developed during fiscal 2004. These strategies included the
consolidation of the operations of the LaCrosse, Wisconsin fulfillment center into the
Roanoke, Virginia fulfillment center, which was completed by July 2005; the relocation of
the International Male and Undergear catalog operations from San Diego,
California to the corporate headquarters in Weehawken, New Jersey, which was completed
February 28, 2005; and the consolidation of the Edgewater facility into the Weehawken, New
Jersey premises, which was completed by May 31, 2005.


On
March 14, 2005, the Company sold all of the stock of Gumps Corp. and Gumps By
Mail, Inc. (collectively, Gumps) to Gumps Holdings, LLC, an
unrelated third party for $8.9 million, including a purchase price adjustment of $0.4
million, pursuant to the terms of a February 11, 2005 Stock Purchase Agreement. The
Company recognized a gain on the sale of approximately $3.6 million in the quarter ended
March 26, 2005.


Results of Operations
13- weeks ended September 24, 2005 compared with the 13- weeks ended September 25,
2004


Net
Income.The Company reported net income applicable to common shareholders of $6.6
million, or $0.30 basic income per share and $0.20 diluted income per share, for the 13-
weeks ended September 24, 2005


15
compared with net income applicable
to common shareholders of $1.3 million, or $0.06 basic income per share and $0.04 diluted
income per share, for the comparable period in 2004.


The
Company primarily attributes the increase in net income to the following:



Improved
operating results generated from a $11.4 million increase in net revenues;
A
favorable impact of $4.5 million from the reversal of an accrual established in fiscal
2000 due to the expiration of Rakesh Kauls rights to pursue his claims against the
Company;Partially
offset by:
An
unfavorable impact of $0.6 million on net interest expense primarily due to interest
costs incurred with the $20.0 million junior secured credit facility with Chelsey Finance
(Chelsey Facility,) which the Company closed on July 8, 2004. See Note 6 of
Notes to the condensed consolidated financial statements for additional information
regarding the Chelsey Facility;
An
unfavorable impact of $0.3 million of discontinued operations representing income from
Gumps on-going operations for the 13- weeks ended September 25, 2004.Net
Revenues.Net revenues increased $11.4 million (13.3%) for the 13-week period ended
September 24, 2005 to $96.8 million from $85.4 million for the comparable period in 2004.
This increase was primarily driven by an increase in catalog circulation levels supported
by deeper inventory positions that enabled higher initial fulfillment rates for customer
orders and lower overall cancellation rates. Higher demand was experienced in The
Company Store, DomesticationsandSilhouettescatalogs, while lower demand was
experienced for the International Male catalogs. Internet sales increased and
comprised 40.0% of combined Internet and catalog revenues for the 13- weeks ended
September 24, 2005 compared with 35.2% for the comparable fiscal period in 2004, and have
increased by approximately $5.5 million, or 20.3%, to $32.6 million for the 13-week period
ended September 24, 2005 from $27.1 million for the comparable period in 2004.


Cost
of Sales and Operating Expenses. Cost of sales and operating expenses increased by
$9.2 million to $59.8 million for the 13- weeks ended September 24, 2005 as compared with
$50.6 million for the comparable period in 2004. Cost of sales and operating expenses
increased to 61.7% of net revenues for the 13-week period ended September 24, 2005 as
compared with 59.2% of net revenues for the comparable period in 2004. As a percentage of
net revenues, this increase was primarily due to increases in product postage and
merchandise costs. The Company has more aggressively liquidated slower moving inventory
through clearance avenues within its catalogs and websites, thus resulting in lower
product margins.


Special
Charges.In December 2000 and June 2004, the Company implemented strategic business
realignment programs that resulted in the recording of special charges for severance,
facility exit costs and fixed asset write-offs. The actions related to the strategic
business realignment programs were taken in an effort to direct the Companys
resources primarily towards a loss reduction strategy and a return to profitability.
Special charges decreased by approximately $0.5 million for the 13- weeks ended September
24, 2005 as compared with the comparable period in 2004. This was primarily due to the
Company recording $0.5 million in severance and related costs associated with the
consolidation of the LaCrosse operations during the 13- weeks ended September 25, 2004.


Selling
Expenses.Selling expenses increased by $2.3 million to $24.1 million for the 13-
weeks ended September 24, 2005 as compared with $21.8 million for the comparable period in
2004. Selling expenses decreased to 24.9% of net revenues for the 13- weeks ended
September 24, 2005 from 25.5% for the comparable period in 2004. As a percentage of net
revenues, this change was primarily due to higher response rates that more than offset the cost of higher catalog
circulation.


General
and Administrative Expenses. General and administrative expenses decreased by $6.4
million to $3.3 million for the 13- weeks ended September 24, 2005 as compared with $9.7
million for the comparable period in 2004. As a percentage of net revenues, general and
administrative expenses declined to 3.4% of net revenues for the 13-week period ended
September 24, 2005 as compared to 11.3% of net revenues for the comparable period in
2004. As a percentage of net revenues, this decrease was primarily due to the reversal of
a $4.5 million accrual


16
established in fiscal 2000
pertaining to Rakesh Kaul. The accrual was reversed due to the expiration of Mr. Kauls
rights to pursue his claims against the Company. In addition the Company incurred lower
compensation and legal expenses during the 13- weeks ended September 24, 2005.


Depreciation
and Amortization.Depreciation and amortization decreased approximately $0.1 million
during the 13- weeks ended September 24, 2005 from the comparable period in 2004. The
decrease was primarily due to property and equipment that have become fully depreciated,
partially offset by the depreciation of newly purchased property and equipment.

  
  Income
    from Operations.The Companys income from operations increased by
    approximately $6.9 million to $9.0 million for the 13- weeks ended September
    24, 2005 from $2.1 million for the comparable period in 2004. See Results
    of Operations  13- weeks ended September 24, 2005 compared with the
    13- weeks ended September 25, 2004  Net Income for further details
    as the relationships are the same excluding the discussion on income tax and
    interest expense.


Interest
Expense, Net.Interest expense, net, increased $0.6 million to $2.2 million for the
13- weeks ended September 24, 2005 from $1.6 million for the comparable period in fiscal
2004. This increase in interest expense is primarily due to $0.5 million of accretion of
the debt discount and $0.2 million of stated interest related to the Chelsey Facility
during the 13- weeks ended September 24, 2005. These increases were partially offset by a
$0.1 million decrease in amortization of debt costs associated with the Wachovia Facility.


Income
Taxes. The benefit for federal and state income taxes is approximately 0.1% of income
before taxes for the 13-week period ended September 24, 2005.


Gain
from discontinued operations of Gumps.On March 14, 2005, the Company sold all
of the stock of to Gumps Holdings, LLC. The Company recognized a gain of $0.3
million representing income from Gumps on-going operations for the 13- weeks ended
September 25, 2004.


  Results of
    Operations  39- weeks ended September 24, 2005 compared with the 39-
    weeks ended September 25, 2004


Net
Income.The Company reported net income applicable to common shareholders of $11.2
million, or $0.50 basic income per share and $0.34 diluted income per share, for the 39-
weeks ended September 24, 2005 compared with net income applicable to common shareholders
of $0.6 million, or $0.03 basic income per share and $0.2 diluted income per share, for
the comparable period in 2004.


The
Company primarily attributes the increase in net income to the following:



Improved
operating results generated from a $32.3 million increase in net revenues;
A
favorable impact of $4.5 million from the reversal of an accrual established in fiscal
2000 due to the expiration of Rakesh Kauls rights to pursue his claims against the
Company;
A
favorable impact of $2.7 million of discontinued operations due to the gain of $3.6
million recognized relating to the March 14, 2005 sale of stock of Gumps;
A
favorable impact of $1.5 million due to the reduction in general and administrative
expenses related to severance.Partially
offset by:
An
unfavorable impact of $2.8 million on net interest expense primarily due to interest
costs incurred with the $20.0 million junior secured credit facility with Chelsey Finance
(Chelsey Facility,) which the Company closed on July 8, 2004. See Note 6 of
Notes to the condensed consolidated financial statements for additional information
regarding the Chelsey Facility;
An
unfavorable impact of $1.7 million related to general and administrative expenses
incurred for the investigation conducted by the Audit Committee of the Board of Directors
in connection with the restatement of the Companys consolidated financial
statements and other accounting-related matters.17
Net
Revenues.Net revenues increased $32.3 million (12.7%) for the 39-week period ended
September 24, 2005 to $286.8 million from $254.5 million for the comparable period in
2004. This increase was primarily driven by an increase in catalog circulation levels
supported by deeper inventory positions that enabled higher initial fulfillment rates for
customer orders and lower overall cancellation rates. Higher demand was experienced in
The Company Store, DomesticationsandSilhouettescatalogs, while lower
demand was experienced for the International Male catalogs. Internet sales
increased and comprised 38.6% of combined Internet and catalog revenues for the 39- weeks
ended September 24, 2005 compared with 34.4% for the comparable fiscal period in 2004, and
have increased by approximately $18.1 million, or 22.6%, to $98.1 million for the 39-week
period ended September 24, 2005 from $80.0 million for the comparable period in 2004.


Cost
of Sales and Operating Expenses. Cost of sales and operating expenses increased by
$20.5 million to $174.8 million for the 39- weeks ended September 24, 2005 as compared
with $154.3 million for the comparable period in 2004. Cost of sales and operating
expenses increased to 60.9% of net revenues for the 39-week period ended September 24,
2005 as compared with 60.6% of net revenues for the comparable period in 2004. As a
percentage of net revenues, this increase was primarily due to increases in product
postage costs, offset by declines in merchandise costs associated with the ability to
source goods that have higher product margins and decreases in information technology
costs due to declines in equipment rentals and maintenance.


Special
Charges.In December 2000 and June 2004, the Company implemented strategic business
realignment programs that resulted in the recording of special charges for severance,
facility exit costs and fixed asset write-offs. The actions related to the strategic
business realignment programs were taken in an effort to direct the Companys
resources primarily towards a loss reduction strategy and a return to profitability.
Special charges decreased by approximately $0.5 million for the 39- weeks ended September
24, 2005 as compared with the comparable period in 2004. This was primarily due to the
Company recording $0.5 million in severance and related costs associated with the
consolidation of the LaCrosse operations during the 39- weeks ended September 25, 2004.


Selling
Expenses.Selling expenses increased by $7.1 million to $72.2 million for the 39-
weeks ended September 24, 2005 as compared with $65.1 million for the comparable period in
2004. Selling expenses decreased to 25.2% of net revenues for the 39- weeks ended
September 24, 2005 from 25.6% for the comparable period in 2004. As a percentage of net
revenues, this change was primarily due to higher response rates that more than offset the cost of higher catalog
circulation.


General
and Administrative Expenses. General and administrative expenses decreased by $6.1
million to $23.1 million for the 39- weeks ended September 24, 2005 as compared with $29.2
million for the comparable period in 2004. As a percentage of net revenues, general and
administrative expenses declined to 8.0% of net revenues for the 39-week period ended
September 24, 2005 as compared to 11.5% of net revenues for the comparable period in 2004.
As a percentage of net revenues, this decrease was primarily due to the $4.5 million
reversal of an accrual related to Rakesh Kaul and severance and other costs
incurred during the 39- weeks ended September 25, 2004 associated with the resignation of
three executives, including the Companys former President. This decrease was
partially offset by additional fees incurred for the investigation conducted by the Audit
Committee of the Board of Directors in connection with the restatement of the
Companys consolidated financial statements and other accounting-related matters.


Depreciation
and Amortization.Depreciation and amortization decreased $0.3 million to $2.2 million
for the 39- weeks ended September 24, 2005 from $2.5 million for the comparable period in
2004. The decrease was primarily due to property and equipment that have become fully
depreciated, partially offset by the depreciation of newly purchased property and
equipment.

  
  Income
    from Operations.The Companys income from operations increased by
    approximately $11.7 million to $14.5 million for the 39- weeks ended September
    24, 2005 from $2.8 million for the comparable period in 2004. See Results
    of Operations  39- weeks ended September 24, 2005 compared with the
    39- weeks ended September 25, 2004  Net Income for further details
    as the relationships are the same excluding the discussion on income tax and
    interest expense.


18
Interest
Expense, Net.Interest expense, net, increased $2.8 million to $6.0 million for the
39- weeks ended September 24, 2005 from $3.2 million for the comparable period in fiscal
2004. This increase in interest expense is primarily due to $2.0 million of accretion of
the debt discount and $1.2 million of stated interest related to the Chelsey Facility
during the 39- weeks ended September 24, 2005. These increases were partially offset by a
decrease in interest expense due to lower average cumulative borrowings relating to the
Wachovia Facility in the amount of $0.4 million.


Income
Taxes. The provision for federal and state income taxes is approximately 0.4% of
income before taxes for the 39-week period ended September 24, 2005.


Gain
from discontinued operations of Gumps.On March 14, 2005, the Company sold all
of the stock of to Gumps Holdings, LLC. The Company recognized a gain of
approximately $3.6 million in the 39- weeks ended September 24, 2005, offset by losses
from Gumps on-going operations through the sale date of approximately $0.6
million.


LIQUIDITY AND CAPITAL
RESOURCES


Overview


In
2005, the liquidity position of the Company continues to strengthen as a result of
improved operating results, proceeds from the sale of Gumps and as a result of
securing the $20.0 million Chelsey Facility on July 8, 2004 and concurrently amending the
terms of the Wachovia Facility. The additional working capital has continued to provide us
the ability to restore inventory to adequate levels in order to support higher demand
driven by an overall increase in catalog circulation. The funding has eliminated
substantially all vendor restrictions involving our credit arrangements. The $8.9 million
in proceeds from the sale of Gumps enabled the Company to pay down $8.1 million of
the Wachovia revolving loan facility during the first quarter of 2005; however, during the
second and third quarters of 2005, a portion of these monies have been utilized to fund
the continuing growth of on-going operations of the Company.


Net
cash used by operating activities.During the 39-week period ended September 24, 2005,
net cash used by operating activities was $3.4 million. This was due primarily to payments
made by the Company to increase inventory and prepaid catalog costs and reduce accrued
liabilities and accounts payable. These were partially offset by an increase in customer
prepayments and credits, payments received on accounts receivables and $13.6 million of
operating cash provided by net income, when adjusted for the gain on the disposition of
Gumps, depreciation, amortization and other non cash items.


Net
cash provided (used) by investing activities.During the 39-week period ended
September 24, 2005, net cash provided by investing activities was $7.5 million. This was
due primarily to $8.9 million in proceeds received from the sale of Gumps,
partially offset by capital expenditures, consisting primarily of purchases and upgrades
to various information technology hardware and software throughout the Company and
purchases of furniture and equipment for the Companys headquarters in New Jersey.


Net
cash (used) provided by financing activities.During the 39-week period ended
September 24, 2005, net cash used by financing activities was $4.5 million, which was
primarily due to net payments of $4.2 million under the Wachovia Facility and payments of
$0.2 million for obligations under capital leases.


Financing Activities


See
Note 6 to the condensed consolidated financial statements for information relating to the
Companys debt and financing activities.


Other Activities


Consolidation
of New Jersey Office Facilities.The Company entered into a 10-year extension of the
lease for its Weehawken, New Jersey premises and has relocated its executive offices to
that facility in 2005. We consolidated all of our New Jersey operations into the Weehawken
facility when the Edgewater, New Jersey facility closed upon the expiration of the lease
on May 31, 2005.


19
Consolidation
of Mens Apparel Business.The Company decided on November 9, 2004 to relocate
and consolidate all functions of International Male and Undergear from San
Diego, California to Weehawken, New Jersey by February 28, 2005. The decision was prompted
by the business need to consolidate operations, reduce costs and leverage its catalog
expertise in New Jersey. We accrued $0.9 million in severance and related costs during the
fourth quarter of 2004 associated with the elimination of 32 California-based full-time
equivalent positions. The payment of these costs began in February 2005 and continued
through August 2005. During the 39- weeks ended September 24, 2005, the Company made
payments of $0.8 million in severance and related costs associated with this
consolidation.


The
projected annual savings from the consolidation of the San Diego, California and the
Edgewater, New Jersey facilities into the Weehawken, New Jersey facility is approximately
$2.1 million.


Consolidation
of Fulfillment Centers.On June 30, 2004 the Company announced plans to consolidate
the operations of the LaCrosse, Wisconsin fulfillment center and storage facility into the
Roanoke, Virginia fulfillment center by June 30, 2005. The LaCrosse fulfillment center and
the LaCrosse storage facility were closed in June 2005 and August 2005, upon the
expiration of their respective leases. The Company substantially completed the
consolidation into the Roanoke, Virginia fulfillment center by the end of June 2005. The
Company accrued $0.5 million in severance and related costs during 2004 and incurred $0.2 million and $0.6 million of
facility exit costs during 2004 and 2005, respectively, associated with the consolidation of the LaCrosse
operations and the elimination of 149 full and part-time positions. The payment of these
costs began in January 2005 and will continue into the fourth quarter of 2005. During the
39- weeks ended September 24, 2005, the Company has made payments of approximately $0.4
million in severance and related costs and $0.6 million in facility exit costs associated with this consolidation.


Delisting
of Common Stock.The Common Stock was delisted from the American Stock Exchange
(AMEX) on February 16, 2005 because of the Restatement which prevented us from
timely filing our Form 10-Q for the fiscal quarter ended September 25, 2004, a condition
of continued AMEX listing. Current trading information about the Companys Common
Stock can be obtained from the Pink Sheets (www.pinksheets.com) under the trading symbol
HNVD.PK.


General.
At September 24, 2005, the Company had $0.1 million in cash and cash equivalents, compared
with $0.5 million at December 25, 2004 and $0.4 million at September 25, 2004. Working
capital and current ratio at September 24, 2005 were $24.9 million and 1.37 to 1,
respectively. Total borrowings, including financing under capital lease obligations, as of
September 24, 2005, aggregated $25.8 million. Remaining availability under the Wachovia
Facility as of September 24, 2005 was $7.2 million, compared with $9.9 million at
September 25, 2004.


Management
believes that the Company has sufficient liquidity and availability under its credit
agreements to fund its planned operations through at least the next twelve months. See
Forward-Looking Statements below.


USES OF ESTIMATES AND
OTHER CRITICAL ACCOUNTING POLICIES


The
condensed consolidated financial statements include all subsidiaries of the Company and
all intercompany transactions and balances have been eliminated. The preparation of
financial statements, in conformity with generally accepted accounting principles,
requires management to make estimates and assumptions that affect the reported amounts of
assets and liabilities, the disclosure of contingent assets and liabilities at the date of
the financial statements, and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.


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 25, 2004 for additional information relating to the
Companys use of estimates and other critical accounting policies.


NEW ACCOUNTING
PRONOUNCEMENTS


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 25, 2004, for additional information relating to new
accounting pronouncements that the Company has adopted.


20
FORWARD-LOOKING
STATEMENTS


This
Form 10-Q contains forward-looking statements within the meaning of the Private
Securities Litigation Reform Act of 1995. The use of words such as
anticipates, estimates, expects, projects,
intends, plans, and believes, among others, generally
identify forward-looking statements. Forward-looking statements are predictions of future
trends and events and as such, there are substantial risks and uncertainties associated
with forward-looking statements, many of which are beyond managements control. Some
of the more material risks and uncertainties are identified in Risk Factors
contained in Item 7 of the Companys Annual Report on Form 10-K for the fiscal year
ended December 25, 2004. We do not intend, and disclaim any obligation, to update any
forward-looking statements.




ITEM 3. QUANTITIVE
AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK


Interest
Rates: The Companys exposure to market risk relates to interest rate
fluctuations for borrowings under the Wachovia Facility, including the term loans, which
bear interest at variable rates, and the Chelsey Facility, which bears interest at 5.0%
above the prime rate publicly announced by Wachovia Bank, N.A. At September 24, 2005,
outstanding principal balances under the Wachovia Facility and Chelsey Facility subject to
variable rates of interest were approximately $15.2 million and $20.0 million,
respectively. If interest rates were to increase by one percent from current levels, the
resulting increase in interest expense, based upon the amount outstanding at September 24,
2005, would be approximately $0.4 million on an annual basis.


In
addition, the Companys exposure to market risk relates to 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, fluctuations in
foreign currency exchange rates, and the ability of the Company to reduce unprofitable
circulation and effectively manage its customer lists.




ITEM 4.
CONTROLS AND PROCEDURES



Our
management, with the participation of our Chief Executive Officer and Chief Financial
Officer, has completed an evaluation of the effectiveness of the design and operation of
our disclosure controls and procedures (as defined in Rule 13a-15 under the Securities
Exchange Act of 1934, as amended (the Exchange Act)) pursuant to Item 307 of
Regulation S-K for the fiscal quarter covered by this quarterly report.




Over
the past year and half, we have implemented a plan to remediate previously identified
weaknesses in our disclosure and internal controls and procedures. This plan was
memorialized in a Remediation Plan adopted by the Audit Committee on July 7, 2005 which
directs management to periodically review the plan to assess its efficacy and requires
that it be revised, updated and augmented from time to time as needed. During the third
fiscal quarter of 2005, management implemented the following additional remedial steps to
enhance our internal and accounting controls and procedures:


*
        Documented our significant accounting policies and implemented a procedure to periodically review and update these policies; and*
        Implemented a policy that requires the preparation of contemporaneous memoranda and related documentation to support key accounting judgments and to maintain and document the significant terms of material contracts and the accounting treatment thereof.As
a result of the restatement of our prior period financial statements, the fact that the
audit of those statements has yet to be completed and the change in our auditors, the
burden on our accounting and financial staff has been greatly increased and has thus far
caused us to be unable to file our periodic SEC reports on a timely basis. While
management believes that current practices and procedures are sufficient to bring to its
attention items required to be disclosed in our periodic SEC filings, after an evaluation
of those practices, we have determined to institute additional procedures to enhance the
effectiveness of our disclosure controls. Subject to the foregoing, management believes
that our disclosure controls effective for purposes of Item 307 of Regulation S-K.






21
PART II 
OTHER INFORMATION


ITEM 1. LEGAL
PROCEEDINGS


See
Note 3 to the condensed consolidated financial statements for information relating to the
Companys legal proceedings.




ITEM 6.
EXHIBITS


31.1  Certification signed by Wayne
P. Garten.


31.2  Certification signed by John
W. Swatek.


32.1  Certification signed by Wayne
P. Garten and John W. Swatek.


22
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.

HANOVER
      DIRECT, INC.
      
      
      (Registrant)By: /s/ John W. Swatek
             
             John W. Swatek 
             Senior Vice President, 
             Chief Financial Officer and Treasurer
      
             (On behalf of the Registrant and as
      principal
             financial officer)Date: December 9, 2005


23