HANOVER DIRECT INC /DE//, 424B4, 1994-03-31

HANOVER DIRECT INC /DE//
424B4, 1994-03-31
CATALOG & MAIL-ORDER HOUSES

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<PAGE> 1
Filed pursuant to Rule 424(b)(4)
Registration No. 33-52353

P R O S P E C T U S

8,000,000 SHARES

[HANOVER LOGO]

COMMON STOCK

---------------------
Of the 8,000,000 shares of Common Stock offered hereby, 7,345,396 are being
issued and sold by Hanover Direct, Inc. ("Hanover" or the "Company") and 654,604
are being sold by a shareholder of the Company (the "Selling Shareholder"). See
"Principal and Selling Shareholders." The Company will not receive any of the
proceeds from the sale of shares by the Selling Shareholder.

The Common Stock of the Company is listed on the American Stock Exchange
(the "AMEX") under the symbol "HNV." On March 30, 1994, the last reported sale
price of the Common Stock as reported on the AMEX was $6 1/2 per share. See
"Price Range of Common Stock."

SEE "INVESTMENT CONSIDERATIONS" FOR A DISCUSSION OF CERTAIN FACTORS THAT
SHOULD BE CONSIDERED BY PROSPECTIVE PURCHASERS OF THE COMMON STOCK OFFERED
HEREBY.
---------------------

THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION, NOR HAS
THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES
COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS
PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------
PROCEEDS TO
PRICE TO UNDERWRITING PROCEEDS TO SELLING
PUBLIC DISCOUNT(1) COMPANY(2) SHAREHOLDER
- --------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Per Share......................... $6.375 $.367 $6.008 $6.008
- --------------------------------------------------------------------------------------------------
Total(3).......................... $51,000,000 $2,936,000 $44,131,139 $3,932,861
- --------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------
</TABLE>

(1) The Company and the Selling Shareholder have agreed to indemnify the several
Underwriters against certain liabilities under the Securities Act of 1933.
See "Underwriting."
(2) Before deducting expenses payable by the Company estimated at $800,000.
(3) The Company has granted the several Underwriters a 30-day option to purchase
up to 1,200,000 additional shares of Common Stock solely to cover
over-allotments, if any. If such option is exercised in full, the total
Price to Public, Underwriting Discount and Proceeds to Company will be
$58,650,000, $3,376,400 and $51,340,739, respectively. See "Underwriting."
---------------------
The shares of Common Stock are offered by the several Underwriters, subject
to prior sale, when, as and if issued to and accepted by them, subject to the
approval of certain legal matters by counsel for the Underwriters and certain
other conditions. The Underwriters reserve the right to withdraw, cancel or
modify such offer and to reject orders in whole or in part. It is expected that
delivery of the shares of Common Stock will be made in New York, New York on or
about April 7, 1994.
---------------------
MERRILL LYNCH & CO. ALEX. BROWN & SONS
INCORPORATED

---------------------
The date of this Prospectus is March 30, 1994.
<PAGE> 2
(INSIDE FRONT COVER 1)

(PHOTOGRAPH 1) (LOGO) (PHOTOGRAPH 2)

(LOGO) (LOGO) (LOGO)

(PHOTOGRAPH 3) (LOGO) (PHOTOGRAPH 4)

IN CONNECTION WITH THIS OFFERING, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT
TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE COMMON STOCK AT
A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN MARKET. SUCH
TRANSACTIONS MAY BE EFFECTED ON THE AMERICAN STOCK EXCHANGE OR OTHERWISE. SUCH
STABILIZING, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME.

2
<PAGE> 3
(INSIDE FRONT COVER 2)

(LOGO) (PHOTOGRAPH 1) (LOGO) (PHOTOGRAPH 2) (LOGO) (PHOTOGRAPH 3) (LOGO)

The Company
is a leading
direct specialty
retailer that
publishes a
(PHOTOGRAPH 4) (LOGO) (PHOTOGRAPH 5) (LOGO) (PHOTOGRAPH 6) portfolio of (PHOTOGRAPH 7)
fourteen branded
specialty catalogs
offering home
furnishings,
general
merchandise
and apparel.

(LOGO) (PHOTOGRAPH 8) (LOGO) (PHOTOGRAPH 9) (LOGO) (PHOTOGRAPH 10) (LOGO)

</TABLE>

<PAGE> 4

AVAILABLE INFORMATION

The Company has filed with the Securities and Exchange Commission (the
"Commission") a Registration Statement on Form S-3, of which this Prospectus
constitutes a part (together with any amendments thereto, the "Registration
Statement"), under the Securities Act of 1933, as amended (the "Securities
Act"), with respect to the Common Stock offered hereby. This Prospectus does not
contain all of the information set forth in the Registration Statement, certain
items of which are contained in schedules and exhibits to the Registration
Statement as permitted by the rules and regulations of the Commission and to
which reference is hereby made for further information with respect to the
Company and the Common Stock offered hereby. Statements made in this Prospectus
concerning the contents of any documents referred to herein are not necessarily
complete. With respect to each such document filed with the Commission as an
exhibit to the Registration Statement, reference is made to the exhibit for a
more complete description of the matter involved, and each such statement shall
be deemed qualified in its entirety by such reference.

The Registration Statement, including the exhibits thereto, and the
financial statements and notes filed as a part thereof, can be inspected and
copied at the public reference facilities maintained by the Commission at Room
1024, 450 Fifth Street, N.W., Washington D.C. 20549, and at the regional offices
of the Commission located at Seven World Trade Center, 13th Floor, New York, New
York 10048, and Northwestern Atrium Center, 500 West Madison Street, Suite 1400,
Chicago, Illinois 60661. Copies of such material can be obtained from the Public
Reference Section of the Commission at 450 Fifth Street, N.W., Washington D.C.
20549.

The Company is subject to the informational requirements of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), and, in accordance
therewith, files reports, proxy statements and other information with the
Commission. Such reports, proxy statements and other information can be
inspected and copied at the public reference facilities maintained by the
Commission referred to above. In addition, copies of such reports, proxy
statements and other information concerning the Company may also be inspected
and copied at the offices of the AMEX at 86 Trinity Place, New York, New York
10006 on which exchange the Common Stock is listed and traded.

INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE

The following documents filed by the Company with the Commission are
incorporated in this Registration Statement by reference: (a) the Annual Report
on Form 10-K for the fiscal year ended January 1, 1994 and (b) the Current
Reports on Form 8-K dated February 17, 1994 and March 9, 1994.

All documents subsequently filed by the Company pursuant to Sections 13(a),
13(c), 14 and 5(d) of the Exchange Act, prior to the termination of the offering
of the Common Stock, shall be deemed to be incorporated by reference in this
Registration Statement and to be a part of the Registration Statement from the
respective date of filing of each such document. Any statement contained in a
document incorporated or deemed to be incorporated by reference herein shall be
deemed to be modified or superseded for purposes of this Prospectus to the
extent that a statement contained herein or in any other subsequently filed
document which also is, or is deemed to be, incorporated by reference herein
modifies or supersedes such statement. Any such statement so modified or
superseded shall not be deemed, except as so modified or superseded, to
constitute a part of this Prospectus.

The Company will provide without charge to each person to whom this
Prospectus is delivered, upon written or oral request, a copy of any or all of
the documents incorporated by reference herein, other than certain exhibits to
such documents. Requests for such documents should be directed to Michael P.
Sherman, Executive Vice President, General Counsel and Secretary, Hanover
Direct, Inc., 1500 Harbor Boulevard, Weehawken, New Jersey 07087. The Company's
telephone number is (201) 863-7300.

3
<PAGE> 5

PROSPECTUS SUMMARY

The following summary is qualified in its entirety by the more detailed
information and financial statements and notes thereto appearing elsewhere in
this Prospectus or incorporated by reference herein. Unless the context
indicates otherwise, all references in this Prospectus to the Company include
the Company, its predecessors, including The Horn & Hardart Company, a Nevada
corporation ("H&H"), and The Hanover Companies, a Nevada corporation ("THC"),
and its consolidated subsidiaries. Unless otherwise indicated, all information
in this Prospectus assumes the over-allotment option granted to the Underwriters
is not exercised. With respect to financial information of the Company, all
references herein to a year or years shall refer to the fiscal year or years of
the Company.

THE COMPANY

The Company is a leading direct specialty retailer that publishes a
portfolio of 14 branded specialty catalogs offering home furnishings, general
merchandise and apparel. The Company's goal for each of its catalogs is to be a
leader in its market niche. To achieve this goal, the Company employs marketing
and merchandising strategies designed to meet the distinctive needs of each
catalog's target customers. The Company's catalogs include Domestications, the
nation's leading specialty home textile catalog, which has grown rapidly with
revenues increasing from approximately $30 million in 1987 to approximately $311
million in 1993. The Company's portfolio of catalogs also includes Colonial
Garden Kitchens, a leading specialty catalog with the largest 12-month customer
list in its category featuring worksaving and lifestyle enhancing items for the
kitchen and home. During 1993, the Company mailed approximately 322 million
catalogs and had total revenues of approximately $643 million. The Company
maintains a proprietary customer list, containing approximately 19 million names
of customers who have made purchases from at least one of the Company's catalogs
within the past 36 months. Since 1991, approximately seven million names have
been added to the list. Approximately seven million of the names on the list
represent customers who have made purchases from at least one of the Company's
catalogs within the last 12 months.

The Company seeks to develop distinct brand identities for each of its
catalogs. To achieve this goal, the Company has adopted a decentralized
operating structure so that all significant decisions, including those regarding
market positioning and strategy, merchandising, circulation levels, catalog
design and inventory management, are made on an individual catalog basis.
However, the Company gains substantial operating efficiencies and cost savings
by centrally operating the purchasing, telemarketing, fulfillment, distribution
and certain administrative functions for all of its catalogs.

The Company's goal is to become the nation's leading direct specialty
retailer and preferred retail source for its customers. The Company's growth
strategy includes: (i) internal catalog growth and development; (ii) strategic
acquisitions; (iii) strategic ventures; (iv) development of international market
opportunities; and (v) exploration of growth prospects in electronic interactive
media.

During 1993, the Company acquired three brand-name catalogs, Gump's, the
well known San Francisco retailer and a leading upscale catalog marketer of
exclusive gifts, The Company Store, an upscale direct marketer of down
comforters and other down and related products for the home, and Tweeds, the
European inspired women's fashion catalog. In addition, in January 1994, the
Company entered into a licensing agreement (the "Sears Agreement") with Sears,
Roebuck and Co. ("Sears") to produce specialty catalogs for the 23 million Sears
customers no longer being served by the recently discontinued Sears catalog.

The Company believes that direct marketing offers several advantages over
traditional retail stores including the convenience, safety and efficiency of
home shopping. These benefits are increasingly important as a result of changing
demographics including the growing number of dual income families and the aging
of the population. From 1987 through 1992, total U.S. catalog sales grew more
rapidly than retail store sales, at an average annual rate of approximately 8%.
The Company believes that direct marketing sales will continue to grow more
rapidly than retail store sales.

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<PAGE> 6

RELATIONSHIP WITH NAR

In the fall of 1991, NAR Group Limited, a British Virgin Islands
corporation (together with its affiliates, "NAR"), effectively gained control of
the Company. Upon completion of the offering of the shares of Common Stock
offered hereby (the "Offering"), NAR will own 46,841,528 shares of Common Stock
and warrants and options to purchase 5,053,735 shares of Common Stock
constituting 53.3% of the outstanding Common Stock of the Company on a
fully-diluted basis (approximately 52.7% if the Underwriters' over-allotment
option is exercised in full). NAR is a private investment holding company that
is a joint venture between the family of Alan G. Quasha, a Director and the
Chairman of the Board of the Company, and Compagnie Financiere Richemont A.G., a
Swiss public company engaged in tobacco, luxury goods and other businesses
("Richemont"). Richemont is the ultimate parent of a family of some of the
world's leading luxury goods trademarks, including Cartier, Piaget, Baume &
Mercier, Alfred Dunhill and Montblanc. See "The Company -- History and
Organization -- Restructuring," "Management -- General," "Principal and Selling
Shareholders" and "Relationship with NAR."

THE OFFERING

<TABLE>
<S> <C>
Common Stock Offered
By the Company.............. 7,345,396 shares
By the Selling
Shareholder.............. 654,604 shares
Common Stock to be Outstanding
after the Offering.......... 97,320,618 shares(a)
Use of Proceeds............... The net proceeds to the Company will be used for general
corporate purposes, including the expansion of the Company's
business. See "Use of Proceeds."
American Stock Exchange
symbol...................... HNV
</TABLE>

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

(a) Includes 5,563,985 shares reserved for issuance under outstanding warrants
and options exercisable within 60 days of March 30, 1994. Excludes 1,180,994
shares reserved for issuance under outstanding options which are not
currently exercisable and 2,737,493 shares reserved for issuance upon the
exercise of options that may be granted in the future under the Company's
stock option plans.

5
<PAGE> 7

SUMMARY CONSOLIDATED FINANCIAL DATA

The summary consolidated financial data for the fiscal years 1989 through
1993 have been derived from the consolidated financial statements of the Company
(successor to H&H) and its subsidiaries, which statements have been audited by
Arthur Andersen & Co., independent public accountants, whose report on certain
of such financial statements is included elsewhere and incorporated by reference
in this Prospectus. Certain reclassifications have been made to the financial
data for the fiscal years prior to 1993 in order to conform with the fiscal 1993
presentation.

In September 1993, the Company was formed in connection with mergers
involving the Company, H&H and THC, a wholly owned subsidiary of H&H. The
mergers were accounted for similarly to a pooling-of-interests, and,
accordingly, the Company's summary consolidated financial data include the
results of H&H and THC for all applicable periods presented.

<TABLE>
<CAPTION>
AS OF JANUARY 1, 1994
-------------------------
ACTUAL AS ADJUSTED(A)
-------- --------------
<S> <C> <C>
(IN THOUSANDS)
BALANCE SHEET DATA (END OF PERIOD):
Working capital...................................................... $ 25,476 $ 68,807
Total assets......................................................... 188,838 232,169
Total debt........................................................... 36,160 36,160
Shareholders' equity................................................. 45,868 89,199
</TABLE>

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

(a) Adjusted to reflect the sale by the Company of 7,345,396 shares of Common
Stock offered hereby at a price of $6.375 per share, less estimated
underwriting discount and offering expenses.

6
<PAGE> 8

INVESTMENT CONSIDERATIONS

In addition to all the other information contained in this Prospectus and
the documents incorporated by reference, prospective purchasers should consider
the investment considerations set forth below prior to deciding whether to
invest in the Common Stock offered hereby.

FUTURE OPERATING RESULTS

The Company's continued revenue growth and positive net income will depend
on its ability to increase catalog sales and to effectively monitor and control
costs. There can be no assurance that the Company's future operations will
generate net income. Furthermore, future operating results depend upon many
factors, including general economic conditions, the ability of the Company to
continue to attract and retain customers successfully, the level of competition
and its ability to successfully identify, forecast and respond to customer
preferences and fashion trends. See "Management's Discussion and Analysis of
Consolidated Financial Condition and Results of Operations."

The Company's Domestications catalog is the nation's leading specialty home
textile catalog with revenues of approximately $311 million in 1993, which
constitute approximately 48% of the Company's revenues in 1993. A decrease in
profitability of Domestications would have a material adverse effect upon the
Company's financial position and results of operations.

RECENT ACQUISITIONS AND NEW BUSINESS DEVELOPMENTS

The Company acquired three businesses during 1993: (i) in May, the Company
acquired the assets of Gump's, the well known San Francisco retailer and a
leading upscale catalog marketer of exclusive gifts; (ii) in August, the Company
acquired the assets of The Company Store, an upscale direct marketer of down
comforters and other down and related products for the home; and (iii) in
September, the Company acquired the stock of Tweeds, the European inspired
women's fashion catalog. None of these companies was profitable at the time of
its acquisition by the Company. In addition, these acquisitions present
relatively new market niches for the Company and the Company must successfully
integrate and develop these newly acquired companies. There can be no assurance
that the Company will be able to successfully integrate or develop these new
businesses or improve their profitability. See "The Company -- Recent Strategic
Acquisitions and Ventures" and "Business -- Growth Strategy -- Strategic
Acquisitions."

In addition, in January 1994, the Company entered into the Sears Agreement
to produce specialty catalogs for the 23 million customers of the recently
discontinued Sears catalog. The Sears Agreement represents the culmination of
successful test marketing by Sears and the Company during 1993. The Sears
Agreement contains increasing performance standards which must be met by the
Company and which allow Sears to terminate the Sears Agreement upon
noncompliance. There can be no assurance that the Company will be able to meet
such performance standards. See "The Company -- Recent Strategic Acquisitions
and Ventures -- Sears" and "Business -- Growth Strategy -- Strategic
Ventures -- Sears Agreement."

COMPUTER SYSTEMS CONVERSION

The Company is currently in the process of upgrading its management
information systems by implementing new integrated software and migrating from a
centralized mainframe to mid-range mini-computers. The Company currently
estimates that the total cost to install and implement the new systems,
including the cost of dedicated internal personnel, will be approximately $13 to
$15 million. The Company plans to bring the new systems on-line for several
catalogs in 1994 (during which time it will maintain its existing systems for
its other catalogs) with the balance of the Company's catalogs to be brought
on-line in 1995. There can be no assurance that the new systems will be
implemented as currently scheduled or that they will achieve the goals
established by the Company, in which case the Company's financial position or
results of operations may be adversely affected. See "Business -- Management
Information Systems."

7
<PAGE> 9

NEW FULFILLMENT FACILITY

The Company owns an interest in the Roanoke, Virginia fulfillment center
which services its Tweeds catalog. The Company plans to consolidate additional
Apparel Group catalogs into this facility and to construct in 1994 an additional
500,000 square foot state-of-the-art facility on a separate site in Roanoke
which, upon its completion, will handle all of Domestications fulfillment needs.
The Company estimates that the total cost of this consolidation effort and the
construction of the new facility will be approximately $18 million, the funds
for which may be derived from this Offering. See "Use of Proceeds." Although the
Company has carefully planned the transition to these facilities in phases,
significant delays or serious unanticipated difficulties arising from the
transition could adversely affect the Company's financial position or results of
operations. See "Business -- Distribution."

FOREIGN SOURCING

Approximately 10% of the Company's merchandise is purchased directly from
foreign suppliers. Although the Company believes that it has established close
relationships with its principal manufacturing sources, the Company's future
success will depend in some measure upon its ability to maintain such
relationships.

The Company's business is subject to the risks generally associated with
conducting business abroad, including adverse fluctuations in currency exchange
rates (particularly those of the U.S. dollar against certain foreign
currencies), changes in import duties or quotas, the imposition of taxes or
other charges on imports, disruptions or delays in shipments and transportation,
labor disputes and strikes. The occurrence of any one or more of the foregoing
could adversely affect the Company's financial position or results of
operations. To date, these factors have not caused any material disruption of
the Company's operations. Also, the Company conducts business with most of its
vendors in United States currency and has not experienced any material
difficulties as a result of any foreign, political, economic or social
liabilities.

INCREASES IN COSTS OF MAILING, PAPER AND PRINTING

Postal rate increases and paper and printing costs affect the cost of the
Company's order fulfillment and catalog and promotional mailings. In 1993, the
Company mailed approximately 322 million catalogs and the aggregate cost of
mailing catalogs and other promotional materials, including printing and paper
costs, totalled approximately $158 million. The Company has contracted for its
paper needs through the end of 1994 and believes its paper costs are competitive
at the present time. However, no assurance can be given that the Company will
not be subject to a significant increase in paper costs. The Company anticipates
a postal rate increase in 1995. Increases in postal rates or paper and printing
costs could have a material negative impact on the Company's financial position
and results of operations to the extent that the Company is unable to pass such
increase directly on to customers or to offset such increase by raising selling
prices or by implementing more efficient printing, mailing, delivery and order
fulfillment systems. See "Business -- Business Strategy -- Leverage Centers."

CONSUMER SPENDING

The success of the Company's operations depends upon a number of factors
relating to consumer spending, including future economic conditions affecting
disposable consumer income such as employment, business conditions, interest
rates and taxation. There can be no assurance that weak economic conditions or
changes in the retail environment or other economic factors that impact the
level of consumer spending would not have a material adverse impact on the
Company.

COMPETITION

The mail order catalog business is highly competitive. The Company's
catalogs compete with other mail order catalogs and retail stores, including
department stores, specialty stores and discount stores. A number of the
Company's competitors have substantially greater financial, distribution and
marketing resources than the Company. The recent substantial sales growth in the
direct marketing industry has encouraged the entry of

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<PAGE> 10

many new competitors and an increase in competition from established companies.
See "Business -- Competition."

RELATIONSHIP WITH NAR

Upon completion of the Offering, NAR will own 53.3% of the Company's
outstanding Common Stock on a fully-diluted basis (approximately 52.7% if the
Underwriters' over-allotment option is exercised in full). Although pursuant to
a stock purchase agreement between the Company and NAR, NAR has agreed to
nominate only six of the Company's 11 Directors until 1996, NAR will have the
power to elect the entire Board of Directors and, except as otherwise provided
by law or the Company's Certificate of Incorporation, to approve any action
requiring shareholder approval without a shareholders meeting. See "The
Company -- History and Organization -- Restructuring," "Management -- General,"
"Principal and Selling Shareholders" and "Relationship with NAR."

SHARES ELIGIBLE FOR FUTURE SALE

There will be 91,756,633 shares of Common Stock outstanding immediately
following the Offering (92,956,633 if the Underwriters' over-allotment option is
exercised in full). Of such amount, 37,034,568 shares (38,234,568 if the
Underwriters' over-allotment option is exercised in full) will be tradeable
without restriction and the remainder will be "restricted securities" under the
Securities Act, and may only be sold pursuant to a registration statement under
the Securities Act or an applicable exemption from the registration requirements
of the Securities Act, including Rule 144 thereunder. Certain shareholders
owning 54,067,462 restricted shares and warrants and options currently
exercisable for 7,894,595 shares have agreed with the Underwriters not to sell
or otherwise dispose of any shares for 180 days after the date of this
Prospectus without the prior consent of Merrill Lynch, Pierce, Fenner & Smith
Incorporated on behalf of the Underwriters. The Company has agreed not to sell
or otherwise dispose of any shares for 180 days after the date of this
Prospectus without the prior written consent of Merrill Lynch, Pierce, Fenner &
Smith Incorporated on behalf of the Underwriters, except in certain
circumstances including shares issued 90 days after the date of this Prospectus
in connection with an acquisition. The Selling Shareholder owning 654,603
restricted shares has agreed with the Underwriters not to sell or otherwise
dispose of any shares for 90 days after the date of this Prospectus without the
prior consent of Merrill Lynch, Pierce, Fenner & Smith Incorporated on behalf of
the Underwriters. In addition, NAR, Sun Life Insurance Company of America ("Sun
Life") and certain executive officers of the Company are entitled to certain
rights with respect to registration of their shares of Common Stock under the
Securities Act. Sales of substantial amounts of Common Stock in the public
market could adversely affect the market price. NAR and such executive officers
have advised the Company that they do not currently intend to sell any shares of
Common Stock owned by them. No predictions can be made as to the effect, if any,
that market sales of such shares or the availability of such shares for future
sale will have on the market price of shares of Common Stock prevailing from
time to time. The prevailing market price of Common Stock after the Offering
could be adversely affected by future sales of substantial amount of Common
Stock by existing shareholders. See "Shares Eligible for Future Sale."

RESTRICTIONS ON DIVIDENDS

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

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<PAGE> 11

THE COMPANY

HISTORY AND ORGANIZATION

History. The Company's direct marketing subsidiary, founded in 1934,
initially operated as a chain of specialty retail women's fashion stores in
Pennsylvania and nearby states under the name Lana Lobell. In 1950, it published
its first catalog offering women's fashion by mail and, by the end of the
decade, a majority of the subsidiary's revenues was derived from catalog sales.
In 1962, the subsidiary first published Hanover House, a catalog featuring
gifts, seasonal, household and novelty items. The Company's direct marketing
subsidiary was acquired in 1972 by The Horn & Hardart Company ("H&H"), a
restaurant company founded in 1911. The Company's direct marketing subsidiary
continued its growth through internal development of new and existing catalogs
utilizing its proprietary customer list as well as through acquisitions of other
catalog companies.

Restructuring. The Company incurred a substantial amount of debt in
connection with the growth of its restaurant business in the 1970s and 1980s.
The Company began restructuring its business in 1989 by disposing of the real
estate assets and operations related to its restaurant business and focusing on
its direct marketing operations. As the Company began the disposition of its
restaurant operations, management believed that the underlying asset values
would at least enable it to repay the debts secured thereby. However, the
Company's withdrawal from the restaurant business coincided with a severe
decline in real estate values in the northeastern United States and elsewhere in
the country. Accordingly, the Company failed to generate sufficient cash
proceeds to repay all of the associated debt. As a result, a high level of debt
remained which placed an excessive burden on the cash flows of the direct
marketing business, the Company's only source of internally generated cash. By
early 1991, vendors and factors were restricting the availability of trade
credit on normal terms, hampering the Company's ability to purchase merchandise.
Because of strong demand for the merchandise in the Company's catalogs and its
inability to obtain adequate trade credit with which to purchase merchandise,
the Company's backorder level increased substantially and it incurred operating
losses in 1990 and 1991. In response, the Company began to take additional
actions and explore financial alternatives available to it to solve its cash
flow problems, including the sale of an equity interest in the Company.

In the fall of 1991, NAR acquired a 48.9% interest in the Company through
an equity investment of $40 million and the extension of a line of credit of up
to $30 million (later increased to $50 million) and implemented a restructuring
program consisting of operational changes, debt reduction and the disposition of
substantially all of the Company's remaining non-direct marketing assets. The
Company reported a loss from continuing operations of approximately $51.1
million in 1991, including $15.3 million of nonrecurring charges, due to
liquidity problems caused by the cash needs of the Company and a loss on
disposal of discontinued operations of $21.1 million.

By the end of 1992, through a series of transactions, including a rights
offering, a sale of preferred stock and exchange offers, and the sale of
substantially all of its restaurant and real estate properties, the Company

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<PAGE> 12

reduced its debt and lease obligations (excluding working capital debt) by
$182.8 million from September 1991. As a result of these transactions, NAR
increased its equity investment by approximately $38.1 million and its interest
in the Company to approximately 56%.

Establishment of New Business Objectives. Subsequent to NAR acquiring
control of the Company, the following key goals were established: (1) develop
distinct brand identities for each of the Company's specialty catalogs; (2)
decentralize the Company's operating structure; (3) identify and utilize the
cost savings and operating efficiencies created by the high sales volumes
generated on a combined basis from the Company's multiple specialty catalogs;
(4) motivate Company employees by linking compensation to both individual and
overall Company performance and encourage employee stock ownership; (5) grow the
Company's catalog business through: (i) internal catalog growth and development;
(ii) strategic acquisitions; (iii) strategic ventures; (iv) development of
international market opportunities; and (v) exploration of growth prospects in
electronic interactive media; and (6) upgrade the Company's management
information systems to better support the growth of its direct marketing
business. Progress has been made toward achieving all of these goals and is
reflected in the Company's financial results. In 1992, due to the impact of the
financial restructuring and operational changes that began in the fourth quarter
of 1991, income from continuing operations improved by approximately $52 million
from a loss of approximately $51 million in 1991 to income of approximately $1
million in 1992. In 1993, income from operations improved approximately $16.3
million to $17.3 million.

Reorganization. In September 1993, the Company changed its name to Hanover
Direct, Inc. and eliminated its two-tier holding company structure. This
reorganization was accounted for similarly to a pooling-of-interests, and,
accordingly, the Company's financial data include the results of H&H and THC for
all applicable periods presented.

RECENT STRATEGIC ACQUISITIONS AND VENTURES

During 1993 and 1994 the Company made the following five strategic
acquisitions:

Gump's. In May 1993, the Company acquired substantially all of the assets
of Gump's Inc., the well known San Francisco retailer and a leading upscale
catalog marketer of exclusive gifts, for a total purchase price of $13.2
million, consisting of $6.9 million in cash and $6.3 million of Common Stock.
Financing for the cash portion of the purchase price was obtained from the sale
of Gump's accounts receivables, cash acquired from Gump's and $1.5 million from
the Company's revolving credit facility. The Company is relocating Gump's retail
store to a new location in downtown San Francisco, which is scheduled to open in
the fall of 1994.

The Company Store. In August 1993, the Company acquired in Chapter 11
bankruptcy proceedings substantially all of the assets of Company Store
Holdings, Inc., an upscale direct marketer of down comforters and other down and
related products for the home sold under The Company Store and Scandia Down
names, for a total purchase price of $7 million, consisting of the issuance of
$4.6 million of notes and $2.4 million of Common Stock.

Tweeds. In September 1993, the Company purchased all of the outstanding
shares of common and preferred stock of Tweeds, Inc. which owns Tweeds, the
European inspired women's fashion catalog, for a total purchase price of $8.8
million, consisting of the assumption of $5.1 million of liabilities, $.1
million in cash and $3.6 million of Common Stock.

Safety Zone. In September 1993, the Company acquired 20% of the
outstanding common stock of Aegis Safety Holdings, Inc. ("Aegis"), a direct
marketer of safety and anti-hazard products through The Safety Zone catalog. The
consideration for the acquisition was the provision by the Company of certain
catalog fulfillment and production services for The Safety Zone catalog at the
Company's cost until August 1998, subject to certain early termination
provisions. The Company also acquired an option to increase its ownership to 50%
of Aegis' common stock until the end of 1996. Aegis has an option to require the
Company to acquire all of Aegis' then outstanding stock after December 31, 1998
if the Company has exercised its option and certain other conditions have been
satisfied. The Company has extended a secured working capital

11
<PAGE> 13

line of up to $1 million to Aegis. Aegis had approximately $9 million in net
sales for the eleven months ended January 1, 1994.

Boston Publishing. In February 1994, the Company acquired a 20%
ownership interest in Boston Publishing Company, Inc. ("BPC"), the publisher of
The Museum Collection, a catalog featuring reproductions, replicas and
adaptations of items contained in museum collections, and Finishing Touches, a
catalog featuring items for the home, in consideration for providing $3.0
million of secured working capital financing, a $.75 million short-term loan and
a $.5 million convertible term loan. As part of the acquisition the Company will
provide BPC with access to the Company's proprietary customer list and catalog
production assistance. BPC had approximately $12 million (unaudited) in revenues
in 1993.

In addition, the Company has recently entered into the following strategic
venture:

Sears. In January 1994, the Company entered into the Sears Agreement with
the direct marketing subsidiary of Sears to produce specialty catalogs for the
23 million customers of the recently discontinued Sears catalog. The specialty
catalogs include: Show Place, based on the Domestications catalog, Great
Kitchens, based on the Colonial Garden Kitchens catalog, and Beautiful Style,
based on the Silhouettes catalog. See "Business -- Merchandising and Catalog
Format." The Sears Agreement has an initial three-year term with automatic
renewals thereafter. Profits and losses from the venture are to be shared
between the parties on an equal basis. As part of the Sears Agreement, the
Company has agreed to issue and deliver to Sears a performance warrant to
purchase 3.5 million shares of Common Stock in 1999 if the licensed business
with Sears has revenues of at least $250 million and earnings before interest
and taxes of at least $30 million in 1998. Alternately, Sears will be entitled
to purchase 7 million shares of Common Stock in 1999 if the licensed business
with Sears has revenues of at least $500 million and earnings before interest
and taxes of at least $60 million in 1998. If neither of these goals is
achieved, the performance warrant will expire unexercised in 1999. The Company
will be required to value the performance warrant at such time as it is deemed
to have become measurable for accounting purposes because the required events
have become probable or have occurred (which may be prior to the date the
warrant is exercisable under the Sears Agreement) (the "Measurement Date"). The
value would be the difference, if any, between the closing market price of the
Common Stock at the Measurement Date and the exercise price of the performance
warrant, multiplied by the applicable number of shares. The value would be
amortized from the Measurement Date through 1998 and would be subject to change
each reporting period based on the closing market price of the Common Stock as
of such reporting date. The warrant exercise price is $10.57 per share. The
terms of the warrant agreement are the subject of negotiation between the
Company and Sears. However, the Company does not believe that the final terms of
this agreement will be materially different than the terms described above. The
Company is obligated to meet various operational performance standards under the
Sears Agreement. If the Company is unable to meet these standards, Sears would
be entitled to terminate the Sears Agreement. The Company is also entitled to
terminate the Sears Agreement in certain circumstances, including if Sears fails
to comply with any material provision of the Sears Agreement. See "Investment
Considerations -- Recent Acquisitions and New Business Developments" and
"Business -- Business Strategy -- Strategic Ventures -- Sears Agreement."

The Company is incorporated in Delaware with its principal executive office
at 1500 Harbor Boulevard, Weehawken, New Jersey 07087. The Company's telephone
number is (201) 863-7300.

12
<PAGE> 14

USE OF PROCEEDS

The net proceeds to the Company from the sale of the 7,345,396 shares of
Common Stock offered by the Company, after deducting estimated offering expenses
and underwriting discount, will be approximately $43,331,139 (approximately
$50,540,739 if the Underwriters' over-allotment option is exercised in full).
The Company will not receive any proceeds from the sale of shares of Common
Stock by the Selling Shareholder.

The Company intends to use the net proceeds (including any net proceeds
received as a result of the exercise of the over-allotment option by the
Underwriters) for general corporate purposes, including the expansion of the
Company's business, consisting of upgrading and increasing its fulfillment
capacity, purchasing new management information systems and making potential
future acquisitions. See "Business -- Properties" and "-- Management Information
Systems." Pending any specific application of the net proceeds, a portion of the
net proceeds will be applied to reduce outstanding indebtedness under the
Company's $52.5 million three year revolving credit facility which expires in
May 1996 (the "Revolving Credit Facility") and the balance will be added to
working capital and invested in short-term interest bearing obligations. At
March 29, 1994, the Company's interest rate under the Revolving Credit Facility
was approximately 8% and the principal amount outstanding thereunder was $24.0
million.

PRICE RANGE OF COMMON STOCK

The Common Stock is traded on the AMEX under the symbol "HNV." The
following table sets forth the high and low sale prices of the Common Stock
reported on the AMEX Composite Tape for the periods shown.

<TABLE>
<CAPTION>
HIGH LOW
---- ---
<S> <C> <C>
1992
First Quarter.............................................................. $3 $1 1/2
Second Quarter............................................................. 2 1/8 1 5/8
Third Quarter.............................................................. 2 1/4 1 3/8
Fourth Quarter............................................................. 2 7/8 1 5/8
</TABLE>

<TABLE>
<S> <C> <C>
1993
First Quarter.............................................................. 4 2 1/16
Second Quarter............................................................. 4 1/2 2 3/4
Third Quarter.............................................................. 5 1/2 4 1/16
Fourth Quarter............................................................. 7 5/8 4 1/2
1994
First Quarter (through March 30, 1994)..................................... 7 7/8 5 7/8
</TABLE>

As of March 28, 1994, there were approximately 4,328 holders of record of
the Common Stock. On March 30, 1994, the last reported sale price of the Common
Stock on the AMEX was $6.50 per share.

DIVIDEND POLICY

13
<PAGE> 15

CAPITALIZATION

The following table sets forth the consolidated capitalization of the
Company at January 1, 1994 and as adjusted to reflect the net proceeds from the
sale of the 7,345,396 shares of Common Stock offered by the Company (assuming
the Underwriters' over-allotment option is not exercised). See "Use of
Proceeds."

<TABLE>
<CAPTION>
AT JANUARY 1, 1994
-----------------------
ACTUAL AS ADJUSTED
--------- -----------
(IN THOUSANDS, EXCEPT
SHARE AND PER SHARE
DATA)
<S> <C> <C>
LONG-TERM DEBT:
Revolving Credit Facility............................................ $ 230 $ 230
9.25% senior subordinated notes due 1998............................. 20,000 20,000
Industrial Revenue bonds due 2003.................................... 8,000 8,000
Notes, debentures and other.......................................... 5,906 5,906
--------- -----------
Total long-term debt.............................................. 34,136 34,136
--------- -----------
SHAREHOLDERS' EQUITY:
6% Series A convertible preferred stock, $10 stated value, 234,900
shares authorized, issued and outstanding......................... $ 2,378 $ 2,378
Common Stock, $.66 2/3 par value, authorized 150,000,000 shares;
83,136,542 shares issued and 82,933,177 shares outstanding;
91,791,145 shares issued and 91,587,780 shares outstanding, as
adjusted(a)....................................................... 55,423 61,193(c)
Capital in excess of par value....................................... 209,834 247,395(c)
Accumulated deficit.................................................. (215,805) (215,805)
Less: Treasury stock and other(b).................................... (5,962) (5,962)
--------- -----------
Total shareholders' equity........................................ 45,868 89,199
--------- -----------
Total capitalization............................................ $ 80,004 $ 123,335
--------- -----------
--------- -----------
</TABLE>

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

(a) Excludes 5,563,985 shares of Common Stock issuable upon exercise of
outstanding options and warrants exercisable within 60 days of March 30,
1994.
(b) Includes deferred compensation and notes receivable from the sale of Common
Stock.
(c) Includes the exercise of warrants to purchase 1,309,207 shares in a
"net-issue" exchange.

14
<PAGE> 16

SELECTED CONSOLIDATED FINANCIAL DATA

The selected financial data for the fiscal years 1989 through 1993 have
been derived from the consolidated financial statements of the Company
(successor to H&H) and its subsidiaries, which have been audited by Arthur
Andersen & Co., independent public accountants, whose report on certain of such
financial statements is included elsewhere and incorporated by reference in this
Prospectus. The following information should be read in conjunction with
"Management's Discussion and Analysis of Consolidated Financial Condition and
Results of Operations" and such financial statements, including the related
notes thereto, included elsewhere herein. Certain reclassifications have been
made to financial data for fiscal years prior to fiscal 1993 in order to conform
with the fiscal 1993 presentation.

In September 1993, the Company was formed in connection with two mergers
involving the Company, H&H and THC, a wholly owned subsidiary of H&H. The
mergers were accounted for similarly to a pooling-of-interests, and,
accordingly, the Company's selected consolidated financial data include the
results of H&H and THC for all applicable periods presented.

<TABLE>
<CAPTION>
FISCAL YEAR
--------------------------------------------------------------
1989 1990 1991 1992 1993
---------- ---------- ---------- ---------- ----------
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Revenues............................. $ 382,637 $ 555,770 $ 623,650 $ 586,562 $ 642,511
Operating income (loss).............. 9,703 10,190 (26,078) 14,402 19,076
Interest expense, net................ 11,084 11,426 18,341 13,135 2,757
Other income (expense)............... 1,868 -- (6,437) -- 888
Income (loss) from continuing
operations......................... 187 (2,136) (51,081) 1,048 17,337
(Loss) from discontinued
operations......................... (9,146) (115,921) (21,119) -- --
---------- ---------- ---------- ---------- ----------
Income (loss) before extraordinary
items and cumulative effect of
accounting change for income
taxes.............................. (8,959) (118,057) (72,200) 1,048 17,337
Extraordinary items.................. -- 2,146 6,915 9,201 --
Cumulative effect of accounting
change for income taxes............ -- -- -- 10,000 --
---------- ---------- ---------- ---------- ----------
Net income (loss).................... (8,959) (115,911) (65,285) 20,249 17,337
Preferred stock dividends(a)......... -- -- 466 3,197 4,093
---------- ---------- ---------- ---------- ----------
Net income (loss) applicable to
common shareholders................ $ (8,959) $ (115,911) $ (65,751) $ 17,052 $ 13,244
---------- ---------- ---------- ---------- ----------
---------- ---------- ---------- ---------- ----------
Primary and fully diluted:
Income (loss) per share from
continuing operations........... $ .01 $ (.15) $ (3.16) $ (.06) $ .17
Income (loss) per share from
discontinued operations......... (.64) (8.24) (1.30) -- --
---------- ---------- ---------- ---------- ----------
Income (loss) per share before
extraordinary items............. (.63) (8.39) (4.46) (.06) .17
Extraordinary items per share...... -- .15 .43 .24 --
Cumulative effect of accounting
change for income taxes per
share........................... -- -- -- .26 --
---------- ---------- ---------- ---------- ----------
Net income (loss) per share
applicable to common
shareholders....................... $ (.63) $ (8.24) $ (4.03) $ .44 $ .17
---------- ---------- ---------- ---------- ----------
---------- ---------- ---------- ---------- ----------
Weighted average number of shares
outstanding........................ 14,145,416 14,068,460 16,287,723 38,467,015 77,064,131
BALANCE SHEET DATA (END OF PERIOD):
Working capital (deficit)............ $ 42,176 $ 8,913 $ (37,636) $ 31,566 $ 25,476
Total assets......................... 324,148 234,761 162,800 134,352 188,838
Total debt........................... 179,251 155,649 127,918 43,362 36,160
Preferred stock of subsidiary........ -- -- 35,247 32,842 --
Shareholders' equity (deficit)....... 53,813 (61,484) (113,632) (19,758) 45,868
</TABLE>

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

(a) There were no cash dividends paid to holders of Common Stock in any of the
respective periods.

15
<PAGE> 17

MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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

<TABLE>
<CAPTION>
FISCAL YEAR
---------------------------
1991 1992 1993
----- ----- -----
<S> <C> <C> <C>
Revenues........................................................ 100.0% 100.0% 100.0%
Cost of sales and operating expenses............................ 65.6 65.1 63.6
Selling expenses................................................ 28.0 23.6 24.6
General and administrative expenses............................. 9.2 8.9 8.9
Income (loss) from operations................................... (4.2) 2.5 3.0
Interest expense, net........................................... 2.9 2.2 .4
Income (loss) from continuing operations before income taxes.... (8.2) .2 2.7
Income tax provision (credit)................................... -- -- --
Income (loss) from continuing operations........................ (8.2)% .2% 2.7%
</TABLE>

RESULTS OF OPERATIONS

1993 Compared with 1992

Net Income. The Company reported net income of $17.3 million or $.17 per
share for the year ended January 1, 1994, compared to net income of $1.0 million
(before extraordinary items and cumulative effect of accounting change) or a
loss of $.06 per share in 1992. Net income for 1992 after extraordinary items
and cumulative effect of accounting change was $20.2 million or $.44 per share.
Per share amounts are expressed after deducting preferred dividends of $3.2
million in 1992 and $4.1 million in 1993.

Revenues. Revenues increased 9.5% from $587 million in 1992 to $643
million in 1993. The higher revenues were due to a 10% increase in revenues
relating to continuing catalogs, which include the initial test marketing of the
Sears venture which began in mid-1993 and resulted in the Sears Agreement in
January 1994. Additionally, approximately $47 million of the increase was
generated by the acquisition of Gump's, The Company Store and Tweeds in the
second half of 1993. Revenues from discontinued catalogs were $63 million and
$19.7 million in 1992 and 1993, respectively.

Non-Apparel revenues increased 23% from $395 million in 1992 to $484
million in 1993. This increase is a result of $38 million of revenues generated
by Gump's and The Company Store which were acquired in the third quarter of 1993
and a 14% increase in revenues related to continuing catalogs. Substantially all
of the increase in revenues from continuing catalogs is related to
Domestications, Colonial Garden Kitchens and Tapestry, of which approximately
40% is attributable to the Sears venture. Revenues from discontinued catalogs
(assuming such catalogs were discontinued at the beginning of 1992) were $10
million and $6.4 million in 1992 and 1993, respectively.

Apparel revenues declined 17% from $192 million in 1992 to $159 million in
1993. Revenues from discontinued catalogs were $53 million and $13 million in
1992 and 1993, respectively, while continuing catalog revenues declined by 2%
from 1992. Additionally, the acquisition of Tweeds in the fourth quarter of 1993
contributed $9 million to revenues. As discussed below, the Company is
continuing to restructure its Apparel catalogs.

The Company mailed approximately 322 million catalogs in 1993, a 13%
increase over 1992, with variations in mailing strategies and volumes amongst
the catalogs. Additionally, the Company was able to increase its average order
size by 9%. Revenues also improved as the Company reduced its order cancellation
and return rates compared to 1992, principally as a result of improving its
in-stock inventory position.

Operating Costs and Expenses. Cost of sales and operating expenses as a
percentage of revenues decreased from 65.1% in 1992 to 63.6% in 1993. The
improvement was attributable to an increase in product margin due to changes in
the sales mix as well as lower inventory markdowns in 1993 and lower shipping
costs

16
<PAGE> 18

due to more efficient shipping methods. Shipping costs were also positively
impacted by fewer split-shipments due to the improved in-stock inventory
position.

Selling expenses increased from 23.6% of revenues in 1992 to 24.6% of
revenues in 1993, representing an increase of $19.3 million. This increase was
due to lower response rates, related principally to an aggressive customer
acquisition campaign primarily in Domestications (which increased the size of
its 12 month customer list by 14%) and from the addition of the selling expenses
for the Gump's retail store. Selling expenses include catalog creation and
mailing costs and rentals of mailing lists from third parties, as well as retail
selling expenses.

General and administrative expenses represented 8.9% of revenues in 1992
and 1993. Such expenses increased $5.3 million, or 10.2%, from 1992 to 1993,
including $5.8 million of expenses for the three companies acquired in 1993.
General and administrative expenses were reduced by lower bad debt expense and
lower credit card commissions, offset by increases in merchandise and marketing
personnel.

Income (Loss) from Operations. Income from operations increased from $14.4
million in 1992, or 2.5% of revenues, to $19.1 million in 1993, or 3.0% of
revenues. Income from operations excluding the discontinued catalogs was $24.6
million in 1992 (comprised of $21.9 million and $2.7 million for Non-Apparel and
Apparel, respectively) compared to $26.7 million in 1993 (comprised of $25.8
million and $.9 million for Non-Apparel and Apparel, respectively). Of this, the
three companies acquired in 1993 generated income from operations of $3 million.
Losses from discontinued catalogs were $9.0 million in 1992 compared to $4.3
million in 1993.

The restructuring of the Apparel catalogs continued in 1993 as the catalog
mix was changed further, with two catalogs being discontinued and the
acquisition of Tweeds, Inc. In order to improve operating results, each Apparel
catalog is being more sharply focused on its target audience and overhead and
circulation levels for certain catalogs have been reduced.

Interest and Other Income (Expense). Interest expense decreased
approximately $8.5 million from $13.4 million in 1992 to $4.9 million in 1993,
due to the Company's financial restructuring which began in the fourth quarter
of 1991 and included a debt reduction of $67 million from the beginning of 1992
to the end of 1993. Interest income was $2.2 million in 1993, an increase of
$1.9 million from 1992, due primarily to the interest portion of a Federal
income tax refund received in fiscal 1993.

Other income of $.9 million in 1993 represents a settlement of a claim in
bankruptcy from a brokerage firm with which the Company had previously had a
contract.

Income Taxes. In 1992 the Company adopted Statement of Financial
Accounting Standards No. 109 -- Accounting for Income Taxes ("SFAS 109"). In
accordance with this statement, the Company recognized a deferred tax asset of
$10 million reflecting the cumulative effect of this accounting change for the
estimated future benefit expected to be realized from the utilization of net
operating loss carryforwards ("NOLs") and deductible temporary differences. The
deferred tax asset consisted of a $63 million gross deferred tax asset less a
$53 million valuation allowance that was established to reflect the annual
limitation on the utilization of certain of the NOLs and an assumed limitation
on the utilization of the remaining deferred tax asset. Realization of the
future tax benefits is dependent on the Company's ability to generate taxable
income within the carryforward period. Future levels of operating income and
taxable income are dependent, in part, upon general economic conditions,
competitive pressures on sales and margins, and other factors beyond the
Company's control.

In 1992 management determined that, based on the successful completion of
the financial restructuring, future operating income of the Company would be
sufficient to utilize $30 million of deductible timing differences and NOLs
prior to their expiration. (See "Results of Operations -- 1992 Compared with
1991" for additional details.) At January 1, 1994, the Company had $147 million
of NOLs and has maintained the $30 million amount of expected future operating
income that will more likely than not utilize the NOLs prior to their
expiration. Management believes that, although the 1993 operating results might
justify a higher amount, in view of its history of operating losses, the $30
million represents a reasonable conservative estimate of the future utilization
of the NOLs and the Company will continue to evaluate the likelihood of future
profit and the necessity of future adjustments to the deferred tax asset
valuation allowance.

17
<PAGE> 19

The Federal income tax provision was $5.9 million in 1993 which was offset
by the utilization of certain NOLs. In addition, the Revenue Reconciliation Act
of 1993 raised the 1993 corporate income tax rate from 34% to 35%, and, as a
result, the Company recognized an additional deferred tax benefit of $.6 million
in 1993. In addition, the Company recorded a state tax provision of $.2 million
in 1992 and $.5 million in 1993.

Shareholders' Equity. The number of shares of Common Stock outstanding
increased by 13,396,345 in 1993 due to: (i) 1,150,733 shares issued in
connection with the Company's equity and incentive plans; (ii) 2,615,928 shares
issued in connection with the acquisitions of Gump's, The Company Store and
Tweeds; (iii) 2,278,128 shares issued upon the conversion of the 7.5% Cumulative
Convertible Preferred Stock; (iv) 18,937,169 shares issued in connection with
the exchange of the Class B 8% Cumulative Preferred Stock and Class B Common
Stock (of which 12,270,503 shares were exchanged); and (v) 684,890 shares issued
as dividends on the Class B 8% Cumulative Preferred Stock. At January 1, 1994,
there were 82,933,177 shares of Common Stock outstanding compared to 69,536,832
shares outstanding at December 26, 1992.

The dividends of $3.2 million in 1992 and $4.1 million in 1993 represent
dividend requirements on the two preferred stocks. These preferred stocks were
converted into Common Stock in 1993, which resulted in the elimination of future
dividends.

1992 Compared with 1991

Net Income. The Company generated net income of $17.1 million, or $.44 per
share, in 1992 compared to a net loss of $65.8 million, or $4.03 per share in
1991. Included in the 1992 net income are $9.2 million of extraordinary gains
resulting from the exchange offers (compared to extraordinary gains of $6.9
million in 1991) and $10 million due to the cumulative effect of the change in
the method of accounting for income taxes. The year ended December 28, 1991
included provisions for losses on disposal of discontinued operations of $21.1
million and restructuring and other non-recurring charges of $15.3 million.

Income (Loss) From Operations. Income from continuing operations improved
$52.1 million from a loss of $51.1 million in 1991 to income of $1 million in
1992. This improvement reflects the impact of the financial restructuring and
operational changes that began in the fourth quarter of 1991 with NAR's
investment in the Company. The financial restructuring has allowed the Company
to eliminate $142.8 million in debt and $40 million of lease obligations and
dispose of its discontinued restaurant operations. Without this cash drain, the
Company's liquidity has significantly improved. The operational changes included
the decentralization of the Company which resulted in a strategic review
throughout the organization of all catalogs, costs and service levels. As a
result, seven catalogs (six Apparel and one Non-Apparel) were discontinued in
late 1991 and early 1992. In 1991 and 1992, these catalogs had a combined loss
from operations of $16.2 and $6.7 million, respectively, on revenues of $97
million and $25 million, respectively. The elimination of these catalogs enabled
the Company to redirect its resources into its core catalogs, thereby improving
its inventory position for the remaining catalogs and allowing for investment in
infrastructure improvements. Revenues from continuing catalogs increased
approximately $35 million or 7% from 1991 to 1992.

The Company's improved liquidity, as well as the elimination of the
uncertainty as to whether the Company would be able to satisfy its debt
obligations, enabled it to normalize its relationships with vendors. This
resulted in higher inventory receipts on a timely basis which significantly
reduced backorder levels and the associated costs. In addition, net interest
expense was reduced in fiscal 1992 by $5.2 million ($9 million on an annualized
basis) as a result of the debt and equity transactions. These reasons, as well
as the elimination of the $15.3 million of non-recurring restructuring,
transaction and other costs resulted in the significant turnaround in the
Company's operating results.

Revenues. Revenues decreased $37 million, or 5.9%, compared to 1991 as the
Company focused on its profitable catalogs and discontinued seven poorer
performing catalogs in late 1991 and early 1992. Revenues from continuing
catalogs increased 7% from $527 million in 1991 to $562 million in 1992. The
Company mailed approximately 375 million catalogs in 1991 compared to
approximately 285 million in 1992, a 24% decrease, but was able to increase its
average order size and response rates. Revenues were also improved as the
Company reduced its order cancellation and return rates by two percentage points
compared to 1991,

18
<PAGE> 20

principally as a result of the normalization of the backorder levels which
peaked at approximately $55 million in 1991 to a low of $11 million at the end
of 1992.

Non-Apparel revenues increased 3% from $383 million in 1991 to $395 million
in 1992. Revenues from continuing catalogs increased 7% to $394 million in 1992.
Revenues from discontinued catalogs were $15.6 million and $.7 million in 1991
and 1992, respectively.

Apparel revenues declined 20% from $240 million in 1991 to $192 million in
1992, although revenues from continuing catalogs increased 6% to $168 million.
Revenues of the discontinued catalogs were $82 million and $24 million in 1991
and 1992, respectively.

Operating Costs and Expenses. Cost of sales and operating expenses as a
percentage of revenues decreased from 65.6% in 1991 to 65.1% in 1992, although
gross margin decreased $9.7 million from 1991 to 1992. The improvement in margin
percentage was attributable to reducing shipping costs by 1% of revenues as
there were less split-shipments and other operational inefficiencies associated
with the 1991 backorder situation. Partially offsetting these improvements was a
change in the sales mix from higher margin fashion merchandise to lower margin
home textile merchandise.

Selling expenses decreased $35.9 million in 1992, of which approximately
$23 million was due to lower circulation resulting from discontinuing certain
catalogs. Selling expenses decreased as a percentage of revenues from 28.0% in
1991 to 23.6% in 1992 due to improved customer order response rates and lower
paper costs.

General and administrative expenses decreased $5.4 million, or 9.4%, from
1991 to 1992. Such expenses decreased as a percentage of sales, from 9.2% in
1991 to 8.9% in 1992. The decrease in expense was due to lower bad debt expense
($1.3 million), lower credit card commissions ($2 million) and reduced space
advertising activity ($2 million). These decreases were partially offset by
increases in consulting and internal development costs for management
information systems and to support the decentralized organization ($2.2
million).

Interest and Other Income (Expense). Interest expense was $13.4 million in
1992, a decrease of $7.1 million over 1991, as a result of debt reduction due to
the rights offering relating to the H&H Common Stock (the "Rights Offering") and
two separate exchange offers for the Company's 14% senior subordinated
debentures due 1997 (the "14% Debentures") and the Company's 7 1/2% convertible
subordinated debentures due 2007 (the "7 1/2% Debentures" and the two exchange
offers being referred to herein as the "Exchange Offers"). Future interest
expense will be reduced on an annualized basis by $9 million, as a result of
this debt reduction. The closing of the transactions in 1991 had the effect of
reducing interest expense due to the retirement of $15.1 million of 7 1/2%
Debentures, the repayment of $5 million of principal amount of 8% Subordinated
Notes due 1994 (the "8% Notes"), as well as a reduction of the interest rate
from 11% to 8% thereon.

Interest income was $.2 million in 1992, a decrease of $1.9 million from
1991. The decrease is due to the Company's overall liquidity position in which
funds were not available to invest in interest bearing instruments.

Extraordinary Items. In 1991, the Company recognized a $6.9 million
extraordinary gain with respect to the retirement of $15.1 million of its 7 1/2%
Debentures. The Company recorded extraordinary gains of $9.2 million in 1992
from the exchange of $11.9 million of 7 1/2% Debentures and $23.4 million of 14%
Debentures into equity.

Income Taxes. At December 26, 1992, the Company had tax NOLs totalling
$142 million, which expire through 2007. Certain transactions the Company
entered into during 1991 resulted in an ownership change with respect to the
Company and, thus, in the imposition of an annual limitation of approximately $4
million on the amount of future taxable income of the Company which may be
offset by the Company's pre-change NOLs. The Company's available NOLs for tax
purposes consists of $98 million of pre-change NOLs (subject to this limitation)
and $44 million of post-change NOLs (not subject to this limitation).

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<PAGE> 21

SFAS 109 requires that the tax benefit of such NOLs be recorded as an asset
to the extent that management assesses the utilization of such NOLs to be "more
likely than not". The deferred tax asset of $10 million recognized in 1992
consists of a $63 million gross deferred tax asset (principally, the expected
tax benefit of the NOLs discussed above) less a $53 million valuation allowance.

The Company believes, based upon successful completion of the financial
restructuring, the disposal of unprofitable discontinued operations, the
Company's history of prior operating earnings in its direct marketing business
and its expectations for the future, that the operating income of the Company
will be sufficient to utilize a substantial portion of the NOLs prior to their
expiration. Since the realization of the future tax benefits is dependent on the
Company's ability to generate taxable income within the carryforward period
(through 2007), the Company believes it would be imprudent to record the entire
benefit, based on income projections through 2007, due to the Company's recent
operating losses. The Company does believe that an appropriate measure of its
current earnings level is to adjust its 1992 income before extraordinary gains
of $1 million by $9 million, which represents the annual interest expense on the
debt that has been retired. Using this $10 million income as a base and three
years as a reasonable time frame, income would not have to grow from its current
level in order to generate the $30 million necessary to utilize NOLs sufficient
to realize the $10 million benefit that was recorded in 1992.

Shareholders' Equity. Net income for the year ended December 26, 1992 was
$17.1 million, or $0.44 per share, as compared to a net loss of $65.8 million,
or $4.03 per share in 1991. Net income from continuing operations in 1992 was $1
million, or a loss of $.06 per share after deducting preferred dividends of $3.2
million, compared to a net loss of $51.1 million, or $3.16 per share in 1991.

Extraordinary items in 1992 were $9.2 million or $.24 per share, compared
to $6.9 million or $.43 per share in 1991. The cumulative effect of accounting
change for income taxes in 1992 was $10 million, or $.26 per share as compared
to no cumulative adjustment in 1991. For the year ended December 26, 1992 there
was no income or loss from discontinued operations compared to a loss of $21.1
million, or $1.30 per share in 1991.

The number of shares of Common Stock outstanding increased in 1992
principally due to the Rights Offering in which 14,396,798 shares were issued,
the Exchange Offers in which 7,548,465 shares were issued and the exchange of
the preferred stock by NAR for 20 million shares of H&H Common Stock. At
December 26, 1992 there was a total of 69,535,089 shares of H&H Class B Common
and H&H Common Stock outstanding compared to 28,537,471 at December 28, 1991.

The dividends of $3.2 million in 1992 represent dividend requirements on
the two preferred stocks that were issued in October 1991 and September 1992. In
1991, the dividend accretion was $.5 million, representing the two months during
which the 8% preferred stock was outstanding in 1991.

LIQUIDITY AND CAPITAL RESOURCES

The Company had $2.6 million in cash and cash equivalents at each of
December 26, 1992 and January 1, 1994. Working capital and the current ratio
were $25.5 million and 1.24 to 1 at January 1, 1994 versus $31.6 million and
1.42 to 1 at December 26, 1992. The Company had substantially paid down its
long-term revolving credit facility at January 1, 1994, compared to a balance of
$21.2 million outstanding at December 26, 1992.

The Company generated $28.0 million in cash from operations in 1993. Cash
was used primarily to support increases of: (i) $12.1 million of inventory as
part of the Company's strategy to increase its in-stock position at the time
customer orders are received; (ii) $5.3 million in prepaid catalog costs to
support the spring mailing activity; and (iii) $4.2 million in capital
expenditures, primarily for its new management information system, while $21.0
million was used for the paydown the Company's revolving credit facility. These
uses of cash were primarily financed by a $24.5 million increase in accounts
payable and operating profits. With the significant improvement in the Company's
financial condition in 1993, it has been successful in restoring normal trade
terms with its vendors, which has resulted in greater leverage of its accounts
payable.

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<PAGE> 22

The Company experiences seasonality in its working capital requirements and
fluctuations in the revolving credit facility will occur, usually within the
first and fourth quarters of the year.

With the Company's financial restructuring completed and the corresponding
improvement in its financial condition, the Company focused in 1993 on
refinancing its remaining indebtedness, simplifying its capital structure and
embarking on a program of investing in infrastructure improvements to support
its growth objectives.

Refinancing of Indebtedness. In May 1993, the Company refinanced its
revolving credit facility that had been previously provided by a subsidiary of
NAR with a new three-year $40 million facility with an independent financial
institution. In October 1993, the Company increased the maximum credit available
to $52.5 million to include Gump's, The Company Store and Tweeds as borrowers
under the facility. A subsidiary of NAR has provided a secured limited guarantee
of $10 million which allows the Company to borrow in excess of its availability
based on a formula, up to the facility's limit. This limited guarantee was
reduced by approximately $5.1 million during the fourth quarter of 1993, and the
guarantee will be eliminated in March 1994 based on the Company's 1993 operating
results. At January 1, 1994, the Company's borrowing base formula would have
enabled the Company to borrow approximately $40 million, compared to the $.2
million that was outstanding.

In August 1993, the Company issued $20 million of 9.25% Senior Subordinated
Notes (the "9.25% Notes") in a private placement with an insurance company. The
Company retired its outstanding $12.4 million of 8% Notes that were due in
October 1994 and $.8 million of its 14% Debentures using the proceeds of the
9.25% Notes, with the remainder to be used for the purchase of additional
fulfillment and warehouse capacity. The Company is required to redeem $6 million
of the 9.25% Notes without penalty by February 15, 1994 (subsequently amended to
May 1, 1994) if the Company has not established or acquired a new distribution
facility by such date. The Company intends to redeem $6 million of the 9.25%
Notes on May 1, 1994.

In 1993, the Company acquired three companies for $.1 million of its own
cash, $4.6 million of debt and $12.3 million of Common Stock. In addition, the
Company has agreed to provide an aggregate of up to $4 million of secured
working capital financing, a $.75 million short-term loan and a $.5 million
convertible note to two entities in which it has acquired an equity interest.

Simplification of Capital Structure. In September 1993, through a series
of mergers involving H&H and THC, the Company changed its name to Hanover
Direct, Inc. and eliminated its two-tier holding company structure.

On December 13, 1993, the Company converted its 7.5% Cumulative Convertible
Preferred Stock into 2,278,128 shares of Common Stock. The holders of the 7.5%
Cumulative Convertible Preferred Stock were paid all accrued and unpaid
dividends in cash amounting to $197,000. On January 1, 1994, 12,270,503 shares
of Class B Common Stock and 40,000 shares of Class B 8% Cumulative Preferred
Stock were exchanged into 18,937,169 shares of Common Stock. All accrued and
unpaid dividends totalling $886,000 were paid in cash in February 1994. As a
result of these transactions, the Company has eliminated approximately $4
million of future annual preferred stock dividend requirements.

On December 10, 1993, the Company issued 234,900 shares of its 6% Series A
Preferred Stock (the "6% Preferred Stock") for an installment note in the amount
of $2.4 million that it had assumed in its acquisition of Tweeds.

As a result of these transactions, the Company's capital structure consists
of 82,933,177 shares of Common Stock and 234,900 shares of 6% Preferred Stock at
January 1, 1994.

Infrastructure Investments. To improve its infrastructure and to support
its growth objectives, the Company intends to construct a new 500,000 square
foot fulfillment center costing approximately $18 million in Roanoke, Virginia
to support the Domestications business and has acquired a 50% interest in a
partnership which owns the 175,000 square foot Tweeds fulfillment center, into
which the Company plans to consolidate its Apparel Group.

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<PAGE> 23

Additionally, the Company is currently in the process of upgrading its
management information systems by implementing new integrated software which it
expects to be fully operational in 1995 and is migrating from a centralized
mainframe to mid-range mini-computers at a total estimated cost of approximately
$13 to $15 million. As of January 1, 1994, the Company has incurred costs of
approximately $5.3 million as part of this plan, including capital leases
aggregating $2.4 million to be paid over four years.

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

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<PAGE> 24

BUSINESS

GENERAL

During 1993, the Company acquired three brand-name catalogs, Gump's, the
well known San Francisco retailer and a leading upscale catalog marketer of
exclusive gifts, The Company Store, an upscale direct marketer of down
comforters and other down and related products for the home sold under The
Company Store and Scandia Down names, and Tweeds, the European inspired women's
fashion catalog. In addition, in January 1994, the Company entered into the
Sears Agreement to produce specialty catalogs for the 23 million Sears customers
no longer being served by the recently discontinued Sears catalog.

BUSINESS STRATEGY

The Company's goal is to become the nation's leading direct specialty
retailer and preferred retail source for its customers. To achieve this goal,
the Company's strategy is to build brand loyalty to each of its catalogs by
satisfying targeted customers through a focused merchandise assortment,
appropriate price points and personalized service. Key elements of the Company's
business strategy are as follows:

Development of Brand Recognition and Catalog Identity. The Company seeks
to develop distinct brand identities for each of its specialty catalogs by
offering a focused selection of merchandise that meets the needs and preferences
of its target customers and increasingly includes exclusive or hard to find
items. Each of the Company's catalogs targets specific market segments and
develops and executes its own merchandising and

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<PAGE> 25

marketing strategy. Through extensive market research and ongoing testing of new
products and concepts, the Company determines, on a catalog by catalog basis,
the appropriate price points, service levels, mailing plans and presentation of
its products. In addition, selected catalogs offer private label or exclusive
merchandise, including products designed by the Company, which further enhance
the brand identity of the catalog.

Decentralized Merchandising and Marketing. To ensure maximum focus on each
of its target customer groups and to respond effectively to changing product
trends and customer tastes, key decisions including market positioning and
strategy, merchandising, circulation levels, catalog design and inventory
management are made separately for each catalog, by a management team
responsible solely for the performance of a single catalog. A significant
portion of the compensation of the key members of each management team is tied
directly to the performance of their respective catalog.

Leverage Centers. The Company's large sales volume enables it to achieve
cost savings and create operating efficiencies for all of its catalogs through
"leverage centers" in telemarketing, paper and printing purchases, postage,
fulfillment, database management and management information services. The
Company is able to purchase printing services, paper and telephone time at
prices lower than those available to smaller direct marketing businesses. In
addition, each of the Company's catalogs has access to the Company's proprietary
customer list. During 1993, the Company embarked on a program to improve the
functioning of and increase the capacity of its telemarketing and distribution
facilities. The Company is also in the process of updating its management
information systems and anticipates that the new systems will be fully installed
and operational during 1995.

Employee Incentives. The Company considers its employees critical to its
long-term success. To create an atmosphere of teamwork and to more closely align
the interests of its employees with those of its shareholders, the Company gives
all employees with at least one year of service the opportunity to buy a
specified number of shares of Common Stock at a 40% discount to the market price
through its All-Employee Equity Incentive Plan. A majority of eligible employees
are shareholders of the Company.

GROWTH STRATEGY

The Company's growth strategy includes: (i) internal catalog growth and
development; (ii) strategic acquisitions; (iii) strategic ventures; (iv)
development of international market opportunities; and (v) exploration of growth
prospects in electronic interactive media.

Internal Catalog Growth and Development. The Company focuses on increasing
the sales of and improving the profitability of its existing catalogs through
strategies designed to capitalize on market opportunities. Such strategies may
include changing catalog circulation, product presentation and product
offerings. The Company tests new products, formats and mailing strategies for
each of its catalogs on an ongoing basis, while underperforming catalogs are
either repositioned to improve profitability or ultimately discontinued. In
1984, the Company launched the Domestications catalog because it perceived a
significant market opportunity for a home textiles catalog. Since such time,
Domestications revenues have increased to approximately $311 million in 1993.
The Company is also experiencing significant growth in other catalogs including
Colonial Garden Kitchens and Tapestry. Since 1992, the Company has discontinued
seven underperforming catalogs.

In addition, from time to time the Company identifies market opportunities
to introduce new branded niche catalogs. The Company typically develops these
new catalogs at competitively advantageous costs by capitalizing on its existing
merchandising and operational expertise, leverage centers and proprietary
customer list. The Company is currently testing a new upscale kitchen and home
product catalog called Kitchen & Home and currently is developing a new fashion
catalog featuring women's sportswear and casual career apparel which will be
designed by the Company and sold under private labels at prices below those
found on similar quality items in department stores. The Company expects to
begin test mailing this catalog this summer.

Strategic Acquisitions. The Company's leverage centers and proprietary
customer list position it to take advantage of the consolidation currently
taking place in the catalog industry. The Company generally seeks to

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<PAGE> 26

acquire catalogs that it believes have established their own brand identity and
can achieve substantially improved profitability by taking advantage of the
operating efficiencies and cost savings provided by the Company's leverage
centers. In 1993, the Company acquired Gump's, the well known San Francisco
retailer and a leading upscale catalog marketer of exclusive gifts, The Company
Store, an upscale direct marketer of down comforters and other down and related
products for the home, and Tweeds, the European inspired women's fashion catalog
featuring relaxed fashions uniquely designed by Tweeds' in-house staff. See "The
Company -- Recent Strategic Acquisitions and Ventures."

The Company acquired a 20% interest in each of Aegis, a direct marketer of
safety and anti-hazard products, and BPC, the publisher of The Museum
Collection, a catalog featuring reproductions, replicas and adaptations of items
contained in museum collections, and Finishing Touches, a catalog featuring
items for the home. As part of the acquisitions, the Company provides Aegis with
certain catalog fulfillment and production services and will provide BPC with
catalog production assistance. See "The Company -- Recent Strategic Acquisitions
and Ventures."

Strategic Ventures. The Company actively pursues opportunities to acquire
equity or other profit-sharing interests in direct marketing ventures. The
Company believes it can offer its co-venturers the use of its large proprietary
customer list, the operating efficiencies and cost savings of its leverage
centers and its merchandising and marketing expertise. The Company has recently
entered into the following strategic venture:

Sears Agreement. In January 1994, the Company entered into the Sears
Agreement to produce specialty catalogs for the 23 million customers of the
recently discontinued Sears catalog. Profits and losses from the venture are to
be shared between the parties on an equal basis. The catalogs currently being
mailed under the program are based on existing Company catalogs and contain a
title page with the Sears name and logo. The specialty catalogs include: Show
Place, based on the Domestications catalog, Great Kitchens, based on the
Colonial Garden Kitchens catalog, and Beautiful Style, based on the Silhouettes
catalog. See "Business -- Merchandising and Catalog Format." The Company and
Sears are currently testing additional catalogs to add to the program. The
Company has sampled a portion of the 23 million names on the Sears list and
found that a vast majority of such names did not otherwise appear on the
Company's 19 million name proprietary customer list. Customers are able to
purchase merchandise using the Sears credit card in addition to the other
methods of payment offered by the Company. The Company also is using its
purchasing, telemarketing, fulfillment and distribution facilities as well as
its management information systems to serve the Sears customers. See "The
Company -- Recent Strategic Acquisitions and Ventures -- Sears."

International Market Opportunities. The Company is currently exploring the
potential for its catalogs in international markets and has registered a number
of its more significant trademarks in several foreign jurisdictions. The
Company's international expansion could take many forms, including the mailing
of existing catalogs overseas or entering into strategic ventures with foreign
partners. The Company has performed limited catalog testing in Canada and
Mexico. The Company currently is exploring new business opportunities in Europe
and Brazil.

Electronic Interactive Media. The Company believes providing home shopping
services via electronic interactive media could be a significant outgrowth of
its direct marketing business and that its experience and expertise in direct
marketing will be directly applicable to retailing via electronic interactive
media. Examples of electronic interactive media retailing that the Company is
exploring include home shopping television, shopping through on-line computer
databases, computer/CD-ROM and other magnetic media. The Company believes that
electronic interactive media retailing is a natural strategic extension of its
direct marketing expertise because the Company already: (i) markets its products
directly to consumers in the convenience of their homes; (ii) utilizes extensive
telemarketing, centralized fulfillment and distribution facilities; and (iii)
manages its operations through a central pool of inventory.

The Company is currently exploring a number of opportunities in electronic
interactive media retailing. These opportunities range from test marketing its
catalogs on selected cable channels to developing home shopping programming for
major television and home shopping networks. The Company currently is
negotiating agreements to conduct several limited tests. In March 1994, the
Company entered into a contract

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<PAGE> 27

with CUC International Inc. ("CUC") in order to participate in an interactive
shop-at-home test. For purposes of the test, CUC's customers will be able to
purchase certain (or selected) merchandise offered for sale in the Company's
catalogs using interactive technology developed by CUC. The in-house computer
hardware and software will be provided by CUC and its marketing partners to
subscribers. The Company will provide merchandising and fulfillment services
during the test. The service is expected to be made available to approximately
20,000 homes in California and Florida and to last at least one year. In
addition, during the spring of 1994, the Company expects to launch a test pilot
with the Via TV home shopping channel in which a 30 minute show featuring the
Hanover House catalog will be aired in three different day parts every two
weeks. Via TV currently reaches approximately four million homes and intends to
grow to ten million homes within the next year.

MERCHANDISING AND CATALOG FORMAT

Each of the Company's specialty catalogs targets distinct market segments
and develops and executes its own merchandising strategy based on a focused
assortment of merchandise that is designed to meet the needs and preferences of
its target customers. Through market research and ongoing testing of new
products and concepts, the Company determines, on a catalog by catalog basis,
the appropriate price points, service levels, mailing plans and presentation of
its products. The Company has placed an increasing emphasis on the use of
exclusive or private label products in a number of its catalogs, including
Domestications, Tweeds and The Company Store, to further enhance the brand
identity of these catalogs.

The Company's specialty catalogs typically range in size from an average of
44 to 100 pages with four to six new editions per year depending on the
seasonality and fashion content of the products offered. Each edition may be
mailed several times each year with slight variations in format and content.
Depending on the catalog's product focus, approximately 30% to 70% of the
merchandise assortment in each edition is seasonal or new items. Catalogs
featuring women's fashions generally have the highest new product introduction
rate. Each catalog employs the services of an outside creative agency or has its
own creative staff which is responsible for the design, layout, copy, feel and
theme of the book. Generally, the initial sourcing of new merchandise for a
catalog begins two to six months before the catalog is mailed. Currently, all
Company catalogs are circulated through the United States Postal Service, but
the Company is participating in tests of alternative delivery systems of
catalogs other than through the United States Postal Service.

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<PAGE> 28

During 1993, the Company streamlined its catalog operations into two main
groups, Apparel and Non-Apparel. The total Company revenues for 1993 and the
percent of total Company revenues for 1993 for each of the Company's catalogs
are set forth below:

<TABLE>
<CAPTION>
1993 PERCENT OF
REVENUES(A) TOTAL REVENUES
-------------- --------------
<S> <C> <C>
(IN THOUSANDS)
NON-APPAREL GROUP
Domestications................................................. $310,573 48.3%
Hanover House.................................................. 41,869 6.5
Colonial Garden Kitchens....................................... 39,604 6.2
Tapestry....................................................... 31,584 4.9
Gump's(b)(c)................................................... 22,653 3.5
The Company Store(b)........................................... 15,244 2.4
Mature Wisdom.................................................. 13,420 2.1
Other(d)....................................................... 2,478 .4
Discontinued Catalogs.......................................... 6,451 1.0
-------------- ------
Total Non-Apparel...................................... $483,876 75.3%
-------------- ------
APPAREL GROUP
International Male............................................. $ 44,759 7.0%
Silhouettes.................................................... 25,268 3.9
Simply Tops.................................................... 23,988 3.7
Essence By Mail................................................ 16,475 2.6
Undergear...................................................... 12,825 2.0
Tweeds(b)...................................................... 9,280 1.5
Sale catalogs and other(e)..................................... 12,773 2.0
Discontinued Catalogs.......................................... 13,267 2.0
-------------- ------
Total Apparel.......................................... $158,635 24.7%
-------------- ------
Total Company(f)....................................... $642,511 100.0%
-------------- ------
-------------- ------
</TABLE>

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

(a) Revenues are net of returns.
(b) Revenues were recorded for these catalogs from the dates of their respective
acquisitions in 1993.
(c) Represents revenues from both the Gump's catalog and retail store.
(d) Represents revenues from the outlet store and surplus inventory liquidation.
(e) Represents revenues from sale catalogs, the outlet stores and surplus
inventory liquidation.
(f) Excludes The Safety Zone which is accounted for on the equity method.

Non-Apparel Group. The catalogs comprising the Non-Apparel Group are as
follows:

DOMESTICATIONS: Domestications is the nation's leading specialty home
textiles catalog and the preferred fashion decorating sourcebook for
today's value-oriented and style-conscious consumer. Domestications
features sheets, towels, comforters, tablecloths and other items for the
home. The catalog has enjoyed significant growth and success, experiencing
a 48% compound annual growth rate during the period from 1987 to 1993. The
layout and presentation of Domestications has a decorator look offering
coordinated decorating ideas for the home. Over 60% of the items offered in
the catalog are exclusive or private label, designed by its in-house staff.
The Company believes that the Domestications target consumer wants stylish
and fashionable merchandise that complements her lifestyle, yet is in
keeping with her desire for value. The Domestications catalog is also
mailed to Sears customers under the name Show Place.

HANOVER HOUSE: Hanover House features gifts, seasonal, household and
novelty items. Hanover House is currently being repositioned to upgrade its
presentation and product mix.

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<PAGE> 29

COLONIAL GARDEN KITCHENS: Colonial Garden Kitchens is a leading
specialty catalog with the largest 12-month buyer list in its category
featuring work saving and lifestyle enhancing items for the kitchen and
home. The Colonial Garden Kitchens catalog is also mailed to Sears
customers under the name Great Kitchens. The Company is currently testing a
new upscale kitchen and home product catalog called Kitchen & Home.

TAPESTRY: Tapestry is a value-oriented home accessories catalog
featuring flatware, dinnerware, furniture, rugs and other home decorating
items.

GUMP'S: Gump's is the well known San Francisco retailer and a leading
upscale catalog marketer of exclusive gifts.

THE COMPANY STORE: The Company Store is an upscale direct marketer of
down comforters and other down and related products for the home.

MATURE WISDOM: Mature Wisdom is one of the leading general merchandise
catalogs catering to the needs of older customers featuring fashions,
health care products and other items for greater ease of living.

THE SAFETY ZONE: The Safety Zone is a direct marketer of safety and
anti-hazard products in which the Company has a 20% interest.

Apparel Group. The catalogs comprising the Apparel Group are as follows:

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

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

SILHOUETTES: Silhouettes is a women's fashion catalog featuring
special occasion and career fashions in sizes 14 to 26. The Silhouettes
catalog is also being mailed to Sears customers under the name Beautiful
Style.

SIMPLY TOPS: Simply Tops is a source for unique apparel, supplying
moderate-priced clothing to women interested in embellished clothing which
makes a statement.

ESSENCE BY MAIL: Essence By Mail is the original catalog featuring
women's fashions and home decorating items reflecting African-American
culture and is a 50% joint venture with Essence Communications, Inc.,
publisher of Essence magazine.

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

MARKETING AND DATABASE MANAGEMENT

The Company maintains one of the largest proprietary customer lists in the
industry containing approximately 19 million names of customers who have
purchased from one of the Company's catalogs within the past 36 months. The list
contains name, gender, residence and historical transaction data (including
catalog(s) purchased from, product classifications, recency of purchase, average
order size and payment method). This database is selectively enhanced with
demographic, socioeconomic, lifestyle and purchase behavior overlays from other
sources.

The Company utilizes proprietary modelling and sophisticated segmentation
analysis, on a catalog by catalog basis, to devise catalog marketing and
circulation strategies which are intended to maximize the contribution by
customer by catalog. This analysis is the basis for the Company's determination
of which of the Company's 14 catalogs (and how frequently) will be mailed to a
particular customer as well as the promotional incentive content of the
catalog(s) such customer receives.

In addition to mailing to customers who exist on its database, the Company
has an ongoing prospect acquisition program designed to attract new customers on
a cost effective basis. The primary source of new

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<PAGE> 30

customers for the Company's catalogs is lists that have been rented from other
mailers and compilers. Prior to mailing to these non proprietary lists, the
lists are edited using statistical segmentation tools to enhance their probable
performance. Other sources of new customers include space advertisements,
promotional inserts in outbound merchandise packages and friend's name cards
inserted in mailed catalogs.

During 1993, the Company mailed approximately 322 million catalogs. Of the
approximately 19 million names on the Company's proprietary customer list,
approximately seven million customers, or approximately 37%, have made at least
one purchase from one of the Company's catalogs within the preceding 12 months.

TELEMARKETING AND CUSTOMER SERVICE

Excellence in customer service is a critical element of the Company's goal
to become the preferred choice for its customers. The Company designs its
service standards to exceed its customers' expectations and supports this with
an unconditional merchandise guarantee. Under the Company's return policy, a
customer may return merchandise for a refund, exchange or replacement if not
satisfied for any reason. The Company's return rate for 1993 was approximately
13% of gross shipments.

In 1993, the Company received approximately 64% of its orders through its
toll-free telephone service. The Company maintains telemarketing facilities in
San Diego, California, Hanover, Pennsylvania, DeSoto, Texas, Roanoke, Virginia
and LaCrosse, Wisconsin that offer convenient customer access seven days per
week, 24 hours per day. The telemarketing facilities utilize state-of-the-art
telephone switching equipment which enables the Company to route calls between
telemarketing centers and enhance prompt customer service. During 1993, the
Company's telemarketing centers processed approximately 11.7 million calls and
received approximately 5.6 million orders. The remaining calls included requests
for copies of catalogs, order status inquiries and other general inquiries. At
peak capacity, the Company's approximately 1,000 full and part time
telemarketing service representatives are capable of handling approximately
11,000 calls per hour.

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

The Company's computerized database provides its telemarketing service
representatives with information concerning a customer's previous orders,
permitting the service representative to establish a personalized dialogue with
the customer. Telemarketing service representatives are provided selling
information which they are trained to use to describe promotional items. With
the installation of the new management information systems in 1994,
telemarketing service representatives will be able to provide customers with
more detailed inventory information.

DISTRIBUTION

The Company maintains distribution centers in Hanover, Pennsylvania,
DeSoto, Texas, Roanoke, Virginia and LaCrosse, Wisconsin. The Company's long
range plan is to maximize efficiencies in merchandise handling and distribution
by consolidating the warehousing and distribution of like items in specific
fulfillment centers. The Company plans to consolidate the Apparel Group catalogs
into the Tweeds Roanoke facility and to construct in 1994 an additional 500,000
square foot state-of-the-art facility on a separate site in Roanoke which, upon
its completion, will handle all of Domestications fulfillment needs. The
Company's facilities processed approximately 13 million packages in 1993.

The Company obtains rate discounts from the United States Postal Service by
automatically weighing each parcel and sorting and trucking packages to a number
of United States Postal Service drop points throughout the country. The
Company's size enables it to efficiently handle packages in this manner. From

29
<PAGE> 31

time to time, the Company uses United Parcel Service, Federal Express and other
expedited delivery services. The Company, on average, shipped approximately
48,000 packages per day in 1993.

PURCHASING

The Company's large sales volume permits it to achieve a variety of
purchasing efficiencies, including the ability to obtain prices and terms which
are more favorable than those available to smaller companies. Major goods and
services used by the Company are purchased or leased from selected suppliers by
its central buying staff. These goods and services include: paper, catalog
printing and printing related services such as order forms and color
separations, communication systems including telephone time and switching
devices, packaging materials, expedited delivery services, computers and
associated network software and hardware. The Company's objective is to achieve
favorable "total costs" reflecting a long-term mutual commitment by the Company
and each supplier for competitive rates and terms as well as the quality, future
maintenance, replacement and modification needs of the Company.

The Company typically enters into annual agreements for paper and printing
with a limited number of suppliers. These agreements permit periodic price
increases or decreases based on prevailing market conditions, changes in
supplier costs and continuous productivity improvements. The Company's telephone
systems are typically contracted for on a three to four year basis. During 1993,
the Company purchased approximately 55 thousand tons of paper and approximately
50 million minutes of telephone time. The Company believes it has developed and
maintains strong relationships with suppliers for key goods and services.

PRODUCT SOURCING

The Company acquires products for resale in its catalogs from numerous
domestic and foreign vendors. No single source supplied more than 8% of the
Company's products in 1993. The Company's vendors are selected based on their
ability to reliably meet the Company's production and quality requirements, as
well as their financial strength and willingness to meet the Company's needs on
an ongoing basis.

MANAGEMENT INFORMATION SYSTEMS

The Company is currently in the process of upgrading its management
information systems by implementing new integrated software and migrating from a
centralized mainframe to mid-range mini-computers. The migration of the
Company's business applications is the first phase of the Company's overall
systems plan developed with the assistance of outside consultants which defines
the mid-and long-term systems and computing strategy for the Company. As part of
this plan, the Company has purchased and will be installing new integrated
software for use in managing all phases of the Company's operations. The new
software is an upgraded version of existing software installed in over 60 mail
order companies which has been designed to meet the Company's requirements as a
high volume publisher of multiple catalogs. The Company plans to bring the new
systems on-line for several catalogs in 1994 with expected completion in 1995.
Delivery, installation and implementation are expected to commence shortly. The
Company currently estimates that the total cost to install and implement the new
systems, including the cost of dedicated internal personnel, will be
approximately $13 to $15 million. See "Investment Considerations -- Computer
Systems Conversion."

The new software system is an on-line, real-time system which includes
order processing, fulfillment, inventory management, list maintenance and
reporting. The implementation of the software will provide the Company with a
flexible system that offers highly sophisticated data manipulation, a high
degree of marketing-oriented and fulfillment functionality and extensive
reporting capabilities. The new management information systems are designed to
permit the Company to achieve substantial improvements in the way its financial,
merchandising, inventory and accounting functions are performed. The new system
was selected to support the Company's decentralized operating structure because
it can be customized for and by each catalog unit.

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<PAGE> 32

CREDIT MANAGEMENT

The Company's customers are able to purchase merchandise using checks or
money orders, the Company's credit cards or third party credit cards. Several of
the Company's catalogs, including Domestications, International Male and Gump's,
offer their own credit cards. Approximately 73% of 1993 sales were paid using
third party credit cards, 19% were paid for with checks or money orders and 8%
were paid with the Company's credit cards.

In December 1992, the Company entered into a three year $75 million credit
facility with General Electric Credit Corporation ("GECC") which provides for
the sale and servicing of accounts receivable originating from the Company's
revolving credit cards. The Company is obligated to repurchase uncollectible
accounts and is required to maintain a specified percentage of all outstanding
receivables sold under the program as a deposit with GECC to service its
obligations under the agreement. The Company is required to pay certain
servicing fees to GECC and the Company earns the finance charge income that GECC
charges to the accounts. GECC's servicing responsibilities include credit
processing, collections, billing/payment processing, reporting and credit card
issuance.

At January 1, 1994, $47 million of outstanding accounts receivable were
being serviced under this agreement, of which $13 million was retained as
deposits.

INVENTORY MANAGEMENT

The Company's inventory management strategy is designed to maintain
inventory levels that provide optimum in-stock positions while maximizing
inventory turnover rates and minimizing the amount of unsold merchandise at the
end of each season. The Company manages inventory levels by monitoring sales and
fashion trends and making purchasing adjustments as necessary and by promotional
sales. Additionally, the Company sells excess inventory in its special sale
catalogs, its outlet stores and to jobbers.

SEASONALITY

Although the Company experiences quarterly variations in sales, such
variations are due primarily to fluctuations in circulation levels rather than
seasonality and are further ameliorated by the Company's diversified portfolio
of catalogs. The Company traditionally mails more catalogs in the second half of
the year.

COMPETITION

The mail order catalog business is highly competitive. The Company's
catalogs compete with other mail order catalogs and retail stores, including
department stores, specialty stores and discount stores. Competitors also exist
in each of the Company's catalog specialty areas, including Spiegel and
Chadwick's of Boston in women's fashion; Spiegel, Touch of Class, Linen Source,
Lands' End, Coming Home and Horchow in home furnishings; Lillian Vernon, Taylor
Gift, Williams Sonoma, Chef's Corner, Harriet Carter and Dr. Leonards in general
merchandise; and Bachrach's, Collections and Road Runner Sports in men's
fashions. The Company also considers general catalog companies such as J.C.
Penney and retail stores as part of its competition. A number of the Company's
competitors have substantially greater financial, distribution and marketing
resources than the Company. The recent substantial sales growth in the direct
marketing industry has encouraged the entry of many new competitors and an
increase in competition from established companies. The Company believes that
the principal bases upon which it competes are quality, value, service, product
offerings, catalog design, convenience, efficiency and safety.

TRADEMARKS

Each of the Company's catalogs has its own federally registered trademark.
Domestications, Tapestry, Hanover House, Colonial Garden Kitchens, Mature
Wisdom, International Male, Undergear, Silhouettes, Simply Tops, Gump's, Tweeds,
The Company Store, Fashion Favorites, Fashion Galaxy and Outtakes are registered
trademarks of the Company. Essence is a trademark used by the Company under
license by Essence Communications, Inc. Show Place, Great Kitchens and Beautiful
Style are trademarks of Sears. The Company

31
<PAGE> 33

also owns numerous trademarks, copyrights and service marks on its logos,
products and catalog offerings. The Company has also protected various
trademarks internationally. The Company vigorously protects such marks and
believes there is substantial goodwill associated with them.

GOVERNMENT REGULATION

The Company is subject to Federal Trade Commission regulations governing
its advertising and trade practices, Consumer Product Safety Commission
regulations governing the safety of the products it sells in its catalogs and
other regulations relating to the sale of merchandise to its customers. The
Company is also subject to the Department of Treasury-Customs regulations with
respect to any goods it imports. To date, such governmental regulations have not
had a material adverse effect on the Company's business.

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

PROPERTIES

The Company's corporate headquarters are located in a modern
84,700-square-foot facility in Weehawken, New Jersey. The facility houses
merchandising and marketing personnel, an art department including photographic
studios, catalog production personnel and corporate and administrative offices.
The Weehawken facility is leased for a 15-year term expiring in 2005.

The Company also occupies a leased office building in Hanover, Pennsylvania
and five warehouse/fulfillment locations in the Hanover area providing a total
of approximately 1,163,000 square feet of space, including its principal
fulfillment center consisting of a twenty acre leasehold with a 265,000 square
foot warehouse and other improvements. The other four warehouse/fulfillment
locations are leased pursuant to short-term leases. The Company intends to
consolidate all or most of the facilities with short-term leases into its new
fulfillment center that will be constructed for Domestications in Roanoke,
Virginia.

Administrative offices in Hanover, Pennsylvania are located in a two-story
building of 123,300 square feet, with a lease expiring in 1994, which contains
renewal options for three five-year periods. Brawn of California, Inc., occupies
30,000 square feet of new office space in San Diego, California pursuant to a
fifteen-year lease that expires in 2004.

Gump's occupies 4,700 square feet of office space in addition to 49,800
square feet of space for its retail store in San Francisco, California. In
addition, Gump's occupies a leased warehouse/fulfillment center in DeSoto, Texas
of approximately 43,000 square feet. This lease expires in 1995.

The Company Store occupies 185,000 square feet for its warehouse center
pursuant to a short-term lease. Additionally, a 150,000 square foot
manufacturing and assembly facility and 58,000 square foot telemarketing and
customer service facility in LaCrosse are owned.

In January 1994, the Company purchased a 50% interest in Blue Ridge
Associates (the "Partnership"), a partnership which owns the Tweeds Roanoke,
Virginia fulfillment center. The Company made a capital contribution of $1.1
million to the Partnership. In addition, the Partnership and the Company entered
into a 15 year lease covering the facility. Under the terms of the lease
agreement and subject to certain conditions specified therein, the Partnership,
as lessor, agreed to expand the facility by not less than 100,000 square feet in
accordance with plans and specifications reasonably acceptable to the parties.
The expanded facility will be leased to the Company on the same terms as the
existing facility, subject to an adjustment in the amount of rent payments and
the expiration date.

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<PAGE> 34

The following chart lists each of the Company's principal properties:

<TABLE>
<CAPTION>
OWNED
OR APPROXIMATE CATALOG
LOCATION LEASED SQUARE FOOTAGE USE(A)
- ----------------------------------- ------- -------------- -----------------------------------
<S> <C> <C> <C>
WAREHOUSE AND DISTRIBUTION CENTERS
Emigsville, PA................... Leased 144,000
Hanover, PA...................... Owned 264,000
Hanover, PA...................... Leased 433,300
Landsville, PA................... Leased 23,000
York, PA......................... Leased 319,000
DeSoto, TX....................... Leased 43,000 Gump's(b)
Roanoke, VA...................... Leased 175,000 Tweeds(c)
LaCrosse, WI..................... Leased 185,000 The Company Store
Roanoke, VA...................... Owned 500,000 Domestications distribution
facility to be constructed in 1994
on a 53 acre site
CORPORATE AND ADMINISTRATIVE
OFFICES
San Diego, CA.................... Leased 30,000 Men's Apparel(d)
San Francisco, CA................ Leased 4,700 Gump's
Edgewater, NJ.................... Leased 65,000 Tweeds
Weehawken, NJ.................... Leased 84,700 Corporate Headquarters
TELEMARKETING AND CUSTOMER SERVICE
Hanover, PA...................... Leased 123,300
LaCrosse, WI..................... Owned 58,000(e)
RETAIL STORES
Beverly Hills, CA................ Leased 1,200 Scandia Down
Costa Mesa, CA................... Leased 1,200 Scandia Down
San Diego, CA.................... Leased 3,800 Men's Apparel
San Francisco, CA................ Leased 49,800 Gump's(f)
West Hollywood, CA............... Leased 3,600 Men's Apparel
Hanover, PA...................... Leased 12,500 Outlet Store
LaCrosse, WI..................... Leased 13,000 The Company Store
Oshkosh, WI...................... Leased 2,000 The Company Store
Kenosha, WI...................... Leased 5,500 The Company Store
Madison, WI...................... Leased 5,500 The Company Store
MANUFACTURING AND ASSEMBLY
LaCrosse, WI..................... Owned 150,000 The Company Store
</TABLE>

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

(a) Unless otherwise noted, the facility services multiple catalogs.
(b) Also a telemarketing center for Gump's.
(c) Also a telemarketing center for Tweeds. The Company owns a 50% interest in
the Partnership which owns this property.
(d) Also a telemarketing center for Men's Apparel.
(e) Also used for executive offices for The Company Store.
(f) Also used for Gump's executive offices. To be replaced by a new store in the
fall of 1994.

The Company also leases 18 properties, all of which are subleased. All of
such properties are part of the Company's discontinued restaurant operations.

EMPLOYEES

As of December 31, 1993, the Company employed approximately 2,280 persons
on a full time basis and approximately 530 persons on a part time basis.
Approximately 120 employees of The Company Store manufacturing facility are
members of the International Ladies Garment Workers Union. The Company believes
its relations with its employees are good.

LEGAL PROCEEDINGS

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

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<PAGE> 35

MANAGEMENT

DIRECTORS AND EXECUTIVE OFFICERS

The Directors and executive officers of the Company are:

<TABLE>
<CAPTION>
NAME AGE POSITION
- ------------------------------ --- -------------------------------------------------------
<S> <C> <C>
Alan G. Quasha................ 44 Chairman of the Board and Director
Jack E. Rosenfeld............. 55 President, Chief Executive Officer and Director
Michael P. Sherman............ 41 Executive Vice President-Corporate Affairs, General
Counsel and Secretary
Wayne P. Garten............... 41 Executive Vice President and Chief Financial Officer
Edward J. O'Brien............. 50 Senior Vice President and Treasurer
David E. Ullman............... 36 Vice President-Controller
Ralph Destino................. 57 Director
J. David Hakman............... 52 Director
S. Lee Kling.................. 65 Director
Theodore H. Kruttschnitt...... 51 Director
Jeffrey Laikind............... 58 Director
Elizabeth Valk Long........... 43 Director
Edmund R. Manwell............. 51 Director
Geraldine Stutz............... 65 Director
Robert F. Wright.............. 68 Director
</TABLE>

INFORMATION CONCERNING DIRECTORS AND EXECUTIVE OFFICERS

Alan G. Quasha has been President of Quadrant Management, Inc., an indirect
wholly-owned subsidiary of NAR which manages NAR's U.S. assets, since its
formation in early 1988. From 1980 to September 1991, he was a partner in the
New York City law firm of Quasha Wessely & Schneider. In addition to his
Directorship at the Company, Mr. Quasha serves as a director of Harken Energy
Corporation, E-Z Serve Corporation, Tejas Power Corporation and NAR. Mr. Quasha
is also a director of Richemont. Mr. Quasha, a designee of NAR, was elected a
Director of the Company and Chairman of the Board in October 1991.

Jack E. Rosenfeld has served as President and Chief Executive Officer of
the Company since October 1990. Mr. Rosenfeld previously served as Executive
Vice President of the Company from May 1988 until October 1990. From 1987
through April 1988, Mr. Rosenfeld was President of Rosenfeld & Co., a consulting
firm and provided consulting services to the Company. Mr. Rosenfeld is also a
director of PSC, Inc., a manufacturer of bar code equipment and Electric Fuel,
Ltd., a developer and manufacturer of electronic batteries and fueling systems
for motor vehicles. Mr. Rosenfeld was elected a Director of the Company in 1974.

Michael P. Sherman has served as Executive Vice President-Corporate Affairs
of the Company since 1990 and as General Counsel and Secretary of the Company
since 1986. Mr. Sherman also served as Senior Vice President of the Company from
1986 through 1990. Mr. Sherman joined the Company in 1983 and was elected Vice
President-Assistant Secretary of the Company in the same year.

Wayne P. Garten has served as Executive Vice President of the Company since
October 1990 and as Chief Financial Officer of the Company since 1989. Mr.
Garten also served as Senior Vice President of the Company from 1989 through
1990. Mr. Garten joined the Company in 1983 and was elected Vice President of
the Company in 1984. Mr. Garten was elected Vice President-Finance of the
Company in 1989.

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<PAGE> 36

Edward J. O'Brien has served as Senior Vice President and Treasurer of the
Company since 1991. Mr. O'Brien joined the Company in 1986 and was elected Vice
President of the Company in 1988.

David E. Ullman joined the Company in August 1991 and was promoted to Vice
President-Controller in December 1992. Prior to joining the Company, Mr. Ullman
was with Arthur Andersen & Co. for ten years, most recently as a manager in the
Audit and Business Advisory Group.

Ralph Destino has been the Chairman of Cartier, Inc., a luxury goods store,
since 1985. Cartier, Inc. is an indirect subsidiary of Richemont, an affiliate
of NAR. Mr. Destino also serves as a director of The Leslie Fay Companies, a
manufacturer of dresses, suits, coats and sportswear which filed for protection
under the U.S. bankruptcy laws. Mr. Destino, a designee of NAR, was elected a
Director of the Company in October 1991.

J. David Hakman has been the Chief Executive Officer of Hakman Capital
Corporation, Burlingame, California, an investment and merchant banking firm,
since 1980. Mr. Hakman also serves as a director of Concord Camera Corp., a firm
which manufactures and distributes cameras. Mr. Hakman is also the Chairman and
a director of AFD Acquisition Corp., which filed for protection under Chapter 11
of the U.S. Code in June 1991 and emerged from Chapter 11 in September 1993. Mr.
Hakman was appointed a Director of the Company in May 1989 and was elected a
Director of the Company in October 1991.

S. Lee Kling is Chairman of the Board of Kling Rechter & Co., a merchant
banking company. He served as Chairman and a director of Landmark Bancshares
Corporation, a bank holding company in St. Louis, Missouri, from 1974 through
1991, when it merged with Magna Group Inc. He served as Landmark's Chief
Executive Officer from 1974 through 1990. Mr. Kling serves on the Boards of
Directors of E-Systems, Inc., a diversified electronics company, Falcon
Products, Inc., a manufacturer of commercial furniture, Bernard Chaus Inc., a
sportswear manufacturer and distributor, Top Air Manufacturing Co., a
manufacturer of agricultural equipment, Lewis Galoob Toys, Inc., a toy company,
Magna Group, Inc., National Beverage Corp. and NationsMart Corp. Mr. Kling was
elected as a Director of the Company in 1983.

Theodore H. Kruttschnitt has been the owner and sole proprietor of
California Innkeepers, Burlingame, California, an owner/operator of hotels and
motor hotels, since May 1970. Mr. Kruttschnitt is also Chairman of the Board of
Burlingame Bancorp, a commercial bank holding company, and serves on the Board
of Directors of Cooper Development Company, a firm which invests in personal
care products businesses. Mr. Kruttschnitt was appointed a Director of the
Company in May 1989 and was elected a Director of the Company in October 1991.

Jeffrey Laikind has been a Managing Director of Prudential Securities
Investment Management (formerly Prudential Bache Securities Inc.), a money
management firm, since 1985. Mr. Laikind is also a director of NAR and a member
of the advisory board of Quadrant. Mr. Laikind, a designee of NAR, was elected a
Director of the Company in October 1991.

Elizabeth Valk Long has been the President of TIME Magazine since July 1991
and a senior vice president of Time Inc., periodical and book publishers, since
April 1989. She served as the publisher of TIME from July 1991 until September
1993; the publisher of PEOPLE from November 1988 until July 1991; and the
publisher of LIFE Magazine from December 1986 until November 1988. Ms. Long, a
designee of NAR, was elected a Director of the Company in October 1991.

Edmund R. Manwell is Senior Partner at the law firm of Manwell & Milton,
San Francisco, California. Mr. Manwell has been associated with this firm since
1982. Mr. Manwell also serves as a director of Dreyer's Grand Ice Cream, Inc.
Mr. Manwell was appointed a Director of the Company in May 1989 and was elected
a Director of the Company in October 1991.

Geraldine Stutz has been the President and Publisher of Panache Press at
Random House Inc., a publishing company, since 1986. She was previously the
Chief Executive Officer and Managing Partner of Henri Bendel, a New York
specialty store. Ms. Stutz also serves as a director of Tiffany & Co. and the
Jones Apparel Group. Ms. Stutz, a designee of NAR, was elected a Director of the
Company in October 1991.

Robert F. Wright has been the President of Robert F. Wright Associates,
Inc., business consultants, since 1988. Prior thereto, he was a senior partner
of the accounting firm Arthur Andersen & Co. Mr. Wright is a

35
<PAGE> 37

director of Reliance Standard Life Insurance Company and affiliates, Williams
Real Estate Co., Inc. and The Navigator Group, Inc., a casualty and property
insurance company. Mr. Wright also serves on the advisory board of Quadrant
Management, Inc., an indirect wholly-owned subsidiary of NAR. Mr. Wright, a
designee of NAR, was elected a Director of the Company in October 1991.

GENERAL

The Company's Board of Directors is divided into three classes of Directors
serving three-year terms. One class of Directors is elected by the shareholders
at each annual meeting to serve until the third annual meeting or until their
successors are elected and qualified. In the case of a vacancy, Directors are
appointed by the Directors then in office to serve the remainder of the term.

Pursuant to Nomination and Standstill Agreement between Theodore H.
Kruttschnitt, J. David Hakman and Edmund R. Manwell and the Company, the Board
was expanded to 11 members and Mr. Kruttschnitt was appointed as a Class III
Director, Mr. Hakman as a Class I Director and Mr. Manwell as a Class II
Director. The Company also agreed to nominate each of Messrs. Kruttschnitt,
Hakman and Manwell for election upon the expiration of their respective terms
provided Mr. Kruttschnitt continues to own certain specified levels of Common
Stock.

Pursuant to the Stock Purchase Agreement, dated October 25, 1991, between
the Company and NAR (the "Stock Purchase Agreement"), the Company agreed to
recommend in its proxy statement for each annual or special meeting of
shareholders at which directors are to be elected during the five year period
from October 25, 1991, and at each such shareholders' meeting, as part of the
management slate for election to the Board of Directors, such number of persons
designated by NAR as will result in the Board's including six persons designated
by NAR. In addition, NAR agreed that for a period of five years from October 25,
1991, so long as the Board of Directors of the Company consists of 11 persons of
whom six are designees of NAR, it will not nominate or propose for nomination or
elect persons to the Board if as a result more than six persons designated by it
would be on the Board at any one time except following an acquisition by a third
party of 20% or more of the voting stock or total assets of the Company. Messrs.
Destino, Laikind, Quasha and Wright and Ms. Stutz and Ms. Long were designated
pursuant to such agreement and were nominated and elected to serve as directors
of the Company at the Company's 1991 Special Meeting of Shareholders.

The Board of Directors has standing Executive, Audit, Stock Option and
Executive Compensation and Nominating Committees.

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

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<PAGE> 38

PRINCIPAL AND SELLING SHAREHOLDERS

The following table sets forth certain information with respect to
beneficial ownership of the Common Stock as of March 30, 1994, and as adjusted
to reflect the sale of 7,345,396 shares by the Company and 654,604 shares by the
Selling Shareholder in the Offering. The information includes beneficial
ownership by the Selling Shareholder, each person (or group of affiliated
persons) who is known to the Company to own beneficially more than 5% of the
Common Stock, by each of the Company's Directors and executive officers, and by
all Directors and executive officers as a group. The persons named on the table
have sole voting and investment power with respect to all shares of Common Stock
shown as beneficially owned by them.

<TABLE>
<CAPTION>
BENEFICIAL OWNERSHIP BENEFICIAL OWNERSHIP
PRIOR TO OFFERING AFTER OFFERING
------------------------- SHARES BEING --------------------------
NAME SHARES PERCENT(A) OFFERED SHARES PERCENT(B)
- ------------------------------------- ---------- ---------- ------------ ---------- -------------
<S> <C> <C> <C> <C> <C>
Alan G. Quasha(c).................... 51,895,263(d) 58.0% -- 51,895,263(d) 53.6%
c/o Quadrant Management, Inc.
127 East 73rd Street
New York, NY 10021
NAR Group Limited(e)................. 51,895,263(d) 58.0 -- 51,895,263(d) 53.6
c/o P.M.M. Services
(B.V.I.) Limited
P.O. Box 438
Road Town, Tortola,
British Virgin Islands
Theodore H. Kruttschnitt(f).......... 5,320,887(h) 6.3 -- 5,320,887(h) 5.8
1350 Bayshore Boulevard
Suite 850
Burlingame, CA 94010
Jack E. Rosenfeld(i)................. 3,849,598(j) 4.5 -- 3,849,598(j) 4.2
c/o Hanover Direct, Inc.
1500 Harbor Boulevard
Weehawken, NJ 07087
Sun Life Insurance Company of
America............................ 1,309,207 1.5 654,604 654,603 *
1999 Avenue of the Stars
Los Angeles, CA 90067
Ralph Destino(g)..................... 20,000(k) * -- 20,000(k) *
J. David Hakman(f)................... 28,434(l) * -- 28,434(l) *
S. Lee Kling(m)...................... 18,511 * -- 18,511 *
Jeffrey Laikind(g)................... 82,000(n) * -- 82,000(n) *
Edmund R. Manwell(f)................. 33,628(n) * -- 33,628(n) *
Geraldine Stutz(g)................... 59,649(n) * -- 59,649(n) *
Elizabeth Valk Long(g)............... 30,000(n) * -- 30,000(n) *
Robert F. Wright(g).................. 70,000(n) * -- 70,000(n) *
Michael P. Sherman(o)................ 236,798(p) * -- 236,798(p) *
Wayne P. Garten(q)................... 227,976(r) * -- 227,976(r) *
Edward J. O'Brien(s)................. 84,060 * -- 84,060 *
David E. Ullman(t)................... 5,253 * -- 5,253 *
Directors and executive officers as a
group (15 persons)................. 10,086,794(u) 11.9 -- 10,086,794(u) 11.0
</TABLE>

37
<PAGE> 39

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

<TABLE>
<S> <C>
* Less than 1%
(a) Percentages computed on the basis of 84,411,237 shares of Common Stock outstanding
as of March 30, 1994 in accordance with Rule 13d-3 promulgated under the Exchange
Act.
(b) Percentages computed on the basis of 91,756,633 shares of Common Stock to be
outstanding after the Offering (see also note j).
(c) Elected a Director and Chairman of the Board of the Company in October 1991. All of
the shares beneficially owned by NAR could also be deemed to be beneficially owned
by Alan G. Quasha, due to his shared investment and voting power with NAR. Excludes
options for 20,000 shares exercisable within 60 days.
(d) Includes warrants and options for 5,053,735 shares exercisable within 60 days.
(e) All of the shares beneficially owned by NAR could also be deemed to be beneficially
owned by Alan G. Quasha, due to his shared investment and voting power with NAR.
(f) Appointed a Director of the Company in May 1989.
(g) Elected a Director of the Company in October 1991.
(h) Includes options for 15,000 shares exercisable within 60 days. Amendment No. 9 to
the Statement on Schedule 13D filed by Mr. Kruttschnitt with the Commission on
March 9, 1994 indicates that Mr. Kruttschnitt is a member of a group which includes
Mr. J. David Hakman and Mr. Edmund R. Manwell.
(i) President, Chief Executive Officer and a Director of the Company since October
1990.
(j) Includes options for 2,627,210 shares exercisable within 60 days.
(k) Options exercisable within 60 days.
(l) Includes options for 15,000 shares exercisable within 60 days.
(m) Elected a Director of the Company in 1983.
(n) Includes options for 20,000 shares exercisable within 60 days.
(o) Served as the Executive Vice President-Corporate Affairs of the Company since 1990.
(p) Includes options for 31,500 shares exercisable within 60 days.
(q) Served as Executive Vice President and Chief Financial Officer of the Company since
October 1990.
(r) Includes options for 32,150 shares exercisable within 60 days.
(s) Served as Senior Vice President and Treasurer of the Company since 1991.
(t) Served as Vice President-Controller of the Company since December 1992.
(u) Excludes 46,841,528 shares and warrants and options for 5,053,735 shares
beneficially owned by NAR but could also be deemed to be beneficially owned by Alan
G. Quasha. Includes options for 20,000 shares exercisable within 60 days and owned
by Alan G. Quasha.
</TABLE>

RELATIONSHIP WITH SUN LIFE

In May 1991, the Company obtained a $10 million 12% short-term working
capital line (the "Interim Credit Agreement") from Sun Life. In connection with
the transaction, the Company paid a fee of 1.25% and issued warrants to Sun Life
to purchase 973,713 shares of Common Stock at $4.00 per share which were
subsequently adjusted to allow for the purchase of 1,610,644 shares at $2.42 per
share in connection with the anti-dilution provision of the warrant agreement.
The Interim Credit Agreement was paid off in October 1991.

In July 1991, the Company issued additional warrants to Sun Life to
purchase 291,667 shares of Common Stock at $5.25 per share which were
subsequently adjusted to allow for the purchase of 349,601 shares at $2.19 per
share in accordance with the anti-dilution provision of the warrant agreement in
order to induce Sun Life to enter into an Intercreditor Agreement with the
Company.

Pursuant to the terms of these warrants, Sun Life may require the Company
to register the warrants or the shares of Common Stock acquired upon exercise of
the warrants.

In August 1993, the Company issued $20 million of 9.25% Senior Subordinated
Notes in a private placement with Sun Life. The Company is required to redeem $6
million of the 9.25% Notes without penalty

38
<PAGE> 40

by May 1, 1994 if the Company has not established or acquired a new distribution
facility by such date. The Company intends to redeem $6 million of the 9.25%
Notes on May 1, 1994.

In March 1994, Sun Life exercised all of its warrants and purchased
1,309,207 shares in a "net-issue" exchange, 654,604 of which will be sold in the
Offering pursuant to the registration rights provisions of the warrants.

RELATIONSHIP WITH NAR

Upon completion of the Offering, NAR will own 46,841,528 shares of Common
Stock and warrants and options to purchase 5,053,735 shares of Common Stock
constituting 53.3% of the outstanding Common Stock of the Company on a fully
diluted basis (approximately 52.7% if the Underwriters' over-allotment option is
exercised in full). Although pursuant to the Stock Purchase Agreement, NAR has
agreed to nominate only six of the Company's 11 Directors until 1996, NAR has
the power to elect the entire Board of Directors and, except as otherwise
provided by law or the Company's Certificate of Incorporation, to approve any
action requiring shareholder approval without a shareholders meeting. See
"Management -- General." NAR is a private investment holding company that is a
joint venture between the family of Alan G. Quasha, a Director and the Chairman
of the Board of the Company, and Richemont. Richemont is the ultimate parent of
a family of some of the world's leading luxury goods trademarks, including
Cartier, Piaget, Baume & Mercier, Alfred Dunhill and Montblanc. NAR's U.S.
assets are managed by Quadrant Management, Inc., an indirect wholly-owned
subsidiary of NAR ("Quadrant") whose management has participated in a number of
restructurings in a variety of industries since 1980. See "Principal and Selling
Shareholders." NAR obtained control of the Company in the fall of 1991. See "The
Company -- History and Organization -- Restructuring."

The Company has entered into a consulting arrangement with Quadrant
pursuant to which it renders management consulting, business advisory and
investment banking services to the Company for annual compensation of $750,000.
Such agreement was in effect during 1993 and has been renewed for 1994.

A subsidiary of NAR has provided a secured limited guarantee of $10 million
which allows the Company to borrow in excess of its availability under the
Credit Facility based on a formula, up to the facility's limit of $52.5 million.
This limited guarantee was reduced by approximately $5.1 million during the
fourth quarter of 1993, and the Company's expects the guarantee to be eliminated
in the first quarter of 1994 based on the Company's fiscal year-end results.

DESCRIPTION OF CAPITAL STOCK

The following general summary of the material terms of the capital stock of
the Company does not purport to be complete and is subject to, and qualified in
its entirety by reference to, the pertinent portions of the Company's
Certificate of Incorporation.

GENERAL

The authorized capital stock of the Company consists of 150,000,000 shares
of Common Stock, 12,270,503 shares of Class B Common Stock, par value $.01 per
share (the "Class B Common Stock"), 40,000 shares of Class B 8% Cumulative
Preferred Stock, par value $.01 and stated value $1,000 per share (the "Class B
Preferred"), 861,900 shares of 7.5% Cumulative Convertible Preferred Stock, par
value $.01 and stated value $20 per share (the "7.5% Preferred"), 234,900 shares
of Series A Convertible Additional Preferred Stock, par value $.01 per share
(the "Series A Preferred Stock"), and 4,765,100 shares of Additional Preferred
Stock, par value $.01 per share (the "Additional Preferred"). On December 13,
1993, the Company converted all the outstanding shares of 7.5% Preferred into
shares of Common Stock. Pursuant to an Option Agreement, dated as of July 20,
1992, the Company exercised its right to require the exchange, as of January 1,
1994, of the 40,000 shares of Class B Preferred and the 12,270,503 shares of
Class B Common Stock outstanding for 18,937,169 shares of Common Stock. As of
January 1, 1994, there were 82,933,177 shares of Common Stock and 234,900 shares
of Series A Preferred Stock outstanding.

39
<PAGE> 41

COMMON STOCK

General. There are no redemption or sinking fund provisions applicable to
the shares of Common Stock and such shares are not entitled to any preemptive
rights.

Voting. Each holder of Common Stock is entitled to one vote for each share
registered in the holder's name on the books of the Company. Since none of the
shares of Common Stock have cumulative voting rights, the holders of more than
50% of the shares can elect all the Directors of the Company in each class of
Directors, if they so choose, and, in that event, the holders of the remaining
shares will not be able to elect any of the Directors. The Board of Directors of
the Company is divided into three classes of Directors, serving staggered
three-year terms. See "Management -- General."

Dividends. Subject to the prior rights of holders of any then issued and
outstanding preferred stock, the holders of Common Stock are entitled to receive
such dividends as may be declared from time to time by the Board of Directors of
the Company from the assets of the Company which are legally available therefor.

Liquidation. Upon the liquidation, dissolution or winding-up of the
Company, holders of Common Stock are entitled to receive, pro rata, after the
prior rights of creditors and holders of any preferred stock have been
satisfied, all the remaining assets of the Company available for distribution.

Transfer Agent and Registrar. Chemical Bank is the Transfer Agent and
Registrar for the Common Stock.

ADDITIONAL PREFERRED

Additional Preferred may be issued at such times, to such persons and for
such consideration as the Board of Directors may determine to be in the
Company's best interest without (except as otherwise required by law) further
authority from the shareholders. Such shares of authorized and unissued
Additional Preferred may be issued with such designations, voting powers,
preferences and relative, participating, optional or other special rights, and
qualifications, limitations and restrictions of such rights, as the Company's
Board of Directors may authorize, including but not limited to: (i) the
distinctive designation of each series and the number of shares that will
constitute such series; (ii) the voting rights, if any, of shares of such
series; (iii) the dividend rate on the shares of such series, any restriction,
limitation or condition upon the payment of such dividends, whether dividends
shall be cumulative and the dates on which dividends are payable; (iv) the
prices at which, and the terms and conditions on which, the shares of such
series may be redeemed, if such shares are redeemable; (v) the purchase or
sinking fund provisions, if any, for the purchase or redemption of shares of
such series; (vi) any preferential amount payable upon shares of such series in
the event of the liquidation, dissolution or winding-up of the Company or the
distribution of its assets; and (vii) the prices or rates of conversion at
which, and the terms and conditions on which, the shares of such series may be
converted into other securities, if such shares are convertible.

SERIES A PREFERRED STOCK

Dividends. The holders of record of shares of Series A Preferred Stock are
entitled to receive preferential cumulative dividends, when and as declared by
the Board of Directors of the Company out of funds legally available therefor,
at a rate of 6% of the stated value per annum. Dividends on the Series A
Preferred Stock commenced to accrue on September 30, 1993.

Liquidation Preference. In the event of any distribution of assets upon
any liquidation, dissolution or winding-up of the Company, whether voluntary or
involuntary, after payment or provision for payment of the debts and other
liabilities of the Company, the holder of each share of the then outstanding
Series A Preferred Stock shall be entitled to receive out of the assets of the
Company, whether such assets are capital, surplus or earnings, an amount equal
to the then stated value of each share of Series A Preferred Stock, before any
payments or distributions are made to, or set aside for, any other equity
security of the Company other than any other series of preferred stock. If the
assets of the Company are insufficient to pay such amounts in full, then the
entire assets of the Company shall be distributed pro rata to the holders of
shares of preferred stock after the holders of the Class B Preferred and the
7.5% Preferred have been paid in full. Neither a

40
<PAGE> 42

consolidation, merger or other business combination of the Company with or into
another corporation or other entity nor a sale or transfer of all or part of the
Company assets for cash, securities or other property shall be considered a
liquidation, dissolution or winding up of the Company.

Conversion. On September 30, 1994, each holder of the Series A Preferred
Stock shall automatically, without any action being required on the part of such
holder, have one-third of each such holders holdings of Series A Preferred Stock
(the "First Conversion Allotment") converted into a number of shares of Common
Stock of the Company determined by dividing the then stated value of the shares
by the Conversion Price. On September 30, 1995, each holder of the Series A
Preferred Stock shall automatically, without any action being required on the
part of such holder, have one-half of each such holders holdings of Series A
Preferred Stock (the "Second Conversion Allotment") converted into a number of
shares of Common Stock determined by dividing the then stated value of the
shares by the Conversion Price. On September 30, 1996, all shares of the Series
A Preferred Stock that remain outstanding (the "Final Conversion Allotment")
shall automatically, without any action being required on the part of the
holders thereof, be converted into a number of shares of Common Stock determined
by dividing the then stated value of the shares by the Conversion Price. Each of
September 30, 1994, September 30, 1995 and September 30, 1996 is referred to
herein as a "Conversion Date." The "Conversion Price" shall be an amount equal
to the average of the per-share closing prices (regular way) for a round lot of
the Common Stock on the AMEX (or, if the Common Stock is then not listed for
trading on the AMEX, such other exchange or system on which the Common Stock
shall from time to time be traded) on each of the five trading days immediately
preceding a Conversion Date.

No fractional shares or scrip representing fractional shares of Common
Stock shall be issued upon conversion of Series A Preferred Stock. Instead of
any fractional share of Common Stock that would otherwise be issuable upon
conversion of any shares of Series A Preferred Stock, the Company will pay a
cash adjustment in respect of such fractional interest in an amount equal to the
same fraction of the Conversion Price per share of Common Stock.

Redemption. The Company shall have the right to redeem the First
Conversion Allotment at any time prior to September 20, 1994, the Second
Conversion Allotment at any time prior to September 20, 1995 and the Final
Conversion Allotment at any time prior to September 20, 1996 at the liquidation
value (initial stated value plus accrued but unpaid dividends) of such shares
payable in cash.

Voting Rights. The holders of the Series A Preferred Stock shall not have
any voting rights except as may be required by law.

Preemptive Rights. The Series A Preferred Stock is not entitled to any
preemptive or subscription rights in respect of any securities of the Company.

SHARES ELIGIBLE FOR FUTURE SALE

Upon completion of this Offering, the Company will have 91,756,633 shares
of Common Stock outstanding (92,956,633 if the Underwriters' over-allotment
option is exercised in full). Of these shares, 37,034,568 shares (38,234,568 if
the Underwriters' over-allotment option is exercised in full) will be tradeable
without restriction and the remainder will be "restricted securities" under the
Securities Act, and may only be sold pursuant to a registration statement under
the Securities Act or an applicable exemption from the registration requirements
of the Securities Act, including Rule 144 and thereunder. NAR, Sun Life and
certain executive officers of the Company are entitled to certain rights with
respect to registration of their shares of Common Stock under the Securities
Act.

In general, under Rule 144 as currently in effect, a person (or persons
whose shares are aggregated), including an affiliate of the Company, who has
beneficially owned restricted shares for at least two years, will be entitled to
sell in any three-month period a number of shares that does not exceed the
greater of (i) 1% of the then outstanding shares of the Common Stock
(approximately 917,566 shares immediately after this Offering) or (ii) the
average weekly trading volume of the Common Stock on the AMEX during the four
calendar weeks immediately preceding the date on which notice of the sale is
filed with the Commission. Sales pursuant to Rule 144 are also subject to
certain other requirements relating to manner of sale, notice and

41
<PAGE> 43

availability of current public information about the Company. A person (or
persons whose shares are aggregated) who is not deemed to have been an affiliate
of the Company at any time during the three months immediately preceding the
sale is entitled to sell restricted shares pursuant to Rule 144(k) without
regard to the limitations described above, provided that three years have
expired since the later of the date on which such restricted shares were
acquired from the Company or the date they were acquired from an affiliate of
the Company.

Certain shareholders who own 54,067,462 restricted shares have agreed with
the Underwriters not to sell or otherwise dispose of any shares for 180 days
after the date of this Prospectus without the prior consent of Merrill Lynch,
Pierce, Fenner & Smith Incorporated on behalf of the Underwriters. The Company
has agreed not to sell or otherwise dispose of any shares for 180 days after the
date of this Prospectus without the prior written consent of Merrill Lynch,
Pierce, Fenner & Smith Incorporated on behalf of the Underwriters, except in
certain circumstances including shares issued 90 days after the date of this
Prospectus in connection with an acquisition. The Selling Shareholder who owns
654,603 restricted shares has agreed with the Underwriters not to sell or
otherwise dispose of any shares for 90 days after the date of this Prospectus
without the prior written consent of Merrill Lynch, Pierce, Fenner & Smith
Incorporated on behalf of the Underwriters.

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<PAGE> 44

CERTAIN UNITED STATES TAX CONSEQUENCES
TO NON-U.S. HOLDERS OF COMMON STOCK

The following is a general discussion of certain U.S. federal income and
estate tax consequences of the ownership and disposition of Common Stock by a
person that, for U.S. federal income tax purposes, is a non-resident alien
individual, a foreign corporation, a foreign partnership or a foreign estate or
trust (a "non-U.S. holder"). This discussion does not consider specific facts
and circumstances that may be relevant to a particular holder's tax position
(including the tax position of certain U.S. expatriates) and therefore does not
address all aspects of U.S. federal tax that may be relevant to non-U.S. holders
in light of their specific circumstances. Nor does this discussion deal with
U.S. state and local or non-U.S. tax consequences of the ownership or
disposition of Common Stock. Furthermore, the following discussion is based on
provisions of the U.S. Internal Revenue Code of 1986, as amended, and
administrative and judicial interpretations as of the date hereof, all of which
are subject to change. Each prospective holder of Common Stock is urged to
consult a tax advisor with respect to the U.S. federal tax consequences of
acquiring, holding and disposing of Common Stock as well as any tax consequences
that may arise under the laws of any U.S. state or municipality or other tax
jurisdiction.

DIVIDENDS

Dividends paid to a non-U.S. holder of Common Stock will be subject to
withholding of U.S. federal income tax at a 30% rate or such lower rate as may
be specified by an applicable income tax treaty, unless the dividends are
effectively connected with the conduct of a trade or business within the United
States or, if an income tax treaty applies, are attributable to a U.S. permanent
establishment of such holder. Dividends that are effectively connected with such
holder's conduct of a trade or business in the United States or, if an income
tax treaty applies, are attributable to a U.S. permanent establishment of such
holder, are subject to tax at rates applicable to U.S. citizens, resident aliens
and domestic U.S. corporations, and are not generally subject to withholding.
Any such effectively connected dividends received by a non-U.S. corporation may,
under certain circumstances: (i) be entitled to the benefit of a dividends
received deduction under U.S. federal income tax law; and (ii) be subject to an
additional "branch profits tax" at a 30% rate or such lower rate as may be
specified by an applicable income tax treaty.

Under current U.S. Treasury regulations, dividends paid to an address in a
foreign country may be presumed to be paid to a resident of that country (unless
the payor has knowledge to the contrary) for purposes of the withholding
discussed above and, under the current interpretation of the U.S. Treasury
regulations, for purposes of determining the applicability of a tax treaty rate.
Under proposed U.S. Treasury regulations, not currently in effect, however, a
non-U.S. holder of Common Stock who wishes to claim the benefit of an applicable
treaty rate would be required to satisfy applicable certification and other
requirements.

A non-U.S. holder of Common Stock that is eligible for a reduced rate of
U.S. withholding tax pursuant to a tax treaty may obtain a refund of any excess
amounts currently withheld by filing an appropriate claim for refund with the
U.S. Internal Revenue Service.

GAIN ON DISPOSITION OF COMMON STOCK

A non-U.S. holder generally will not be subject to U.S. federal income tax
in respect of gain recognized on a disposition of Common Stock unless: (i) the
gain is effectively connected with a trade or business of the non-U.S. holder in
the United States; (ii) in the case of a non-U.S. holder who is an individual
and holds the Common Stock as a capital asset, such holder is present in the
United States for 183 or more days in the taxable year of the sale and the gain
from such sale is considered to be derived from sources within the United States
under applicable U.S. federal tax principles; or (iii) the Company has been at
some time during the five-year period ending on the date of the disposition of
the Common Stock a "U.S. real property holding corporation" for federal income
tax purposes and the non-U.S. holder held, directly or indirectly at any time
during such five-year period, more than 5% of the Common Stock. Gain from the
sale of Common Stock held as a capital asset by an individual non-U.S. holder
will generally not be considered to be derived from sources within the United
States for the purposes of the foregoing unless either: (i) such individual's
"tax home" for United States federal income tax purposes is in the United
States; or (ii) such gain is attributable to an office

43
<PAGE> 45

or other fixed place of business maintained by such individual within the United
States. The Company has not been at any time during the five-year period ending
on the date of this registration statement and does not anticipate becoming a
"U.S. real property holding corporation" for federal income tax purposes.

In addition, in certain circumstances, capital gain realized on the sale of
Common Stock may be exempted from United States taxation under an applicable
income tax treaty.

FEDERAL ESTATE TAXES

Common Stock owned or treated as owned by an individual non-U.S. holder at
the time of death will generally be included in such holder's gross estate for
U.S. federal estate tax purposes, unless an applicable estate tax treaty
provides otherwise.

U.S. INFORMATION REPORTING REQUIREMENT AND BACKUP WITHHOLDING TAX

U.S. information reporting requirements, other than the reporting of
dividend payments for purposes of the withholding tax noted above, and backup
withholding tax generally will not apply to dividends paid to non-U.S. holders
that are either subject to the 30% withholding discussed above or that are not
so subject because an applicable tax treaty reduces such withholding. Otherwise,
backup withholding of U.S. federal income tax at a rate of 31% may apply to
dividends paid with respect to the Common Stock to holders that are not "exempt
recipients" and that fail to provide certain information (including the holder's
U.S. taxpayer identification number) in the manner required by U.S. law and
applicable regulations or to report certain payments which are taxable for
United States federal income tax purposes. Under current U.S. Treasury
regulations, the payor of the dividends may generally rely on the payees'
address outside the United States in determining that the withholding or
applicable treaty exemption provisions discussed above apply, and, consequently,
that the backup withholding provisions do not apply. Under proposed U.S.
Treasury regulations, not currently in effect, however, a payor of dividends
would be permitted to rely on an applicable treaty exemption as the basis for an
exemption from the backup withholding provisions only if the recipient satisfies
applicable certification requirements.

As a general proposition, U.S. information reporting and backup withholding
requirement will not apply to a payment made outside the United States of the
proceeds of a sale of Common Stock through an office outside the United States
of a non-U.S. broker. However, U.S. information reporting requirements (but,
currently, not backup withholding) will apply to a payment made outside the
United States of the proceeds of a sale of Common Stock through an office
outside the United States of a broker that is a U.S. person, that derives 50% or
more of its gross income for certain periods from the conduct of a trade or
business in the United States, or that is a "controlled foreign corporation"
determined under United States federal income tax law, unless the broker has
documentary evidence in its records that the holder is a non-U.S. holder and
certain conditions are met, or the holder otherwise establishes an exemption.
Payment by a U.S. office of a broker of the proceeds of a sale of Common Stock
is currently subject to both U.S. backup withholding and information reporting
unless the holder certifies non-U.S. status under penalties of perjury or
otherwise establishes an exemption.

A non-U.S. holder generally may obtain a refund of any excess amounts
withheld under the backup withholding rules by filing the appropriate claim for
refund with the U.S. Internal Revenue Service.

These backup withholding and information reporting rules are under review
by the Treasury Department and their application to the Common Stock could be
changed by the enactment of new requirements.

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<PAGE> 46

UNDERWRITING

Merrill Lynch, Pierce, Fenner & Smith Incorporated ("Merrill Lynch") and
Alex. Brown & Sons Incorporated are acting as representatives (the
"Representatives") of each of the Underwriters named below (the "Underwriters").
Subject to the terms and conditions set forth in a purchase agreement (the
"Purchase Agreement") among the Company, the Selling Shareholder and the
Underwriters, the Company, for its own account, and the Selling Shareholder have
agreed to sell to the Underwriters, and each of the Underwriters has severally
agreed to purchase from the Company and the Selling Shareholder, the number of
shares of Common Stock set forth opposite its name below:

<TABLE>
<CAPTION>
NUMBER
UNDERWRITERS OF SHARES
---------
<S> <C>
Merrill Lynch, Pierce, Fenner & Smith
Incorporated............................................... 2,000,000
Alex. Brown & Sons Incorporated......................................... 2,000,000
Bear, Stearns & Co. Inc. ............................................... 160,000
Dillon, Read & Co. Inc. ................................................ 160,000
Goldman, Sachs & Co. ................................................... 160,000
Kidder, Peabody & Co. Incorporated...................................... 160,000
Lazard Freres & Co. .................................................... 160,000
Lehman Brothers Inc. ................................................... 160,000
Morgan Stanley & Co. Incorporated....................................... 160,000
Oppenheimer & Co., Inc. ................................................ 160,000
PaineWebber Incorporated................................................ 160,000
Prudential Securities Incorporated...................................... 160,000
Robertson, Stephens & Company........................................... 160,000
Salomon Brothers Inc ................................................... 160,000
Smith Barney Shearson Inc. ............................................. 160,000
Advest, Inc. ........................................................... 80,000
Allen & Company Incorporated............................................ 80,000
Robert W. Baird & Co. Incorporated...................................... 80,000
William Blair & Company................................................. 80,000
The Chicago Corporation................................................. 80,000
Dain Bosworth Incorporated.............................................. 80,000
Fahnestock & Co. Inc. .................................................. 80,000
First Manhattan Co. .................................................... 80,000
Furman Selz Incorporated................................................ 80,000
Janney Montgomery Scott Inc. ........................................... 80,000
Kemper Securities, Inc. ................................................ 80,000
Ladenburg, Thalmann & Co. Inc. ......................................... 80,000
C.J. Lawrence/Deutsche Bank Securities Corporation...................... 80,000
Legg Mason Wood Walker, Incorporated.................................... 80,000
Needham & Company, Inc. ................................................ 80,000
Neuberger & Berman...................................................... 80,000
Rothschild Inc. ........................................................ 80,000
Sutro & Co. Incorporated................................................ 80,000
Tucker Anthony Incorporated............................................. 80,000
Wessels, Arnold & Henderson............................................. 80,000
Wheat, First Securities, Inc. .......................................... 80,000
Brean Murray, Foster Securities Inc. ................................... 40,000
The Buckingham Research Group Incorporated.............................. 40,000
Cleary Gull Reiland & McDevitt Inc. .................................... 40,000
Davenport & Co. of Virginia, Inc. ...................................... 40,000
Roney & Co. ............................................................ 40,000
The Seidler Companies Incorporated...................................... 40,000
---------
Total...................................................... 8,000,000
---------
---------
</TABLE>

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<PAGE> 47

In the Purchase Agreement, the several Underwriters have agreed, subject to
the terms and conditions set forth therein, to purchase all of the shares of
Common Stock being sold pursuant to such agreement if any shares are purchased.
Under certain circumstances, the commitments of non-defaulting Underwriters may
be increased.

The Representatives have advised the Company and the Selling Shareholder
that the Underwriters propose initially to offer the shares of Common Stock to
the public at the public offering price set forth on the cover page of this
Prospectus, and to certain dealers at such price less a concession not in excess
of $.19 per share of Common Stock. After the Offering, the public offering price
and concession may be changed.

The Company has granted an option to the Underwriters, exercisable during
the 30-day period after the date of this Prospectus, to purchase up to an
aggregate of 1,200,000 additional shares of Common Stock at the public offering
price set forth on the cover page of this Prospectus, less the underwriting
discount. The Underwriters may exercise this option only to cover
over-allotments, if any, made on the sale of the Common Stock offered hereby. To
the extent that the Underwriters exercise this option, each Underwriter will be
obligated, subject to certain conditions, to purchase the number of additional
shares of Common Stock proportionate to such Underwriter's initial amount
reflected in the foregoing table.

The Company and certain other shareholders of the Company, prior to the
Offering, have agreed not to sell or otherwise dispose of any shares of Common
Stock or securities convertible into or exchangeable or exercisable for Common
Stock (except for shares offered pursuant to the Offering) without the prior
written consent of Merrill Lynch on behalf of the Underwriters for a period of
180 days (and in the case of the Selling Shareholder, 90 days) after the date of
this Prospectus; provided, however, that the Company may issue shares of Common
Stock or securities convertible into or exchangeable or exercisable for Common
Stock (i) 90 days after the date of this Prospectus as consideration for the
acquisition by the Company of stock or assets of another entity or (ii) to the
eligible participants in the Company's stock plans pursuant to the terms
thereof. See "Shares Eligible for Future Sale."

The Company and the Selling Shareholder have agreed to indemnify the
several Underwriters against certain liabilities, including liabilities under
the Securities Act.

LEGAL MATTERS

The validity of the shares of Common Stock offered hereby is being passed
upon for the Company by Whitman Breed Abbott & Morgan, New York, New York.
Certain legal matters will be passed upon for the Underwriters by Fried, Frank,
Harris, Shriver & Jacobson (a partnership including professional corporations),
New York, New York.

EXPERTS

The consolidated balance sheets of Hanover Direct, Inc. (successor to The
Horn & Hardart Company) and subsidiaries as of January 1, 1994 and December 26,
1992, and the related consolidated statements of income (loss), shareholders'
(deficit) equity and cash flows for each of the three fiscal years in the period
ended January 1, 1994 and schedules included and incorporated by reference in
this prospectus and elsewhere in the registration statement have been audited by
Arthur Andersen & Co., independent public accountants, as indicated in their
reports with respect thereto, and are included herein in reliance upon the
authority of said firm as experts in accounting and auditing in giving said
reports. Reference is made to said reports, which include an explanatory
paragraph with respect to the change in its method of accounting for income
taxes as discussed in Notes 1 and 10 to the consolidated financial statements.

The consolidated balance sheets of Company Store Holdings, Inc. and
subsidiaries (Debtors-in-Possession) as of August 1, 1992 and July 27, 1991, and
the related consolidated statements of operations, shareholders' investment
(deficit) and cash flows for each of the three years in the period ended August
1, 1992 incorporated by reference in this prospectus and elsewhere in the
Registration Statement have been audited by Arthur Andersen & Co., independent
public accountants, as indicated in their reports with respect thereto, and are
included herein in reliance upon the authority of said firm as experts in
accounting and auditing in giving said reports. Reference is made to said
reports which include an explanatory paragraph that

46
<PAGE> 48

describes Company Store Holdings, Inc.'s filing for bankruptcy and its ability
to continue as a going concern, discussed in Note 2 to the consolidated
financial statements.

The financial statements of Tweeds, Inc. as of and for the years ended June
30, 1991 and July 30, 1990 which are incorporated herein by reference, have been
so included in reliance upon the report of Deloitte & Touche, independent
auditors (of which the report contains explanatory language with respect to the
substantial doubt about the entity's ability to continue as a going concern),
incorporated herein by reference, given upon the authority of said firm as
experts in auditing and accounting.

The balance sheets of Tweeds, Inc. as of January 31, 1993 and February 2,
1992, and the related statements of operations, stockholders' equity and cash
flows for the year ended January 31, 1993, and the period from July 1, 1991 to
February 2, 1992 incorporated by reference in this Prospectus and elsewhere in
the Registration Statement have been audited by KPMG Peat Marwick, independent
public accountants, as indicated in their reports with respect thereto, and are
included herein in reliance upon the authority of said firm as experts in
accounting and auditing.

The consolidated financial statements of Gump's Inc. at February 27, 1993
and February 29, 1992 and February 23, 1991 and for each of the three years in
the period ended February 27, 1993, incorporated by reference in this Prospectus
and Registration Statement have been audited by Ernst & Young, independent
auditors, as set forth in their reports thereon (which contain an explanatory
paragraph with respect to the Company's ability to continue as a going concern)
appearing elsewhere herein are incorporated by reference. Such consolidated
financial statements are included in reliance upon the authority of such firm as
experts in accounting and auditing.

47
<PAGE> 49

HANOVER DIRECT, INC. AND SUBSIDIARIES

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Public Accountants.............................................. F-2
Consolidated Balance Sheets as of December 26, 1992 and January 1, 1994............... F-3
Consolidated Statements of Income (Loss) for the Years Ended December 28, 1991,
December 26, 1992 and January 1, 1994............................................... F-5
Consolidated Statements of Shareholders' (Deficit) Equity for the Years Ended
December 28, 1991, December 26, 1992 and January 1, 1994............................ F-6
Consolidated Statements of Cash Flows for the Years Ended December 28, 1991,
December 26, 1992 and January 1, 1994............................................... F-7
Notes to Consolidated Financial Statements for the Years Ended December 28, 1991,
December 26, 1992 and January 1, 1994............................................... F-8
</TABLE>

F-1
<PAGE> 50

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To the Shareholders of Hanover Direct, Inc.:

We have audited the accompanying consolidated balance sheets of Hanover
Direct, Inc. (a Delaware corporation) (successor to The Horn & Hardart Company,
see Note 1 to the Consolidated Financial Statements) and subsidiaries as of
December 26, 1992 and January 1, 1994, and the related consolidated statements
of income (loss), shareholders' (deficit) equity and cash flows for each of the
three fiscal years in the period ended January 1, 1994. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.

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

In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Hanover Direct, Inc. and
subsidiaries as of December 26, 1992 and January 1, 1994, and the results of
their operations and their cash flows for each of the three fiscal years in the
period ended January 1, 1994 in conformity with generally accepted accounting
principles.

As discussed in Notes 1 and 10 to the Consolidated Financial Statements,
effective December 29, 1991 the Company changed its method of accounting for
income taxes.

ARTHUR ANDERSEN & CO.

New York, New York
February 28, 1994

F-2
<PAGE> 51

HANOVER DIRECT, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 26, 1992 AND JANUARY 1, 1994

<TABLE>
<CAPTION>
DECEMBER 26, JANUARY 1,
1992 1994
------------ ----------
(IN THOUSANDS)
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents........................................ $ 2,553 $ 2,583
Accounts receivable, net of allowance for doubtful accounts
of $2,892 in 1992 and $2,509 in 1993.......................... 22,840 19,043
Inventories...................................................... 58,270 80,429
Deferred tax asset, net.......................................... 2,800 2,975
Prepaid catalog costs............................................ 18,277 25,571
Other current assets............................................. 2,058 2,374
------------ ----------
Total Current Assets..................................... 106,798 132,975
------------ ----------
Property and Equipment, at cost
Land............................................................. 205 1,171
Buildings and building improvements.............................. 4,462 7,862
Leasehold improvements........................................... 5,696 6,242
Furniture, fixtures and equipment................................ 16,309 22,551
Construction in progress......................................... -- 5,434
------------ ----------
26,672 43,260
Accumulated depreciation and amortization........................ (15,761) (18,341)
------------ ----------
Net Property and Equipment............................... 10,911 24,919
------------ ----------
Excess of Cost Over Net Assets of Acquired Businesses, net......... 8,710 18,463
Deferred Tax Asset, net............................................ 7,200 7,656
Other Assets, net.................................................. 733 4,825
------------ ----------
Total Assets............................................. $134,352 $ 188,838
------------ ----------
------------ ----------
</TABLE>

See Notes to Consolidated Financial Statements.

F-3
<PAGE> 52

HANOVER DIRECT, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS (CONTINUED)
AS OF DECEMBER 26, 1992 AND JANUARY 1, 1994

<TABLE>
<CAPTION>
DECEMBER 26, JANUARY 1,
1992 1994
------------ ----------
(IN THOUSANDS, EXCEPT SHARE
AND PER SHARE AMOUNTS)
<S> <C> <C>
LIABILITIES AND SHAREHOLDERS' (DEFICIT) EQUITY
Current Liabilities:
Current portion of long-term debt and capital lease obligations.... $ 73 $ 2,024
Accounts payable................................................... 49,741 78,905
Dividends payable.................................................. -- 886
Accrued liabilities................................................ 21,363 20,653
Customer prepayments and credits................................... 4,055 5,031
------------ ----------
Total Current Liabilities.................................. 75,232 107,499
------------ ----------
Noncurrent Liabilities:
Long-term debt..................................................... 43,184 32,313
Capital lease obligations.......................................... 105 1,823
Other.............................................................. 2,747 1,335
------------ ----------
Total Noncurrent Liabilities............................... 46,036 35,471
------------ ----------
Total Liabilities.......................................... 121,268 142,970
------------ ----------
Commitments and Contingencies
Preferred Stock:
7.5% cumulative, convertible, $.01 par value, authorized 861,900
shares; issued 529,114 shares in 1992........................... 6,526 --
Class B 8% cumulative, convertible, $.01 par value, authorized and
issued 40,000 shares in 1992.................................... 26,316 --
------------ ----------
Total Preferred Stock...................................... 32,842 --
------------ ----------
Shareholders' (Deficit) Equity:
6% Preferred Stock, convertible, $10 stated value, authorized
5,000,000 shares; issued 234,900 shares in 1993................. -- 2,378
Class B Common Stock, $.01 par value, authorized and issued
12,270,503 shares in 1992....................................... 123 --
Common Stock, $.66 2/3 par value, authorized 150,000,000 shares;
issued 58,154,584 shares in 1992 and 83,136,542 shares in
1993............................................................ 38,774 55,423
Capital in excess of par value..................................... 178,149 209,834
Accumulated deficit................................................ (229,049) (215,805)
------------ ----------
(12,003) 51,830
Less:
Treasury stock, at cost (2,169,713 shares in 1992
and 1,120,032 shares in 1993)................................... (7,170) (3,130)
Notes receivable from sale of Common Stock......................... -- (1,774)
Deferred compensation.............................................. (585) (1,058)
------------ ----------
Shareholders' (Deficit) Equity..................................... (19,758) 45,868
------------ ----------
Total Liabilities and Shareholders' (Deficit) Equity....... $134,352 $ 188,838
------------ ----------
------------ ----------
</TABLE>

See Notes to Consolidated Financial Statements.

F-4
<PAGE> 53

HANOVER DIRECT, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME (LOSS)
FOR THE YEARS ENDED DECEMBER 28, 1991, DECEMBER 26, 1992 AND JANUARY 1, 1994

<TABLE>
<CAPTION>
1991 1992 1993
-------- -------- --------
(IN THOUSANDS, EXCEPT PER
SHARE AMOUNTS)
<S> <C> <C> <C>
REVENUES....................................................... $623,650 $586,562 $642,511
-------- -------- --------
Operating costs and expenses:
Cost of sales and operating expenses......................... 409,098 381,716 408,387
Selling expenses............................................. 174,401 138,494 157,811
General and administrative expenses.......................... 57,329 51,950 57,237
Restructuring expenses....................................... 8,900 -- --
-------- -------- --------
649,728 572,160 623,435
-------- -------- --------
INCOME (LOSS) FROM OPERATIONS.................................. (26,078) 14,402 19,076
Interest expense............................................. (20,525) (13,379) (4,925)
Interest income.............................................. 2,184 244 2,168
Other income (expense)....................................... (6,437) -- 888
-------- -------- --------
Income (loss) from continuing operations before income taxes... (50,856) 1,267 17,207
Income tax provision (benefit)................................. 225 219 (130)
-------- -------- --------
INCOME (LOSS) FROM CONTINUING OPERATIONS....................... (51,081) 1,048 17,337
Provision for loss on disposal of discontinued operations...... (21,119) -- --
-------- -------- --------
Income (loss) before extraordinary items and cumulative effect
of accounting change......................................... (72,200) 1,048 17,337
Extraordinary items............................................ 6,915 9,201 --
Cumulative effect of accounting change for income taxes........ -- 10,000 --
-------- -------- --------
NET INCOME (LOSS).............................................. (65,285) 20,249 17,337
Preferred stock dividends...................................... (466) (3,197) (4,093)
-------- -------- --------
Net income (loss) applicable to Common Shareholders............ $(65,751) $ 17,052 $ 13,244
-------- -------- --------
-------- -------- --------
Net income (loss) per share:
Income (loss) from continuing operations..................... $ (3.16) $ (0.06) $ 0.17
(Loss) from discontinued operations.......................... (1.30) -- --
-------- -------- --------
Income (loss) before extraordinary items and cumulative
effect of accounting change............................... (4.46) (0.06) 0.17
Extraordinary items............................................ 0.43 0.24 --
Cumulative effect of accounting change for income taxes........ -- 0.26 --
-------- -------- --------
Net income (loss) per share.................................... $ (4.03) $ 0.44 $ 0.17
-------- -------- --------
-------- -------- --------
</TABLE>

See Notes to Consolidated Financial Statements.

F-5
<PAGE> 54

HANOVER DIRECT, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' (DEFICIT) EQUITY
FOR THE YEARS ENDED DECEMBER 28, 1991, DECEMBER 26, 1992 AND JANUARY 1, 1994
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
PREFERRED STOCK
CLASS B 8% PREFERRED STOCK PREFERRED STOCK CLASS B COMMON STOCK
CUMULATIVE 7.5% CUMULATIVE SERIES A, 6.0% $.01 PAR VALUE
------------------ ------------------ ---------------- --------------------
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
------- -------- -------- ------- ------- ------ ----------- ------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 29, 1990................ 0 $ 0 0 $ 0 0 $ 0 0 $ 0
Net loss....................................
Issuance of warrants........................
Executive employment contracts..............
Shares to 401k savings plan.................
Payment on notes receivable.................
Issuance of Class B Common Stock............ 13,333,334 133
Amortization of deferred compensation.......
Termination of Employee Stock Ownership
Plan.......................................
------- -------- -------- ------- ------- ------ ----------- ------
BALANCE AT DECEMBER 28, 1991................ 0 $ 0 0 $ 0 0 $ 0 13,333,334 $133
Net income..................................
Issuance of Common Stock to and redemption
of Class B Common Stock by NAR............. (13,333,334) (133)
Issuance of Class B Common Stock............ 12,270,503 123
Amortization of deferred compensation.......
Issuance of Common Stock in connection with
Rights Offering............................
14% Exchange Offer..........................
7 1/2% Exchange Offer.......................
Stock Dividend to NAR.......................
Issuance of Common Stock....................
Transfer of ESOP shares to treasury.........
------- -------- -------- ------- ------- ------ ----------- ------
BALANCE AT DECEMBER 26, 1992................ 0 $ 0 0 $ 0 0 $ 0 12,270,503 $123
Net income..................................
Mergers of H&H & THC into
Hanover Direct, Inc........................ 40,000 25,516 569,532 7,158
Exchange of Class B 8% Preferred and Common
Stock...................................... (40,000) (25,516) (12,270,503) (123)
Conversion of 7.5% Preferred Stock.......... (569,532) (7,158)
Issuance of Preferred Stock................. 234,900 2,342
Stock dividends............................. 36
Amortization of deferred compensation.......
Issuance of Common Stock....................
------- -------- -------- ------- ------- ------ ----------- ------
BALANCE AT JANUARY 1, 1994.................. 0 $ 0 0 $ 0 234,900 $2,378 0 $ 0
------- -------- -------- ------- ------- ------ ----------- ------
------- -------- -------- ------- ------- ------ ----------- ------

NOTES
COMMON STOCK CAPITAL RECEIVABLE
$.66 2/3 PAR VALUE IN EXCESS TREASURY STOCK FROM SALE
-------------------- OF PAR ACCUM. --------------------- OF COMMON
SHARES AMOUNT VALUE (DEFICIT) SHARES AMOUNT STOCK
---------- ------- --------- --------- ---------- -------- ---------
<S> <C> <C>
BALANCE AT DECEMBER 29, 1990................ 14,812,863 $ 9,874 $ 124,228 $(180,350) (900,943) $ (7,865) $ (270)
Net loss.................................... (65,751)
Issuance of warrants........................ 3,286
Executive employment contracts.............. 1,281,458 854 6,287 (1,281,458) (3,845)
Shares to 401k savings plan................. (56) 12,502 109
Payment on notes receivable................. 270
Issuance of Class B Common Stock............ 1,867
Amortization of deferred compensation.......
Termination of Employee Stock Ownership
Plan.......................................
---------- ------- --------- --------- ---------- -------- ---------
BALANCE AT DECEMBER 28, 1991................ 16,094,321 $10,728 $ 135,612 $(246,101) (2,169,899) $(11,601) $ 0
Net income.................................. 17,052
Issuance of Common Stock to and redemption
of Class B Common Stock by NAR............. 20,000,000 13,334 24,146
Issuance of Class B Common Stock............ 410
Amortization of deferred compensation.......
Issuance of Common Stock in connection with
Rights Offering............................ 14,396,798 9,603 11,086
14% Exchange Offer.......................... 4,099,625 2,733 5,123
7 1/2% Exchange Offer....................... 3,448,840 2,299 5,773 45,006 393
Stock Dividend to NAR....................... (3,764) 601,233 5,249
Issuance of Common Stock.................... 115,000 77 (237)
Transfer of ESOP shares to treasury......... (646,053) (1,211)
---------- ------- --------- --------- ---------- -------- ---------
BALANCE AT DECEMBER 26, 1992................ 58,154,584 $38,774 $ 178,149 $(229,049) (2,169,713) $ (7,170) $ 0
Net income.................................. 13,244
Mergers of H&H & THC into
Hanover Direct, Inc........................
Exchange of Class B 8% Preferred and Common
Stock...................................... 18,937,169 12,625 13,014
Conversion of 7.5% Preferred Stock.......... 2,278,128 1,519 5,639
Issuance of Preferred Stock.................
Stock dividends............................. (438) 684,890 2,946
Amortization of deferred compensation.......
Issuance of Common Stock.................... 3,766,661 2,505 13,470 364,791 1,094 (1,774)
---------- ------- --------- --------- ---------- -------- ---------
BALANCE AT JANUARY 1, 1994.................. 83,136,542 $55,423 $ 209,834 $(215,805) (1,120,032) $ (3,130) $(1,774)
---------- ------- --------- --------- ---------- -------- ---------
---------- ------- --------- --------- ---------- -------- ---------

DEFERRED
COMP. TOTAL
-------- ---------
BALANCE AT DECEMBER 29, 1990................ $ (7,101) $ (61,484)
Net loss.................................... (65,751)
Issuance of warrants........................ 3,286
Executive employment contracts.............. (1,297) 1,999
Shares to 401k savings plan................. 53
Payment on notes receivable................. 270
Issuance of Class B Common Stock............ 2,000
Amortization of deferred compensation....... 1,145 1,145
Termination of Employee Stock Ownership
Plan....................................... 4,850 4,850
-------- ---------
BALANCE AT DECEMBER 28, 1991................ $ (2,403) $(113,632)
Net income.................................. 17,052
Issuance of Common Stock to and redemption
of Class B Common Stock by NAR............. 37,347
Issuance of Class B Common Stock............ 533
Amortization of deferred compensation....... 607 607
Issuance of Common Stock in connection with
Rights Offering............................ 20,689
14% Exchange Offer.......................... 7,856
7 1/2% Exchange Offer....................... 8,465
Stock Dividend to NAR....................... 1,485
Issuance of Common Stock.................... (160)
Transfer of ESOP shares to treasury......... 1,211 0
-------- ---------
BALANCE AT DECEMBER 26, 1992................ $ (585) $ (19,758)
Net income.................................. 13,244
Mergers of H&H & THC into
Hanover Direct, Inc........................ 32,674
Exchange of Class B 8% Preferred and Common
Stock...................................... 0
Conversion of 7.5% Preferred Stock.......... 0
Issuance of Preferred Stock................. 2,342
Stock dividends............................. 2,544
Amortization of deferred compensation....... 599 599
Issuance of Common Stock.................... (1,072) 14,223
-------- ---------
BALANCE AT JANUARY 1, 1994.................. $ (1,058) $ 45,868
-------- ---------
-------- ---------
</TABLE>

See Notes to Consolidated Financial Statements

F-6
<PAGE> 55

HANOVER DIRECT, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 28, 1991, DECEMBER 26, 1992 AND JANUARY 1, 1994

<TABLE>
<CAPTION>
1991 1992 1993
-------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss).................................................. $(65,285) $ 20,249 $ 17,337
Adjustments to reconcile net income (loss) to net cash provided
(used) by operating activities:
Depreciation and amortization...................................... 11,568 5,188 4,122
Noncash portion of loss provision.................................. 19,516 -- --
Noncash portion of extraordinary gains............................. (6,915) (9,201) --
Noncash portion of cumulative effect of an accounting change....... -- (10,000) --
Noncash portion of ESOP termination................................ 4,734 -- --
Noncash portion of contract settlement............................. 2,652 -- --
Deferred taxes..................................................... -- -- (631)
Other, net......................................................... 216 368 (33)
Changes in assets and liabilities, net of effects of acquired
businesses and dispositions of assets:
Payment for repurchase of mail order customer receivables.......... -- (35,301) --
Net proceeds from sale of mail order customer receivables.......... 11,332 37,008 --
Accounts receivable, net........................................... (4,427) 13,321 8,907
Inventories........................................................ 10,662 (9,854) (12,081)
Prepaid catalog costs.............................................. 12,606 9,470 (5,305)
Other current assets............................................... 3,254 (671) 282
Accounts payable................................................... (23,937) (17,292) 24,530
Accrued liabilities................................................ (9,811) (12,821) (10,650)
Dividend payable................................................... -- -- 886
Customer prepayments and credits................................... -- (3,508) 684
-------- -------- --------
Net cash provided (used) by operating activities..................... (33,835) (13,044) 28,048
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Decrease in restricted cash........................................ 557 5,765 --
Acquisitions of property and equipment............................. (1,320) (1,431) (4,239)
Purchase of businesses............................................. -- -- (100)
Net proceeds from sales of property................................ 3,025 17,256 --
Other, net......................................................... (647) -- (313)
-------- -------- --------
Net cash provided (used) by investing activities..................... 1,615 21,590 (4,652)
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net payments under revolving credit facility....................... $ -- $ -- $(20,965)
Proceeds from issuance of debt..................................... 21,602 9,583 20,000
Net proceeds from issuance of Preferred Stock and Class B Common
Stock............................................................ 29,281 27,533 --
Payments of long-term debt and capital lease obligations........... (18,060) (68,720) (19,856)
Proceeds from Rights Offering...................................... -- 19,748 --
Cash dividends paid................................................ -- -- (890)
Payment of debenture issuance costs................................ (2,665) (825) --
Payment of debt issuance costs..................................... -- -- (1,560)
Loan to ESOP....................................................... (1,050) -- --
Proceeds from issuance of Common Stock............................. -- -- 912
Other, net......................................................... (1,593) -- (1,007)
-------- -------- --------
Net cash provided (used) by financing activities..................... 27,515 (12,681) (23,366)
-------- -------- --------
Net increase (decrease) in cash and cash equivalents................. (4,705) (4,135) 30
Cash and cash equivalents at the beginning of the year............... 11,393 6,688 2,553
-------- -------- --------
Cash and cash equivalents at end of the year......................... $ 6,688 $ 2,553 $ 2,583
-------- -------- --------
-------- -------- --------
SUPPLEMENTAL CASH FLOW DISCLOSURES:
Interest paid...................................................... $ 21,325 $ 12,547 $ 4,883
Income taxes paid.................................................. 755 226 71
Issuance of warrants............................................... 3,286 -- --
</TABLE>

See Notes to Consolidated Financial Statements.

F-7
<PAGE> 56

HANOVER DIRECT, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 28, 1991, DECEMBER 26, 1992 AND JANUARY 1, 1994

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Merger -- Hanover Direct, Inc. ("HDI") was formed in connection with the
September 8, 1993 merger (the "Merger") involving HDI, The Horn & Hardart
Company ("H&H") and The Hanover Companies ("THC"), a wholly-owned subsidiary of
H&H. The Merger consisted of the merger of H&H into HDI, followed by the merger
of THC into HDI. The purpose of the Merger was to create a single corporation to
replace the then-existing two-tier structure whereby H&H and THC were both
subject to the filing requirements of Section 13 of the Securities Exchange Act
of 1934, as amended. The financial statements of THC had previously been
included in the consolidated financial statements of H&H.

The Merger was consummated by (i) the exchange to holders of shares of H&H
Common Stock shares of HDI Common Stock, (ii) the exchange to holders of shares
of THC 7.5% Preferred Stock shares of HDI's 7.5% Preferred Stock, and (iii) the
exchange to holders of shares of THC Class B Preferred Stock shares of HDI's
Class B Preferred Stock, each such distribution being on a one-for-one-basis.

The Merger was accounted for similarly to a pooling-of-interests and,
accordingly, HDI's Consolidated Financial Statements include the results of H&H
and THC for all applicable periods presented.

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

Fiscal Year -- The Company operates on a 52/53 week fiscal year. The years
ended December 28, 1991 and December 26, 1992 were 52 week years. The year ended
January 1, 1994 was a 53 week year.

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

Prepaid Catalog Costs -- Costs related to mail order catalogs and
promotional material are amortized over their estimated productive lives, based
on projected net shipments, not exceeding six months.

Depreciation and Amortization -- Depreciation and amortization of property
and equipment are provided on the straight-line method at rates based on the
lesser of the estimated useful lives of the assets or terms of leases as
follows: buildings and building improvements, 30 years; furniture, fixtures and
equipment, 3-10 years; and leasehold improvements, over the terms of the related
leases. Expenditures for maintenance and repairs are charged to operations as
incurred; major improvements are capitalized.

Construction in Progress -- Construction in progress includes the costs to
upgrade the Company's management information systems. These costs will be
depreciated and amortized over five years or the life of any leases, whichever
is shorter, and depreciation will commence when the assets are placed in
service. The Company capitalized $5.3 million of such costs as of January 1,
1994.

Excess of Cost Over Net Assets of Acquired Businesses -- Excess of cost
over the net assets of acquired businesses is being amortized on a straight-line
basis over periods up to forty years. Accumulated amortization was $3,458,000
and $3,878,000 at December 26, 1992 and January 1, 1994, respectively.

Mailing Lists -- The costs of acquired mailing lists are amortized over a
five year period. Mailing lists, included in Other Assets, amounted to $89,000
and $2,274,000 at December 26, 1992 and January 1, 1994, respectively, and are
carried net of accumulated amortization of $6,020,000 and $6,295,000,
respectively.

Change in Accounting for Income Taxes -- Effective December 29, 1991
(beginning of fiscal year 1992), the Company adopted Statement of Financial
Accounting Standards No. 109 -- Accounting for Income Taxes ("SFAS 109"). This
standard requires, among other things, recognition of future tax benefits,
measured by enacted rates, attributable to deductible temporary differences
between financial statement and income tax

F-8
<PAGE> 57

HANOVER DIRECT, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

bases of assets and liabilities and to tax net operating loss carryforwards, to
the extent that realization of such benefits is "more likely than not".

Cash and Cash Equivalents -- For purposes of the Consolidated Statements of
Cash Flows, the Company considers all highly liquid temporary investments with
an original maturity of less than ninety days as cash equivalents.

Net Income (Loss) Per Share -- Net income (loss) per share was computed
using the weighted average number of common shares outstanding. The weighted
average number of shares used in the calculation for both primary and fully
diluted net income (loss) per share in 1991 and 1992 were 16,287,723 and
38,467,015 shares, respectively. For 1993 the weighted average number of shares
for primary and fully diluted net income (loss) per share were 75,625,330 and
77,064,131 shares, respectively. Common share equivalents for purposes of net
income (loss) per share are stock options and warrants.

Supplemental Earnings Per Share -- Assuming that the rights offering and
exchange offers discussed in Notes 2 and 7 had been consummated at the beginning
of fiscal year 1992, the weighted average number of shares outstanding would
have been 68,795,471, and earnings per share for 1992 would have been as
follows:

Income from continuing operations.................................$.09
Net income........................................................$.37

The supplemental earnings per share was calculated assuming that the
Company eliminated $9 million of interest on the debt that was retired and the
Company incurred additional dividends on $.8 million on the preferred stock.

Assuming that the conversions of the 7.5% Preferred Stock and the exchange
of the Class B 8% Preferred Stock and the Class B Common Stock had been
consummated at the beginning of fiscal year 1993, the weighted average number of
shares outstanding for primary and fully diluted earnings per share would have
been 84,408,807 and 85,847,608 and earnings per share would have been $.21 and
$.20, respectively. This supplemental earnings per share calculation assumes
that the Company eliminated $4.1 million of preferred stock dividends.

Supplemental Disclosure of Noncash Activities

<TABLE>
<CAPTION>
1992 1993
------- --------
<S> <C> <C>
(IN THOUSANDS)
Exchange of THC 8% Cumulative Preferred Stock and issuance of
20,000,000 shares of Common Stock............................... $35,847 $ --
------- --------
------- --------
Exchange of 14% Senior Subordinated Debentures for Common Stock
and THC 7.5% Preferred Stock.................................... $18,575 $ --
------- --------
------- --------
Exchange of 7 1/2% Convertible Subordinated Debentures for Common
Stock and THC 7.5% Preferred Stock.............................. $11,900 $ --
------- --------
------- --------
Dividend on 7.5% Preferred Stock paid-in-kind..................... $ -- $ 610
------- --------
------- --------
Dividend on Class B 8% Preferred Stock paid in Common Stock....... $ -- $ 2,508
------- --------
------- --------
Exchange of 8.0% Class B Preferred Stock for Common Stock......... $ -- $ 25,516
------- --------
------- --------
Exchange of Class B Common Stock for Common Stock................. $ -- $ 123
------- --------
------- --------
Exchange of 7.5% Convertible Preferred Stock for Common Stock..... $ -- $ 7,158
------- --------
------- --------
Issuance of 6.0% Preferred Stock.................................. $ -- $ 2,342
------- --------
------- --------
Capital Lease Obligations......................................... $ -- $ 2,541
------- --------
------- --------
Issuance of Common Stock for notes receivable..................... $ -- $ 1,915
------- --------
------- --------
</TABLE>

F-9
<PAGE> 58

HANOVER DIRECT, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

<TABLE>
<CAPTION>
1992 1993
------- --------
(IN THOUSANDS)
<S> <C> <C>
Acquisition of businesses:
Fair value of assets acquired................................... $ 38,578
Fair value of liabilities assumed............................... (26,180)
Common stock issued............................................. (12,298)
--------
Net cash paid................................................... $ 100
--------
--------
</TABLE>

There were no significant noncash activities in 1991.

2. TRANSACTIONS WITH NAR GROUP LIMITED

On October 25, 1991 the Company's shareholders approved several
transactions among the Company, THC and NAR Group Limited ("NAR") pursuant to
which NAR acquired 13,333,334 shares of Class B Common Stock of the Company and
40,000 shares of 8% Cumulative Preferred Stock of THC (the "Hanover Preferred
Stock"), for an aggregate purchase price of $40 million. The purchase price was
paid by the surrender by NAR of $15.1 million principal amount of the Company's
7 1/2% Convertible Subordinated Debentures due March 1, 2007 (valued under the
Purchase Agreement at $7.5 million) plus $31.3 million in cash (representing the
difference between $32.5 million and the sum of (i) accrued interest on the
debentures and (ii) $1 million of reimbursable expenses payable to NAR under the
stock purchase agreement). NAR also received warrants to purchase 1,210,901
shares of the Company's Common Stock at exercise prices ranging from $4.00 to
$5.25 per share and expiring in five years. The exercise prices were
subsequently adjusted to prices ranging from $2.19 to $2.42 per share in
accordance with the anti-dilution provisions of the warrant agreements.

The Company entered into this transaction in July 1991, expecting that this
transaction would close by September 30, 1991 so it could apply the proceeds to
repay an interim borrowing which matured on the same date. Unforeseeable delays
prevented the Company from obtaining required consents from certain creditors
which were conditions to closing the transactions. As a result of these delays,
the Company was required to satisfy the maturing interim borrowing out of
working capital. Using working capital to satisfy these borrowings caused
increased strain on the Company's already poor cash flow which further strained
its relationship with its vendors. The Company closed the above transactions on
October 25, 1991 and received an equity infusion of approximately $40 million. A
working capital line of credit of approximately $30 million had previously been
made available to the Company by a subsidiary of NAR. Although the Company
believed that the resulting capital provided to it would be sufficient to return
the Company to profitability and enable the Company to pay off $46.1 million of
debt that was due in October 1992, it became apparent thereafter, that due to
the Company's high debt service requirements and other operational difficulties,
it still did not possess the sufficient liquidity to obtain the necessary
merchandise on a timely basis. The Company, therefore, required additional
capital to permit it to maintain satisfactory credit relations with its vendors
and other trade creditors, as well as to satisfy the debt that was due in
October 1992.

The stock purchase agreement had granted NAR an option to cause the Company
to conduct a rights offering in the event that the Company did not achieve
certain earnings in the fourth quarter of 1991. In the event that NAR exercised
that option it would have been committed to purchase any shares of Common Stock
not subscribed for in such Rights Offering by the Company's other shareholders.
Thus, it appeared to the Company that the most likely source of additional
capital was NAR. Because the Company had a significant loss in the fourth
quarter of 1991, in December 1991 NAR indicated to the Company that it would not
exercise its option to cause the Company to conduct a Rights Offering but
indicated that it would be willing to make an additional equity investment in
the Company on terms other than those contemplated by the agreement.

F-10
<PAGE> 59

HANOVER DIRECT, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

In July 1992, the Company and NAR entered into a Definitive Agreement, the
terms of which were subsequently approved by the Company's shareholders on
September 23, 1992, at which time the following transactions were consummated:

- NAR exchanged its 40,000 shares of the Hanover Preferred Stock and
13,333,334 shares of the Class B Common Stock for 20 million shares of
Common Stock of the Company.

- NAR purchased 12,270,503 shares of the Company's Class B Common Stock and
40,000 shares of a newly-created Class B 8% Cumulative Preferred Stock
(the "Class B Preferred Stock"), for an aggregate purchase price of $28.4
million. Pursuant to the terms of the Preferred Stock, the Company had the
right to require the exchange of the Hanover Preferred Stock and the Class
B Common Stock into 18,937,169 shares of Common Stock at any time after
the date on which the per-share closing price had been greater than $6.00
for 20 consecutive trading days.

- The Company conducted a rights offering (the "Rights Offering") in which
the Company's shareholders (other than NAR) subscribed to 7,636,905 shares
of Common Stock at $1.50 per share for an aggregate of $11.5 million. NAR
purchased the remaining 6,759,893 shares not subscribed for $1.50 per
share for an aggregate of approximately $10 million. NAR received a
standby commitment fee of $177,000 and an underwriting fee of $405,000
representing 4% of the offering price of all shares it purchased that were
not purchased by other shareholders in the Rights Offering.

On January 1, 1994, the Company exercised its right to require the exchange
of 40,000 shares of the Class B Preferred Stock and 12,270,503 shares of the
Class B Common Stock into 18,937,169 shares of Common Stock.

3. ACQUISITIONS

Gump's

In July 1993, the Company acquired substantially all of the mail order and
retail assets of Gump's, Inc. ("Gump's"). Gump's is an upscale catalog marketer
of exclusive gifts and the legendary San Francisco retailer. The consideration
given for the assets acquired was $13.2 million and consisted of $6.9 million in
cash and 1,327,330 shares of Common Stock valued at $4.78 per share or $6.3
million. The $6.9 million of cash used for the purchase of the assets was
comprised of (i) proceeds of the sale of Gump's accounts receivable aggregating
$2.8 million; (ii) $2.6 million of Gump's cash acquired by the Company as part
of the assets acquired; and (iii) $1.5 million of additional credit under the
Company's revolving credit facility, as amended.

In connection with the above transaction, the Company amended its agreement
with General Electric Capital Corp. ("GECC") for the sale and servicing of
accounts receivable to include the Gump's accounts receivable under its $75
million facility. The Company also amended its revolving credit facility to
increase the maximum credit available by $5 million for Gump's and to include
two wholly-owned subsidiaries of the Company as borrowers under the revolving
credit facility.

The Company Store

In August 1993, the Company acquired certain assets of Company Store
Holdings, Inc. ("CSH"), The Company Store, Inc., Scandia Down Corporation and
Southern California Comfort Corporations (collectively, "The Company Store").
The Company Store is a direct marketer of down comforters, other down products
and home furnishings.

The consideration given for the assets acquired was $7 million and
consisted of (i) 516,824 shares of the Company's Common Stock, valued at $4.64
per share, or $2.4 million, and (ii) two promissory notes in the aggregate
principal amount of $1.1 million issued by a subsidiary of the Company, with
interest thereon at six percent (6%) per annum due on October 31, 1994 and $3.5
million principal amount of secured notes issued

F-11
<PAGE> 60

HANOVER DIRECT, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

by certain subsidiaries of the Company with interest thereon at six percent (6%)
per annum, with principal and interest payments payable monthly on a fifteen
year amortization, with the remaining balance due and payable on August 31,
1998.

In October 1993, the Company amended its revolving credit facility to
increase the maximum credit available by $5 million for The Company Store and to
include The Company Store as a borrower under the facility.

Tweeds

In September 1993, the Company acquired all of the outstanding shares of
Tweeds, Inc. Tweeds is a well-known European-inspired women's fashion catalog.

The purchase price was $8.8 million and consisted of: (i) $.1 million in
cash; (ii) 771,774 shares of the Company's Common Stock, valued at $4.60 per
share, or $3.6 million and (iii) the assumption of $5.1 million of liabilities.
In October 1993, the Company amended its revolving credit facility to increase
its maximum credit available by $2.5 million for Tweeds and to include Tweeds as
a borrower under the facility.

Accounting for Acquisitions

The acquisitions of Gump's, The Company Store and Tweeds have been
accounted for using the purchase method of accounting with an estimated excess
of cost over net assets of acquired businesses of approximately $10.2 million
recorded, based upon the fair values of the assets acquired and liabilities
assumed. In addition, the Company recorded $2.5 million representing the fair
value of acquired mailing lists. The operating results of the acquired companies
are included in consolidated net income from their respective dates of
acquisition.

The following represents the unaudited pro forma results of operations for
the years ended December 26, 1992 and January 1, 1994 as if these three
acquisitions had occurred at the beginning of fiscal years 1992 and 1993 (in
thousands except per share amounts):

<TABLE>
<CAPTION>
(UNAUDITED)
1992 1993
-------- --------
<S> <C> <C>
Revenues....................................................... $733,454 $723,749
-------- --------
-------- --------
Income (loss) before extraordinary items and cumulative effect
of accounting change for income taxes........................ $ (3,720) $ 10,160
-------- --------
-------- --------
Net income applicable to Common Shareholders................... $ 12,284 $ 6,067
-------- --------
-------- --------
Per Share:
Income (loss) per share before extraordinary items and
cumulative effect of accounting change for income taxes... $ (.17) $ .08
Extraordinary items............................................ .23 --
Cumulative effect of accounting change for income taxes........ .24 --
-------- --------
Net income..................................................... $ .30 $ .08
-------- --------
-------- --------
</TABLE>

The pro forma information does not purport to be indicative of the results
that actually would have been obtained if the operations were combined during
the periods presented, and is not intended to be a projection of future results
or trends.

F-12
<PAGE> 61

HANOVER DIRECT, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The Safety Zone

In September 1993, the Company acquired 20% of the outstanding common stock
of Aegis Safety Holdings, Inc. ("Aegis"), a direct marketer of safety and
anti-hazard products through The Safety Zone catalog. The consideration for the
investment was the provision by the Company of certain catalog fulfillment and
financial services to Aegis at the Company's cost until August 1998, subject to
certain early termination provisions. The Company also acquired an option to
purchase an additional 460,714 shares at $7.00 per share, subject to
anti-dilution provisions which would increase its ownership to 50% of Aegis
common stock. This option expires at the end of 1996. Aegis has an option to
require the Company to acquire all of Aegis' then outstanding stock after
December 31, 1998 if the Company has exercised its option and certain other
conditions have been satisfied. The Company has agreed to extend a secured
working capital line of up to $1 million to Aegis in 1994. Aegis had
approximately $9 million in net sales for the eleven months ended January 1,
1994.

Boston Publishing Company

In February 1994, the Company entered into an agreement with Boston
Publishing Company, Inc. ("BPC") whereby the Company acquired a 20% equity
interest in BPC and agreed to provide certain catalog related services to the
Boston based publisher. The Company will also provide BPC with a secured
three-year revolving credit facility of up to $3 million, a secured $.75 million
short-term loan, and a $.5 million five year convertible note. The note is
convertible into equity representing approximately 4% of BPC. The Company also
acquired an option to acquire an additional 1,536,345 shares at $2.08 per share
subject to anti-dilution provisions which would increase its ownership to 50% in
BPC. The BPC shareholders will have the right to require the Company to purchase
their shares in fiscal year 1997 under certain circumstances.

BPC publishes the Museum Collections catalog featuring unique, well-valued
museum replicas, reproductions and adaptations; and the Finishing Touches
catalog, featuring decorative merchandise for the home. BPC had approximately
$12 million (unaudited) in revenues in 1993.

The investments in Aegis and BPC are accounted for by the equity method of
accounting.

4. SEARS LICENSING AGREEMENT

In January 1994, the Company entered into a licensing agreement (the "Sears
Agreement") with the direct marketing subsidiary of Sears Roebuck and Co.
("Sears"), to produce specialty catalogs for customers of the recently
discontinued Sears catalog. The specialty catalogs include: Show Place, based on
the Domestications catalog, Great Kitchens, based on the Colonial Garden
Kitchens catalog, and Beautiful Style, based on the Silhouettes catalog. The
Sears Agreement has an initial three-year term and continues thereafter unless
terminated by either party. Profits and losses from the venture are to be shared
between the parties on an equal basis.

The Company also issued to Sears a performance warrant to purchase 3.5
million shares of Common Stock in 1999 if the licensed business with Sears has
revenues of at least $250 million and earnings before interest and taxes of at
least $30 million in 1998. Alternately, Sears will be entitled to purchase 7
million shares of Common Stock in 1999 if the licensed business with Sears has
revenues of at least $500 million and earnings before interest and taxes of at
least $60 million in 1998. If neither of these goals are achieved, the
performance warrant will expire unexercised in 1999. The Company will be
required to value the performance warrant at such time as it is deemed to have
become measurable for accounting purposes because the required events have
become probable or have occurred (which may be prior to the date the warrant is
exercisable under the Sears Agreement) (the "Measurement Date"). The value would
be the difference, if any, between the closing market price of the Common Stock
at the Measurement Date and the exercise price of the

F-13
<PAGE> 62

HANOVER DIRECT, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

performance warrant, multiplied by the applicable number of shares. The value
would be amortized from the Measurement Date through 1998 and would be subject
to change each reporting period based on the closing market price of the Common
Stock as of such reporting date. The warrant exercise price is $10.57 per share.
The Company is obligated to meet various operational performance standards and
if the Company is unable to meet these standards, Sears would be entitled to
terminate the agreement. The Company is also entitled to terminate the agreement
in certain circumstances, including if Sears fails to comply with any material
provision of the Sears Agreement.

5. ACCOUNTS RECEIVABLE, NET

On December 22, 1992, the Company repurchased all receivables then owned by
certain trusts ($52.7 million), and concurrently entered into an agreement with
an unrelated third party which provides for the sale and servicing of accounts
receivable originating from the Company's revolving credit card.

The Company remains obligated to repurchase uncollectible accounts pursuant
to the recourse provisions of the agreement and is required to maintain a
specified percentage of all outstanding receivables sold under the program as a
deposit with the third party to secure its obligations under the agreement. The
Company is required to pay certain servicing fees to the third party and the
Company earns the finance charge income that is charged to the accounts.

The uncollected balances of accounts receivable sold under this program
were $51.3 million, of which $15.3 million represents deposits under the
agreement and $2.7 million are accounts not purchased under the agreement which
are included in Accounts receivable at December 26, 1992. At January 1, 1994,
the uncollected balances of accounts receivable under this program were $47.0
million, of which $13.0 million represents deposits under the agreement. The
total reserve balance maintained for the repurchase of uncollectible accounts
was $5.5 million and $3.1 million at December 26, 1992 and January 1, 1994,
respectively, of which $3.5 million and $1.7 million, respectively, are included
in Accrued liabilities and the remaining balance is included in the allowance
for doubtful accounts.

Receivables sold under this agreement are considered financial instruments
with off-balance sheet risk as defined in Statement of Financial Accounting
Standards No. 105.

Because the Company's sales are primarily made to individual customers
located throughout the United States, the Company believes there are no
concentrations of credit risks.

6. ACCRUED LIABILITIES

Accrued liabilities consists of the following (in thousands):

<TABLE>
<CAPTION>
DECEMBER
26, JANUARY 1,
1992 1994
----------- ----------
<S> <C> <C>
Compensation............................................ $ 3,298 $ 3,642
Interest................................................ 1,033 746
Insurance............................................... 1,434 736
Reserve for future sales returns........................ 3,901 4,911
Reserve for repurchase of accounts receivable sold with
recourse.............................................. 3,500 1,735
Net liabilities of discontinued operations.............. 4,944 977
Other................................................... 3,253 7,906
----------- ----------
$ 21,363 $ 20,653
----------- ----------
----------- ----------
</TABLE>

F-14
<PAGE> 63

HANOVER DIRECT, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

7. LONG-TERM DEBT

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

<TABLE>
<CAPTION>
DECEMBER 26, JANUARY 1,
1992 1994
------------ ----------
<S> <C> <C>
Revolving Credit Facility................................ $ 21,195 $ 230
Industrial Revenue Bonds with variable interest rates
averaging 4.3% in 1992 and 3.7% in 1993 due 2003....... 8,000 8,000
6% Notes Payable due 1994................................ -- 1,100
6% Mortgage Notes Payable due 1998....................... -- 3,452
9.25% Senior Subordinated Notes due 1998................. -- 20,000
7 1/2% Convertible Subordinated Debentures due 2007...... 751 751
14% Senior Subordinated Debentures....................... 825 --
8% Subordinated Notes.................................... 12,360 --
Other.................................................... 76 56
------------ ----------
43,207 33,589
Less current portion..................................... 23 1,276
------------ ----------
Noncurrent portion....................................... $ 43,184 $ 32,313
------------ ----------
------------ ----------
</TABLE>

Revolving Credit Facility

On May 5, 1993, the Company consummated a three-year, $40 million credit
facility with a financial institution, replacing the previous facility with
Quadrant Capital Corporation ("QCC"), a subsidiary of NAR, that had been entered
into in 1991. The new facility (the "Revolving Credit Facility") provides for
cash borrowings and letters of credit based on eligible inventory, with a $10
million sublimit for letters of credit. The interest rate on the funds borrowed
under the Revolving Credit Facility is the prime rate of Philadelphia National
Bank plus two percent per annum. Subsequent to May 5, 1993, the Company amended
the Revolving Credit Facility to include Gump's, The Company Store and Tweeds,
as borrowers under the agreement and the limit was increased to $52.5 million.
The facility is guaranteed by the Company and is secured by inventory and other
assets of its principal operating subsidiaries. In addition, a subsidiary of NAR
provided a secured limited guarantee of $10 million which allowed the Company to
borrow funds in excess of its availability, based on a formula, up to the
facility's limit. The guarantee is reduced based upon availability under the
agreement and the Company's cash flow, as defined, and accordingly, was reduced
by $5.1 million in the fourth quarter of 1993 and will be eliminated in March
1994.

The loan agreement contains working capital and net worth covenants, debt
incurrence restrictions, dividend restrictions, and prepayment penalties.

The face amount of unexpired documentary letters of credit at December 26,
1992 and January 1, 1994 were $1.7 million and $5.7 million, respectively. In
addition, the Company had issued $5.7 million of standby letters of credit at
December 26, 1992.

Industrial Revenue Bonds due 2003

The Industrial Revenue Bonds are due on December 1, 2003 and are secured by
the related assets purchased from the proceeds of the bonds and by an
irrevocable letter of credit in the amount of $8.6 million. The obligations are
guaranteed by the Company.

F-15
<PAGE> 64

HANOVER DIRECT, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

6% Notes Payable due 1994

In connection with the purchase of The Company Store, a subsidiary of the
Company entered into two secured promissory notes in the aggregate amount of
$1.1 million. The promissory notes bear interest at 6% per annum and are due
October 31, 1994. The promissory notes are secured by equipment of The Company
Store.

6% Mortgage Notes Payable due 1998

In connection with the purchase of The Company Store, certain subsidiaries
of the Company entered into two secured notes in the aggregate amount of $3.5
million with interest at 6% per annum with principal and interest payments
payable monthly on a fifteen year amortization with the remaining balance due on
August 31, 1998. The mortgage notes payable are non-recourse notes and are not
guaranteed by the Company. The mortgage notes payable are secured by the
manufacturing and office facilities of The Company Store.

9.25% Senior Subordinated Notes due 1998

On August 17, 1993, the Company issued $20 million of 9.25% Senior
Subordinated Notes due 1998 ("9.25% Notes") in a private placement with an
insurance company. The Company utilized the funds to retire approximately $14
million of other subordinated debt. Under the terms of the 9.25% Notes, the
Company must redeem $6 million without penalty by February 15, 1994,
(subsequently amended to May 1, 1994) if the Company has not established or
acquired a new distribution facility by such date.

The 9.25% Notes mature on August 1, 1998 and require quarterly interest
payments. The 9.25% Notes require that the Company maintain certain minimum net
worth, working capital, debt to earnings and fixed charge coverage ratios. Under
the terms of the related Registration Rights Agreement, the Company is required
to file a "shelf" registration statement under the Securities Act of 1933, by
February 13, 1994 (subsequently extended until March 15, 1994) and use its best
effort to cause the registration to be declared effective by June 13, 1994.

7 1/2% Convertible Subordinated Debentures due 2007

On September 23, 1992, the Company consummated an exchange offer with
holders of these debentures, pursuant to which the Company issued 40,500 shares
of its Common Stock and 13,500 shares of 7.5% Preferred Stock (hereinafter
defined) in exchange for $540,000 of the debentures that were tendered. This
resulted in an extraordinary gain of $.3 million in 1992.

On November 9, 1992, the Company, with the consent of a majority of holders
of these debentures, amended the indenture to allow, for the 30 day period
ending on December 4, 1992, holders of the debentures to be able to convert
their debentures into Common Stock at a conversion price of $3.33 per share
instead of $10.31 per share. As a result, the Company converted approximately
$11.4 million of these debentures into 3,408,340 shares of Common Stock and
recorded an extraordinary gain of approximately $1.6 million based on the fair
market value of the shares issued.

14% Senior Subordinated Debentures

In 1992, the Company defaulted with respect to the payment of interest on
these debentures. The Company and holders of 75% of the 14% Debentures entered
into an exchange agreement (the "14% Exchange Offer") by which such holders
would exchange their debentures for a combination of cash and 7.5% Preferred
Stock (hereinafter defined) and Common Stock of the Company. On September 23,
1992, the Company consummated the 14% Exchange Offer resulting in the exchange
of $23.5 million (of the $24.3 million) of 14% Debentures outstanding for $4.85
million in cash and 4,099,625 shares of its Common

F-16
<PAGE> 65

HANOVER DIRECT, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Stock and 403,088 shares of 7.5% Cumulative Convertible Preferred Stock ("7.5%
Preferred Stock"). A subsidiary of QCC owned and exchanged approximately $1.7
million or 7% of these debentures.

The Company recorded an extraordinary gain in 1992 of approximately $6.2
million as a result of the 14% Exchange Offer. The gain was calculated based on
the cash and the fair market value of the securities issued in exchange for the
debt retired, net of approximately $1.3 million in transaction costs. The gain
also includes interest that was forgiven as part of the 14% Exchange Offer
amounting to approximately $3.7 million.

The defaulted interest was paid to the remaining bondholders on November 4,
1992 and the Company was no longer in default. On August 17, 1993, the Company
paid off the remaining $825,000 of 14% debentures with proceeds from the 9.25%
Notes.

8% Subordinated Notes

The 8% Subordinated Notes were due on October 15, 1994. They had originally
been due in October, 1991, and carried an interest rate of 11%. In connection
with the restructuring of the Company's debt obligations in 1991, these notes
were partially paid down by $5.0 million, and extended to 1994 with the interest
rate lowered to 8%. The Company was required to pay an amount equal to 3% per
year if, at final maturity or earlier redemption, NAR's compound annual rate of
return on the Company's Common Stock, together with any dividends on the Class B
Preferred, had exceeded 20% after adjustment to eliminate general market changes
as reflected in movements of the Dow Jones Industrial Average. The Company
redeemed all of the outstanding notes at the face amount plus accrued interest
on August 17, 1993, with the proceeds of the 9.25% Notes.

General

At January 1, 1994, the aggregate annual principal payments required on all
long-term debt were as follows (in thousands): 1994 -- $1,276, 1995 -- $161,
1996 -- $437, 1997 -- $181, 1998 -- $22,783 and thereafter $8,751.

8. CAPITAL STOCK

On September 8, 1993 HDI was formed through a series of mergers involving
H&H and THC. The Merger was consummated by (i) the exchange to holders of shares
of H&H Common Stock shares of the HDI's Common Stock, (ii) the exchange to
holders of shares of THC 7.5% Preferred Stock shares of 7.5% Preferred Stock,
and (iii) the exchange to holders of shares of THC Class B Preferred Stock
shares of the HDI's Class B Preferred Stock, each such distribution being on a
one-for-one-basis.

On December 13, 1993, the Company converted all of the 7.5% Preferred Stock
into 2,278,128 shares of Common Stock. The holders of the 7.5% Preferred Stock
were paid all outstanding dividends in cash amounting to $197,000. These shares
had been issued in connection with the 1992 7 1/2% Exchange Offer. Each share
was convertible into four shares of Common Stock at the time on which the
per-share closing price of the Common Stock on the American Stock Exchange
exceeded $6.00 for 20 trading days in a consecutive 30 day trading period, which
occurred on November 11, 1993.

On January 1, 1994, 12,270,503 shares of Class B Common Stock and 40,000
shares of Class B Preferred Stock were exchanged into 18,937,169 shares of
Common Stock.

Dividends on the Class B Preferred Stock aggregated $3.3 million in fiscal
1993 and were paid through the issuance of 684,890 shares of Common Stock and
$693,000 in cash. The Common Stock issued in connection with these dividends was
valued at the average per-share closing price of the Common Stock during the 20
consecutive trading days immediately preceding the date on which the dividends
were paid. On

F-17
<PAGE> 66

HANOVER DIRECT, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

January 1, 1994, the Company had accrued dividends payable of $886,000 on the
Class B Preferred Stock which were paid in cash on February 22, 1994.

6% Series A Convertible Preferred Stock

On December 10, 1993, in connection with the Company's acquisition of
Tweeds, the Company entered into an exchange agreement with a major vendor of
Tweeds. Under the exchange agreement, the Company issued 234,900 shares of its
6% Series A Preferred Stock (6% Preferred Stock) for an installment note, dated
March 29, 1993, as amended, in the amount of approximately $2.4 million issued
by Tweeds. Dividends on the 6% Preferred Stock began accruing on September 30,
1993.

The 6% Preferred Stock shall be converted into Common Stock of the Company
over a three year period on September 30, 1994, 1995, and 1996. The conversion
price shall be an amount equal to the average of the per share closing prices
for the five trading days proceeding the conversion dates.

The 6% Preferred Stock has a stated value of $10 per share and has a
liquidation preference of an amount equal to the stated value of each share of
the 6% Preferred Stock plus accrued dividends or $2,385,000 at January 1, 1994.
The Company has the right to redeem the 6% Preferred Stock at its initial stated
value plus accrued dividends, payable in cash.

Warrants

The warrants outstanding at January 1, 1994, are as follows:

<TABLE>
<CAPTION>
WARRANTS EXERCISE EXPIRATION
ISSUED PRICE DATE
- --------- -------- ----------
<S> <C> <C>
3,151,945 $ 2.42 05/08/96
349,601 2.19 05/10/96
3,157,884 2.91 07/08/96
334,550 2.19 07/10/96
- ---------
6,993,980
- ---------
- ---------
</TABLE>

Of the above warrants issued, 5,033,735 warrants are held by NAR and
affiliates.

In addition, as previously discussed, the Company issued to Sears a
performance warrant to purchase up to 7 million shares of Common Stock in 1999.
This performance warrant is not reflected in the above table.

At January 1, 1994, there were 82,933,177 shares of Common Stock and
234,900 shares of 6% Series A Preferred Stock outstanding. Additionally, an
aggregate of 18,367,717 shares of Common Stock were reserved for (i) the
exercise of outstanding options (535,250), (ii) the exercise of outstanding
warrants (13,993,980) including the Sears performance warrant discussed above,
(iii) the Executive Equity Incentive Plan (1,736,170), (iv) the Restricted Stock
Award Plan (314,200), and (v) the All Employee Equity Investment Plan
(1,788,117).

Other Transactions

In July 1993, the Company filed a Form S-3 with the Securities and Exchange
Commission registering 3,750,000 shares of the Company's Common Stock for the
purpose of the Gump's acquisition and future business combination transactions.
As of January 1, 1994, 2,615,928 shares have been issued in connection with the
Gump's, The Company Store and Tweeds acquisitions.

On February 16, 1994, the Company entered into an agreement with Sun Life
Insurance Company of America ("Sun Life") whereby Sun Life will exercise its
1,960,245 warrants in a cashless or net-issue exchange with the Company and the
Company will issue 1,309,207 shares of Common Stock. The number of

F-18
<PAGE> 67

HANOVER DIRECT, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

shares of the Company's Common Stock to be received by Sun Life upon the
"cashless" exercise of its warrants was determined based upon the average
closing price of the Common Stock on the American Stock Exchange for the ten day
trading period ended on February 15, 1994, which is $7.163 per share.

Dividend Restrictions

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

9. EMPLOYEE BENEFIT PLANS

Stock Option Plan

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

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

Changes in options outstanding and options available for grant, expressed
in number of shares, are as follows:

<TABLE>
<CAPTION>
1991 1992 1993
---------- ---------- ----------
<S> <C> <C> <C>
Options outstanding, beginning of period......... 1,231,623 945,965 603,765
Expired.......................................... (28,433) (164,200) (214,165)
Cancelled........................................ (257,225) (178,000) (24,350)
---------- ---------- ----------
Options outstanding, end of period............... 945,965 603,765 365,250
---------- ---------- ----------
---------- ---------- ----------
Options exercisable, end of period............... 571,833 502,675 365,250
---------- ---------- ----------
---------- ---------- ----------
Available for grant of options, end of period.... 1,012,118 1,345,318 1,583,833
---------- ---------- ----------
---------- ---------- ----------
</TABLE>

The option prices range from $2.75 per share to $9.625 per share, with
amounts as follows: $2.75 -- 200,000 shares, $5.00 -- 144,550 shares,
$7.00 -- 6,200 shares, $8.00 -- 7,000 shares and $9.625 -- 7,500 shares.

Prior to 1992, three directors were granted non-qualified options outside
of the Plan to purchase a total of 50,000 shares. Of these options 45,000 shares
expire in 1994 and 5,000 shares expire in 1995. The option price ranges from
$5.00 per share to $7.25 per share. The table above does not include these
option grants.

On September 23, 1992, six directors were granted options to purchase
20,000 shares each, at market price, which at that time was $1.75 per share.
These option grants were approved at the 1993 annual meeting of shareholders and
expire in 1997. The table above does not include these option grants.

Hanover Direct, Inc. Savings Plan

The 401(K) Savings Plan (the "Plan") allows eligible employees to
contribute a percentage of their base compensation to the Plan. The Company
makes matching contributions of one-third of the employees' pre-tax
contributions. Participants may invest contributions in various investment
funds, in addition to a guaranteed investment fund or in the Company's Common
Stock.

F-19
<PAGE> 68

HANOVER DIRECT, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The Company's contributions charged to expense for 1991, 1992 and 1993 were
$241,000, $265,000 and $431,000, respectively.

Supplemental Retirement Plan

The Supplemental Retirement Plan (the "Plan") allows eligible employees to
make contributions to a trust where, prior to October 1993, they were invested
for each participant in life insurance having a cash surrender value and
carrying a term benefit payable to the beneficiary selected by the participant.
The Company makes matching contributions. In October 1993, the Company amended
and restated the Plan. Participant contributions are invested by the trust for
each participant in a tax free money market fund. Company contributions in 1991,
1992 and 1993 amounted to $130,000, $179,000 and $130,000, respectively.

The Plan permits eligible employees to contribute up to 4% of their salary.
The Company matches all participant contributions, up to the 4% threshold. The
Plan is not tax-qualified under the applicable provisions of the Internal
Revenue Code of 1986, as amended.

Incentive Compensation Plan

Bonus arrangements with certain executives and key employees generally
provide for additional compensation based upon the attainment of certain profit
levels, as well as other performance measures. These bonuses approximated $1.6
million and $.4 million in 1992 and 1993, respectively. There were no bonuses
paid in 1991. Under the bonus plan, 25% of the bonus is paid in restricted stock
that participants vest in over a three year period. In fiscal 1993, 89,220
shares were issued in connection with the Incentive Compensation Plan.

Executive Equity Incentive Plan

On December 17, 1992, the Board of Directors adopted the 1993 Executive
Equity Incentive Plan (the "Incentive Plan"). Such plan was approved by
Shareholders at the 1993 Annual Meeting. Pursuant to the Incentive Plan, options
to purchase shares of the Company's Common Stock will be granted from time to
time by the Compensation Committee of the Board of Directors to selected
executives of the Company or its affiliates. For each such option granted, the
selected executive will receive the right to purchase on a specified date (the
"Tandem Investment Date") a number of shares of the Company's Common Stock
("Tandem Shares") equal to one-half the maximum number of shares of the
Company's Common Stock covered by such option. An aggregate of 2,400,000 shares
of the Company's Common Stock have been reserved for issuance under the
Incentive Plan. Company financing is available under the Incentive Plan to pay
for the purchase price of the Tandem Shares.

The purchase price per share of the Company's Common Stock upon exercise of
a stock option was $2.50 ("Option Price") for all options granted before the
ratification of the Incentive Plan by the Shareholders, and the fair market
value of a share of the Company's Common Stock on the date of grant of such
option for all other options. Options granted under the Incentive Plan become
exercisable three years after the date of grant and expire six years from the
date of grant. The purchase price shall be paid in full at the time of purchase
in cash, or shares of the Company's Common Stock valued at their fair market
value or in combination thereof. The difference between the Option Price and the
fair market value of the Common Stock on the Tandem Investment Date aggregated
$601,000 and is being amortized over the three year period that the options
become exercisable. The amortization for fiscal 1993 was $170,000.

In 1993, 663,830 shares were purchased at prices ranging from $3.125 to
$4.50 for a total consideration of $2,133,156. The employees paid $710,000 and
the Company accepted notes in the amount of $1,423,000 which are due in 1999.
The notes bear interest at 3.96% to 5.54%, and 1,327,660 options were granted to
such employees at prices ranging from $2.50 to $4.50.

F-20
<PAGE> 69

HANOVER DIRECT, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Restricted Stock Award Plan

On December 17, 1992, the Board of Directors adopted the 1993 Restricted
Stock Award Plan (the "Restricted Stock Plan"). Each full-time or permanent
part-time employee of the Company or its affiliates selected by the Compensation
Committee who holds a key position that the Compensation Committee shall have
designated for eligibility in the Restricted Stock Plan, has attained the age of
18, has performed at least 12 months of continuous service with the Company or
an affiliate of the Company, and is not covered by a collective bargaining
agreement may participate in the Restricted Stock Plan. Pursuant to the
Restricted Stock Plan, the Compensation Committee from time to time may award
shares of the Company's Common Stock ("Award Shares") to such participants. The
Award Shares received by such participants are not transferable (other than by
will or the laws of descent and distribution) until the vesting date or when
such participant attains the age of 65, dies, or becomes permanently disabled,
and are subject to forfeiture in the event the participant ceases to be an
employee prior to that date. An aggregate of 500,000 shares of the Company's
Common Stock have been reserved for issuance under the Restricted Stock Plan.
During 1993, 185,800 shares were awarded to participants aggregating $650,000.
Such amount is being amortized over a three year vesting period. Amortization in
1993 was $188,000.

All Employee Equity Investment Plan

On December 17, 1992, the Board of Directors adopted the 1993 All Employee
Equity Investment Plan (the "Investment Plan"), subject to the approval of
Shareholders at the 1993 Annual Meeting. Each full-time or permanent part-time
employee of the Company or its affiliates who has attained the age of 18, has
met certain standards of continuous service with the Company or an affiliate of
the Company and is not covered by a collective bargaining agreement may
participate in the Investment Plan.

An eligible employee shall be granted a right to purchase a specific number
of shares of the Company's Common Stock by the Compensation Committee, based on
the eligible employee's salary level. The purchase price of the Company's Common
Stock in the Investment Plan shall be the average market value of a share of the
Company's Common Stock during the 20 days prior to the first day of the
subscription period, less a 40% discount. The Shares received by such
participants are not transferable (other than by will or the laws of descent and
distribution) until the vesting date or when such participant attains the age of
65, dies, or becomes permanently disabled, and are subject to forfeiture in the
event the participant ceases to be an employee prior to that date. An aggregate
of 2,000,000 shares of the Company's Common Stock have been reserved for
issuance under the Investment Plan. During fiscal 1993, 211,883 shares were
purchased by employees at an average discounted price of $2.32. The difference
between the market price and discounted price aggregated $422,000 and is being
amortized over a three year vesting period. Amortization in 1993 was $46,000.

Employee Stock Ownership Plan

The Employee Stock Ownership Plan (the "ESOP") was terminated December 28,
1991. Because the value of the unallocated shares was not sufficient upon
termination to fully satisfy the ESOP's indebtedness to the Company, a charge of
$4.7 million was recognized in 1991 and is reflected in Other income (expense).
Shares allocated to participants at December 28, 1991 were approximately
288,000. These shares became vested upon termination of the ESOP. In November
1992, after receiving approval of the termination from the Internal Revenue
Service, the Company transferred 646,053 nonvested shares into its Treasury. The
vested shares were distributed in 1993.

10. INCOME TAXES

Effective December 29, 1991, the Company adopted Statement of Financial
Accounting Standards No. 109 -- Accounting for Income Taxes (SFAS 109). In
accordance with this statement, for the year ended December 26, 1992, the
Company recognized a deferred tax asset of $10 million, reflecting the
cumulative

F-21
<PAGE> 70

HANOVER DIRECT, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

effect of the accounting change for the benefit expected to be realized from the
utilization of net operating loss carryforwards ("NOLs") and deductible
temporary differences. For the year ended January 1, 1994, the Company
recognized an additional deferred tax asset of $.6 million, reflecting the
effect of the increase in the Federal corporate income tax rate (from 34% to
35%) on the benefit expected to be realized from the utilization of NOLs
carryforwards and deductible temporary differences.

At January 1, 1994, the Company had tax NOLs totalling $147 million, which
expire as follows: In the year 2000 -- $1 million, 2001 -- $21 million,
2003 -- $15 million, 2004 -- $14 million, 2005 -- $21 million, 2006 -- $47
million, 2007 -- $28 million.

The Company also has $.9 million of charitable contribution carryforwards
that expire in 1994 through 1997 and $1.7 million of general business tax credit
carryforwards that expire in 1998 through 2003.

Under Section 382 of the Internal Revenue Code of 1986, certain
transactions the Company entered into during 1991 resulted in an ownership
change with respect to the Company and, thus, in the imposition of an annual
limitation ("the Section 382 limitation") of approximately $4 million on the
amount of taxable income of the Company which may be offset by the Company's
pre-change NOL, charitable contribution and business tax credit carryforwards.
The Company's available NOLs for tax purposes consists of $97 million of
pre-change NOL (subject to the Section 382 limitation) and $50 million of
post-change NOL (not subject to the Section 382 limitation). The Company's
charitable contribution carryforwards and business tax credit carryforwards are
pre-change items subject to the Section 382 limitation.

The unused portion of the $4 million annual Section 382 limitation for any
year may be carried forward to succeeding years to increase the annual
limitation for those succeeding years. In addition, the Company's entire $97
million of pre-change NOL may be used to offset future taxable income realized
within five years of the date of change of ownership from built-in gains
(generally, taxable income from the sale of appreciated assets held by the
Company at the date of change in ownership) without reference to the Section 382
limitation.

A reconciliation of the Company's net income for financial statement
purposes to taxable income (loss) for the years ended December 26, 1992 and
January 1, 1994 is as follows (in thousands):

<TABLE>
<CAPTION>
1992 1993
-------- --------
<S> <C> <C>
Net income..................................................... $ 20,249 $ 17,337
Income tax provision (benefit)................................. 219 (130)
-------- --------
Income before income taxes..................................... 20,468 17,207
-------- --------
Differences between income before taxes for financial statement
purposes and taxable income:
Cumulative effect of accounting change for income taxes...... (10,000) --
State income taxes........................................... (219) (501)
Utilization of carryovers.................................... -- (2,543)
Permanent differences........................................ 3,687 28
Net change in temporary differences.......................... (41,678) (14,191)
-------- --------
(48,210) (17,207)
-------- --------
Taxable income (loss).......................................... $(27,742) $ --
-------- --------
-------- --------
</TABLE>

Changes during 1992 and 1993 in temporary differences principally relate to
restaurant closing expenses and losses on asset disposals accrued in 1990 and
1991, which are deductible for income tax purposes in the year in which the
assets are actually disposed and expenses are paid.

F-22
<PAGE> 71

HANOVER DIRECT, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The components of the net deferred tax asset at January 1, 1994 are as
follows (in millions):

<TABLE>
<CAPTION>
NON-
CURRENT CURRENT TOTAL
------- ------- ------
<S> <C> <C> <C>
Federal tax NOL, charitable contribution and business tax
credit carryforwards....................................... $ -- $ 55.2 $ 55.2
Allowance for doubtful accounts.............................. .8 -- .8
Accrued liabilities.......................................... 3.6 -- 3.6
Tax basis in net assets of discontinued operations in excess
of financial statement amount.............................. .3 -- .3
Other........................................................ .4 -- .4
------- ------- ------
Deferred Tax Asset........................................... 5.1 55.2 60.3
Valuation allowance........................................ (2.1) (47.6) (49.7)
------- ------- ------
Deferred Tax Asset, net...................................... $ 3.0 $ 7.6 $ 10.6
------- ------- ------
------- ------- ------
</TABLE>

The Company has established a valuation allowance for a portion of the
deferred tax asset, due to the Section 382 limitation and limiting the
utilization of the remaining deferred tax asset.

SFAS 109 requires that the future tax benefit of such NOLs be recorded as
an asset to the extent that management assesses the utilization of such NOLs to
be "more likely than not". In 1992 management determined, based upon the
conversion of interest-bearing debentures to equity, the issuance of additional
Common Stock, the disposal of unprofitable discontinued restaurant operations,
the Company's history of prior operating earnings in the direct marketing
business and its expectations for the future, that the operating income of the
Company will, more likely than not, be sufficient to utilize $30 million of
deductible temporary differences and NOLs prior to their expiration. In making
such determination, the Company adjusted 1992 income by eliminating interest
expense related to retired debt and assumed that such adjusted 1992 income level
could be obtained in each of the next three years.

Realization of the future tax benefits is dependent on the Company's
ability to generate taxable income within the carryforward period and the
periods in which net temporary differences reverse. Future levels of operating
income and taxable income are dependent upon general economic conditions,
competitive pressures on sales and margins, postal and other delivery rates, and
other factors beyond the Company's control. Accordingly, no assurance can be
given that sufficient taxable income will be generated for utilization of the
NOLs and reversals of temporary differences. At January 1, 1994, the Company has
maintained the $30 million amount of expected future operating income that will
"more likely than not" utilize the deductible temporary differences and NOLs
prior to their expiration. Management believes that although the 1993 operating
results might justify a higher amount, in view of its history of operating
losses, the $30 million represents a reasonable conservative estimate of the
future utilization of the NOLs and the Company will continue to evaluate the
likelihood of future profit and the necessity of future adjustments to the
deferred tax asset valuation allowance.

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

The Federal income tax provision was $5.9 million in 1993 which was offset
by the utilization of certain NOLs. In addition, a $.6 million deferred tax
benefit was recorded in 1993 as a result of the increase in the Federal
corporate income tax rates from 34% to 35%. The Company's Federal income tax
provision consists of

F-23
<PAGE> 72

HANOVER DIRECT, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

zero in 1991 and 1992. The Company's provision for state income taxes consists
of $.2 million in 1991, $.2 million in 1992 and $.5 million in 1993.

Total tax expense for each of the three fiscal years presented differ from
the amount computed by applying the statutory tax rate of 35% (34% in 1992 and
1991) due to the following:

<TABLE>
<CAPTION>
1991 1992 1993
PERCENT PERCENT PERCENT
OF PRE-TAX OF PRE-TAX OF PRE-TAX
LOSS INCOME INCOME
---------- ---------- ----------
<S> <C> <C> <C>
Tax (benefit) at statutory rate........................ (34.0)% 34.0% 35.0%
Cumulative effect of accounting change for income
taxes................................................ -- (16.6) --
State and local taxes.................................. 0.3 1.1 1.9
Effect of federal rate change on deferred tax asset.... -- -- (3.7)
Stock issuance expenses................................ -- 5.5 --
Net reversal of temporary differences.................. -- (69.2) (28.9)
Loss for which no tax benefit could be recognized...... 30.8 -- --
Utilization of contribution and NOL carryover.......... -- -- (5.4)
Tax NOL for which no benefit could be recognized....... -- 46.1 --
Other.................................................. 3.2 0.2 0.3
---------- ---------- ----------
0.3% 1.1% (0.8)%
---------- ---------- ----------
---------- ---------- ----------
</TABLE>

11. LEASES

Certain leases to which the Company is a party provide for payment of real
estate taxes and other expenses. Most leases are operating leases and include
various renewal options with specified minimum rentals. Rental expense for
operating leases related to continuing operations were as follows (in
thousands):

<TABLE>
<CAPTION>
1991 1992 1993
------ ------ ------
<S> <C> <C> <C>
Minimum rentals............................................. $6,807 $8,910 $9,458
------ ------ ------
------ ------ ------
</TABLE>

Future minimum lease payments under noncancellable operating and capital
leases relating to continuing operations, that have initial or remaining terms
in excess of one year, together with the present value of the net minimum lease
payments as of January 1, 1994, are as follows (in thousands):

<TABLE>
<CAPTION>
OPERATING CAPITAL
YEAR ENDING LEASES LEASES
---------------------------------------------------------------- --------- -------
<S> <C> <C>
1994............................................................ $ 7,257 $ 873
1995............................................................ 4,527 732
1996............................................................ 3,425 694
1997............................................................ 2,703 454
1998............................................................ 2,627 --
Thereafter...................................................... 17,706 --
--------- -------
Total minimum lease payments.................................... $38,245 2,753
---------
---------
Less amount representing interest (a)........................... 182
-------
Present value of minimum lease payments (b)..................... $ 2,571
-------
-------
</TABLE>

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

(a) Amount necessary to reduce net minimum lease payments to present value
calculated at the Company's incremental borrowing rate at the inception of
the leases.
(b) Reflected in the balance sheet as current and noncurrent capital lease
obligations of $50,000 and $105,000 in 1992 and $748,000 and $1,823,000 in
1993, respectively.

12. DISCONTINUED RESTAURANT OPERATIONS

In 1992, the Company sold substantially all of the properties remaining
from its discontinued restaurant operations. The Company realized net proceeds
from such sales of approximately $17.3 million of which approximately $14.9
million was used to reduce outstanding indebtedness. In addition, in exchange
for notes, cash and stock valued at $3.9 million, the Company was relieved of
$20.4 million in future rent obligations.

F-24
<PAGE> 73

HANOVER DIRECT, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Revenues applicable to discontinued operations were $10 million in 1991.
Interest expense allocated to discontinued operations was $1.6 million and $1.9
million for the years 1991 and 1992, respectively. There was no interest expense
allocated to discontinued operations for the year ended January 1, 1994.

At December 26, 1992 and January 1, 1994, reserves for discontinued
restaurant operations approximated $3.5 million and $2.6 million, respectively.
Charges against these reserves were $7.7 million and $0.9 million for the years
ended December 26, 1992 and January 1, 1994, respectively.

The future minimum lease payments under noncancellable leases as of January
1, 1994, are as follows: 1994 -- $1.7 million; 1995 -- $1.7 million;
1996 -- $1.5 million; 1997 -- $1.5 million; 1998 -- $1.4 million and thereafter
$14.8 million. The above amounts exclude annual sublease income of $1.8 million
from subleases which have the same expiration as the underlying leases.

13. RESTRUCTURING CHARGES AND TRANSACTION COSTS

In 1991, in connection with the restructuring activities, the Company
recorded charges of approximately $5.8 million. These charges were primarily
related to severance costs ($.6 million), the costs associated with the
restructuring of certain catalogs, including inventory costs ($2.6 million), and
other restructuring costs ($2.6 million). The operating results of 1991 also
include charges of approximately $4.8 million which were directly related to the
stock purchase agreement transaction. These charges include approximately $1.7
million of transaction fees which have been classified as Other income (expense)
and increased compensation costs directly related to the change in control
provisions included in certain executive employment contracts. In addition, the
Company incurred a charge of $3.1 million in connection with the settlement of
the employment contract of the former Chairman and CEO of the Company.

14. MANAGEMENT COMPENSATION AGREEMENTS

In connection with consummating the transactions in the stock purchase
agreement and as a condition thereto, the Company entered into an employment
agreement (the "Employment Agreement") with Jack E. Rosenfeld, the President and
Chief Executive Officer of the Company. The Employment Agreement provides for
(1) a five-year term commencing on October 25, 1991, at a base salary of
$500,000 per year; (2) a payment to a trust on behalf of Mr. Rosenfeld of
916,667 shares of Common Stock in lieu of a cash payment of $1,564,000 to which
he would have been entitled in connection with a change in control, 250,000 of
such shares to vest in equal annual installments over three years with the
vested shares distributable to Mr. Rosenfeld at the end of the employment term
or the earlier termination of his employment; (3) the grant of an option to Mr.
Rosenfeld, which has expired, to purchase shares of Common Stock in the event
the Company achieved certain earnings in the fourth quarter of 1991; and (4) the
grant of registration rights under the Securities Act of 1933, as amended, for
shares of Common Stock owned by Mr. Rosenfeld. On October 25, 1991, NAR entered
into an agreement with Mr. Rosenfeld pursuant to which he may purchase from NAR
prior to October 25, 1996, 1,213,605 shares of Common Stock at a price per share
of $2.00 (subject to adjustment) plus 10% per year through the exercise period.
This agreement was amended on September 23, 1992 to provide that NAR would grant
to Mr. Rosenfeld in March 1993 the right to purchase an additional 1,213,605
shares of Common Stock ("Rights Shares") at a price per share of $1.50 (subject
to adjustment) plus 10% per year from September 1992 through the exercise
period.

In connection with the stock purchase agreement, the Company entered into
employment agreements with each of Messrs. Michael P. Sherman, Wayne P. Garten
and Edward J. O'Brien, executive officers of the Company. These agreements were
substantially the same as such officers' existing employment agreements, except
that they provided for cash payments to Messrs. Sherman, Garten and O'Brien of
$281,714, $221,621 and $90,000, respectively, and contribution to a trust on
behalf of such officers of 156,979 shares, 147,812 shares and 60,000 shares of
Common Stock of the Company, respectively, in connection with the change in
control effected by the NAR transaction and in lieu of their right to receive a
cash change in control payment.

F-25
<PAGE> 74

HANOVER DIRECT, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Pursuant to the terms of the trust, such Common Stock was distributed to each
such officer during fiscal 1993. Messrs. Sherman, Garten and O'Brien were
granted certain registration rights under the Securities Act of 1933, as
amended, with respect to the shares of Common Stock granted to each of them.

15. RELATED PARTY TRANSACTIONS

Approximately $85,000 was paid for the rental of property pursuant to an
operating lease to a partnership in which the wife of the Chief Executive
Officer and President of the Company, Jack E. Rosenfeld, is a partner. Jack E.
Rosenfeld is also a director of the Company.

On September 23, 1992, a transaction was approved by the Company's
shareholders pursuant to which NAR acquired 62% of the Company's Common Stock.
See Note 2 for a description of the transaction. At January 1, 1994, NAR owned
57% of the Company's outstanding Common Stock.

Since January 1993, pursuant to a consulting arrangement, QCC renders
management consulting, business advisory and investment banking services to the
Company for an annual fee of $750,000.

16. COMMITMENTS AND CONTINGENCIES

The Company is obligated under various employment contracts with key
executives extending through 1995. The aggregate payments due under such
contracts is $2.0 million.

In connection with certain disposal transactions, the Company remains
contingently liable with respect to lease obligations for 10 restaurant
properties, should the buyers fail to perform under the agreements. The future
minimum lease payments as of January 1, 1994, are as follows (in thousands):
1994 -- $459; 1995 -- $445; 1996 -- $366; 1997 -- $278; 1998 -- $192 and
thereafter $737.

In January 1994, the Company purchased for $1.1 million a 50% interest in
Blue Ridge Associates (the "Partnership"), a partnership which owns the Tweeds
Roanoke, Virginia fulfillment center. In connection with the Partnership, a
subsidiary of the Company is contingently liable with respect to the obligations
of the Partnership. The Partnership has a mortgage on the Roanoke fulfillment
center in the amount of $6.6 million.

In May 1992 the United States Supreme Court reaffirmed an earlier decision
which allowed direct marketing companies to make sales into states where they do
not have a physical presence without collecting sales taxes with respect to
those sales. The Court, however, noted that Congress has the power to change
this law. Forty-six states plus the District of Columbia have sales or use taxes
or authorize local governmental units to impose sales or use taxes. The Company
sells merchandise in all fifty states plus the District of Columbia. Various
states are increasing their efforts by various means, including lobbying
Congress, to impose on direct marketers the burden of collecting sales and use
taxes on the sale of products shipped to state residents. The imposition of a
sales and use tax collection obligation on the Company in states to which it
ships products would result in additional administrative expense to the Company
and higher costs to its customers for the same merchandise currently being
purchased by them. This may have a negative effect on customer response rates
and revenue levels, thereby negatively affecting the Company's sales and
profitability. Under the law as it presently exists, the Company believes that
it collects sales tax in all jurisdictions that it is required to do so.

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

17. SUBSEQUENT EVENT

On February 18, 1994, the Company filed a registration statement on Form
S-3 with the Securities and Exchange Commission registering 10 million shares of
its Common Stock, including 4,154,604 shares on

F-26
<PAGE> 75

HANOVER DIRECT, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

behalf of two selling shareholders. The net proceeds from the offering with
respect to the Company's shares will be used for general corporate purposes,
including the expansion of the Company's business. The registration statement
has not yet become effective.

18. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)

<TABLE>
<CAPTION>
FIRST SECOND THIRD FOURTH
1992 QUARTER QUARTER QUARTER QUARTER
- ------------------------------------------------ -------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C>
Revenues........................................ $128,787 $142,861 $144,769 $170,145
Gross profit.................................... 42,698 51,337 48,924 61,887
Income from operations.......................... 2,133 3,123 2,291 6,855
Income (loss) from continuing operations........ (1,823) (899) (1,246) 5,016
Extraordinary items............................. -- 1,209 6,501 1,491
Cumulative effect of accounting change for
income taxes.................................. 10,000 -- -- --
-------- -------- -------- --------
Net income...................................... 8,177 310 5,255 6,507
Preferred stock dividends....................... (700) (700) (800) (997)
-------- -------- -------- --------
Net income (loss) applicable to Common
Shareholders.................................. $ 7,477 $ (390) $ 4,455 $ 5,510
-------- -------- -------- --------
-------- -------- -------- --------
Net income (loss) per share:
Income (loss) from continuing operations...... $ (.09) $ (.05) $ (.07) $ .06
Extraordinary items........................... -- .04 .22 .02
Cumulative effect of accounting change for
income taxes............................... .35 -- -- --
-------- -------- -------- --------
Net income (loss)............................... $ .26 $ (.01) $ .15 $ .08
-------- -------- -------- --------
-------- -------- -------- --------
</TABLE>

<TABLE>
<CAPTION>
FIRST SECOND THIRD FOURTH
1993 QUARTER QUARTER QUARTER QUARTER
- ------------------------------------------------ -------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C>
Revenues........................................ $121,565 $144,319 $147,890 $228,737
Gross profit.................................... 43,585 52,578 51,233 86,728
Income from operations.......................... 2,937 3,963 3,056 9,120
Net income...................................... 2,477 4,356 2,492 8,012
Preferred stock dividends....................... (1,000) (1,005) (1,006) (1,082)
-------- -------- -------- --------
Net income applicable to Common Shareholders.... $ 1,477 $ 3,351 $ 1,486 $ 6,930
-------- -------- -------- --------
-------- -------- -------- --------
Net income per share............................ $ .02 $ .05 $ .02 $ .09
-------- -------- -------- --------
-------- -------- -------- --------
</TABLE>

F-27
<PAGE> 76
(INSIDE BACK COVER)

The Company's goal
is to become the
nation's leading direct
(PHOTOGRAPH 1) specialty retailer and (PHOTOGRAPH 2)
preferred retail source
for its customers.

The Company The Company recently
identifies market entered into a strategic
opportunities to (LOGO) venture with Boston
introduce new branded Publishing Company,
niche catalogs, such as publisher of the Museum
Kitchen & Home. Collections and Finishing
Touches catalogs.

In January 1994,
Hanover entered into
an agreement with
Sears to produce
(PHOTOGRAPH 3) specialty catalogs for (PHOTOGRAPH 4)
the 23 million Sears
customers no longer
being served by the
recently discontinued
Sears catalog.

Domestications(R), Tapestry(R), Hanover House(R), Colonial Garden
Kitchens(R), Mature Wisdom(R), International Male(R), Undergear(R),
Silhouettes(R), Simply Tops(R), Gump's(R), Tweeds(R), and The Company Store(R)
are federally registered trademarks of the Company. This prospectus also
contains other registered and unregistered trademarks and service marks owned by
the Company and by others.
<PAGE> 77

- ------------------------------------------------------
- ------------------------------------------------------
NO DEALER, SALESPERSON OR OTHER INDIVIDUAL HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR MAKE ANY REPRESENTATIONS NOT CONTAINED IN THIS PROSPECTUS IN
CONNECTION WITH THE OFFERING COVERED BY THIS PROSPECTUS. IF GIVEN OR MADE, SUCH
INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED
BY THE COMPANY, THE SELLING SHAREHOLDER OR THE UNDERWRITERS. THIS PROSPECTUS
DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY THE
COMMON STOCK IN ANY JURISDICTION WHERE, OR TO ANY PERSON TO WHOM, IT IS UNLAWFUL
TO MAKE SUCH OFFER OR SOLICITATION. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR
ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE AN IMPLICATION
THAT THERE HAS NOT BEEN ANY CHANGE IN THE FACTS SET FORTH IN THIS PROSPECTUS OR
IN THE AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF.
---------------------
TABLE OF CONTENTS

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Available Information................. 3
Incorporation of Certain Documents by
Reference........................... 3
Prospectus Summary.................... 4
Investment Considerations............. 7
The Company........................... 10
Use of Proceeds....................... 13
Price Range of Common Stock........... 13
Dividend Policy....................... 13
Capitalization........................ 14
Selected Consolidated Financial
Data................................ 15
Management's Discussion and Analysis
of Consolidated Financial Condition
and
Results of Operations............... 16
Business.............................. 23
Management............................ 34
Principal and Selling Shareholders.... 37
Relationship with NAR................. 39
Description of Capital Stock.......... 39
Shares Eligible for Future Sale....... 41
Certain United States Tax Consequences
to Non-U.S. Holders of Common
Stock............................... 43
Underwriting.......................... 45
Legal Matters......................... 46
Experts............................... 46
Index to Consolidated Financial
Statements.......................... F-1
</TABLE>

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

- ------------------------------------------------------
- ------------------------------------------------------
8,000,000 SHARES
[LOGO]
COMMON STOCK
-----------------------------
PROSPECTUS
-----------------------------
MERRILL LYNCH & CO.

ALEX. BROWN & SONS
INCORPORATED
MARCH 30, 1994
- ------------------------------------------------------
- ------------------------------------------------------
<PAGE> 78

APPENDIX TO ELECTRONIC FORMAT DOCUMENT

(INSIDE FRONT COVER 1)

(PHOTOGRAPH 1) -- is a cover of a Gump's catalog with an oriental table and vase

(PHOTOGRAPH 2) -- is a cover of a Hanover House catalog with a staircase basket

(PHOTOGRAPH 3) -- is a cover of a Tweeds catalog with a woman on a pier

(PHOTOGRAPH 4) -- is a cover of a Domestications catalog with a bed

(INSIDE FRONT COVER 2)

(PHOTOGRAPH 1) -- is a cover of an International Male catalog

(PHOTOGRAPH 2) -- is a cover of The Company Store catalog

(PHOTOGRAPH 3) -- is a cover of an Undergear catalog

(PHOTOGRAPH 4) -- is a cover of a Tapestry catalog

(PHOTOGRAPH 5) -- is a cover of The Safety Zone catalog

(PHOTOGRAPH 6) -- is a cover of a Colonial Garden Kitchens catalog

(PHOTOGRAPH 7) -- is a cover of a Simply Tops catalog

(PHOTOGRAPH 8) -- is a cover of a Silhouettes catalog

(PHOTOGRAPH 9) -- is a cover of an Essence catalog

(PHOTOGRAPH 10) -- is a cover of a Mature Wisdom catalog

(INSIDE BACK COVER)

(PHOTOGRAPH 1) -- is a cover of a Kitchen & Home catalog

(PHOTOGRAPH 2) -- are covers of the Finishing Touches and Museum Collections
catalog

(PHOTOGRAPH 3) -- are covers of two Sears catalogs -- Beautiful Style and Great
Kitchens

(PHOTOGRAPH 4) -- is a cover of the Sears catalog, Show Place