<PAGE>

                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                  FORM 10-Q/A
                                Amendment No. 1

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

                For the quarterly period ended SEPTEMBER 27, 2003

                         Commission file number 1-08056

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

                    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)

                                 (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 [ ]

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). YES [ ] NO [X]

Common stock, par value $.66 2/3 per share: 138,315,800 shares outstanding
(excluding treasury shares) as of November 7, 2003.

<PAGE>


                                EXPLANATORY NOTE



     This Amendment No. 1 to our Quarterly Report on Form 10-Q for the quarter
ended September 27, 2003, as originally filed on November 11, 2003, is being
filed to amend and reflect the restatement of our Consolidated Balance Sheets as
September 27, 2003 and December 28, 2002, in order to comply with EITF Issue No.
95-22, "Balance Sheet Classification of Borrowings Outstanding under Revolving
Credit Agreements that Include Both a Subjective Acceleration Clause and a
Lock-Box Arrangement" ("EITF 95-22"). We re-examined the provisions of our
revolving loan facility and, based on EITF 95-22 and certain provisions in the
credit agreement, we are required to reclassify our revolving loan facility from
long-term to short-term debt, though the existing revolving loan facility does
not mature until January 31, 2007. As a result, we reclassified $13,164 and
$8,819 (in thousands) as of September 27, 2003 and December 28, 2002,
respectively, from Long-term debt to Short-term debt and capital lease
obligations that is classified as current liabilities. See Notes 9 and 12
of Notes to Consolidated Financial Statements for further discussion. Each item
of the Quarterly Report on Form 10-Q as filed on November 11, 2003 that was
affected by the restatement has been amended and restated. This Form 10-Q/A
contains no changes to the Consolidated Statements of Income (Loss), Changes in
Stockholder's Equity (Deficiency), or Cash Flows as previously reported,
although this Form 10-Q/A does include changes in the Balance Sheets and
disclosures as described below:

Part I - Item 1. Condensed Consolidated Financial Statements - Condensed
Consolidated Balance Sheets - Liabilities and Stockholders' Deficiency - Amount
for Short-term debt and capital lease obligations, total current
liabilities, long-term debt and total non-current liabilities at September 27,
2003 and December 28, 2002 have been restated from amounts originally reported
as follows:

<TABLE>
<CAPTION>
(IN THOUSANDS)                             September 27, 2003        December 28, 2002
                                        --------------------------------------------------
                                        As Previously     As      As Previously      As
                                          Reported     Restated      Reported     Restated
                                        --------------------------------------------------
<S>                                        <C>          <C>          <C>         <C>
Short-term debt and
   capital lease obligations               $ 10,831     $ 23,995     $  3,802    $ 12,621
Total current liabilities                  $ 72,424     $ 85,588     $ 78,848    $ 87,667
Long-term debt                             $ 22,820     $  9,656     $ 21,327    $ 12,508
Total non-current liabilities              $135,005     $121,841     $ 27,714    $ 18,895
</TABLE>

Part I - Item 1. Condensed Consolidated Financial Statements - Notes to
Unaudited Condensed Consolidated Financial Statements - 9. Amendments to
Congress Loan and Security Agreement has been updated to provide disclosure
concerning the reclassification of the Company's revolving loan facility
pursuant to EITF 95-22.

Part I - Item 2. Management's Discussion and Analysis of Consolidated Financial
Condition and Results of Operations - Liquidity and Capital Resources - the
section titled "Congress Credit Facility" has been updated to provide disclosure
concerning the reclassification of the Company's revolving loan facility
pursuant to EITF 95-22.
<PAGE>

                              HANOVER DIRECT, INC.

                                TABLE OF CONTENTS

<TABLE>
<CAPTION>
                                                                                            Page
                                                                                            ----
<S>                                                                                         <C>
Part I - Financial Information

    Item 1. Financial Statements

       Condensed Consolidated Balance Sheets -
         September 27, 2003 and December 28, 2002 ........................................    2

       Condensed Consolidated Statements of Income (Loss) - 13- and 39- weeks ended
         September 27, 2003 and September 28, 2002 .......................................    4

       Condensed Consolidated Statements of Cash Flows - 39- weeks ended
         September 27, 2003 and September 28, 2002 .......................................    5

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

    Item 2. Management's Discussion and Analysis of Consolidated Financial Condition and
         Results of Operations ...........................................................   20

    Item 3. Quantitative and Qualitative Disclosures about Market Risk ...................   31

    Item 4. Controls and Procedures ......................................................   31

Part II - Other Information

    Item 1. Legal Proceedings ............................................................   32

    Item 5. Other Information ............................................................   35

    Item 6. Exhibits and Reports on Form 8-K .............................................   37

    Signatures ...........................................................................   39
</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>
                                                     AS RESTATED    AS RESTATED
                                                    SEPTEMBER 27,   DECEMBER 28,
                                                        2003            2002
                                                    -------------   ------------
                                                     (UNAUDITED)
<S>                                                 <C>             <C>
                   ASSETS
CURRENT ASSETS:
      Cash and cash equivalents                      $    931         $    785
      Accounts receivable, net                         12,539           16,945
      Inventories                                      53,000           53,131
      Prepaid catalog costs                            15,770           13,459
      Other current assets                              3,834            3,967
                                                     --------         --------
         Total Current Assets                          86,074           88,287
                                                     --------         --------
PROPERTY AND EQUIPMENT, AT COST:
      Land                                              4,361            4,395
      Buildings and building improvements              18,210           18,205
      Leasehold improvements                            9,895            9,915
      Furniture, fixtures and equipment                56,240           56,094
      Construction in progress                            471                -
                                                     --------         --------
                                                       89,177           88,609
      Accumulated depreciation and amortization       (61,705)         (59,376)
                                                     --------         --------
         Property and equipment, net                   27,472           29,233
                                                       ------           ------
Goodwill, net                                           9,278            9,278
Deferred tax assets                                     2,300           12,400
Other assets                                              253              902
                                                     --------         --------
         Total Assets                                $125,377         $140,100
                                                     ========         ========
</TABLE>

                             Continued on next page.

                                       2
<PAGE>

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

<TABLE>
<CAPTION>
                                                                                AS RESTATED   AS RESTATED
                                                                               SEPTEMBER 27,  DECEMBER 28,
                                                                                   2003           2002
                                                                               -------------  ------------
                                                                                (UNAUDITED)
<S>                                                                            <C>            <C>
                       LIABILITIES AND SHAREHOLDERS' DEFICIENCY
CURRENT LIABILITIES:
     Short-term debt and capital lease obligations                               $  23,995     $  12,621
     Accounts payable                                                               40,522        42,873
     Accrued liabilities                                                            12,066        26,351
     Customer prepayments and credits                                                6,705         4,722
     Deferred tax liabilities                                                        2,300         1,100
                                                                                 ---------     ---------
              Total Current Liabilities                                             85,588        87,667
                                                                                 ---------     ---------
NON-CURRENT LIABILITIES:
     Long-term debt                                                                  9,656        12,508
     Series B Participating Preferred Stock, authorized, issued
         and outstanding 1,622,111 shares at September 27, 2003; liquidation
         preference of $112,964 at September 27, 2003                              104,437             -
     Other                                                                           7,748         6,387
                                                                                 ---------     ---------
              Total Non-current Liabilities                                        121,841        18,895
                                                                                 ---------     ---------
              Total Liabilities                                                    207,429       106,562
                                                                                 ---------     ---------
SERIES B PARTICIPATING PREFERRED STOCK, authorized, issued
     and outstanding 1,622,111 shares at December 28, 2002; liquidation
     preference was $92,379 at December 28, 2002                                         -        92,379
SHAREHOLDERS' DEFICIENCY:
     Common Stock, $.66 2/3 par value, authorized 300,000,000 shares;
         140,436,729 shares issued at September 27, 2003 and December
         28, 2002                                                                   93,625        93,625
     Capital in excess of par value                                                325,923       337,507
     Accumulated deficit                                                          (498,254)     (486,627)
                                                                                 ---------     ---------
                                                                                   (78,706)      (55,495)
                                                                                 ---------     ---------
Less:
     Treasury stock, at cost (2,120,929 shares at September 27, 2003 and
        December 28, 2002)                                                          (2,996)       (2,996)
     Notes receivable from sale of Common Stock                                       (350)         (350)
                                                                                 ---------     ---------
              Total Shareholders' Deficiency                                       (82,052)      (58,841)
                                                                                 ---------     ---------
              Total Liabilities and Shareholders' Deficiency                     $ 125,377     $ 140,100
                                                                                 =========     =========
 </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 39- WEEKS ENDED
                                                            --------------------------------     ---------------------------------
                                                             SEPTEMBER 27,     SEPTEMBER 28,      SEPTEMBER 27,      SEPTEMBER 28,
                                                                 2003               2002              2003               2002
                                                            --------------     -------------     --------------      -------------
<S>                                                         <C>                <C>               <C>                 <C>
NET REVENUES                                                  $  96,633           $ 106,030         $ 304,872           $ 329,393
                                                              ---------           ---------         ---------           ---------
OPERATING COSTS AND EXPENSES:
     Cost of sales and operating expenses                        62,557              68,890           194,361             210,379
     Special charges                                                193               1,463               681               1,696
     Selling expenses                                            22,787              25,355            74,099              76,554
     General and administrative expenses                         10,092              11,834            30,857              36,806
     Depreciation and amortization                                1,068               1,393             3,389               4,376
                                                              ---------           ---------         ---------           ---------
                                                                 96,697             108,935           303,387             329,811
                                                              ---------           ---------         ---------           ---------

(LOSS) INCOME FROM OPERATIONS                                       (64)             (2,905)            1,485                (418)
     Gain on sale of Improvements                                     -                   -             1,911                 318
                                                              ---------           ---------         ---------           ---------

(LOSS) INCOME BEFORE INTEREST AND
     INCOME TAXES                                                   (64)             (2,905)            3,396                (100)
     Interest expense, net                                        5,274               1,277             7,842               4,016
                                                              ---------           ---------         ---------           ---------

LOSS BEFORE INCOME TAXES                                         (5,338)             (4,182)           (4,446)             (4,116)
     Provision for deferred federal income taxes                 11,300                   -            11,300                   -
     Provision for state income taxes                                 7                  30                17                  90
                                                              ---------           ---------         ---------           ---------

NET LOSS AND COMPREHENSIVE
     LOSS                                                       (16,645)             (4,212)          (15,763)             (4,206)
     Preferred stock dividends and accretion                          -               4,185             7,922              10,593
                                                              ---------           ---------         ---------           ---------

      SHAREHOLDERS                                            $ (16,645)          $  (8,397)        $ (23,685)          $ (14,799)
                                                              =========           =========         =========           ==========
NET LOSS PER COMMON SHARE:
     Net loss per common share - basic and diluted            $    (.12)          $    (.06)        $    (.17)          $    (.11)
                                                              =========           =========         =========           =========
     Weighted average common shares outstanding -
     basic (thousands)                                          138,316             138,316           138,316             138,268
                                                              =========           =========         =========           =========
     Weighted average common shares outstanding -
     diluted (thousands)                                        138,316             138,316           138,316             138,268
                                                              =========           =========         =========           =========
</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 39- WEEKS ENDED
                                                                                ------------------------------
                                                                                SEPTEMBER 27,    SEPTEMBER 28,
                                                                                    2003              2002
                                                                                -------------    -------------
<S>                                                                             <C>              <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss                                                                        $    (15,763)    $     (4,206)
Adjustments to reconcile net loss to net cash used by operating activities:
     Depreciation and amortization, including deferred fees                            4,206            5,483
     Provision for doubtful accounts                                                     281                -
     Special charges                                                                      16                -
     Deferred tax asset                                                               11,300                -
     Gain on the sale of Improvements                                                 (1,911)            (318)
     Loss on the sale of property and equipment                                           70                -
     Interest expense related to Series B Participating Preferred Stock
       redemption price increase                                                       4,482                -
     Compensation expense related to stock options                                       473              724
Changes in assets and liabilities:
     Accounts receivable                                                               4,125            3,863
     Inventories                                                                         131              972
     Prepaid catalog costs                                                            (2,311)          (4,231)
     Accounts payable                                                                 (2,351)            (860)
     Accrued liabilities                                                             (14,285)          (5,692)
     Customer prepayments and credits                                                  1,983            2,255
     Other, net                                                                        1,570           (2,078)
                                                                                ------------     ------------
Net cash used by operating activities                                                 (7,984)          (4,088)
                                                                                ------------     ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
     Acquisitions of property and equipment                                           (1,715)            (597)
     Proceeds from sale of Improvements                                                2,000              318
     Costs related to the early release of escrow funds                                  (89)               -
     Proceeds from disposal of property and equipment                                      2                -
                                                                                ------------     ------------
Net cash provided (used) by investing activities                                         198             (279)
                                                                                ------------     ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
     Net borrowings under Congress revolving loan facility                            11,373            3,419
     Borrowings under Congress Tranche B term loan facility                                -            3,500
     Payments under Congress Tranche A term loan facility                             (1,493)          (1,493)
     Payments under Congress Tranche B term loan facility                             (1,350)            (864)
     Payments of long-term debt and capital lease obligations                             (8)            (102)
     Borrowings under capital lease obligations                                            -               32
     Payment of debt issuance costs                                                     (243)            (528)
     Proceeds from issuance of common stock                                                -               25
     Series B Participating Preferred Stock Transaction Cost Adjustment                    -              216
     Payment of estimated Richemont tax obligation on Series B Participating
       Preferred Stock accretion                                                        (347)               -
                                                                                ------------     ------------
Net cash provided by financing activities                                              7,932            4,205
                                                                                ------------     ------------
Net increase (decrease) in cash and cash equivalents                                     146             (162)
Cash and cash equivalents at the beginning of the year                                   785            1,121
                                                                                ------------     ------------
Cash and cash equivalents at the end of the period                              $        931     $        959
                                                                                ============     ============

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid for:
     Interest                                                                   $      2,480     $      2,451
     Income taxes                                                               $        665     $        193
Non-cash investing and financing activities:
     Series B Participating Preferred Stock redemption price increase           $      7,575     $     10,593
</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 28, 2002. 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
Statement of Financial Accounting Standards ("SFAS") No. 131, "Disclosures about
Segments of an Enterprise and Related Information," the consolidated operations
of the Company are reported as one segment.

Uses of Estimates and Other Critical Accounting Policies

         In addition to the use of estimates and other critical accounting
policies disclosed in our Annual Report on Form 10-K for the fiscal year ended
December 28, 2002, an understanding of the below use of estimates and other
critical accounting policies is necessary to analyze our financial results for
the 13 and 39-week periods ended September 27, 2003.

         Revenue is recognized for catalog and internet sales when merchandise
is shipped to customers and at the time of sale for retail sales. Shipping terms
for catalog and internet sales are FOB shipping point, and title passes to the
customer at the time and place of shipment. Prices for all merchandise are
listed in the Company's catalogs and Web sites and are confirmed with the
customer upon order. The customer has no cancellation privileges other than
customary rights of return that are accounted for in accordance with SFAS No. 48
"Revenue Recognition When Right of Return Exists." The Company accrues a sales
return allowance for estimated returns of merchandise subsequent to the balance
sheet date that relate to sales prior to the balance sheet date. Amounts billed
to customers for shipping and handling fees related to catalog and internet
sales are included in other revenues at the time of shipment.

         During June 2003, the Company established and issued a new Company-wide
vacation and sick policy to better administer vacation and sick benefits. For
purposes of the policy, employees were converted to a fiscal year for earning
vacation benefits. Under the new policy, vacation benefits are deemed earned and
thus accrued ratably throughout the fiscal year and employees must utilize all
vacation earned by the end of the same year. Generally, any unused vacation
benefits not utilized by the end of a fiscal year will be forfeited. In prior
periods, employees earned vacation in the twelve months prior to the year that
it would be utilized. The policy has been modified in certain locations to
comply with state and local laws or written agreements. As a result of the
transition to this new policy, the Company has recognized a benefit of
approximately $0.5 million and $1.3 million for the 13 and 39- weeks ended
September 27, 2003. Approximately $0.2 million and $0.7 million of general and
administrative expenses were reduced as a result of the recognition of this
benefit for the 13 and 39- weeks ended September 27, 2003, respectively.
Approximately $0.3 million and $0.6 million of operating expenses were reduced
as a result of the recognition of this benefit for the 13 and 39- weeks ended
September 27, 2003, respectively.

         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 28, 2002, for additional
information relating to the Company's use of estimates and other critical
accounting policies.

2.       ACCUMULATED DEFICIENCY RESTRICTIONS

         The Company is restricted from paying dividends at any time on its
Common Stock or from acquiring its capital

                                       6
<PAGE>

stock by certain debt covenants contained in agreements to which the Company is
a party.

3.       NET LOSS PER COMMON SHARE

         Net loss per common 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" ("FAS
128"). The weighted average number of shares used in the calculation for both
basic and diluted net loss per common share for the 13-week periods ended
September 27, 2003 and September 28, 2002 was 138,315,800 shares. The weighted
average number of shares used in the calculation for both basic and diluted net
loss per common share for the 39-week periods ended September 27, 2003 and
September 28, 2002 was 138,315,800 and 138,268,327 shares, respectively. Diluted
net loss per common share equals basic net loss per common share as the
inclusion of potentially dilutive securities would have an anti-dilutive impact
on the dilutive calculation as a result of the net losses incurred during the 13
and 39-week periods ended September 27, 2003 and September 28, 2002. Currently,
all potentially dilutive securities consist of options to purchase shares of the
Company's Common Stock that have been issued and are outstanding. Outstanding
options to purchase 14.0 million shares for the 13 and 39-week periods ended
September 27, 2003 and 14.3 million shares for the 13 and 39-week periods ended
September 28, 2002 of the Company's Common Stock at prices ranging from $0.20 to
$3.50 were excluded from the per share calculations of diluted earnings per
share because they would have been anti-dilutive. Options that had exercise
prices below the average price of a common share for the 13-week periods ended
September 27, 2003 and September 28, 2002 were 798,615 and 472,671,
respectively. Options that had exercise prices below the average price of a
common share for the 39-week periods ended September 27, 2003 and September 28,
2002 were 19,651 and 3,207,612, 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. 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
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 that was designated to
be an `insurance' charge." On August 21, 2001, the Company filed an appeal of
the order with the Oklahoma Supreme Court 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 Oklahoma Supreme Court has not yet ruled on the pending
appeal. Oral argument on the appeal, if scheduled, was expected during the first
half of 2003 but has yet to be scheduled by the Court. The Company believes it
has defenses against the claims and plans to conduct a vigorous defense of this
action.

         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 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,

                                       7
<PAGE>

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. 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 and Hanover Direct Virginia. 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 and Home, and Silhouettes, as defendants, and (2) granted the Company's
Motion to Stay the action in favor of the previously filed Oklahoma action. The
Company believes it has defenses against the claims and plans to conduct a
vigorous defense of this action.

         A lawsuit was commenced as both a class action and for the benefit of
the general public 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 allegedly 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 and the general public 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 seeks (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 fee, tax and sales tax
collected unlawfully, together with interest, (ii) an order enjoining Brawn from
charging customers insurance fee 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 Plaintiff
alleged that 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 denied the Motion to Stay. The Wilson case proceeded
to trial before the Honorable Dian Elan Wick of the Superior Court of California
for the County of San Francisco, and the Judge, sitting without a jury, heard
evidence from April 15-17, 2003. The Court requested and received closing
arguments and Proposed Statements of Decision in July 2003. On September 18,
2003, the Court issued its Proposed Statement of Decision and Proposed Judgment
After Trial (the "Proposed Judgment"). The Proposed Judgment would find: 1) that
Jacq Wilson has abandoned his individual claims and has pursued the case only on
behalf of the general public; 2) that Brawn had violated Business and
Professions Code Section 17200 and 17500 by identifying its $1.48 charge to
customers as an `insurance' charge and that said charge was for an illusory
benefit that was likely to deceive consumers; and 3) that plaintiff had failed
to prove that Brawn had violated Business and Professions Code Section 17200 by
collecting, sales tax on delivery charges for goods shipped to its customers.
The Proposed Judgment would order Brawn to "locate, identify and pay restitution
to each of its customers for each transaction in which a $1.48 charge for
`insurance' was paid from February 13, 1998 through January 15, 2003" with
interest from the date paid. The Proposed Judgment states that such restitution
must be made on or before June 30, 2004. On October 10, 2003 Brawn filed its
Objections to the Court's Proposed Decision and its Amended [Tentative]
Statement of Decision, based on Brawn's belief that the Court failed to properly
consider certain undisputed evidence, reached other conclusions not supported by
any admissible evidence and improperly applied the law concerning the insurance
fee. (Plaintiff's co-counsel (on the tax matter) requested an opportunity to
respond and intended to file its response on or before October 24, 2003.) The
potential estimated exposure is in the range of $0 to $4.0 million. If the trial
court fails to amend or modify its Proposed Judgment, the Company expects to
take an appeal and conduct a vigorous defense of this action.

         A class action lawsuit was commenced on October 28, 2002 entitled John
Morris, individually and on behalf of all other persons & entities similarly
situated v. Hanover Direct, Inc., and Hanover Brands, Inc. (referred to here as
"Hanover"), No. L 8830-02 in the Superior Court of New Jersey, Bergen County --
Law Division. The plaintiff brings the action individually and on behalf of a
class of all persons and entities in New Jersey who purchased merchandise from
Hanover within six years prior to filing of the lawsuit and continuing to the
date of judgment. On the basis of a purchase made by the plaintiff in August
2002 of certain clothing from Hanover (which was from a men's division

                                       8
<PAGE>

catalog, the only one which retained the insurance line item in 2002), the
Plaintiff claims that for at least six years, Hanover maintained a policy and
practice of adding a charge for "insurance" to the orders it received and
concealed and failed to disclose its policy with respect to all class members.
Plaintiff claims that Hanover's conduct was (i) in violation of the New Jersey
Consumer Fraud Act, as otherwise deceptive, misleading and unconscionable; (ii)
such as to constitute Unjust Enrichment of Hanover at the expense and to the
detriment of plaintiff and the class; and (iii) unconscionable per se under the
Uniform Commercial Code for contracts related to the sale of goods. Plaintiff
and the class seek damages equal to the amount of all insurance charges,
interest thereon, treble and punitive damages, injunctive relief, costs and
reasonable attorneys' fees, and such other relief as may be just, necessary, and
appropriate. Plaintiff filed an Amended Complaint adding International Male as a
defendant. On December 13, 2002, the Company filed a Motion to Stay the Morris
action in favor of the previously filed Martin action. Hearing on the Motion to
Stay took place on June 6, 2003 and the Court granted the Company's motion to
stay until December 31, 2003, at which time the Court will revisit the issue if
the parties request that it do so. The Company plans to conduct a vigorous
defense of this action.

         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 $298,650 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 or $850,000
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 within the 30 days following his resignation. 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 and every of Mr. Kaul's causes of action, challenging all substantive
assertions, raising several defenses and 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
seeks summary judgment: dismissing Mr. Kaul's claim for severance under his
employment agreement on the ground that he failed to provide the Company with a
general release of, among other things, claims for change of control benefits;
dismissing Mr. Kaul's claim for attorneys' fees on the grounds that they are not
authorized under his employment agreement; dismissing Mr. Kaul's claims related
to change in control benefits based on an administrative decision that he is not
entitled to continued participation in the plan or to future benefits
thereunder; dismissing Mr. Kaul's claim for a tandem bonus payment on the ground
that no payment is owing; dismissing Mr. Kaul's claim for vacation payments
based on Company policy regarding carry over vacation; and seeking judgment on
the Company's counterclaim for unjust enrichment based on Mr. Kaul's failure to
pay under a tax note. Mr. Kaul seeks summary judgment: dismissing the Company's
defenses and counterclaims relating to a release on the grounds that he tendered
a release or that the Company is estopped from requiring him to do so;
dismissing the Company's defenses and counterclaims relating to his alleged
violations of his non-compete and confidentiality obligations on the grounds
that he did not breach the obligations as defined in the agreement; and
dismissing the Company's claims based on his alleged breach of fiduciary duty,
including those based on his monthly car allowance payments and the leased space
to his wife, on the grounds that he was entitled to the car payments and did not
involve himself in or make misrepresentations in connection with the leased
space. The Company has concurrently moved to amend its Answer and Counterclaims
to state a claim that it had cause for terminating Mr. Kaul's employment based
on,

                                       9
<PAGE>

among other things, after acquired evidence that Mr. Kaul received a monthly car
allowance and other benefits totaling $412,336 that had not been authorized by
the Company's Board of Directors and that his wife's lease and related expense
was not properly authorized by the Company's Board of Directors, and to clarify
or amend the scope of the Company's counterclaims for reimbursement. The
briefing on the motions is completed and the parties are awaiting the decision
of the Court. 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.

         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
trial in the Nevada case began on November 18, 2002 and ended on January 17,
2003. The parties in the Nevada case submitted post trial briefs by the end of
May 2003, and a decision is expected in the near future. The Order for the stay
in the Lemelson case 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 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, and has not
established a reserve.

         In early March 2003, the Company learned that one of its business units
had engaged in certain travel transactions that may have constituted violations
under the provisions of U.S. government regulations promulgated pursuant to 50
U.S.C. App. 1-44, which proscribe certain transactions related to travel to
certain countries. The Company immediately commenced an inquiry into the matter,
incurred resulting charges, made an initial voluntary disclosure to the
appropriate U.S. government agency under its program for such disclosures and
has submitted to that agency a detailed report on the results of the inquiry. In
addition, the Company has taken steps to ensure that all of its business units
are acting in compliance with the travel and transaction restrictions and other
requirements of all applicable U.S. government programs. Although the Company is
uncertain of the extent of the penalties, if any, that may be imposed on it by
virtue of the transactions voluntarily disclosed, it does not currently believe
that any such penalties will have a material effect on its business or financial
condition.

         On July 17, 2003, the Company filed an action in the Supreme Court of
the State of New York, County of New York (Index No. 03/602269) against
Richemont Finance S.A. ("Richemont"), and Chelsey Direct, LLC, a Delaware
limited liability company ("Chelsey"), seeking a declaratory judgment as to
whether Richemont improperly transferred all of Richemont's securities in the
Company consisting of 29,446,888 shares of Common Stock and 1,622,111 shares of
Series B Participating Preferred Stock (collectively, the "Shares") to Chelsey
on or about May 19, 2003 and whether the Company can properly recognize the
transfer of those Shares from Richemont to Chelsey under federal and/or state
law. On July 29, 2003, Chelsey answered the Company's complaint, alleged certain
affirmative defenses and raised three counterclaims against the Company,
including Delaware law requiring the registration of the Shares, damages,
including attorney's fees, for the failure to register the Shares, and tortious
interference with contract. Chelsey also moved for a preliminary injunction
directing the Company to register the ownership of the Shares in Chelsey's name.
Chelsey later moved for summary judgment dismissing the Company's complaint.
Subsequently, Chelsey moved to compel production of certain documents and for
sanctions and/or costs. On August 28, 2003, Richemont moved to dismiss the
Company's complaint. It subsequently filed a motion seeking sanctions and/or
costs against the Company. On October 27, 2003, the Court granted Chelsey's
motion for summary judgment and Richemont's motion to dismiss and ordered that
judgment be entered dismissing the case in its entirety. The Court also denied
Chelsey's and Richemont's motions for sanctions and Chelsey's motion to compel
production of certain documents.

                                      10
<PAGE>

         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 asset write-offs. Special charges recorded in fiscal
years 2002, 2001 and 2000 relating to the strategic business realignment program
were $4.4 million, $11.3 million and $19.1 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 strategy and a
return to profitability.

         In the first quarter of 2003, special charges were recorded in the
amount of $0.3 million. These charges consisted primarily of additional
severance costs associated with the Company's strategic business realignment
program. During the second and third quarters of 2003, special charges of $0.2
million were recorded during each quarter. These charges were incurred primarily
to revise estimated losses related to sublease arrangements for office
facilities in San Francisco, California. Increased anticipated losses on
sublease arrangements for the San Francisco office space resulted from the loss
of a subtenant, coupled with declining market values in that area of the
country.

         As of the end of the third quarter of 2003, a liability of
approximately $2.4 million was included within Accrued Liabilities and a
liability of approximately $3.5 million was included within Other Non-current
Liabilities. These liabilities relate to future payments in connection with the
Company's strategic business realignment program. They are expected to be
satisfied no later than February 2010 and consist of the following (in
thousands):

<TABLE>
<CAPTION>
                                 SEVERANCE &  REAL ESTATE  INFORMATION
                                  PERSONNEL     LEASE &     TECHNOLOGY
                                    COSTS     EXIT COSTS      LEASES      TOTAL
                                    -----     ----------      ------      -----
<S>                              <C>         <C>           <C>          <C>
Balance at December 29, 2001      $  2,546    $   8,137    $     373    $  11,056

2002 Expenses                        1,817        2,952            -        4,769
Paid in 2002                        (2,911)      (4,672)        (210)      (7,793)
                                  --------    ----------   ---------    ---------

Balance at December 28, 2002      $  1,452    $   6,417    $     163    $   8,032

2003 Expenses                          257          421            -          678
Paid in 2003                        (1,356)      (1,324)        (131)      (2,811)
                                  --------    ----------   ---------    ---------

Balance at September 27, 2003      $   353    $   5,514    $      32    $   5,899
                                  ========    ==========   =========    =========
</TABLE>


         A summary of the liability related to real estate lease and exit costs,
by location, as of September 27, 2003 and December 28, 2002 is as follows (in
thousands):

<TABLE>
<CAPTION>
                                                                         SEPTEMBER 27,    DECEMBER 28,
                                                                             2003             2002
                                                                         ------------     ------------
<S>                                                                      <C>              <C>
Gump's facility, San Francisco, California                                $    3,404       $    3,349

Corporate facility, Weehawken, New Jersey                                      1,695            2,325

Corporate facility, Edgewater, New Jersey                                        306              439

Administrative and telemarketing facility, San Diego, California                 107              179

Retail store facilities, Los Angeles and San Diego, California                     2              125
                                                                          ----------       ----------

Total Lease and Exit Cost Liability                                       $    5,514       $    6,417
                                                                          ==========       ==========
</TABLE>

                                       11
<PAGE>

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
service agreement with the buyer for a period of three years.

         The asset purchase agreement between the Company and HSN provided that
if Keystone Internet Services failed to perform its obligations during the first
two years of the services contract, the purchaser could 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 of
approximately $33.0 million, had 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.

         On March 27, 2003, the Company and HSN amended the asset purchase
agreement to provide for the release of the remaining $2.0 million balance of
the escrow fund and to terminate the escrow agreement. By agreeing to the terms
of the amendment, HSN forfeited its ability to receive a reduction in the
original purchase price of up to $2.0 million if Keystone Internet Services
failed to perform its obligations during the first two years of the services
contract. In consideration for the release, Keystone Internet Services issued a
credit to HSN for $100,000, which could be applied by HSN against any invoices
of Keystone Internet Services to HSN. This credit was utilized by HSN during the
March 2003 billing period. On March 28, 2003, the remaining $2.0 million escrow
balance was received by the Company, thus terminating the escrow agreement.

         The Company recognized a net gain on the sale of approximately $23.2
million, net of a non-cash goodwill charge of $6.1 million, in fiscal year 2001,
which represented the excess of the net proceeds from the sale over the net
assets acquired by HSN, the goodwill associated with the Improvements business
and expenses related to the transaction. During fiscal year 2002, the Company
recognized approximately $0.6 million of the deferred gain consistent with the
terms of the escrow agreement. During the 13- weeks ended March 29, 2003, the
Company recognized the remaining net deferred gain of $1.9 million from the
receipt of the escrow balance on March 28, 2003. This gain was reported net of
the costs incurred to provide the credit to HSN of approximately $0.1 million.

7.       CHANGES IN MANAGEMENT AND EMPLOYMENT

         On November 3, 2003, Charles E. Blue was appointed Chief Financial
Officer of the Company effective November 11, 2003, replacing Edward M. Lambert
as Chief Financial Officer, effective on such date, in connection with the
Company's ongoing strategic business realignment program. Mr. Blue joined the
Company in 1999 and had most recently served as Senior Vice President, Finance,
a position eliminated by this finance department restructuring.

         Mr. Lambert will continue to serve as Executive Vice President of the
Company until January 2, 2004. In connection with such change, Mr. Lambert and
the Company have entered into a severance agreement dated November 4, 2003
providing a minimum of $600,000 and a maximum of $640,000 of cash payments as
well as other benefits that will be accrued and paid in the fourth quarter of
2003. Mr. Lambert is also entitled to receive a payment under the Company's 2003
Management Incentive Plan; however, the Company's current forecast does not
project any such payment for the 2003 Plan year.

         The Company entered into Amendment No. 3 to the Hanover Direct, Inc.
Key Executive Eighteen Month Compensation Continuation Plan, effective October
29, 2003, making certain technical amendments thereto to reflect the names of
each of the Company's current subsidiaries. Similar changes were made to the
Company's other Compensation Continuation Plans.

         On September 29, 2003, the Company issued shares at a price of $0.27
per option to purchase 100,000 shares of the Company's Common Stock to two
newly-elected board members.

         The Company entered into an Amendment No. 3 to Employment Agreement
effective as of August 3, 2003 between Thomas C. Shull and the Company (1)
extending the term of the Company's Employment Agreement with Mr.

                                       12
<PAGE>

Shull to March 31, 2006, (2) adjusting his Base Compensation (as defined) to
$855,000 per annum, subject to certain exceptions described therein, (3)
extending the termination date of Mr. Shull's 2000 options to the end of the
agreement term, and (4) making certain technical amendments set forth therein.

         The Company effected salary reduction for participants in its 2003
Management Incentive Plan, including Executive Officers, effective with the pay
period starting August 3, 2003, of 5% of base pay.

         On August 1, 2003, the Company issued shares at a price of $0.25 per
option to purchase 210,000 shares of the Company's Common Stock to the then
existing six board members and 35,000 shares at a price of $0.25 per option of
the Company's Common Stock to a consultant to the Company per their agreement.

         On July 29, 2003, the Company issued shares at a price of $0.25 per
option to purchase 100,000 shares of the Company's Common Stock to two
newly-elected board members.

8.       RECENTLY ISSUED ACCOUNTING STANDARDS

         In May 2003, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics
of both Liabilities and Equity" ("FAS 150"). FAS 150 establishes standards for
how an issuer classifies and measures certain financial instruments with
characteristics of both liabilities and equity. It requires that an issuer
classify a financial instrument that is within its scope as a liability, many of
which had been previously classified as equity or between the liabilities and
equity sections of the consolidated balance sheet. The provisions of FAS 150 are
effective for financial instruments entered into or modified after May 31, 2003,
and otherwise is effective at the beginning of the first interim period
beginning after June 15, 2003. It is to be implemented by reporting the
cumulative effect of a change in accounting principle for financial instruments
created before the issuance of FAS 150 and still existing at the beginning of
the interim period of adoption. The Company has adopted the provisions of FAS
150 and has been impacted by the requirement to reclassify its Series B
Participating Preferred Stock as a liability as opposed to between the
liabilities and equity sections of the consolidated balance sheet. Based upon
the requirements set forth by FAS 150, this reclassification was subject to
implementation beginning on June 29, 2003. Upon implementation of FAS 150, the
Company has reflected the accretion of the preferred stock balance as an
increase in Total Liabilities with a corresponding reduction in capital in
excess of par value, because the Company has an accumulated deficit. Such
accretion has been recorded as interest expense, resulting in a decrease in Net
Income (Loss) and Comprehensive Income (Loss) of $4.5 million for the 13 and 39-
weeks ended September 27, 2003. In addition, based upon the Company's current
projections for 2003, it is estimated the Company may not incur a tax
reimbursement obligation for 2003 relating to the increases in the Liquidation
Preference of the Series B Participating Preferred Stock and will file for a
refund of the $0.3 million Federal tax payment made in March 2003. Due to the
FAS 150 requirements to reclassify the Series B Participating Preferred Stock to
liabilities and to record the accretion of the preferred stock balance as
interest expense, the refund has been treated as a decrease to interest expense
on the Condensed Consolidated Statements of Income (Loss) for the third quarter
and an increase of Capital in excess of par value on the Condensed Consolidated
Balance Sheets. If FAS 150 was applicable for fiscal year 2002, Net Loss and
Comprehensive Loss would have been $24.7 million. Net Income (Loss) Applicable
to Common Shareholders and Net Income (Loss) Per Common Share remains unchanged
in comparison with the Company's classification of the instrument prior to June
29, 2003. In addition, there is no cumulative effect of a change in accounting
principle as a result of the implementation of FAS 150. As of September 27,
2003, the implementation of FAS 150 has increased Total Liabilities by
approximately $104.4 million. Shareholders' Deficiency remained unchanged since
the balance had previously been classified between Total Liabilities and
Shareholders' Deficiency on the Condensed Consolidated Balance Sheet. The
classification of the Series B Preferred Stock as a liability under FAS 150
should not change its classification as equity under state law.

         In January 2003, the Securities and Exchange Commission issued a new
disclosure regulation, "Conditions for Use of Non-GAAP Financial Measures"
("Regulation G"), which is effective for all public disclosures and filings made
after March 28, 2003. Regulation G requires public companies that disclose or
release information containing financial measures that are not in accordance
with generally accepted accounting principles ("GAAP") to include in the
disclosure or release a presentation of the most directly comparable GAAP
financial measure and a reconciliation of the disclosed non-GAAP financial
measure to the most directly comparable GAAP financial measure. The Company
became subject to Regulation G in fiscal 2003 and believes that it is in
compliance with the new disclosure requirements.

                                       13
<PAGE>

         In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation-Transition and Disclosure - An Amendment of SFAS No.
123" ("FAS 148"). FAS 148 provides alternative methods of transition for a
voluntary change to the fair value-based method of accounting for stock-based
employee compensation. In addition, FAS 148 amends the disclosure requirements
of SFAS No. 123 to require prominent disclosures in both annual and interim
financial statements about the method of accounting for stock-based employee
compensation and the effect of the method used on reported results. The Company
has established several stock-based compensation plans for the benefit of its
officers and employees. Since 1996, the Company has accounted for its
stock-based compensation to employees using the fair value-based methodology
under SFAS No. 123, thus FAS 148 has had no effect on the Company's results of
operations or financial position. For the 13- weeks ended September 27, 2003 and
September 28, 2002, the Company recorded stock compensation expense of
approximately $0.1 million during each period. For the 39- weeks ended September
27, 2003 and September 28, 2002, the Company recorded stock compensation expense
of $0.5 million and $0.7 million, respectively.

         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 has adopted the
provisions of FAS 146 for exit or disposal activities initiated after December
31, 2002.

         In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other
Intangible Assets" ("FAS 142"). 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 both
September 27, 2003 and September 28, 2002 was $9.3 million. The Company adopted
FAS 142 effective January 1, 2002 and, as a result, has not recorded an
amortization charge for goodwill since that time. The Company obtained the
services of an independent appraisal firm during the second quarter ended June
28, 2003 to assist in the assessment of its annual goodwill impairment. The
results of the appraisal indicated that goodwill was not impaired based upon the
requirements set forth in FAS 142.

9.       AMENDMENTS TO CONGRESS LOAN AND SECURITY AGREEMENT

         In August 2003, the Company amended the Congress Credit Facility to
make certain technical amendments thereto, including the amendment of the
definition of Consolidated Net Worth and the temporary release of a $3 million
availability reserve established thereunder. The temporary release of the $3
million availability reserve will be removed by the end of fiscal year 2003.

         In October 2003, the Company amended the Congress Credit Facility to
extend the expiration thereof from January 31, 2004 to January 31, 2007, to
reduce the amount of revolving loans available thereunder to $43,000,000, to
make adjustments to the sublimits available to the various borrowers thereunder,
to amend the EBITDA covenant to specify minimum levels of EBITDA that must be
achieved during the Company's fiscal years ending 2004, 2005 and 2006, to permit
the borrowing under certain circumstances of up to $1,000,000 against certain
inventory in transit to locations in the United States, and to make certain
other technical amendments.

                                       14
<PAGE>
     In November 2003, the Company amended the Congress Credit Facility to
change the definition of Consolidated Net Worth so as to provide that for the
purposes of calculating such amount for the Company's fiscal year ending
December 27, 2003, the Company's net deferred tax assets in the amount of
$11,300,000 that are required to be fully reserved pursuant to SFAS No. 109,
"Accounting for Income Taxes" ("FAS 109"), shall be added back for the purposes
of determining the Company's assets. See Note 11 of the Company's Condensed
Consolidated Financial Statements. The Company also amended the definition of
Consolidated Working Capital so as to provide that for the purposes of
calculating such amount for the Company's fiscal year ending December 27, 2003,
the Company's current deferred tax liabilities in the amount of $2,300,000,
shall be added back for the purposes of determining the Company's current
liabilities. See Note 11 of the Company's Condensed Consolidated Financial
Statements.

     The Company has restated its Consolidated Balance Sheets as of September
27, 2003 and December 28, 2002 to properly classify the Congress Credit Facility
as a current liability in accordance with EITF No. 95-22, "Balance Sheet
Classification of Borrowings Outstanding under Revolving Credit Agreements that
Include Both a Subjective Acceleration Clause and a Lock-Box Arrangement" ("EITF
95-22"). This restatement has no impact on the Company's results of operations
or cash flows for the 13- and 39- weeks ended September 27, 2003. The Congress
Credit Facility is classified as a current liability in accordance with EITF
95-22 since the loan and security agreement contains a subjective acceleration
clause and contractual provisions that require the cash receipts of the Company
to be used to repay amounts outstanding under the Congress Credit Facility.

     The Company has re-examined the provisions of the Congress Credit Facility.
Based on EITF 95-22 and certain provisions in the credit agreement, the Company
is required to reclassify its revolving loan facility from long-term to
short-term debt, though the existing revolving loan facility does not mature
until January 31, 2007. As a result, the Company reclassified $13,164 and $8,819
(in thousands) as of September 27, 2003 and December 28, 2002, respectively,
from Long-term debt to Short-term debt and capital lease obligations that is
classified as current liabilities.

         As of September 27, 2003, the Company had $33.6 million of cumulative
borrowings outstanding under the Congress Credit Facility. Total cumulative
borrowings comprise $20.2 million under the Revolving Loan Facility, bearing a
variable interest rate as of September 27, 2003 of 4.5%, $7.0 million under the
Tranche A Term Loan, bearing a variable interest rate as of September 27, 2003
of 4.75%, and $6.4 million under the Tranche B Term Loan, bearing a fixed
interest rate of 13.0%.

10.      SERIES B PARTICIPATING PREFERRED STOCK

         On December 19, 2001, the Company issued to Richemont 1,622,111 shares
of Series B Participating Preferred Stock having a par value of $0.01 per share
(the "Series B Preferred Stock") in exchange for all of the outstanding shares
of the Series A Cumulative Participating Preferred Stock issued to Richemont on
August 24, 2000 for $70.0 million and 74,098,769 shares of the Common Stock of
the Company held by Richemont and the reimbursement of expenses of $1 million to
Richemont (the "Richemont Transaction"). The Richemont Transaction was made
pursuant to an Agreement, dated as of December 19, 2001 (the "Richemont
Agreement"), between the Company and Richemont. Richemont agreed, as part of the
Richemont Transaction, to forego any claim it had to the accrued but unpaid
dividends on the Series A Cumulative Participating Preferred Stock. As part of
the Richemont Transaction, the Company (i) released Richemont, the individuals
appointed by Richemont to the Board of Directors of the Company and certain of
their respective affiliates and representatives (collectively, the "Richemont
Group") from any claims by or in the right of the Company against any member of
the Richemont Group that arise out of Richemont's acts or omissions as a
stockholder of or lender to the Company or the acts or omissions of any
Richemont board designee in his capacity as such and (ii) entered into an
Indemnification Agreement (the "Indemnification Agreement") with Richemont
pursuant to which the Company agreed to indemnify each member of the Richemont
Group from any losses suffered as a result of any third party claim which is
based upon Richemont's acts as a stockholder of or lender to the Company or the
acts or omissions of any Richemont board designee in his capacity as such. The
Indemnification Agreement is not limited as to term and does not include any
limitations on maximum future payments thereunder.

         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 on 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 as described below in further detail.

         By letter dated September 2, 2003, the Company advised Chelsey that a
Voting Trigger (as defined in the Certificate of Designations, Powers,
Preferences and Rights (the "Certificate of Designations") of the Series B
Preferred Stock of the Company had occurred due to the failure by the Company to
redeem any shares of Series B Preferred Stock on or prior to August 31, 2003. As
a result, the holder or holders of the Series B Preferred Stock had the
exclusive right, voting separately as a class and by taking such actions as are
set forth in Section 7(b) of the Certificate of Designations, to elect two
directors of the Company (the "Director Right"). On September 16, 2003, Chelsey
exercised the Director Right and elected Martin L. Edelman and Wayne P. Garten
to the Company's Board of Directors. Messrs. Edelman and Garten returned certain
related paperwork to the Company on September 29, 2003, upon which they
effectively joined the Board.

         In the event of the liquidation, dissolution or winding up of the
Company, the holders of the Series B Preferred

                                       15
<PAGE>

Stock are entitled to a liquidation preference (the "Liquidation Preference"),
which was initially $47.36 per share. During each period set forth in the table
below, the Liquidation Preference shall equal the amount set forth opposite such
period:

<TABLE>
<CAPTION>
                                                      LIQUIDATION PREFERENCE
            PERIOD                                           PER SHARE                     TOTAL VALUE
            ------                                           ---------                     -----------
<S>                                                   <C>                               <C>
March 1, 2002 - May 31, 2002                                  $ 49.15                   $  79,726,755.65
June 1, 2002 - August 31, 2002                                $ 51.31                   $  83,230,515.41
September 1, 2002 - November 30, 2002                         $ 53.89                   $  87,415,561.79
December 1, 2002 - February 28, 2003                          $ 56.95                   $  92,379,221.45
March 1, 2003 - May 31, 2003                                  $ 60.54                   $  98,202,599.94
June 1, 2003 - August 31, 2003                                $ 64.74                   $ 105,015,466.14
September 1, 2003 - November 30, 2003                         $ 69.64                   $ 112,963,810.04
December 1, 2003 - February 29, 2004                          $ 72.25                   $ 117,197,519.75
March 1, 2004 - May 31, 2004                                  $ 74.96                   $ 121,593,440.56
June 1, 2004 - August 31, 2004                                $ 77.77                   $ 126,151,572.47
September 1, 2004 - November 30, 2004                         $ 80.69                   $ 130,888,136,59
December 1, 2004 - February 28, 2005                          $ 83.72                   $ 135,803,132.92
March 1, 2005 - May 31, 2005                                  $ 86.85                   $ 140,880,340.35
June 1, 2005 - August 23, 2005                                $ 90.11                   $ 146,168,422.21
</TABLE>

         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.

         Commencing January 2003, the Company utilizes the interest method to
account for the accretion of the Series B Preferred Stock up to the maximum
amount of its Liquidation Preference. The application of the interest method
yields a result different from the above Liquidation Preference table during the
interim periods prior to the maximum Liquidation Preference. The accompanying
Condensed Consolidated Balance Sheet and Condensed Consolidated Statements of
Cash Flows indicate the result of the Company's use of the interest method.

         In May 2003, the FASB issued FAS 150 that establishes standards for how
an issuer classifies and measures certain financial instruments with
characteristics of both liabilities and equity. It requires that an issuer
classify a financial instrument that is within its scope as a liability, many of
which had been previously classified as equity or between the liabilities and
equity sections of the consolidated balance sheet. The provisions of FAS 150 are
effective for financial instruments entered into or modified after May 31, 2003,
and otherwise is effective at the beginning of the first interim period
beginning after June 15, 2003. It is to be implemented by reporting the
cumulative effect of a change in accounting principle for financial instruments
created before the issuance of FAS 150 and still existing at the beginning of
the interim period of adoption. The Company has adopted the provisions of FAS
150 and has been impacted by the requirement to reclassify its Series B
Participating Preferred Stock as a liability as opposed to between the
liabilities and equity sections of the consolidated balance sheet. Based upon
the requirements set forth by FAS 150, this reclassification was subject to
implementation beginning on June 29, 2003. Upon implementation of FAS 150, the
Company has reflected the accretion of the preferred stock balance as an
increase in Total Liabilities with a corresponding reduction in capital in
excess of par value, because the Company has an accumulated deficit. Such
accretion in the amount of $4.5 million has been recorded as interest expense,
resulting in a decrease in Net Income (Loss) and Comprehensive Income (Loss). In
addition, the accompanying Condensed Consolidated Statement of Income (Loss)
presents $7.9 million of preferred stock dividends and accretion incurred prior
to the implementation of FAS 150. This amount comprised $7.6 million for the
accretion of the preferred stock balance and $0.3 million for the payment made
on behalf of Richemont to the Internal Revenue Service as described below in
further detail.

         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 consistent with Delaware General Corporation Law. The Company may
redeem all or less than all of the then outstanding shares of Series B

                                       16
<PAGE>

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. Richemont did not appoint such an observer.

         During autumn 2002, Company management conducted a strategic review of
the Company's business and operations. As part of such review, Company
management considered the Company's obligations under the Richemont Agreement
and the Company's prospects and options for redemption of the Series B Preferred
Stock issued to Richemont pursuant thereto in accordance with the Richemont
Agreement terms. The review took into account the results of the Company's
strategic business realignment program in 2001 and 2002, the relative strengths
and weaknesses of the Company's competitive position and the economic and
business climate, including the depressed business environment for mergers and
acquisitions.

         As a result of this review, Company management and the Company's Board
of Directors have concluded that it is unlikely that the Company will be able to
accumulate sufficient capital, surplus, or other assets under Delaware corporate
law or to obtain sufficient debt financing to either:

         1.       Redeem at least 811,056 shares of the Series B Preferred Stock
                  by August 31, 2003, as allowed for by the Richemont Agreement,
                  thereby resulting in the occurrence of a "Voting Trigger"
                  which will allow Richemont to have the option of electing two
                  members to the Company's Board of Directors; or

         2.       Redeem all of the shares of Series B Preferred Stock by August
                  31, 2005, as required by the Richemont Agreement, thereby
                  obligating the Company to take all measures permitted under
                  the Delaware General Corporation Law to increase the amount of
                  its capital and surplus legally available to redeem the Series
                  B Preferred Shares, without a material improvement in either
                  the business environment for mergers and acquisitions or other
                  factors, unforeseeable at the time.

         Management believes that the Company has sufficient liquidity and
availability under its credit agreement to fund its planned operations through
at least December 31, 2004. The unlikelihood that the Company will be able to
redeem the Series B Preferred Stock is not expected to limit the ability of the
Company to use current and future net earnings or cash flow to satisfy its
obligations to creditors and vendors. See "Cautionary Statements" below. In
addition, the redemption price of the Series B Preferred Stock does not accrete
after August 31, 2005.

         Company management met with representatives of Richemont on October 29,
2002 and outlined the results of management's strategic review in the context of
the Company's obligations to Richemont under the Richemont Agreement, and
discussed an alternative to the method for the redemption of the Series B
Preferred Stock. Under this alternative proposal, that the Company had
previously presented to Richemont, the Company would exchange two business
divisions, Silhouettes and Gump's, for all of Richemont's Series B Preferred
Stock (the "Proposal").

         Pursuant to the terms of the Richemont Agreement, the redemption value
of the Series B Preferred Stock as of the date of the Proposal was $87 million.
Management based the Proposal terms on a valuation of Silhouettes and Gump's
using the valuation multiple employed in USA Network's June 2001 purchase of the
Company's Improvements

                                       17
<PAGE>

business division. The Proposal also included a willingness on the part of the
Company to provide continued fulfillment services for Silhouettes and Gump's on
terms to be negotiated. On November 18, 2002, a representative of Richemont
confirmed in writing to the Company that Richemont rejected the Proposal.
Representatives of Richemont indicated that it had no interest in the proffered
assets and disputed their valuation implied in the Company's Proposal.

         Following the Proposal made to Richemont in the fall of 2002, on May
13, 2003, the Company made another proposal to Richemont to purchase all of
Richemont's securities in the Company consisting of 29,446,888 shares of Common
Stock of the Company (the "Common Shares") and 1,622,111 shares of Series B
Preferred Stock of the Company (the "Series B Preferred Stock" and, together
with the Common Shares, the "Shares") for a purchase price of US $45 million,
subject to a number of material contingencies, including the consummation of the
sale of certain assets of the Company to a third party or parties within 120
days and the consent of the Company's Board of Directors, shareholders and its
secured lender to such transactions. The Company's proposal, if consummated,
would have resulted in a reduction in the number of shares of Common Stock of
the Company outstanding from 138,315,800 to 108,868,912 and a reduction in the
number of shares of Series B Preferred Stock of the Company outstanding from
1,622,111 to 0. Richemont did not respond to the Company's May 2003 proposal.

         As a result of filings made by Richemont and certain related parties
with the Securities and Exchange Commission on May 21, 2003, the Company learned
that Richemont sold to Chelsey, on May 19, 2003 all of the Shares for a purchase
price equal to US $40 million. The Company was not a party to such transaction
and did not provide Chelsey with any material, non-public information in
connection with such transaction, nor did the Company's Board of Directors
endorse the transaction. As a result of the transaction, Chelsey may succeed to
Richemont's rights in the Common Shares and the Series B Preferred Stock,
including the right of the holder of the Series B Preferred Stock to a
Liquidation Preference with respect to such shares which was equal to
$98,202,600 on May 19, 2003, the date of the purported sale of the Shares, and
which increases to and caps at $146,168,422 on August 23, 2005, the final
redemption date of the Series B Preferred Stock.

         On May 30, 2003, the Company reported that it believed that Richemont
sold the Common Shares and the Series B Preferred Stock to Chelsey while in the
possession of material, non-public information and was examining its rights with
respect to the transaction. The Company further reported that, by letter dated
May 27, 2003, the Company had requested that its transfer agent for the Common
Shares not register the transfer of the Common Shares from Richemont to Chelsey,
in whole or in part, without first notifying the Company of any request to do so
and without having first received the Company's agreement in writing to do so
while the Company was examining these issues. The Company also reported that it
intended to treat in a similar fashion any request for transfer of the Series B
Preferred Stock for which it acts as the transfer agent while it was examining
these issues.

         By letter dated July 7, 2003, the Company made a definitive proposal to
Chelsey and Richemont to purchase all the Shares for a purchase price of US $45
million. This proposal was subject to a number of material contingencies,
including the consummation of the sale of certain of the Company's assets to a
third party within 60 days and the consent of the Company's Board of Directors
and its secured lender, as well as the Company's shareholders, if necessary, to
such transactions. By letter dated July 11, 2003, Chelsey rejected the Company's
proposal describing it as "inadequate and grossly undervalued" and making
numerous other assertions as to the Company's responsibilities to it. A copy of
Chelsey's July 11, 2003 letter, as well as a copy of the Company's July 14, 2003
response, were filed by the Company with the SEC on July 15, 2003 pursuant to a
Current Report on Form 8-K to which reference is hereby made.

         On July 17, 2003, the Company filed an action in the Supreme Court of
the State of New York, County of New York (Index No. 03/602269) against
Richemont and Chelsey seeking a declaratory judgment as to whether Richemont
improperly transferred all of Richemont's securities in the Company consisting
of the Shares to Chelsey on or about May 19, 2003 and whether the Company can
properly recognize the transfer of those Shares from Richemont to Chelsey under
federal and/or state law. On July 29, 2003, Chelsey answered the Company's
complaint, alleged certain affirmative defenses and raised three counterclaims
against the Company, including Delaware law requiring the registration of the
Shares, damages, including attorney's fees, for the failure to register the
Shares, and tortious interference with contract. Chelsey also moved for a
preliminary injunction directing the Company to register the ownership of the
Shares in Chelsey's name. Chelsey later moved for summary judgment dismissing
the Company's complaint. Subsequently, Chelsey moved to compel production of
certain documents and for sanctions and/or costs. On August 28, 2003, Richemont
moved to dismiss the Company's complaint. It subsequently filed a motion seeking

                                       18
<PAGE>

sanctions and/or costs against the Company. On October 27, 2003, the Court
granted Chelsey's motion for summary judgment and Richemont's motion to dismiss
and ordered that judgment be entered dismissing the case in its entirety. The
Court also denied Chelsey's and Richemont's motions for sanctions and Chelsey's
motion to compel production of certain documents.

         On Thursday, August 7, 2003 representatives of Chelsey attended a
regularly scheduled meeting of the Board of Directors of the Company at the
invitation of management of the Company endorsed by its Board of Directors.
Senior management of the Company was also present at the meeting. The Company
had requested that Chelsey make a brief (15-20 minute) presentation to the Board
solely with respect to (1) Chelsey's vision and proposed plan for value creation
opportunities at the Company above and beyond those currently articulated by
management in its recent SEC filings and other public statements; and (2)
Chelsey's specific proposal for the terms of an exchange offer by which the
Series B Preferred Stock would be exchanged for Common Stock of the Company
and/or Chelsey's specific counteroffer to the Company's July 7, 2003 proposal.
The Company wanted to afford Chelsey the opportunity to speak directly to the
entire Board of Directors and senior management of the Company and articulate
how Chelsey's approach would benefit all the Company's stakeholders.

         At the meeting, Chelsey's representatives delivered to the Company a
document entitled "Recapitalization of Hanover Direct, Inc. Summary of Terms"
(the "Chelsey Proposal") and made a presentation to the Board of Directors
regarding the Chelsey Proposal. That presentation was purportedly summarized in
Chelsey's Amendment No. 3 to Schedule 13D as Exhibit E.

         The Company's Board of Directors referred the Chelsey Proposal to its
Transactions Committee for consideration with a view towards making a
recommendation to the Board of Directors. The Transactions Committee, composed
of independent directors of the Company, provides assistance to the directors in
fulfilling their responsibility to the shareholders by recommending appropriate
actions to the Board of Directors on matters that require Board approval,
including material transactions with shareholders owning more than ten percent
(10%) of the voting securities of the Company. The Transactions Committee
engaged financial advisors and counsel to assist it in its deliberations with
respect to the Chelsey Proposal.

         On September 18, 2003, representatives of Chelsey attended a meeting
with legal and financial advisors to the Transactions Committee of the Board of
Directors of the Company at which a document entitled "Recapitalization of
Hanover Direct, Inc. - Summary of Counteroffer Terms" (the "Counterproposal")
was discussed. The Counterproposal responded to Chelsey's Proposal to the
Company at the August 7 meeting of the Board of Directors. Chelsey's
representatives did not accept the Counterproposal. Negotiations between the
parties ensued in the weeks thereafter.

         On November 10, 2003, the Company signed a Memorandum of Understanding
with Chelsey and Regan Partners, L.P. setting forth the agreement in principle
to recapitalize the Company, reconstitute the Board of Directors and settle
outstanding litigation between the Company and Chelsey. The Memorandum of
Understanding had been approved by the Transactions Committee of the Board of
Directors of the Company.

         The parties agreed to effect within ten days or as soon thereafter as
possible a binding Recapitalization Agreement that would, upon the closing of
the transactions set forth in the Recapitalization Agreement, exchange 564,819
shares of a newly issued Series C Preferred Stock and 81,857,833 shares of newly
issued common stock for the 1,622,111 shares of Series B Preferred Stock
currently held by Chelsey, subject to adjustment if the transaction is not
consummated by December 17, 2003. If the closing takes place on or before
December 17, 2003, the Series C Preferred Stock will have an aggregate
liquidation preference of $56,481,900 while the outstanding Series B Preferred
Stock has a current aggregate liquidation preference of $112,963,810 and a
maximum final liquidation preference of $146,168,422 on August 23, 2005. With
the issuance of the new common shares, Chelsey will have a majority equity and
voting interest in the Company.

         Upon the execution of the Recapitalization Agreement, the Company will
reconstitute the Board to eight members including four designees of Chelsey.
The Recapitalization Agreement is subject to the approval of the Transactions
Committee and the Board of Directors of the Company. It is also subject to
other consents including the approval of Congress Financial Corporation. The
Company intends to prepare and file with the Securities and Exchange Commission
and transmit to all equity holders of the Company, as required by Rule 14f-1 of
the Securities Exchange Act of 1934, as amended, a statement regarding its
intent to effect a change in majority of directors as promptly as practicable.
Following the expiration of ten days following the filing and mailing of the
statement, the Board of Directors will increase to nine members, with the
additional director being a Chelsey designee.

        The proposed Series C Preferred Stock, with a liquidation preference of
$100 per share, carries a quarterly dividend, starting on January 1, 2006 at 6%
and increasing each year by 1 1/2%. In lieu of cash dividends, the Company may
elect to accrue dividends at a rate equal to 1% higher than the annual cash
dividend rate. The Series C Preferred Stock has a redemption date of January 1,
2009. The Company shall redeem the maximum number of shares of Series C
Preferred Stock as possible with the net proceeds of certain asset and equity
sales, including the disposition of the Company's non-core assets, not required
to be used to repay Congress Financial Corporation pursuant to the terms of the
19th Amendment to the Loan and Security Agreement, and Chelsey shall be
required to accept such redemptions.

        The Recapitalization Agreement will also define the duties of the
Transactions Committee and provide for the reconstitution of the committees of
the Board of Directors, mutual releases and termination of litigation between
the Company and Chelsey, voting agreements between Chelsey and Regan Partners, a
major shareholder of the Company, registration rights for the new common shares
and agreements to recommend certain amendments to the Company's Certificate of
Incorporation, including a 10-for-1 reverse stock split and a decrease in the
par value of the Common Stock from $.66 2/3 per share to $.01 per share, at the
first annual meeting of shareholders following the closing.

        If the closing of the Recapitalization Agreement has not occurred by
November 30, 2003, then the Company will pay Chelsey $1 million by December 3,
2003. If the closing has not occurred by the close of business on December 17,
2003, then the Memorandum of Understanding shall cease to be effective unless
either the Company or Chelsey elects to extend the closing past such date. If
the Company makes such election, the number of shares of Common Stock and
Series C Preferred Stock issued to Chelsey in the Recapitalization shall be
adjusted pursuant to the terms of the agreement. If Chelsey makes such an
election, there shall be no adjustment to the number of shares. In either case,
the Closing shall occur no later than February 29, 2004.

        The Memorandum of Understanding has been filed with the Securities and
Exchange Commission as an exhibit to the Company's Current Report on Form 8-K
dated November 10, 2003. The Company strongly recommends that interested parties
refer to it for a full and complete understanding of the terms and conditions of
the Memorandum of Understanding.

         For Federal income tax purposes, the increases in the Liquidation
Preference of the Series B Preferred Stock are considered distributions by the
Company to the holder of the Series B Preferred Stock, deemed made on the
commencement dates of the quarterly increases, as discussed above. These
distributions may be taxable dividends to the holder of the Series B Preferred
Stock, provided the Company has accumulated or current earnings and profits
("E&P") for each year in which the distributions are deemed to be made. Under
the terms of the Richemont Transaction, the Company is obligated to reimburse
the holder of the Series B Preferred Stock for any U.S. income tax incurred
pursuant to the Richemont Transaction. This reimbursement obligation is
transferable upon sale of the Series B Preferred Stock. Since Richemont's sale
of the Series B Preferred Stock to Chelsey has been recognized as valid (See
Note 4), the Company's tax reimbursement obligation is inapplicable to Chelsey,
because Chelsey is treated as a partnership for U.S. tax purposes and, as such,
does not incur any U.S. income taxes. Based on the Company's past income tax
filings and its current income tax position, the Company had an E&P deficit as
of December 28, 2002. Accordingly, the Company did not incur a tax reimbursement
obligation for the year 2002. The Company must have current E&P in the years
2003, 2004 or 2005 to incur a tax reimbursement obligation for the scheduled
increases in Liquidation Preference. If the Company does not have current E&P in
one of those years, no tax reimbursement obligation would exist for that
particular year. The Company does not have the ability to project the exact
future tax reimbursement obligation; however, it has estimated the potential
obligation to be $0 to $2.2 million, depending upon actual 2003 E&P since
Chelsey has been determined to be the holder of the Series B Preferred Stock. In
March 2003, a payment of $0.3 million was made on behalf of Richemont to the
Internal Revenue Service. The payment was reflected as a reduction of Capital in
excess of par value on the Condensed Consolidated Balance Sheets and as an
increase to Preferred stock dividends and accretion on the Condensed
Consolidated Statements of Income (Loss). Based upon the Company's current
projections for 2003, it is estimated the Company may not incur a tax
reimbursement obligation for 2003 relating to the increases in the Liquidation
Preference of the Series B Participating Preferred Stock and will file for a
refund of the $0.3 million Federal tax payment made in March 2003. Due to the
FAS 150 requirements to reclassify the Series B Participating Preferred Stock to
liabilities and to record the accretion of the preferred stock balance as
interest expense, the refund has been treated as a decrease to interest expense
on the Condensed Consolidated Statements of Income (Loss) for the third quarter
and an increase of capital in excess of par value on the Condensed Consolidated
Balance Sheets. See Note 8 for additional details regarding the implementation
of FAS 150.

11.      INCOME TAXES

         SFAS No. 109, "Accounting for Income Taxes", requires that the future
tax benefit of the Company's net operating losses ("NOLs") be recorded as an
asset to the extent that management assesses the utilization of such NOLs to be
"more-likely-than-not". Based upon the Company's assessment, at December 28,
2002, of numerous factors, including its future operating plans, management
reduced its net deferred tax asset from $15.0 million to $11.3 million via a
$3.7 million deferred Federal income tax provision. Due to a number of factors,
including the continued softness in the market for the Company's products,
management has lowered its projections of taxable income for fiscal years 2003
and 2004. As a result of these lower projections of future taxable income, the
future utilization of the Company's NOLs is no longer "more-likely-than-not".
The Company has made a decision to fully reserve the remaining net deferred tax
asset by increasing the valuation allowance via an $11.3 million deferred
Federal income tax provision during the third quarter ended September 27, 2003.

                                       19
<PAGE>
12.   RESTATEMENT

         The Company has re-examined the provisions of its revolving loan
facility and based on EITF 95-22 and certain provisions in the Credit Agreement,
the Company is  required to reclassify its revolving loan facility from
long-term to short-term debt, though the existing revolving loan facility does
not mature until January 31, 2007. As a result, the Company reclassified $13,164
and $8,819 (in thousands) as of September 27, 2003 and December 28, 2002,
respectively, from Long-term debt to Short-term debt and capital lease
obligations that is classified as current liabilities.

A summary of the effects of the restatement on our Consolidated Balance Sheets
as of September 28, 2003 and December 28, 2002 follows:
<TABLE>
<CAPTION>
(IN THOUSANDS)                             September 27, 2003        December 28, 2002
                                        --------------------------------------------------
                                        As Previously     As      As Previously      As
                                          Reported     Restated      Reported     Restated
                                        --------------------------------------------------
<S>                                        <C>          <C>          <C>         <C>
Short-term debt and
   capital lease obligations               $ 10,831     $ 23,995     $  3,802    $ 12,621
Total current liabilities                  $ 72,424     $ 85,588     $ 78,848    $ 87,667
Long-term debt                             $ 22,820     $  9,656     $ 21,327    $ 12,508
Total non-current liabilities              $135,005     $121,841     $ 27,714    $ 18,895
</TABLE>

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                 39- WEEKS ENDED
                                             ------------------------------  -----------------------------
                                             SEPTEMBER 27,    September 28,  SEPTEMBER 27,   SEPTEMBER 28,
                                                 2003             2002           2003            2002
                                             -------------    -------------  -------------   -------------
<S>                                          <C>              <C>            <C>             <C>
Net revenues                                   100.0%           100.0%          100.0%          100.0%
Cost of sales and operating expenses            64.8             65.0            63.8            63.9
Special charges                                  0.2              1.4             0.2             0.5
Selling expenses                                23.6             23.9            24.3            23.2
General and administrative expenses             10.4             11.2            10.1            11.2
Depreciation and amortization                    1.1              1.3             1.1             1.3
(Loss) income from operations                   (0.1)            (2.8)            0.5            (0.1)
Gain on sale of Improvements                     0.0              0.0             0.6             0.1
Interest expense, net                            5.4              1.2             2.6             1.2
Provision for deferred federal income taxes     11.7              0.0             3.7             0.0
Provision for state income taxes                 0.0              0.0             0.0             0.0
Net loss and comprehensive loss                (17.2)%           (4.0)%          (5.2)%          (1.2)%
</TABLE>

RESULTS OF OPERATIONS - 13- WEEKS ENDED SEPTEMBER 27, 2003 COMPARED WITH THE 13-
WEEKS ENDED SEPTEMBER 28, 2002

         Net Loss and Comprehensive Loss. The Company reported a net loss of
$16.6 million for the 13- weeks ended September 27, 2003 compared with a net
loss of $4.2 million for the comparable period in the year 2002. The $12.4
million increase in net loss was primarily due to an $11.3 million deferred
Federal income tax provision incurred to increase the valuation allowance and
fully reserve the remaining net deferred tax asset. Due to a number of factors,
including the continued softness in the market for the Company's products,
management has lowered its projections of future taxable income for fiscal years
2003 and 2004. As a result of lower projections of future taxable income, the
future utilization of the Company's net operating losses is no longer
"more-likely-than-not". In addition, the increase in net loss was also due to
the recording of $4.5 million of additional interest expense incurred on the
Series B Participating Preferred Stock as a result of the implementation of FAS
150. Effective June 29, 2003, FAS 150 required the Company to reclassify its
Series B Participating Preferred Stock as a liability and reflect the accretion
of the preferred stock balance as interest expense. If FAS 150 were applicable
for the 13- weeks ended September 28, 2002, net loss would have been $8.4
million. This increase was partially offset by continued reductions in general
and administrative expenses and a decrease in special charges and depreciation
and amortization. Net loss per common share was $0.12 and $0.06 for the 13-
weeks ended September 27, 2003 and September 28, 2002, respectively. The
weighted average number of shares of Common Stock outstanding used in both the
basic and diluted net loss per common share calculation was 138,315,800 for both
the 13- weeks ended September 27, 2003 and September 28, 2002.

         Net Revenues. Net revenues decreased $9.4 million (8.9%) for the
13-week period ended September 27, 2003 to $96.6 million from $106.0 million for
the comparable fiscal period in the year 2002. The decrease was due principally
to softness in demand and a 10.1% reduction in overall circulation for
continuing businesses from the comparable fiscal period in 2002. This reduction
resulted from the Company's continued efforts to reduce unprofitable circulation
and remain focused on its strategy of increasing profitable circulation.
Internet sales continued to grow, and comprised 28.9% of combined Internet and
catalog revenues for the 13- weeks ended September 27, 2003, and have increased
by approximately $4.6 million or 21.3% to $26.2 million from $21.6 million for
the comparable fiscal period in the year 2002.

         Cost of Sales and Operating Expenses. Cost of sales and operating
expenses decreased to 64.8% of net revenues for the 13-week period ended
September 27, 2003 as compared with 65.0% of net revenues for the comparable
period in the year 2002. This decrease was primarily due to lower merchandise
costs resulting from improved pricing associated with foreign merchandise
sourcing in combination with a decrease in volume of promotional offers during
the period.
                                       20
<PAGE>

         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 asset write-offs. Special charges for the
13- weeks ended September 27, 2003 were $0.2 million, incurred to revise and
increase estimated losses related to sublease arrangements in connection with
office facilities in San Francisco, California resulting from the loss of a
subtenant, coupled with declining market values in that area of the country. For
the 13- weeks ended September 28, 2002, the Company recorded special charges of
$1.5 million to integrate The Company Store and Domestications divisions and
cover additional charges related to the Company's plan to consolidate its office
space at its corporate offices in New Jersey.

         Selling Expenses. Selling expenses decreased by $2.6 million to $22.8
million for the 13- weeks ended September 27, 2003 as compared with $25.4
million for the comparable fiscal period in the year 2002. As a percentage
relationship to net revenues, selling expenses decreased to 23.6% for the 13-
weeks ended September 27, 2003 from 23.9% for the comparable period in the year
2002. This change was due primarily to decreases in paper and printing costs
realized from the Company's continued efforts to reduce unprofitable
circulation.

         General and Administrative Expenses. General and administrative
expenses decreased by $1.7 million to $10.1 million for the 13- weeks ended
September 27, 2003 as compared with $11.8 million for the comparable period in
the year 2002. As a percentage relationship to net revenues, general and
administrative expenses were 10.4% of net revenues for the 13- weeks ended
September 27, 2003 compared with 11.2% of net revenues for the comparable period
in the year 2002. This decrease was primarily due to reductions in payroll costs
and incentive compensation, legal costs and the benefit recognized from the
implementation of the Company's new vacation and sick policy.

         Depreciation and Amortization. Depreciation and amortization decreased
approximately $0.3 million to $1.1 million for the 13- weeks ended September 27,
2003 from $1.4 million for the comparable period in the year 2002. The decrease
was primarily due to capital expenditures that have become fully amortized
during fiscal year 2003. As a percentage relationship to net revenues,
depreciation and amortization was 1.1% for the 13- weeks ended September 27,
2003 and 1.3% for the comparable period in the year 2002.

         Loss from Operations. The Company's loss from operations decreased by
$2.8 million to $0.1 million for the 13- weeks ended September 27, 2003 from a
loss of $2.9 million for the comparable period in the year 2002. See "Results of
Operations - 13- weeks ended September 27, 2003 compared with the 13- weeks
ended September 28, 2002 - Net Income and Comprehensive Income" above for
further details.

         Gain on Sale of the Improvements Business. During the 13- weeks ended
September 27, 2003 and September 28, 2002, the Company did not recognize any
gain relating to the sale of the Improvements business. Effective March 28,
2003, the remaining $2.0 million escrow balance was received by the Company,
thus terminating the agreement. See Note 6 of Notes to the Condensed
Consolidated Financial Statements.

         Interest Expense, Net. Interest expense, net increased $4.0 million to
$5.3 million for the 13- weeks ended September 27, 2003 from $1.3 million for
the comparable period in the year 2002. The increase in interest expense is
primarily due to the recording of $4.5 million of Series B Participating
Preferred Stock dividends and accretion as interest expense based upon the
implementation of FAS 150. Effective June 29, 2003, FAS 150 required the Company
to reclassify its Series B Participating Preferred Stock as a liability and
reflect the accretion of the preferred stock balance as interest expense. This
increase was partially offset by a $0.3 million expected refund for the March
2003 payment made on behalf of Richemont to the Internal Revenue Service
relating to the increases in the Liquidation Preference of the Series B
Participating Preferred Stock. The Company must have current earnings and
profits to incur a tax reimbursement obligation for the scheduled increases in
Liquidation Preference and currently estimates its obligation for 2003 to be $0.
Because FAS 150 required the reclassification of the Series B Participating
Preferred Stock to liabilities and the recording of increases in the liquidation
preference as interest expense, the expected refund on Federal Taxes previously
paid has been treated as a decrease to interest expense. In addition to this
refund, the increase in interest expense was also partially offset by a decrease
in amortization from deferred financing costs relating to the Company's
amendments to the Congress Credit Facility.

         Income Taxes. During the 13- weeks ended September 27, 2003, the
Company made a decision to fully reserve the remaining net deferred tax asset by
increasing the valuation allowance via an $11.3 million deferred Federal income
tax provision. Due to a number of factors, including the continued softness in
the market for the Company's products, management has lowered its projections of
taxable income for fiscal years 2003 and 2004. As a result of lower

                                       21
<PAGE>
projections of future taxable income, the future utilization of the Company's
net operating losses is no longer "more-likely-than-not".

RESULTS OF OPERATIONS - 39- WEEKS ENDED SEPTEMBER 27, 2003 COMPARED WITH THE 39-
WEEKS ENDED SEPTEMBER 28, 2002

         Net Loss and Comprehensive Loss. The Company reported a net loss of
$15.8 million for the 39- weeks ended September 27, 2003 compared with a net
loss of $4.2 million for the comparable period in the year 2002. The $11.6
million increase in net loss was primarily due to an $11.3 million deferred
Federal income tax provision incurred to increase the valuation allowance and
fully reserve the remaining net deferred tax asset. Due to a number of factors,
including the continued softness in the market for the Company's products,
management has lowered its projections of future taxable income for fiscal years
2003 and 2004. As a result of lower projections of future taxable income, the
future utilization of the Company's net operating losses is no longer
"more-likely-than-not". In addition, the increase in net loss was also due to
the recording of $4.5 million of additional interest expense incurred based upon
the implementation of FAS 150. Effective June 29, 2003, FAS 150 required the
Company to reclassify its Series B Participating Preferred Stock to liabilities
and to reflect the accretion of the preferred stock balance as interest expense.
This was partially offset by continued reductions in general and administrative
expenses, a decrease in special charges and depreciation and amortization, and
the recording of a $1.9 million deferred gain during the 39- weeks ended
September 27, 2003 related to the June 29, 2001 sale of the Company's
Improvements business. Net loss per common share was $0.17 for the 39- weeks
ended September 27, 2003 and $0.11 for the 39- weeks ended September 28, 2002.
The per share amounts were calculated after deducting preferred dividends and
accretion of $7.9 million and $10.6 million for the 39- weeks ended September
27, 2003 and September 28, 2002, respectively. In addition, the per share
amounts were calculated after deducting additional preferred dividends and
accretion of $4.5 million incurred as interest expense after June 28, 2003. The
weighted average number of shares of Common Stock outstanding used in both the
basic and diluted net loss per common share calculation was 138,315,800 for the
39- weeks ended September 27, 2003 and 138,268,327 for the 39- weeks ended
September 28, 2002. This increase in weighted average shares was due to
issuances of Common Stock within the Company's stock-based compensation plans.

         Net Revenues. Net revenues decreased $24.5 million (7.4%) for the
39-week period ended September 27, 2003 to $304.9 million from $329.4 million
for the comparable fiscal period in the year 2002. The decrease is due
principally to softness in demand and a 5.9% reduction in overall circulation
for continuing businesses from the comparable fiscal period in 2002. This
reduction resulted from the Company's continued efforts to reduce unprofitable
circulation and remain focused on its strategy of increasing profitable
circulation. Internet sales continued to grow, and comprised 27.6% of combined
Internet and catalog revenues for the 39- weeks ended September 27, 2003, and
have increased by $17.5 million or 28.3% to $79.2 million from $61.7 million for
the comparable fiscal period in the year 2002.

         Cost of Sales and Operating Expenses. Cost of sales and operating
expenses decreased to 63.8% of net revenues for the 39-week period ended
September 27, 2003 from 63.9% of net revenues for the comparable period in the
year 2002. This slight decrease was primarily due to reductions in merchandise
cost resulting from improved pricing associated with foreign merchandise
sourcing and reductions in spending related to the information technology
systems area that have resulted from actions taken in connection with those in
the Company's strategic business realignment program. These decreases in costs,
however, were partially offset by an increase in product postage costs for the
period. Telemarketing and distribution costs continued to remain consistent with
the comparable fiscal period in the year 2002.

         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 asset write-offs. Special charges
recorded for the 39- weeks ended September 27, 2003 were $0.7 million. These
charges consisted primarily of additional severance costs and revised increases
in estimated losses related to sub-lease arrangements in connection with office
facilities in San Francisco, California, resulting from the loss of a subtenant,
coupled with declining market values in that area of the country. For the 39-
weeks ended September 28, 2002, the Company recorded $1.7 million in charges
associated with the strategic business realignment program. These charges
consisted primarily of additional facility and exit costs resulting from the
Company's plan to further consolidate its office space at its corporate offices
in New Jersey. In addition, special charges for the 39-week period ended
September 28, 2002, consist 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 storage
facility.

                                       22
<PAGE>

         Selling Expenses. Selling expenses decreased by $2.5 million to $74.1
million for the 39- weeks ended September 27, 2003 from $76.6 million for the
comparable fiscal period in the year 2002. As a percentage relationship to net
revenues, selling expenses increased to 24.3% for the 39- weeks ended September
27, 2003 from 23.2% for the comparable period in the year 2002. This change was
due primarily to increases in catalog preparation, printing and postage costs,
partially offset by reduced paper prices.

         General and Administrative Expenses. General and administrative
expenses decreased by $5.9 million to $30.9 million for the 39- weeks ended
September 27, 2003 from $36.8 million for the comparable period in the year
2002. As a percentage relationship to net revenues, general and administrative
expenses were 10.1% of net revenues for the 39- weeks ended September 27, 2003
compared with 11.2% of net revenues for the comparable period in the year 2002.
This decrease was primarily due to reductions in payroll costs and incentive
compensation, legal costs and the benefit recognized from the implementation of
the Company's new vacation and sick policy.

         Depreciation and Amortization. Depreciation and amortization decreased
$1.0 million to $3.4 million for the 39- weeks ended September 27, 2003 from
$4.4 million for the comparable period in the year 2002. The decrease is
primarily due to capital expenditures that have become fully amortized during
fiscal year 2003. As a percentage relationship to net revenues, depreciation and
amortization was 1.1% for the 39- weeks ended September 27, 2003 and 1.3% for
the comparable period in the year 2002.

         Income (Loss) from Operations. The Company's income from operations
increased by $1.9 million to $1.5 million for the 39- weeks ended September 27,
2003 from a loss of $0.4 million for the comparable period in the year 2002. See
"Results of Operations - 39- weeks ended September 27, 2003 compared with the
39- weeks ended September 28, 2002 - Net Income and Comprehensive Income" above
for further details.

         Gain on Sale of the Improvements Business. During the 39- weeks ended
September 27, 2003, the Company recognized the remaining deferred gain of $1.9
million consistent with the terms of the March 27, 2003 amendment made to the
asset purchase agreement relating to the sale of the Improvements business. For
the 39- weeks ended September 28, 2002, the Company recognized $0.3 million of
the deferred gain consistent with the terms of the escrow agreement. See Note 6
of Notes to the Condensed Consolidated Financial Statements.

         Interest Expense, Net. Interest expense, net increased $3.8 million to
$7.8 million for the 39- weeks ended September 27, 2003 from $4.0 million for
the comparable period in the year 2002. The increase in interest expense is
primarily due to the recording of $4.5 million of Series B Participating
Preferred Stock dividends and accretion as interest expense based upon the
implementation of FAS 150. Effective June 29, 2003, FAS 150 required the Company
to reclassify its Series B Participating Preferred Stock to liabilities and to
reflect the accretion of the preferred stock balance as interest expense. This
increase was partially offset by a $0.3 million expected refund for the March
2003 payment made on behalf of Richemont to the Internal Revenue Service
relating to the increases in the Liquidation Preference of the Series B
Participating Preferred Stock. The Company must have current earnings and
profits to incur a tax reimbursement obligation for the scheduled increases in
Liquidation Preference and currently estimates its obligation for 2003 to be $0.
In addition to this refund, the increase in interest expense was also partially
offset by a decrease in amortization from deferred financing costs relating to
the Company's amendments to the Congress Credit Facility.

         Income Taxes. During the 39- weeks ended September 27, 2003, the
Company made a decision to fully reserve the remaining net deferred tax asset by
increasing the valuation allowance via an $11.3 million deferred Federal income
tax provision. Due to a number of factors, including the continued softness in
the market for the Company's products, management has lowered its projections of
taxable income for fiscal years 2003 and 2004. As a result of lower projections
of future taxable income, the future utilization of the Company's net operating
losses is no longer "more-likely-than-not".

LIQUIDITY AND CAPITAL RESOURCES

         Net cash used by operating activities. During the 39-week period ended
September 27, 2003, net cash used by operating activities was $8.0 million. The
use of cash was due to increases in prepaid catalog costs and decreases in both
accrued liabilities and accounts payable. The payment of compensation and
severance benefits accrued as of


                                       23
<PAGE>

December 28, 2002 was the primary factor causing the reduction in accrued
liabilities. The use of cash was partially offset by positive cash flow
generated by decreases in accounts receivable and increases in customer
prepayments and credits.

         Net cash provided by investing activities. During the 39-week period
ended September 27, 2003, net cash provided by investing activities was $0.2
million. This was due to proceeds received relating to the deferred gain of $2.0
million associated with the sale of the Improvements business. These proceeds
were partially offset by $1.7 million of capital expenditures, consisting
primarily of upgrades to the Company's distribution and fulfillment equipment
located at its Roanoke, Virginia fulfillment facility, telemarketing hardware,
and various computer software upgrades. An additional $0.1 million of costs
relating to the early release of escrow funds associated with the sale of the
Improvements business also contributed to the offset of the proceeds received
from the sale.

         Net cash provided by financing activities. During the 39-week period
ended September 27, 2003, net cash provided by financing activities was $7.9
million, which was primarily due to increased net borrowings of $11.4 million
under the Congress revolving loan facility. These borrowings were partially
offset by monthly payments made relating to both the Congress Tranche A and
Tranche B term loan facilities as well as a payment of $0.3 million for the
Company's obligation to remit withholding taxes on behalf of Richemont for
estimated taxes due from the scheduled increases in Liquidation Preference on
the Series B Preferred Stock. See Note 10 of the Company's Condensed
Consolidated Financial Statements.

         Changes to 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, as amended, expires on January 31, 2004 and comprises
a revolving loan facility, a $17.5 million Tranche A Term Loan and an $8.4
million Tranche B Term Loan. Total cumulative borrowings under the Congress
Credit Facility, however, are subject to limitations based upon specified
percentages of eligible receivables and eligible inventory, and the Company is
required to maintain $3.0 million of excess credit availability at all times.
The Congress Credit Facility, as amended, is secured by all the assets of the
Company and places restrictions on the incurrence of additional indebtedness and
on the payment of Common Stock dividends.

         In April 2003, the Company amended the Congress Credit Facility to
allow the Company's chief financial officer or its corporate controller to
certify the financial statements required to be delivered to Congress under the
Congress Credit Facility, rather than the chief financial officer of each
subsidiary borrower or guarantor.

         In August 2003, the Company amended the Congress Credit Facility to
make certain technical amendments thereto, including the amendment of the
definition of Consolidated Net Worth and the temporary release of a $3 million
availability reserve established thereunder. The temporary release of the $3
million availability reserve will be removed by the end of fiscal year 2003.

         In October 2003, the Company amended the Congress Credit Facility to
extend the expiration thereof from January 31, 2004 to January 31, 2007, to
reduce the amount of revolving loans available thereunder to $43,000,000, to
make adjustments to the sublimits available to the various borrowers thereunder,
to amend the EBITDA covenant to specify minimum levels of EBITDA that must be
achieved during the Company's fiscal years ending 2004, 2005 and 2006, to permit
the borrowing under certain circumstances of up to $1,000,000 against certain
inventory in transit to locations in the United States, and to make certain
other technical amendments.

                                       24
<PAGE>
     In November 2003, the Company amended the Congress Credit Facility to
change the definition of Consolidated Net Worth so as to provide that for the
purposes of calculating such amount for the Company's fiscal year ending
December 27, 2003, the Company's net deferred tax assets in the amount of
$11,300,000 that are required to be fully reserved pursuant to SFAS No. 109,
"Accounting for Income Taxes" ("FAS 109"), shall be added back for the purposes
of determining the Company's assets. See Note 11 of the Company's Condensed
Consolidated Financial Statements. The Company also amended the definition of
Consolidated Working Capital so as to provide that for the purposes of
calculating such amount for the Company's fiscal year ending December 27, 2003,
the Company's current deferred tax liabilities in the amount of $2,300,000,
shall be added back for the purposes of determining the Company's current
liabilities. See Note 11 of the Company's Condensed Consolidated Financial
Statements.

      The Company has restated its Consolidated Balance Sheets as of September
27, 2003 and December 28, 2002 to properly classify the revolving loan facility
as a current liability in accordance with EITF No. 95-22, "Balance Sheet
Classification of Borrowings Outstanding under Revolving Credit Agreements that
Include Both a Subjective Acceleration Clause and a Lock-Box Arrangement" ("EITF
95-22"). This restatement has no impact on the Company's results of operations
or cash flows for the 13- and 39- weeks ended September 27, 2003. The revolving
loan facility is classified as a current liability in accordance with EITF 95-22
since the loan and security agreement contains a subjective acceleration clause
and contractual provisions that require the cash receipts of the Company be used
to repay amounts outstanding under the Congress Credit Facility.

     The Company has re-examined the provisions of the Congress Credit Facility.
Based on EITF 95-22 and certain provisions in the credit agreement, the Company
is required to reclassify its revolving loan facility from long-term to
short-term debt, though the existing revolving loan facility does not mature
until January 31, 2007. As a result, the Company reclassified $13,164 and $8,819
(in thousands) as of September 27, 2003 and December 28, 2002, respectively,
from Long-term debt to Short-term debt and capital lease obligations that is
classified as current liabilities.

      A summary of the effects of the restatement on our Consolidated Balance
Sheets as of September 27, 2003 and December 28, 2002 follows:

         As of September 27, 2003, the Company had $33.6 million of cumulative
borrowings outstanding under the Congress Credit Facility. Total cumulative
borrowings comprise $20.2 million under the Revolving Loan Facility, bearing a
variable interest rate as of September 27, 2003 of 4.5%, $7.0 million under the
Tranche A Term Loan, bearing a variable interest rate as of September 27, 2003
of 4.75%, and $6.4 million under the Tranche B Term Loan, bearing a fixed
interest rate of 13.0%.

         Achievement 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 and the Company's ability
to operate effectively during the remaining 2003 fiscal year and the 2004 fiscal
year. In the event of a softer than expected economic climate, management has
available several courses of action to maintain liquidity and help maintain
compliance with financial covenants, including selective reductions in catalog
circulation, additional expense reductions and sales of non-core assets.

         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 service agreement with the buyer for a period of
three years.

         The asset purchase agreement between the Company and HSN provided that
if Keystone Internet Services failed to perform its obligations during the first
two years of the services contract, the purchaser could 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 of
approximately $33.0 million, had 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.

         On March 27, 2003, the Company and HSN amended the asset purchase
agreement to provide for the release of the remaining $2.0 million balance of
the escrow fund and to terminate the escrow agreement. By agreeing to the terms
of the amendment, HSN forfeited its ability to receive a reduction in the
original purchase price of up to $2.0 million if Keystone Internet Services
failed to perform its obligations during the first two years of the services
contract. In consideration for the release, Keystone Internet Services issued a
credit to HSN for $100,000, which could be applied by HSN against any invoices
of Keystone Internet Services to HSN. This credit was utilized by HSN during the
March 2003 billing period. On March 28, 2003, the remaining $2.0 million escrow
balance was received by the Company, thus terminating the escrow agreement.

         The Company recognized a net gain on the sale of approximately $23.2
million, net of a non-cash goodwill charge of $6.1 million, in fiscal year 2001,
which represented the excess of the net proceeds from the sale over the net
assets acquired by HSN, the goodwill associated with the Improvements business
and expenses related to the transaction. During fiscal year 2002, the Company
recognized approximately $0.6 million of the deferred gain consistent with the
terms of the escrow agreement. During the 13- weeks ended March 29, 2003, the
Company

                                       25
<PAGE>

recognized the remaining net deferred gain of $1.9 million from the receipt of
the escrow balance on March 28, 2003. This gain was reported net of the costs
incurred to provide the credit to HSN of approximately $0.1 million.

         General. At September 27 2003, the Company had $0.9 million in cash and
cash equivalents, compared with $1.0 million at September 28, 2002. Total
cumulative borrowings, including financing under capital lease obligations, as
of September 27, 2003, aggregated $33.6 million. Remaining availability under
the Congress Credit Facility as of September 27, 2003 was $7.2 million. The
Company had approximately $0.4 million in short-term capital commitments as of
September 27, 2003.

         Management believes that the Company has sufficient liquidity and
availability under its credit agreement to fund its planned operations through
at least December 31, 2004. See "Cautionary Statements," below. 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 9 of the Condensed Consolidated Financial Statements.

USES OF ESTIMATES AND OTHER CRITICAL ACCOUNTING POLICIES

         In addition to the use of estimates and other critical accounting
policies disclosed in our Annual Report on Form 10-K for the fiscal year ended
December 28, 2002, an understanding of the below use of estimates and other
critical accounting policies is necessary to analyze our financial results for
the 13 and 39-week periods ended September 27, 2003.

         Revenue is recognized for catalog and internet sales when merchandise
is shipped to customers and at the time of sale for retail sales. Shipping terms
for catalog and internet sales are FOB shipping point, and title passes to the
customer at the time and place of shipment. Prices for all merchandise are
listed in the Company's catalogs and Web sites and are confirmed with the
customer upon order. The customer has no cancellation privileges other than
customary rights of return that are accounted for in accordance with SFAS No. 48
"Revenue Recognition When Right of Return Exists." The Company accrues a sales
return allowance for estimated returns of merchandise subsequent to the balance
sheet date that relate to sales prior to the balance sheet date. Amounts billed
to customers for shipping and handling fees related to catalog and internet
sales are included in other revenues at the time of shipment.

         During June 2003, the Company established and issued a new Company-wide
vacation and sick policy to better administer vacation and sick benefits. For
purposes of the policy, employees were converted to a fiscal year for earning
vacation benefits. Under the new policy, vacation benefits are deemed earned and
thus accrued ratably throughout the fiscal year and employees must utilize all
vacation earned by the end of the same year. Generally, any unused vacation
benefits not utilized by the end of a fiscal year will be forfeited. In prior
periods, employees earned vacation in the twelve months prior to the year that
it would be utilized. The policy has been modified in certain locations to
comply with state and local laws or written agreements. As a result of the
transition to this new policy, the Company has recognized a benefit of
approximately $0.5 million and $1.3 million for the 13 and 39- weeks ended
September 27, 2003. Approximately $0.2 million and $0.7 million of general and
administrative expenses were reduced as a result of the recognition of this
benefit for the 13 and 39- weeks ended September 27, 2003, respectively.
Approximately $0.3 million and $0.6 million of operating expenses were reduced
as a result of the recognition of this benefit for the 13 and 39- weeks ended
September 27, 2003, respectively.

         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 28, 2002, for additional
information relating to the Company's use of estimates and other critical
accounting policies.

NEW ACCOUNTING PRONOUNCEMENTS

         In May 2003, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics
of both Liabilities and Equity" ("FAS 150"). FAS 150 establishes standards for
how an issuer classifies and measures certain financial instruments with
characteristics of both liabilities and equity. It requires that an issuer
classify a financial instrument that is within its scope as a liability, many of
which had been previously classified as equity or between the liabilities and
equity sections of the consolidated balance sheet.

                                       26
<PAGE>
The provisions of FAS 150 are effective for financial instruments entered into
or modified after May 31, 2003, and otherwise is effective at the beginning of
the first interim period beginning after June 15, 2003. It is to be implemented
by reporting the cumulative effect of a change in accounting principle for
financial instruments created before the issuance of FAS 150 and still existing
at the beginning of the interim period of adoption. The Company has adopted the
provisions of FAS 150 and has been impacted by the requirement to reclassify its
Series B Participating Preferred Stock as a liability as opposed to between the
liabilities and equity sections of the consolidated balance sheet. Based upon
the requirements set forth by FAS 150, this reclassification was subject to
implementation beginning on June 29, 2003. Upon implementation of FAS 150, the
Company has reflected the accretion of the preferred stock balance as an
increase in Total Liabilities with a corresponding reduction in capital in
excess of par value, because the Company has an accumulated deficit. Such
accretion has been recorded as interest expense, resulting in a decrease in Net
Income (Loss) and Comprehensive Income (Loss) of $4.5 million for the 13 and 39-
weeks ended September 27, 2003. Based upon the Company's current projections for
2003, it is estimated the Company may not incur a tax reimbursement obligation
for 2003 relating to the increases in the Liquidation Preference of the Series B
Participating Preferred Stock and will file for a refund of the $0.3 million
Federal tax payment made in March 2003. Due to the FAS 150 requirements to
reclassify the Series B Participating Preferred Stock to liabilities and to
record the accretion of the preferred stock balance as interest expense, the
refund has been treated as a decrease to interest expense on the Condensed
Consolidated Statements of Income (Loss) for the third quarter and an increase
of capital in excess of par value on the Condensed Consolidated Balance Sheets.
If FAS 150 was applicable for fiscal year 2002, Net Loss and Comprehensive Loss
would have been $24.7 million. Net Income (Loss) Applicable to Common
Shareholders and Net Income (Loss) Per Common Share remains unchanged in
comparison with the Company's classification of the instrument prior to June 29,
2003. In addition, there is no cumulative effect of a change in accounting
principle as a result of the implementation of FAS 150. As of September 27,
2003, the implementation of FAS 150 has increased Total Liabilities by
approximately $104.4 million. Shareholders' Deficiency remained unchanged since
the balance had previously been classified between Total Liabilities and
Shareholders' Deficiency on the Condensed Consolidated Balance Sheet. The
classification of the Series B Preferred Stock as a liability under FAS 150
should not change its classification as equity under state law.

         In January 2003, the Securities and Exchange Commission issued a new
disclosure regulation, "Conditions for Use of Non-GAAP Financial Measures"
("Regulation G"), which is effective for all public disclosures and filings made
after March 28, 2003. Regulation G requires public companies that disclose or
release information containing financial measures that are not in accordance
with generally accepted accounting principles ("GAAP") to include in the
disclosure or release a presentation of the most directly comparable GAAP
financial measure and a reconciliation of the disclosed non-GAAP financial
measure to the most directly comparable GAAP financial measure. The Company
became subject to Regulation G in fiscal 2003 and believes that it is in
compliance with the new disclosure requirements.

         In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation-Transition and Disclosure - An Amendment of SFAS No.
123" ("FAS 148"). FAS 148 provides alternative methods of transition for a
voluntary change to the fair value-based method of accounting for stock-based
employee compensation. In addition, FAS 148 amends the disclosure requirements
of SFAS No. 123 to require prominent disclosures in both annual and interim
financial statements about the method of accounting for stock-based employee
compensation and the effect of the method used on reported results. The Company
has established several stock-based compensation plans for the benefit of its
officers and employees. Since 1996, the Company has accounted for its
stock-based compensation to employees using the fair value-based methodology
under SFAS No. 123, thus FAS 148 has had no effect on the Company's results of
operations or financial position. For the 13- weeks ended September 27, 2003 and
September 28, 2002, the Company recorded stock compensation expense of
approximately $0.1 million during each period. For the 39- weeks ended September
27, 2003 and September 28, 2002, the Company recorded stock compensation expense
of $0.5 million and $0.7 million, respectively.

         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 has adopted the
provisions of FAS 146 for exit or disposal activities initiated after December
31, 2002.

                                       27
<PAGE>

         In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other
Intangible Assets" ("FAS 142"). 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 both
September 27, 2003 and September 28, 2002 was $9.3 million. The Company adopted
FAS 142 effective January 1, 2002 and, as a result, has not recorded an
amortization charge for goodwill since that time. The Company obtained the
services of an independent appraisal firm during the second quarter ended June
28, 2003 to assist in the assessment of its annual goodwill impairment. The
results of the appraisal indicated that goodwill was not impaired based upon the
requirements set forth in FAS 142.

         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 28, 2002 and Note 8 of the
Condensed Consolidated Financial Statements for additional information relating
to new accounting pronouncements that the Company has adopted.

SEASONALITY

         The Company does not consider its business seasonal. The revenues for
the Company are proportionally consistent for each quarter during a fiscal year.
The percentage of annual revenues for the first, second, third and fourth
quarters recognized by the Company, respectively, were as follows: 2002 - 23.9%,
24.9%, 23.2% and 28.0%; and 2001 - 27.1%, 25.1%, 22.1% and 25.7%.

FORWARD-LOOKING STATEMENTS

         The following statements from above constitute forward-looking
statements 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 agreement to fund its planned operations through
at least December 31, 2004."

         "The unlikelihood that the Company will be able to redeem the Series B
Preferred Shares is not expected to limit the ability of the Company to use
current and future net earnings or cash flow to satisfy its obligations to
creditors and vendors."

CAUTIONARY STATEMENTS

         The following material identifies important factors that could cause
actual results to differ materially from those expressed in the forward-looking
statements 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 reduce unprofitable circulation and to
         effectively manage its customer lists.

-        The ability of the Company to achieve projected levels of sales and the
         ability of the Company to reduce costs commensurate with sales
         projections. Increases in postage, printing and paper prices and/or the
         inability of the

                                       28
<PAGE>

         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 success of the Amazon.com
         venture. 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, catalog and direct marketing
         industries. The risk that key vendors or suppliers may reduce or
         withdraw trade credit to the Company, convert the Company to a cash
         basis or otherwise change credit terms, or require the Company to
         provide letters of credit or cash deposits to support its purchase of
         inventory, increasing the Company's cost of capital and impacting the
         Company's ability to obtain merchandise in a timely manner. 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, 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.

-        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 that results in noncompliance by the Company with
         the terms of the Congress Credit Facility requiring remediation.

-        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 maintain advance rates under the Congress
         Credit Facility that are at least as favorable as those obtained in the
         past due to market conditions affecting the value of the inventory,
         which is periodically re-appraised in order to re-set such advance
         rates.

-        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.

                                       29
<PAGE>

-        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 ability of the Company to obtain certain types of
         insurance, including directors' and officers' liability insurance, or
         to accept reduced policy limits or coverage, or to incur substantially
         increased costs to obtain the same or similar coverage, due to recently
         enacted and proposed changes to laws and regulations affecting public
         companies, including the provisions of the Sarbanes-Oxley Act of 2002
         and rules of the Securities and Exchange Commission thereunder.

-        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 non-core assets due to market
         conditions or otherwise.

-        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 redeem the Series B Preferred Stock on a
         timely basis, or at all, actions by any holder in response thereto, if
         any, and future interpretations of applicable law and contract.

-        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, terminate or renegotiate the
         leases of its vacant facilities in Weehawken, New Jersey and other
         locations.

-        The ability of the Company to evaluate and implement the requirements
         of the Sarbanes-Oxley Act of 2002 and the rules of the Securities and
         Exchange Commission thereunder, as well as proposed changes to listing
         standards by the American Stock Exchange, in a cost effective manner.

-        The ability of the Company to achieve cross channel synergies, create
         successful affiliate programs, effect profitable brand extensions or
         establish popular loyalty and buyers' club programs.

-        Uncertainty in the U.S. economy and decreases in consumer confidence
         leading to a slowdown in economic growth and spending resulting from
         the invasion of, war with and occupation of Iraq, which may result in
         future acts of terror. Such activities, either domestically or
         internationally, may affect the economy and consumer confidence and
         spending within the United States and adversely affect the Company's
         business.

-        The inability of the Company to continue to source goods from foreign
         sources, particularly India and Pakistan, leading to increased costs of
         sales.

-        The necessity of the Company obtaining the approval of Congress
         Financial Corporation to any recapitalization proposal or
         counter-proposal made by Chelsey.

-        Any recapitalization of the Company potentially constituting an Event
         of Default under the Congress Credit Facility.

-        Any recapitalization of the Company potentially constituting a Change
         in Control under the Company's Key Executive Eighteen Month
         Compensation Continuation Plan, Key Executive Twelve Month Compensation
         Continuation Plan, Key Executive Six Month Compensation Continuation
         Plan and Director Change of Control Plan.

                                       30
<PAGE>

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 Congress revolving credit
facility and its term financing facilities, which bear interest at variable
rates. At September 27, 2003, outstanding principal balances under these
facilities subject to variable rates of interest were approximately $27.2
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
September 27, 2003, would be approximately $0.3 million on an annual basis.

ITEM 4. CONTROLS AND PROCEDURES

        DISCLOSURE CONTROLS AND PROCEDURES. The Company's management, with the
participation of the Company's Chief Executive Officer and Chief Financial
Officer, has evaluated the effectiveness of the Company's disclosure controls
and procedures (as such term is detailed in Rules 13a-15(e) and 15d-15(e) under
the Securities Exchange Act of 1934, as amended (the "Exchange Act")) as of the
end of the period covered by this report. Based on such evaluation, the
Company's Chief Executive Officer and Chief Financial Officer have concluded
that, as of the end of such period, the Company's disclosure controls and
procedures are effective in recording, processing, summarizing and reporting, on
a timely basis, information required to be disclosed by the Company in the
report it files or submits under the Exchange Act.

        INTERNAL CONTROL OVER FINANCIAL REPORTING. There have not been any
changes in the Company's internal control over financial reporting (as such term
is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the
fiscal quarter to which this report relates that have materially affected, or
are reasonably likely to materially affect, the Company's internal control over
financial reporting.

                                       31
<PAGE>

PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

         A class action lawsuit was commenced on March 3, 2000 entitled Edwin L.
Martin v. Hanover Direct, Inc. and John Does 1 through 10, bearing case no.
CJ2000-177 in the State Court of Oklahoma (District Court in and for Sequoyah
County). Plaintiff commenced the action on behalf of himself and a class of
persons who have at any time purchased a product from the Company and paid for
an "insurance charge." The complaint sets forth claims for breach of contract,
unjust enrichment, recovery of money paid absent consideration, fraud and a
claim under the New Jersey Consumer Fraud Act. The complaint alleges that the
Company charges its customers for delivery insurance even though, among other
things, the Company's common carriers already provide insurance and the
insurance charge provides no benefit to the Company's customers. Plaintiff also
seeks a declaratory judgment as to the validity of the delivery insurance. The
damages sought are (i) an order directing the Company to return to 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. 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
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 that was designated to
be an `insurance' charge." On August 21, 2001, the Company filed an appeal of
the order with the Oklahoma Supreme Court 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 Oklahoma Supreme Court has not yet ruled on the pending
appeal. Oral argument on the appeal, if scheduled, was expected during the first
half of 2003 but has yet to be scheduled by the Court. The Company believes it
has defenses against the claims and plans to conduct a vigorous defense of this
action.

         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 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. 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 and Hanover Direct
Virginia. 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 and Home,
and Silhouettes, as defendants, and (2) granted the Company's Motion to Stay the
action in favor of the previously filed Oklahoma action. The Company believes it
has defenses against the claims and plans to conduct a vigorous defense of this
action.

         A lawsuit was commenced as both a class action and for the benefit of
the general public 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 allegedly 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 and the general public 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

                                       32
<PAGE>

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
seeks (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 fee, tax and
sales tax collected unlawfully, together with interest, (ii) an order enjoining
Brawn from charging customers insurance fee 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 Plaintiff alleged that 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 denied the Motion to
Stay. The Wilson case proceeded to trial before the Honorable Dian Elan Wick of
the Superior Court of California for the County of San Francisco, and the Judge,
sitting without a jury, heard evidence from April 15-17, 2003. The Court
requested and received closing arguments and Proposed Statements of Decision in
July 2003. On September 18, 2003, the Court issued its Proposed Statement of
Decision and Proposed Judgment After Trial (the "Proposed Judgment"). The
Proposed Judgment would find: 1) that Jacq Wilson has abandoned his individual
claims and has pursued the case only on behalf of the general public; 2) that
Brawn had violated Business and Professions Code Section 17200 and 17500 by
identifying its $1.48 charge to customers as an `insurance' charge and that said
charge was for an illusory benefit that was likely to deceive consumers; and 3)
that plaintiff had failed to prove that Brawn had violated Business and
Professions Code Section 17200 by collecting, sales tax on delivery charges for
goods shipped to its customers. The Proposed Judgment would order Brawn to
"locate, identify and pay restitution to each of its customers for each
transaction in which a $1.48 charge for `insurance' was paid from February 13,
1998 through January 15, 2003" with interest from the date paid. The Proposed
Judgment states that such restitution must be made on or before June 30, 2004.
On October 10, 2003 Brawn filed its Objections to the Court's Proposed Decision
and its Amended [Tentative] Statement of Decision, based on Brawn's belief that
the Court failed to properly consider certain undisputed evidence, reached other
conclusions not supported by any admissible evidence and improperly applied the
law concerning the insurance fee. (Plaintiff's co-counsel (on the tax matter)
requested an opportunity to respond and intended to file its response on or
before October 24, 2003.) The potential estimated exposure is in the range of $0
to $4.0 million. If the trial court fails to amend or modify its Proposed
Judgment, the Company expects to take an appeal and conduct a vigorous defense
of this action.

         A class action lawsuit was commenced on October 28, 2002 entitled John
Morris, individually and on behalf of all other persons & entities similarly
situated v. Hanover Direct, Inc., and Hanover Brands, Inc. (referred to here as
"Hanover"), No. L 8830-02 in the Superior Court of New Jersey, Bergen County --
Law Division. The plaintiff brings the action individually and on behalf of a
class of all persons and entities in New Jersey who purchased merchandise from
Hanover within six years prior to filing of the lawsuit and continuing to the
date of judgment. On the basis of a purchase made by the plaintiff in August
2002 of certain clothing from Hanover (which was from a men's division catalog,
the only one which retained the insurance line item in 2002), the Plaintiff
claims that for at least six years, Hanover maintained a policy and practice of
adding a charge for "insurance" to the orders it received and concealed and
failed to disclose its policy with respect to all class members. Plaintiff
claims that Hanover's conduct was (i) in violation of the New Jersey Consumer
Fraud Act, as otherwise deceptive, misleading and unconscionable; (ii) such as
to constitute Unjust Enrichment of Hanover at the expense and to the detriment
of plaintiff and the class; and (iii) unconscionable per se under the Uniform
Commercial Code for contracts related to the sale of goods. Plaintiff and the
class seek damages equal to the amount of all insurance charges, interest
thereon, treble and punitive damages, injunctive relief, costs and reasonable
attorneys' fees, and such other relief as may be just, necessary, and
appropriate. Plaintiff filed an Amended Complaint adding International Male as a
defendant. On December 13, 2002, the Company filed a Motion to Stay the Morris
action in favor of the previously filed Martin action. Hearing on the Motion to
Stay took place on June 6, 2003 and the Court granted the Company's motion to
stay until December 31, 2003, at which time the Court will revisit the issue if
the parties request that it do so. The Company plans to conduct a vigorous
defense of this action.

         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 $298,650 for 13 weeks of
accrued and unused vacation,

                                       33
<PAGE>

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 or $850,000 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 within
the 30 days following his resignation. 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 and every of Mr. Kaul's
causes of action, challenging all substantive assertions, raising several
defenses and 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 seeks summary judgment: dismissing
Mr. Kaul's claim for severance under his employment agreement on the ground that
he failed to provide the Company with a general release of, among other things,
claims for change of control benefits; dismissing Mr. Kaul's claim for
attorneys' fees on the grounds that they are not authorized under his employment
agreement; dismissing Mr. Kaul's claims related to change in control benefits
based on an administrative decision that he is not entitled to continued
participation in the plan or to future benefits thereunder; dismissing Mr.
Kaul's claim for a tandem bonus payment on the ground that no payment is owing;
dismissing Mr. Kaul's claim for vacation payments based on Company policy
regarding carry over vacation; and seeking judgment on the Company's
counterclaim for unjust enrichment based on Mr. Kaul's failure to pay under a
tax note. Mr. Kaul seeks summary judgment: dismissing the Company's defenses and
counterclaims relating to a release on the grounds that he tendered a release or
that the Company is estopped from requiring him to do so; dismissing the
Company's defenses and counterclaims relating to his alleged violations of his
non-compete and confidentiality obligations on the grounds that he did not
breach the obligations as defined in the agreement; and dismissing the Company's
claims based on his alleged breach of fiduciary duty, including those based on
his monthly car allowance payments and the leased space to his wife, on the
grounds that he was entitled to the car payments and did not involve himself in
or make misrepresentations in connection with the leased space. The Company has
concurrently moved to amend its Answer and Counterclaims to state a claim that
it had cause for terminating Mr. Kaul's employment based on, among other things,
after acquired evidence that Mr. Kaul received a monthly car allowance and other
benefits totaling $412,336 that had not been authorized by the Company's Board
of Directors and that his wife's lease and related expense was not properly
authorized by the Company's Board of Directors, and to clarify or amend the
scope of the Company's counterclaims for reimbursement. The briefing on the
motions is completed and the parties are awaiting the decision of the Court. 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.

         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
trial in the Nevada case began on November 18, 2002 and ended on January 17,
2003. The parties in the Nevada case submitted post trial briefs by the end of
May 2003, and a decision is expected in the near future. The Order for the stay
in the Lemelson case 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

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<PAGE>

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 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, and has not established a reserve.

         In early March 2003, the Company learned that one of its business units
had engaged in certain travel transactions that may have constituted violations
under the provisions of U.S. government regulations promulgated pursuant to 50
U.S.C. App. 1-44, which proscribe certain transactions related to travel to
certain countries. The Company immediately commenced an inquiry into the matter,
incurred resulting charges, made an initial voluntary disclosure to the
appropriate U.S. government agency under its program for such disclosures and
has submitted to that agency a detailed report on the results of the inquiry. In
addition, the Company has taken steps to ensure that all of its business units
are acting in compliance with the travel and transaction restrictions and other
requirements of all applicable U.S. government programs. Although the Company is
uncertain of the extent of the penalties, if any, that may be imposed on it by
virtue of the transactions voluntarily disclosed, it does not currently believe
that any such penalties will have a material effect on its business or financial
condition.

         On July 17, 2003, the Company filed an action in the Supreme Court of
the State of New York, County of New York (Index No. 03/602269) against
Richemont Finance S.A. ("Richemont"), and Chelsey Direct, LLC, a Delaware
limited liability company ("Chelsey"), seeking a declaratory judgment as to
whether Richemont improperly transferred all of Richemont's securities in the
Company consisting of 29,446,888 shares of Common Stock and 1,622,111 shares of
Series B Participating Preferred Stock (collectively, the "Shares") to Chelsey
on or about May 19, 2003 and whether the Company can properly recognize the
transfer of those Shares from Richemont to Chelsey under federal and/or state
law. On July 29, 2003, Chelsey answered the Company's complaint, alleged certain
affirmative defenses and raised three counterclaims against the Company,
including Delaware law requiring the registration of the Shares, damages,
including attorney's fees, for the failure to register the Shares, and tortious
interference with contract. Chelsey also moved for a preliminary injunction
directing the Company to register the ownership of the Shares in Chelsey's name.
Chelsey later moved for summary judgment dismissing the Company's complaint.
Subsequently, Chelsey moved to compel production of certain documents and for
sanctions and/or costs. On August 28, 2003, Richemont moved to dismiss the
Company's complaint. It subsequently filed a motion seeking sanctions and/or
costs against the Company. On October 27, 2003, the Court granted Chelsey's
motion for summary judgment and Richemont's motion to dismiss and ordered that
judgment be entered dismissing the case in its entirety. The Court also denied
Chelsey's and Richemont's motions for sanctions and Chelsey's motion to compel
production of certain documents.

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

ITEM 5. OTHER INFORMATION

         On July 17, 2003, the Company increased the size of its Board of
Directors from five to seven members and elected Jeffrey A. Sonnenfeld and A.
David Brown as members of the newly-expanded Board of Directors, subject to the
fulfillment of certain conditions precedent, which were fulfilled on July 29,
2003. As a result of this action, the Committees of the Board were reconstituted
as follows: The members of the Audit Committee are Robert H. Masson (Chairman),
E. Pendleton James and Kenneth J. Krushel. The members of the Compensation
Committee are Jeffrey A. Sonnenfeld (Chairman), A. David Brown and Robert H.
Masson. The members of the Nominating Committee are E. Pendleton James
(Chairman), A. David Brown and Jeffrey A. Sonnenfeld. The members of the
Transactions Committee are Kenneth J. Krushel (Chairman), A. David Brown, E.
Pendleton James, Robert H. Masson and Jeffrey A. Sonnenfeld.

         On July 23, 2003, the Company increased the size of its Executive
Committee from three to five members, subject to the fulfillment of certain
conditions precedent, which were fulfilled on July 29, 2003, and reconstituted
the Executive Committee to include Thomas C. Shull, the Chairman of the Board,
President and Chief Executive Officer of

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<PAGE>

the Company, Robert H. Masson, the Chairman of the Company's Audit Committee,
Kenneth J. Krushel, the Chairman of the Company's Transactions and Executive
Committees, Basil P. Regan, and Jeffrey A. Sonnenfeld, the Chairman of the
Company's Compensation Committee.

         By letter dated September 2, 2003, the Company advised Chelsey Direct,
LLC ("Chelsey") that a Voting Trigger (as defined in the Certificate of
Designations, Powers, Preferences and Rights (the "Certificate of Designations")
of the Series B Participating Preferred Stock (the "Series B Preferred Stock")
of the Company had occurred due to the failure by the Company to redeem any
shares of Series B Preferred Stock on or prior to August 31, 2003. As a result,
the holder or holders of the Series B Preferred Stock had the exclusive right,
voting separately as a class and by taking such actions as are set forth in
Section 7(b) of the Certificate of Designations, to elect two directors of the
Company (the "Director Right"). On September 16, 2003, Chelsey exercised the
Director Right and elected Martin L. Edelman and Wayne P. Garten to the
Company's Board of Directors. Messrs. Edelman and Garten returned certain
related paperwork to the Company on September 29, 2003, upon which they
effectively joined the Board.

         On November 3, 2003, Charles E. Blue was appointed Chief Financial
Officer of the Company effective November 11, 2003, replacing Edward M. Lambert
as Chief Financial Officer, effective on such date, in connection with the
Company's ongoing strategic business realignment program. Mr. Blue joined the
Company in 1999 and had most recently served as Senior Vice President, Finance,
a position eliminated by this finance department restructuring.

         Mr. Lambert will continue to serve as Executive Vice President of the
Company until January 2, 2004. In connection with such change, Mr. Lambert and
the Company have entered into a severance agreement dated November 4, 2003
providing a minimum of $600,000 and a maximum of $640,000 of cash payments as
well as other benefits that will be accrued and paid in the fourth quarter of
2003. Mr. Lambert is also entitled to receive a payment under the Company's 2003
Management Incentive Plan; however, the Company's current forecast does not
project any such payment for the 2003 Plan year.

         On Thursday, August 7, 2003 representatives of Chelsey attended a
regularly scheduled meeting of the Board of Directors of the Company at the
invitation of management of the Company endorsed by its Board of Directors.
Senior management of the Company was also present at the meeting. The Company
had requested that Chelsey make a brief (15-20 minute) presentation to the Board
solely with respect to (1) Chelsey's vision and proposed plan for value creation
opportunities at the Company above and beyond those currently articulated by
management in its recent SEC filings and other public statements; and (2)
Chelsey's specific proposal for the terms of an exchange offer by which the
Series B Preferred Stock would be exchanged for Common Stock of the Company
and/or Chelsey's specific counteroffer to the Company's July 7, 2003 proposal.
The Company wanted to afford Chelsey the opportunity to speak directly to the
entire Board of Directors and senior management of the Company and articulate
how Chelsey's approach would benefit all the Company's stakeholders.

         At the meeting, Chelsey's representatives delivered to the Company a
document entitled "Recapitalization of Hanover Direct, Inc. Summary of Terms"
(the "Chelsey Proposal") and made a presentation to the Board of Directors
regarding the Chelsey Proposal. That presentation was purportedly summarized in
Chelsey's Amendment No. 3 to Schedule 13D as Exhibit E.

         The Company's Board of Directors referred the Chelsey Proposal to its
Transactions Committee for consideration with a view towards making a
recommendation to the Board of Directors. The Transactions Committee, composed
of independent directors of the Company, provides assistance to the directors in
fulfilling their responsibility to the shareholders by recommending appropriate
actions to the Board of Directors on matters that require Board approval,
including material transactions with shareholders owning more than ten percent
(10%) of the voting securities of the Company. The Transactions Committee
engaged financial advisors and counsel to assist it in its deliberations with
respect to the Chelsey Proposal.

         On September 18, 2003, representatives of Chelsey attended a meeting
with legal and financial advisors to the Transactions Committee of the Board of
Directors of the Company at which a document entitled "Recapitalization of
Hanover Direct, Inc. - Summary of Counteroffer Terms" (the "Counterproposal")
was discussed. The Counterproposal responded to Chelsey's Proposal to the
Company at the August 7 meeting of the Board of Directors. Chelsey's
representatives did not accept the Counterproposal. Negotiations between the
parties ensued in the weeks thereafter.

         On November 10, 2003, the Company signed a Memorandum of Understanding
with Chelsey and Regan Partners, L.P. setting forth the agreement in principle
to recapitalize the Company, reconstitute the Board of Directors and settle
outstanding litigation between the Company and Chelsey. The Memorandum of
Understanding had been approved by the Transactions Committee of the Board of
Directors of the Company.

        The parties agreed to effect within ten days or as soon thereafter as
possible a binding Recapitalization Agreement that would, upon the closing of
the transactions set forth in the Recapitalization Agreement, exchange 564,819
shares of a newly issued Series C Preferred Stock and 81,857,833 shares of newly
issued common stock for the 1,622,111 shares of Series B Preferred Stock
currently held by Chelsey, subject to adjustment if the transaction is not
consummated by December 17, 2003. If the closing takes place on or before
December 17, 2003, the Series C Preferred Stock will have an aggregate
liquidation preference of $56,481,900 while the outstanding Series B Preferred
Stock has a current aggregate liquidation preference of $112,963,810 and a
maximum final liquidation preference of $146,168,422 on August 23, 2005. The new
common shares will have an effective issue price of $.69. With the issuance of
the new common shares, Chelsey will have a majority equity and voting interest
in the Company.

         Upon the execution of the Recapitalization Agreement, the Company will
reconstitute the Board to eight members, including four designees of Chelsey.
The Recapitalization Agreement is subject to the approval of the Transactions
Committee and the Board of Directors of the Company. It is also subject to
other consents including the approval of Congress Financial Corporation. The
Company intends to prepare and file with the Securities and Exchange Commission
and transmit to all equity holders of the Company, as required by Rule 14f-1 of
the Securities Exchange Act of 1934, as amended, a statement regarding its
intent to effect a change in majority of directors as promptly as practicable.
Following the expiration of ten days following the filing and mailing of the
statement, the Board of Directors will increase to nine members, with the
additional director being a Chelsey designee.

        The proposed Series C Preferred Stock, with a liquidation preference of
$100 per share, carries a quarterly dividend, starting on January 1, 2006 at 6%
and increasing each year by 1 1/2%. In lieu of cash dividends, the Company may
elect to accrue dividends at a rate equal to 1% higher than the annual cash
dividend rate. The Series C Preferred Stock has a redemption date of January 1,
2009. The Company shall redeem the maximum number of shares of Series C
Preferred Stock as possible with the net proceeds of certain asset and equity
sales, including the disposition of the Company's non-core assets, not required
to be used to repay Congress Financial Corporation pursuant to the terms of the
19th Amendment to the Loan and Security Agreement, and Chelsey shall be
required to accept such redemptions.

        The Recapitalization Agreement will also define the duties of the
Transactions Committee and provide for the reconstitution of the committees of
the Board of Directors, mutual releases and termination of litigation between
the Company and Chelsey, voting agreements between Chelsey and Regan Partners, a
major shareholder of the Company, registration rights for the new common shares
and agreements to recommend certain amendments to the Company's Certificate of
Incorporation, including a 10-for-1 reverse stock split and a decrease in the
par value of the Common Stock from $.66 2/3 per share to $.01 per share, at the
first annual meeting of shareholders following the closing.

        If the closing of the Recapitalization Agreement has not occurred by
November 30, 2003, then the Company will pay Chelsey $1 million by December 3,
2003. If the closing has not occurred by the close of business on December 17,
2003, then the Memorandum of Understanding shall cease to be effective unless
either the Company or Chelsey elects to extend the closing past such date. If
the Company makes such election, the number of shares of Common Stock and
Series C Preferred Stock issued to Chelsey in the Recapitalization shall be
adjusted pursuant to the terms of the agreement. If Chelsey makes such an
election, there shall be no adjustment to the number of shares. In either case,
the Closing shall occur no later than February 29, 2004.

        The Memorandum of Understanding has been filed with the Securities and
Exchange Commission as an exhibit to the Company's Current Report on Form 8-K
dated November 10, 2003. The Company strongly recommends that interested parties
refer to it for a full and complete understanding of the terms and conditions of
the Memorandum of Understanding.

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<PAGE>

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a)  Exhibits:

10.1     Twenty-sixth Amendment to Loan and Security Agreement, dates as of
         August 29, 2003, among Congress Financial Corporation and certain
         Subsidiaries of the Company. Incorporated by reference to the
         Company's Quarterly Report on Form 10-Q for the quarter ended
         September 27, 2003.

10.2     Twenty-seventh Amendment to Loan and Security Agreement, dates as of
         October 31, 2003, among Congress Financial Corporation and certain
         Subsidiaries of the Company. Incorporated by reference to the
         Company's Quarterly Report on Form 10-Q for the quarter ended
         September 27, 2003.

10.3     Twenty-eighth Amendment to Loan and Security Agreement, dates as of
         November 4, 2003, among Congress Financial Corporation and certain
         Subsidiaries of the Company. Incorporated by reference to the
         Company's Quarterly Report on Form 10-Q for the quarter ended
         September 27, 2003.

10.4     Amendment No. 3 to the Hanover Direct, Inc. Key Executive Eighteen
         Month Compensation Continuation Plan. Incorporated by reference to the
         Company's Quarterly Report on Form 10-Q for the quarter ended
         September 27, 2003.

10.5     Amendment No. 2 to the Hanover Direct, Inc. Key Executive Twelve Month
         Compensation Continuation Plan. Incorporated by reference to the
         Company's Quarterly Report on Form 10-Q for the quarter ended
         September 27, 2003.

10.6     Amendment No. 2 to the Hanover Direct, Inc. Key Executive Six Month
         Compensation Continuation Plan. Incorporated by reference to the
         Company's Quarterly Report on Form 10-Q for the quarter ended
         September 27, 2003.

31.1     Certification signed by Thomas C. Shull. FILED HEREWITH.

31.2     Certification signed by Charles E. Blue. FILED HEREWITH.

32.1     Certification signed by Thomas C. Shull and Charles E. Blue.
         FILED HEREWITH.

(b)  Reports on Form 8-K:

1.1      Form 8-K, filed July 15, 2003 -- reporting pursuant to Item 5 of such
         Form the exchange of certain correspondence with Chelsey Direct, LLC.

1.2      Form 8-K, filed July 17, 2003 - reporting pursuant to Item 5 of such
         Form the filing by the Company of an action in the Supreme Court of the
         State of New York against Richemont Finance S.A. and Chelsey Direct,
         LLC.

1.3      Form 8-K, filed July 30, 2003 - reporting pursuant to Item 5 of such
         Form the increase in the size of the Company's Board of Directors and
         the election of Jeffrey A. Sonnenfeld and A. David Brown as directors.

1.4      Form 8-K, filed August 1, 2003 - reporting pursuant to Item 5 of such
         Form certain agreements of the parties in the matter of Hanover Direct,
         Inc. v. Richemont Finance S.A. and Chelsey Direct, LLC.

1.5      Form 8-K, filed August 5, 2003 -- reporting pursuant to Item 5 of such
         Form scheduling information regarding its conference call with
         management to review the operating results for the fiscal quarter ended
         June 28, 2003.

1.6      Form 8-K, filed August 7, 2003 - reporting pursuant to Item 9 of such
         Form (information furnished pursuant to Item 12 of such Form) the
         issuance of a press release announcing operating results for the fiscal
         quarter ended June 28, 2003.

1.7      Form 8-K, filed August 11, 2003 - reporting pursuant to Item 9 of such
         Form an unofficial transcript of its conference call with management to
         review the operating results for the quarter ended June 28,

                                       37
<PAGE>

         2003.

1.8      Form 8-K, filed August 14, 2003 - reporting pursuant to Item 5 of such
         Form that (i) on Thursday, August 7, 2003 representatives of Chelsey
         Direct, LLC attended a regularly scheduled meeting of the Company's
         Board of Directors at the invitation of management of the Company
         endorsed by its Board of Directors, (ii) at the meeting, Chelsey's
         representatives delivered to the Company a document entitled
         "Recapitalization of Hanover Direct, Inc. Summary of Terms" and made a
         presentation to the Board of Directors regarding the Proposal, (iii)
         the Company's Board of Directors referred the Proposal to its
         Transactions Committee for consideration with a view towards making a
         recommendation to the Board of Directors, (iv) the Transactions
         Committee had engaged financial advisors and counsel to assist it in
         its deliberations with respect to the Proposal and would need time to
         properly consider and respond to the Proposal, and (v) the Company had
         agreed to the temporary registration of the 29,446,888 shares of Common
         Stock of the Company and the 1,622,111 shares of Series B Participating
         Preferred Stock of the Company sold by Richemont Finance S.A.
         ("Richemont") to Chelsey Direct, LLC on or about May 19, 2003, pending
         the resolution of certain litigation between the Company, Chelsey and
         Richemont described in the Company's Current Reports on Form 8-K filed
         on July 17, 2003 and August 1, 2003.

1.9      Form 8-K, filed September 9, 2003 - reporting pursuant to Item 5 of
         such Form the existence of an Escrow Agreement, dated as of July 2,
         2003, by and among Richemont, Chelsey and JPMorgan Chase Bank, as
         escrow agent, and the side letter referred to therein, dated as of May
         19, 2003, by and between Richemont and Chelsey.

2.0      Form 8-K, filed September 9, 2003 - reporting pursuant to Item 5 of
         such Form that prior to a meeting with representatives of Chelsey
         Direct, LLC on September 18, 2003, advisors to the Transactions
         Committee of the Board of Directors of the Company delivered to Chelsey
         a document entitled "Recapitalization of Hanover Direct, Inc. - Summary
         of Counteroffer Terms," which responded to the proposal made by Chelsey
         to the Company at a meeting of the Board of Directors held on August 7,
         2003, which counterproposal Chelsey rejected.

2.1      Form 8-K, filed October 2, 2003 - reporting pursuant to Item 5 of such
         Form that (i) a Voting Trigger (as defined in the Certificate of
         Designations, Powers, Preferences and Rights of the Series B
         Participating Preferred Stock of the Company) had occurred, (ii) that
         Chelsey Direct, LLC had elected Martin L. Edelman and Wayne P. Garten
         to the Company's Board of Directors and (iii) Messrs. Edelman and
         Garten had returned certain related paperwork to the Company on
         September 29, 2003, upon which they effectively joined the Board.

2.2      Form 8-K, filed November 4, 2003 - reporting pursuant to Item 5 of such
         Form information regarding the issuance of the Twenty-Seventh Amendment
         to the Company's Loan and Security Agreement with Congress Financial
         Corporation and the appointment of Mr. Charles E. Blue as Chief
         Financial Officer, effective November 11, 2003, and the resignation of
         Edward M. Lambert as Chief Financial Officer effective on such date.

2.3      Form 8-K, filed November 7, 2003 - reporting pursuant to Item 5 of such
         Form information regarding its conference call with management to
         review operating results for the quarter ended September 27, 2003.

2.4      Form 8-K, filed November 10, 2003 - reporting pursuant to Item 5 of
         such Form the Company entering into a Memorandum of Understanding with
         Chelsey Direct, LLC and Regan Partners, L.P. and issuing a press
         release announcing that it had signed the Memorandum of Understanding.

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<PAGE>

                                   SIGNATURES

         Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this amendment no. 1 to report to be signed on
its behalf by the undersigned thereunto duly authorized.

                                  HANOVER DIRECT, INC.

                                  Registrant

                                  By:    /s/  Charles E. Blue
                                  ---------------------------------------------
                                              Charles E. Blue

                                            Senior Vice President and
                                             Chief Financial Officer
                                         (On behalf of the Registrant and as
                                            principal financial officer)

Date: April 9, 2004

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